The Austrian School of Economics

Posted by PITHOCRATES - March 3rd, 2014

Economics 101

(Originally published February 27th, 2012)

Because of the Unpredictable Human Element in all Economic Exchanges the Austrian School is more Laissez-Faire

Name some of the great inventions economists gave us.  The computer?  The Internet?  The cell phone?  The car?  The jumbo jet?  Television?  Air conditioning?  The automatic dishwasher?  No.  Amazingly, economists did not invent any of these brilliant inventions.  And economists didn’t predict any of these inventions.  Not a one.  Despite how brilliant they are.  Well, brilliant by their standard.  In their particular field.  For economists really aren’t that smart.  Their ‘expertise’ is in the realm of the social sciences.  The faux sciences where people try to quantify the unquantifiable.  Using mathematical equations to explain and predict human behavior.  Which is what economists do.  Especially Keynesian economists.  Who think they are smarter than people.  And markets.

But there is a school of economic thought that doesn’t believe we can quantify human activity.  The Austrian school.  Where Austrian economics began.  In Vienna.  Where the great Austrian economists gathered.  Carl Menger.  Ludwig von Mises.  And Friedrich Hayek.  To name a few.  Who understood that economics is the sum total of millions of people making individual human decisions.  Human being key.  And why we can’t reduce economics down to a set of mathematical equations.  Because you can’t quantify human behavior.  Contrary to what the Keynesians believe.  Which is why these two schools are at odds with each other.  With people even donning the personas of Keynes and Hayek to engage in economic debate.

Keynesian economics is more mainstream than the Austrian school.  Because it calls for the government to interfere with market forces.  To manipulate them.  To make markets produce different results from those they would have if left alone.  Something governments love to do.  Especially if it calls for taxing and spending.  Which Keynesian economics highly encourage.  To fix market ‘failures’.  And recessions.  By contrast, because of the unpredictable human element in all economic exchanges, the Austrian school is more laissez-faire.  They believe more in the separation of the government from things economic.  Economic exchanges are best left to the invisible hand.  What Adam Smith called the sum total of the millions of human decisions made by millions of people.  Who are maximizing their own economic well being.  And when we do we maximize the economic well being of the economy as a whole.  For the Austrian economist does not believe he or she is smarter than people.  Or markets.  Which is why an economist never gave us any brilliant invention.  Nor did their equations predict any inventor inventing a great invention.  And why economists have day jobs.  For if they were as brilliant and prophetic as they claim to be they could see into the future and know which stocks to buy to get rich so they could give up their day jobs.  When they’re able to do that we should start listening to them.  But not before.

Low Interest Rates cause Malinvestment and Speculation which puts Banks in Danger of Financial Collapse

Keynesian economics really took off with central banking.  And fractional reserve banking.  Monetary tools to control the money supply.  That in the Keynesian world was supposed to end business cycles and recessions as we knew them.  The Austrian school argues that using these monetary tools only distorts the business cycle.  And makes recessions worse.  Here’s how it works.  The central bank lowers interest rates by increasing the money supply (via open market transactions, lowering reserve requirements in fractional reserve banking or by printing money).  Lower interest rates encourage people to borrow money to buy houses, cars, kitchen appliances, home theater systems, etc.  This new economic activity encourages businesses to hire new workers to meet the new demand.  Ergo, recession over.  Simple math, right?  Only there’s a bit of a problem.  Some of our worst recessions have come during the era of Keynesian economics.  Including the worst recession of all time.  The Great Depression.  Which proves the Austrian point that the use of Keynesian policies to end recessions only makes recessions worse.  (Economists debate the causes of the Great Depression to this day.  Understanding the causes is not the point here.  The point is that it happened.  When recessions were supposed to be a thing of the past when using Keynesian policies.)

The problem is that these are not real economic expansions.  They’re artificial ones.  Created by cheap credit.  Which the central bank creates by forcing interest rates below actual market interest rates.  Which causes a whole host of problems.  In particular corrupting the banking system.  Banks offer interest rates to encourage people to save their money for future use (like retirement) instead of spending it in the here and now.  This is where savings (or investment capital) come from.  Banks pay depositors interest on their deposits.  And then loan out this money to others who need investment capital to start businesses.  To expand businesses.  To buy businesses.  Whatever.  They borrow money to invest so they can expand economic activity.  And make more profits.

But investment capital from savings is different from investment capital from an expansion of the money supply.  Because businesses will act as if the trend has shifted from consumption (spending now) to investment (spending later).  So they borrow to expand operations.  All because of the false signal of the artificially low interest rates.  They borrow money.  Over-invest.  And make bad investments.  Even speculate.  What Austrians call malinvestments.  But there was no shift from consumption to investment.  Savings haven’t increased.  In fact, with all those new loans on the books the banks see a shift in the other direction.  Because they have loaned out more money while the savings rate of their depositors did not change.  Which produced on their books a reduction in the net savings rate.  Leaving them more dangerously leveraged than before the credit expansion.  Also, those lower interest rates also decrease the interest rate on savings accounts.  Discouraging people from saving their money.  Which further reduces the savings rate of depositors.  Finally, those lower interest rates reduce the income stream on their loans.  Leaving them even more dangerously leveraged.  Putting them at risk of financial collapse should many of their loans go bad.

Keynesian Economics is more about Power whereas the Austrian School is more about Economics

These artificially low interest rates fuel malinvestment and speculation.  Cheap credit has everyone, flush with borrowed funds, bidding up prices (real estate, construction, machinery, raw material, etc.).  This alters the natural order of things.  The automatic pricing mechanism of the free market.  And reallocates resources to these higher prices.  Away from where the market would have otherwise directed them.  Creating great shortages and high prices in some areas.  And great surpluses of stuff no one wants to buy at any price in other areas.  Sort of like those Soviet stores full of stuff no one wanted to buy while people stood in lines for hours to buy toilet paper and soap.  (But not quite that bad.)  Then comes the day when all those investments don’t produce any returns.  Which leaves these businesses, investors and speculators with a lot of debt with no income stream to pay for it.  They drove up prices.  Created great asset bubbles.  Overbuilt their capacity.  Bought assets at such high prices that they’ll never realize a gain from them.  They know what’s coming next.  And in some darkened office someone pours a glass of scotch and murmurs, “My God, what have we done?”

The central bank may try to delay this day of reckoning.  By keeping interest rates low.  But that only allows asset bubbles to get bigger.  Making the inevitable correction more painful.  But eventually the central bank has to step in and raise interest rates.  Because all of that ‘bidding up of prices’ finally makes its way down to the consumer level.  And sparks off some nasty inflation.  So rates go up.  Credit becomes more expensive.  Often leaving businesses and speculators to try and refinance bad debt at higher rates.  Debt that has no income stream to pay for it.  Either forcing business to cut costs elsewhere.  Or file bankruptcy.  Which ripples through the banking system.  Causing a lot of those highly leveraged banks to fail with them.  Thus making the resulting recession far more painful and more long-lasting than necessary.  Thanks to Keynesian economics.  At least, according to the Austrian school.  And much of the last century of history.

The Austrian school believes the market should determine interest rates.  Not central bankers.  They’re not big fans of fractional reserve banking, either.  Which only empowers central bankers to cause all of their mischief.  Which is why Keynesians don’t like Austrians.  Because Keynesians, and politicians, like that power.  For they believe that they are smarter than the people making economic exchanges.  Smarter than the market.  And they just love having control over all of that money.  Which comes in pretty handy when playing politics.  Which is ultimately the goal of Keynesian economics.  Whereas the Austrian school is more about economics.

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Alphabet and Writing

Posted by PITHOCRATES - November 27th, 2013

Technology 101

(Originally published November 23rd, 2011)

The Necessary Information to Survive in Prehistory was Minimal and did not Require a Written Language

Hunters and gatherers had little need for language.  For they did little in life but hunt, gather, eat, sleep and propagate the species.  Much like wildlife today.  Such as feral cats.  Abandoned house cats.  Who mate and produce more feral cats.  And these animals are survivors.  They hunt.  Gather food from human garbage.  Eat.  Sleep.  And reproduce.  If you ever had any in your neighborhood you know that they can be very loud, too.  Making a variety of sounds.  Meows, cries, growls and hisses.  Not an advanced language.  But sufficient to survive.  And enough to keep you from trying to pick one up.

Early man was similar to feral cats.  They had a limited language.  That allowed them to survive.  And make modest advances.  They made tools out of stone.  Used fire.  Made clothes from animal hides.  Even left art on the walls of caves.  Far more than any wild animal ever did.  But they didn’t do much more.  If they did it was probably nothing to write about.  Because they didn’t.  Write about it.  Either because they had no written language.  Or because they were a modest people.

History starts with written language.  Before that we have only archaeology.  And best guesses.  But based on the archaeology they weren’t doing much.  Other than surviving.  And in these prehistory times life was pretty simple.  See above.  The necessary information to survive was minimal.  Eat.  And don’t die.  It wasn’t necessary to write that down.  So they didn’t.  Memory was more than sufficient.  And it was like that for millions of years.

The Phoenician Alphabet was the Basis for the Greek and Latin Alphabets

But then the simple became complex.  There were food surpluses that allowed a division of labor that led to trade.  And a burgeoning economy.  Which required a more sophisticated way of communicating.  And a system of maintaining records of economic exchanges.  For memory and talking just wasn’t good enough anymore.

In the 4th millennium BC, in Mesopotamia, this began with clay tokens to represent an economic commodity.  And the first system of accounting was simply counting and storing these tokens.  But as the division of labor produced an ever more complex economy, the number of tokens used became too great.  So they represented the economic commodity with a symbol scratched in a clay tablet.  Instead of counting tokens they read these tablets.  We call this writing cuneiform.   Which was later used to write down the spoken Sumerian language.

Over time we developed alphabets.  We represented the sounds of the words we spoke with letters.  The Phoenician alphabet being one of the first alphabets.  Used by one of the greatest traders and merchants of all time.  The Phoenicians.  Which spread this language around.  Giving rise to Canaanite and Aramaic.  Aramaic giving rise to Arabic and Hebrew.  Incidentally, all languages without vowels.  But the granddaddy of all alphabets was Greek.  Which added vowels.  And formed the basis for Latin.  As well as all other western languages.

We Know about the Glory of Greece and the Grandeur of Rome because they Wrote about It

Athens was the cradle of modern civilization.  The Athenian empire grew because it was based on a complex trade economy.  Ditto for the Roman Empire.  At the height of their power the civilized world spoke their languages.  Conducted their trade in Latin or Greek.  Wrote their laws in Latin or Greek.  Conducted their diplomacy in Latin or Greek.  Why?  Because they could.  Their alphabets and their written language allowed them to manage the complex.

And they wrote.  A lot.  We know so much about Greece and Rome because we can read what they wrote.  And we can build on the glory that was Greece.  And the grandeur that was Rome.  Because we, too, have complex trade economies.  Giving us comforts in life that not even the Greeks or Romans could have dreamt about.

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Keynesian Economics

Posted by PITHOCRATES - October 14th, 2013

Economics 101

(Originally published February 20th, 2012)

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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The Greatest Threat to an Oppressive Dictatorship is Free Market Capitalism

Posted by PITHOCRATES - September 22nd, 2013

Week in Review

When people enter economic exchanges voluntarily everybody wins.  For example, let’s say one person has a hundred dollars of spare cash.  And another person owns a mountain bicycle that sells for $350 new.  The one with the money wants to buy a mountain bicycle.  The one with the mountain bicycle needs cash and wants to sell the bike. These two people meet.  And exchange the $100 for the bicycle.  And both walk away with something they valued more.  The person originally with the $100 valued the bicycle more than the $100.  And the person originally with the bicycle valued the $100 more than the bicycle.  Each person wins in this voluntary economic exchange.

Now contrast that to a managed economy.  Where a few decide for everyone else.  Such as in socialism.  Or communism.  Say, in the former Soviet Union.  Where the economic planners decide to make more tractor parts and less toilet paper and laundry detergent.  Resulting in shelves full of tractor parts no one wanted to buy.  And empty shelves where there was once toilet paper and laundry detergent.  As you can see, when you have forced economic exchanges no one wins.

Countries with economic systems based on free market capitalism where people enter economic exchanges voluntarily have historically had the highest standards of living.  Whereas countries with managed economic systems have had the lowest standards of living.  Liberty and prosperity are synonymous with the United Kingdom, the United States, Canada, Australia and Hong Kong.  Which were once all part of the British Empire.  Which ruled the world and kept the peace for a hundred years or so.  The Pax Britannica.  She was able to do this because of her wealth.  Generated from free market capitalism.  The rule of law.  Representative government.  Sound money.  And free trade.  Things that today give these nations immigration problems.  Because everyone wants to go to these nations for a better life.

In capitalist nations people live better because there is a profit incentive.  Whereas the countries these immigrants left typically put people before profits.  Where instead of letting market forces set prices and allocate limited resources that have alternative uses the government decides.  Like they did in the former Soviet Union.  And the more government interferes with these market forces the more these economic decisions become political.  Where friends of the ruling power get those limited resources first and at favorable prices.  Allowing them and the ruling powers to profit handsomely from this political favoritism.  At the expense of the people who have to do with less.

The profit incentive puts people first.  Because in free market capitalism market forces are the people.  Hundreds of millions of people coming together to make voluntary economic exchanges.  Where each individual person looks out for his or her best interests.  But when a ‘caring’ government manages the economy to put the people first that government interferes with those market forces.  And goes against the will of the people.  Making the people worse off.  Which is why immigration is always from a country where there is less free market capitalism to a country where there is more free market capitalism.  Because the quality of life increases with increasing amounts of capitalism.  So we should be careful what we ask for when we ask to put people first.  Even when the Pope joins the ‘put the people first’ choir (see Pope condemns idolatry of cash in capitalism by Lizzy Davies posted 9/22/2013 on theguardian).

Pope Francis has called for a global economic system that puts people and not “an idol called money” at its heart, drawing on the hardship of his immigrant family as he sympathised with unemployed workers in a part of Italy that has suffered greatly from the recession…

“Where there is no work, there is no dignity,” he said, in ad-libbed remarks after listening to three locals, including an unemployed worker who spoke of how joblessness “weakens the spirit”. But the problem went far beyond the Italian island, said Francis, who has called for wholesale reform of the financial system…

Sardinia, one of Italy’s autonomous regions with a population of 1.6 million, has suffered particularly badly during the economic crisis, with an unemployment rate of 20%, eight points higher than the national average, and youth unemployment of 51%.

Last summer the island’s hardship became national news when Stefano Meletti, a 49-year-old miner, slashed his wrists on television during a protest aimed at keeping the Carbosulcis coal mine open.

There was one other thing these nations born of the British Empire shared.  Judeo-Christian values.  They lived by the Ten Commandments.  And the Golden Rule.  The good Christians of the British Empire followed the teachings of Christ.  “Do unto others as you would have them do unto you.”  These Judeo-Christian values went hand-in-hand with free market capitalism.  It’s what made us choose to live by the rule of law.  To honor the contracts we made with one another.  To voluntarily enter economic exchanges instead of just stealing and pillaging our neighbors.

Money doesn’t have value.  It’s a temporary storage of value.  It is our human capital that has value.  Our ability to create things that have value.  Things that other people will voluntarily enter into economic exchanges to trade for with things of value they created.  Whether it be a physical good.  Or money from a paycheck they earned creating value for an employer who uses it to produce a service or good.

Capitalists don’t worship money.  For money only makes those economic exchanges more efficient.  By eliminating the search costs of the barter system.  It’s human capital that capitalists are interested in.  This is what they worship.  People.  Unlocking the latent talent in all of us.  To bring incredible things into existence.  Sanitation.  Waste water treatment plants.  New farming advancements.  Coal-fired power plants.  Things that allowed greater groups of people to live together in growing cities.  Where we have food, clean water and shelter.  Things we take for granted in capitalists nations.  Things that are luxuries in North Korea.  An anti-capitalist country that puts people before profits.  Where people worship the ruling dictator (primarily to avoid imprisonment, torture and death).  And the only people that do well are those close to the ruling power.

We don’t need a new financial system.  We just need to return to what it was before governments intervened into the free market economy to put people first.  Before we completely forget the Ten Commandments.  And the Golden Rule.  For once we use the power of government to nullify contracts to help their crony friends we no longer have a nation of laws.  But one of political favors.  Where the friends of power do well.  While those with no power live at the mercy of those in power.

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Macroeconomic Disequilibrium

Posted by PITHOCRATES - September 24th, 2012

Economics 101

In the Barter System we Traded our Goods and Services for the Goods and Services of Others

Money.  It’s not what most people think it is.  It’s not what most politicians think it is.  Or their Keynesian economists.  They think it’s wealth.  That it has value.  But it doesn’t.  It is a temporary storage of value.  A medium of exchange.  And that alone.  Something that we created to make economic trades easier and more efficient.  And it’s those things we trade that have value.  The things that actually make wealth.  Not the money we trade for these things.

In our first economic exchanges there was no money.  Yet there were economic exchanges.  Of goods and services.  That’s right, there was economic activity before money.  People with talent (i.e., human capital) made things, grew things or did things.  They traded this talent with the talent of other people.  Other people with human capital.  Who made things, grew things or did things.  Who sought each other out.  To trade their goods and services for the goods and services of others.  Which you could only do if you had talent yourself.

This is the barter system.  Trading goods and services for goods and services.  Without using money.  Which meant you only had what you could do for yourself.  And the things you could trade for.  If you could find people that wanted what you had.  Which was the great drawback of the barter system.  The search costs.  The time and effort it took to find the people who had what you wanted.  And who wanted what you had.  It proved to be such an inefficient way to make economic transactions that they needed to come up with a better way.  And they did.

The Larger the Wheat Crop the Greater the Inflation and the Higher the Prices paid in Wheat

They found something to temporarily hold the value of their goods and services.  Money.  Something that held value long enough for people to trade their goods and services for it.  Which they then traded for the goods and services they wanted.  Greatly decreasing search costs.  Because you didn’t have to find someone who had what you wanted while having what they wanted.  You just had to take a sack of wheat (or something else that was valuable that other people would want) to market.  When you found what you wanted you simply paid an amount of wheat for what you wanted to buy.  Saving valuable time that you could put to better use.  Producing the goods or services your particular talent provided.

Using wheat for money is an example of commodity money.  Something that has intrinsic value.  You could use it as money and trade it for other goods and services.  Or you could use it to make bread.  Which is what gives it intrinsic value.  Everyone needs to eat.  And bread being the staple of life wheat was very, very valuable.  For back then famine was a real thing.  While living through the winter was not a sure thing.  So the value of wheat was life itself.  The more you had the less likely you would starve to death.  Especially after a bad growing season.  When those with wheat could trade it for a lot of other stuff.  But if it was a year with a bumper crop, well, that was another story.

If farmers flood the market with wheat because of an exceptional growing season then the value for each sack of wheat isn’t worth as much as it used to be.  Because there is just so much of it around.  Losing some of its intrinsic value.  Meaning that it won’t trade for as much as it once did.  The price of wheat falls.  As well as the value of money.  In other words, the bumper crop of wheat depreciated the value of wheat.  That is, the inflation of the wheat supply depreciated the value of the commodity money (wheat).  If the wheat crop was twice as large it would lose half of its value.  Such that it would take two sacks of wheat to buy what one sack once bought.  So the larger the wheat crop the greater the inflation and the higher the prices (except for wheat, of course).  On the other hand if a fire wipes out a civilization’s granary it will contract the wheat supply.  Making it more valuable (because there is less of it around).  Causing prices to fall (except for wheat, of course).  The greater the contraction (or deflation) of the wheat supply the greater the appreciation of the commodity money (wheat).  And the greater prices fall.  Because a little of it can buy a lot more than it once did.

Keynesian Expansionary Monetary Policy has only Disrupted Normal Market Forces

Creating a bumper crop of wheat is not easy.  Unlike printing fiat money.  It takes a lot of work to plow the additional acreage.  It takes additional seed.  Sowing.  Weeding.  Etc.  Which is why commodity money works so well.  Whether it’s growing wheat.  Or mining a precious metal like gold.  It is not easy or cheap to inflate.  Unlike printing fiat money.  Which is why people were so willing to accept it for payment.  For it was a relative constant.  They could accept it without fear of having to spend it quickly before it lost its value.  This brought stability to the markets.  And let the automatic price system match supply to the demand of goods and services.  If things were in high demand they would command a high price.  That high price would encourage others to bring more of those things to market.  If things were not in high demand their prices would fall.  And fewer people would bring them to market.  When supply equaled demand the market was in equilibrium.

Prices provide market signals.  They tell suppliers what the market wants more of.  And what the market wants less of.  That is, if there is a stable money supply.  Because this automatic price system doesn’t work so well during times of inflation.  Why?  Because during inflation prices rise.  Providing a signal to suppliers.  Only it’s a false signal.  For it’s not demand raising prices.  It’s a depreciated currency raising prices.  Causing some suppliers to increase production even though there is no increase in demand.  So they will expand production.  Hire more people.  And put more goods into the market place.  That no one will buy.  While inflation raises prices everywhere in the market.  Increasing the cost of doing business.  Which raises prices throughout the economy.  Because consumers are paying higher prices they cannot buy as much as they once did.  So all that new production ends up sitting in wholesale inventories.  As inventories swell the wholesalers cut back their orders.  And their suppliers, faced with falling orders, have to cut back.  Laying off employees.  And shuttering facilities.  All because inflation sent false signals and disrupted market equilibrium.

This is something the Keynesians don’t understand.  Or refuse to understand.  They believe they can control the economy simply by continuously inflating the money supply.  By just printing more fiat dollars.  As if the value was in the money.  And not the things (or services) of value we create with our human capital.  Economic activity is not about buying things with money.  It’s about using money to efficiently trade the things we make or do with our talent.  Inflating the money supply doesn’t create new value.  It just raises the price (in dollars) of our talents.  Which is why Keynesian expansionary monetary policy has been such a failure.  For their macroeconomic policies only disrupt normal market forces.  Which result in a macroeconomic disequilibrium.  Such as raising production in the face of falling demand.  Because of false price signals caused by inflation.  Which will only bring on an even more severe recession to restore that market equilibrium.  And the longer they try to prevent this correction through inflationary actions the longer and more severe the recession will be.

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Comparative Advantage and Free Trade

Posted by PITHOCRATES - May 21st, 2012

Economics 101

Mercantilism benefited only Protected Industries which Profited Handsomely from Higher Consumer Prices  

The Age of Discovery ushered in the era of mercantilism.  An era of trade.  But protected trade.  Tariffs, quotas, protectionism, restrictions, subsidies, etc.  You name it they used it.  To favor their trade position and their domestic industries.  And to restrict that of everyone else.  For mercantilism was a zero-sum game.  You only did well if others did not.  A thought that still has traction today.  Especially in older, inefficient industries.  That cannot compete with international competition that provides better quality at lower prices.  Such as textiles.  Steel.  Automobiles.  The Americans protected these industries in the face of better foreign competition.  Which only hastened their decline.

A protected industry has no incentive to improve.  When protective tariffs raise prices of lower-priced and higher-quality imports consumers buy the inferior domestic goods.  Because the tariffs make the better goods more costly.  So when a business has a captive audience their only focus is in maintaining that protectionism giving them that advantage.  Not improving their quality.  Or improving their productivity to lower their prices.  Why?  Because they don’t have to.  So prices continue to rise to pay for inefficient labor and management.  And quality continues to decline due to the lack of real competition forcing them to continually provide a better product.  By improving designs.  Production methods.  And making capital investments in new machinery and equipment.

This is the cost of protectionism.  Poorer quality and higher prices.  Because of the misguided belief in the zero-sum game of mercantilism.  There was a reason why mercantilism was abandoned for free trade.  Because free trade was better.  For consumers.  Giving them lower prices and higher quality.  Whereas mercantilism benefited only those protected industries which profited handsomely from those higher consumer prices.  And the government officials who granted those favorable protectionist policies.

The Consumer gets Lower Prices AND Higher Quality thanks to the Division of Labor, Specialization and Comparative Advantage

As civilization advanced so did the division of labor.  People began to specialize.  Instead of growing our own food, making our own tools, spinning our own pottery, etc., we did only one thing.  And did it well.  Then we traded the things we made for the things we didn’t make.  This division of labor created a middle class.  And this middle class would take their goods to market to trade with other middle class artisans.  At first bartering with each other.  Trading good for good.  Then they introduced a temporary storage of value into the economy.  Money.  Making those trades easier by reducing search times.  Trading your goods for money.  And your money for goods.  Making life a lot simpler at the market.

Let’s take a closer look at the division of labor.  Let’s consider two artisans.  A toolmaker.   And a potter.  Both are skilled craftspeople.  And can make an assortment of goods.  But each excels at one particular skill.  The toolmaker can make 10 plows a day.  But if he makes 2 pottery bowls he can only make 4 plows in that same day.  The potter can make 12 pottery bowls in a day.  But if he makes 3 plows he can only make 5 pottery bowls in that same day.  Each can make more of their specialty.  But when they try to make other things in addition to their specialty they can’t make as much of their specialty as before.  So there is a cost to the toolmaker to make pottery.  To make 2 bowls cost the toolmaker 6 plows.  And there is a cost to the potter to make tools.  To make 3 plows cost the potter 7 bowls.  So the economy as a whole is better off when the toolmaker and the potter focus all of their energies in their own specialty.  When they do we get 10 plows and 12 bowls in one day.  When they don’t we only get 7 plows and 7 bowls.

We call this economic principle comparative advantage.  Where we look at economic output.  Which is what matters.  The more we bring to market the better it is for consumers.  Because greater quantities mean lower prices.  And when these skilled craftspeople focus on their specialty they improve the overall quality of the goods they bring to market.  So the consumer gets lower prices AND higher quality.  Thanks to the division of labor.  Specialization.  And comparative advantage.

We will always Have Jobs regardless the Size of our Imports for Having a Job is the Only Way to Buy those Imported Goods

If you multiply this over and over again to represent all the individual economic exchanges throughout the world you see why free trade is better than the protectionist policies of mercantilism.  Because it provides consumers with greater economic output at lower prices and higher quality.  This is why nations practicing free trade have the highest standards of living.  Because their people can walk into large department stores and fill their carts with inexpensive, high quality goods on a moderate paycheck.  Which could never happen if the mercantilists had their way.

The old inefficient industries want tariffs to increase the costs of those goods we fill our shopping carts with.  Including the food we eat.  And the cars we drive.  They use lofty arguments about protecting American jobs.  But those protectionist policies destroy jobs by increasing costs for businesses throughout the supply chain.  Raising consumer prices everywhere.  Reducing the amount of things we can buy.  Meaning businesses can’t grow and create new jobs.  Or they have to cut back production and eliminate existing jobs.

There’s also a lot of talk about the balance of payments.  Which actually meant something during the days of the gold standard.  For any trade deficits had to be paid for with gold.  But we don’t have the gold standard anymore.  Governments everywhere abandoned it in favor of irresponsible government spending.  So we don’t have to pay for trade deficits with gold.  Most money today is just electronic entries in a computer.  International capital flows have never been greater.  There are currency markets where people actively trade the world’s currencies.  So trade deficits don’t mean the same thing they once did in the mercantile world.  Then there’s the argument that if all our manufacturing jobs go overseas there will be no jobs for Americans.  If we import everything and export nothing there will be jobs everywhere but here.  Sounds like a problem.  But can that happen?  Not unless we get those imports for free.  So we will always have jobs regardless the size of our imports.  For having a job is the only way to buy the imported goods in those department stores.

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Market Economy, Command Economy and Market Failures

Posted by PITHOCRATES - April 30th, 2012

Economics 101

Money replaced the Barter System making it Easier to Trade Freely and Voluntarily

We did our first economic exchanges in a market economy.  Agricultural advances gave us our first food surpluses.  These food surpluses gave people free time.  To do other things besides growing food.  Like developing an alphabet and writing.  Mathematics.  A code of laws.  And we made material goods.  Like pottery.  Farming tools.  Processing olive oil for lamps.  People who were good at making one thing made a lot of that one thing and traded with other people.  Who were good at making one thing themselves.  These people met.  And traded.  Freely and voluntarily.

Free trade.  A key element of the market economy.  Where people freely met and traded the things they made.  With other people who are freely trading the things they made.  Free trade came before money.  We bartered our first trades.  Trading goods for goods.  We then created money to make our trades easier.  Reducing the search time to find people to trade with.

Money is something that can store value.  Which allowed people to trade their goods for money.  Then they took that money and traded it with someone else.  To get something they wanted.  Money allowed people to spend less time finding people to trade with.  Because you didn’t have to find that one person that had what you wanted AND was willing to trade it for what you made.  Money allowed us to advance beyond the barter system.  Which proved more and more inefficient as we produced more and more goods.

Because of Market Failures the Government taxes to Provide Public Goods and Eliminate the Free-Rider Problem

As we produced more and more goods our standard of living rose.  We had more things in our lives that made that life easier.  More comfortable.  And more enjoyable.  Civilizations with a bustling market economy were great places to live.  Because there were a lot of nice things to make life better.  Which other people saw.  From beyond the civilization.  And they wanted what they saw.  And they took it.  By force.  Raiding parties would enter a developed civilization and rape, murder and plunder.  So to enjoy the amenities of an advanced civilization required the ability to protect your civilization.  Which led to one of the first market failures.  The failure of the market to provide city defenses through the free and voluntary trading of people engaged in economic activity.

We call it a market failure because building city defenses and creating an army are things the market economy can’t provide.  One person can’t make a fort or an army.  And trade it with someone else.  It’s too big.  It takes a lot of people and a lot of effort to make these things.  But it doesn’t take everyone.  If everyone else is contributing one person could skip contributing.  That person would still be able to enjoy the benefits of that fort and army.  Living in safety.  And enjoy living in safety for free.  Something we call the free-rider problem.  The fort and army are examples of public goods.  Things the free market can’t provide.  Or that the free market fails to provide.  Not that the market is broken or operating poorly.  It’s because people rarely act freely and voluntarily to benefit other people.  Because any time and money spent doing this is time and money taken away from their own families.  Which would bring hardship to them.  So the government provides these things that are necessary AND cause personal hardship to individuals to provide.  The government forces everyone to contribute.  Which minimizes the hardship each individual must bear.

Some in power like to take this further.  And call things that people can provide for themselves that benefit only themselves public goods, too.  Such as health care.  Higher education.  Housing.  Food.  Everything the people can buy for themselves by working to earn the money to buy these things.  And when they do they alone enjoy the benefits of these goods.  These goods they incurred hardships to obtain.  By working to earn a paycheck.  Or sacrificing other things to have these things instead.  It’s their call.  Their choice.  A choice they enter freely and voluntarily.  Therefore these things are not public goods.  But that doesn’t stop some people from acting like they are public goods.  Usually to help them win an election to office.  Or to overthrow the government.

A Command Economy reduced Economic Activity and Introduced a Police State

Civilizations with a bustling market economy were great places to live.  If you had talent and ability.  If you did then you could work hard and trade your talent and ability for a paycheck.  That you could use to trade for other things in that bustling economy.  Those with great talent and ability would be able to trade these for great paychecks.  Those with less talent and ability would be able to trade these for lesser paychecks.  Which, of course, caused income inequality.  Which is a handy thing to exploit if you want to seize power.  So you can enjoy the best things the civilization has to offer.  When your talent and ability only can trade for one of those lesser paychecks.

History is full of people trying to seize power.  So this is nothing new.  What was new was the way these people seized power.  By using the teachings of Karl Marx and Friedrich Engels.  As they wrote in the Communist Manifesto.  Who attacked market economies.  And capitalism.  Saying that the new middle class, the bourgeois, maximized profits by exploiting the working class.  The proletariat.  Which they said was unfair.  And that the only way to make things fair was to destroy the very concept of private property.  Because only the bourgeois accumulated private property.  The proletariat had none.  And only got poorer and poorer while the bourgeois got richer and richer.  Under their system, then, nothing belonged to the person.  Everything belonged to the state.  If you created something with your talent and ability it belonged to the state.  And then the state determined how to distribute the fruit of your labors.  Basically according to the rule ‘from those according to ability to those according to need’.  Those with the greatest need got the most stuff.  And those with the most ability worked the hardest.  Well, you can just guess how that worked out.  Everyone tried to show as little ability as possible and the greatest need as possible.

Because people weren’t the masters of their talent and ability anymore they couldn’t trade freely and voluntarily.  Which meant there was no longer a market economy.  Instead there was a command economy.  Where the government made all the decisions.  What to make.  How to use resources.  Where people lived.  Where they worked.  And what prices they paid for the things in the state-run stores.  Which had shelves full of things no one wanted to buy.  And empty shelves where the staples went (soap, toilet paper, etc.).  Because the government decided what to bring to the state-run stores.  And in what quantity.  Not people trading freely and voluntarily.  Which reduced economic activity.  Reduced living standards.  And introduced a police state.  Because anyone who had a chance to escape to a market economy did.  Which is why the East Germans built a wall in Berlin.  To keep their people from escaping their command economy.  And going to the market economy across the street.

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The Austrian School of Economics

Posted by PITHOCRATES - February 27th, 2012

Economics 101

Because of the Unpredictable Human Element in all Economic Exchanges the Austrian School is more Laissez-Faire

Name some of the great inventions economists gave us.  The computer?  The Internet?  The cell phone?  The car?  The jumbo jet?  Television?  Air conditioning?  The automatic dishwasher?  No.  Amazingly, economists did not invent any of these brilliant inventions.  And economists didn’t predict any of these inventions.  Not a one.  Despite how brilliant they are.  Well, brilliant by their standard.  In their particular field.  For economists really aren’t that smart.  Their ‘expertise’ is in the realm of the social sciences.  The faux sciences where people try to quantify the unquantifiable.  Using mathematical equations to explain and predict human behavior.  Which is what economists do.  Especially Keynesian economists.  Who think they are smarter than people.  And markets.

But there is a school of economic thought that doesn’t believe we can quantify human activity.  The Austrian school.  Where Austrian economics began.  In Vienna.  Where the great Austrian economists gathered.  Carl Menger.  Ludwig von Mises.  And Friedrich Hayek.  To name a few.  Who understood that economics is the sum total of millions of people making individual human decisions.  Human being key.  And why we can’t reduce economics down to a set of mathematical equations.  Because you can’t quantify human behavior.  Contrary to what the Keynesians believe.  Which is why these two schools are at odds with each other.  With people even donning the personas of Keynes and Hayek to engage in economic debate.

Keynesian economics is more mainstream than the Austrian school.  Because it calls for the government to interfere with market forces.  To manipulate them.  To make markets produce different results from those they would have if left alone.  Something governments love to do.  Especially if it calls for taxing and spending.  Which Keynesian economics highly encourage.  To fix market ‘failures’.  And recessions.  By contrast, because of the unpredictable human element in all economic exchanges, the Austrian school is more laissez-faire.  They believe more in the separation of the government from things economic.  Economic exchanges are best left to the invisible hand.  What Adam Smith called the sum total of the millions of human decisions made by millions of people.  Who are maximizing their own economic well being.  And when we do we maximize the economic well being of the economy as a whole.  For the Austrian economist does not believe he or she is smarter than people.  Or markets.  Which is why an economist never gave us any brilliant invention.  Nor did their equations predict any inventor inventing a great invention.  And why economists have day jobs.  For if they were as brilliant and prophetic as they claim to be they could see into the future and know which stocks to buy to get rich so they could give up their day jobs.  When they’re able to do that we should start listening to them.  But not before.

Low Interest Rates cause Malinvestment and Speculation which puts Banks in Danger of Financial Collapse

Keynesian economics really took off with central banking.  And fractional reserve banking.  Monetary tools to control the money supply.  That in the Keynesian world was supposed to end business cycles and recessions as we knew them.  The Austrian school argues that using these monetary tools only distorts the business cycle.  And makes recessions worse.  Here’s how it works.  The central bank lowers interest rates by increasing the money supply (via open market transactions, lowering reserve requirements in fractional reserve banking or by printing money).  Lower interest rates encourage people to borrow money to buy houses, cars, kitchen appliances, home theater systems, etc.  This new economic activity encourages businesses to hire new workers to meet the new demand.  Ergo, recession over.  Simple math, right?  Only there’s a bit of a problem.  Some of our worst recessions have come during the era of Keynesian economics.  Including the worst recession of all time.  The Great Depression.  Which proves the Austrian point that the use of Keynesian policies to end recessions only makes recessions worse.  (Economists debate the causes of the Great Depression to this day.  Understanding the causes is not the point here.  The point is that it happened.  When recessions were supposed to be a thing of the past when using Keynesian policies.)

The problem is that these are not real economic expansions.  They’re artificial ones.  Created by cheap credit.  Which the central bank creates by forcing interest rates below actual market interest rates.  Which causes a whole host of problems.  In particular corrupting the banking system.  Banks offer interest rates to encourage people to save their money for future use (like retirement) instead of spending it in the here and now.  This is where savings (or investment capital) come from.  Banks pay depositors interest on their deposits.  And then loan out this money to others who need investment capital to start businesses.  To expand businesses.  To buy businesses.  Whatever.  They borrow money to invest so they can expand economic activity.  And make more profits.

But investment capital from savings is different from investment capital from an expansion of the money supply.  Because businesses will act as if the trend has shifted from consumption (spending now) to investment (spending later).  So they borrow to expand operations.  All because of the false signal of the artificially low interest rates.  They borrow money.  Over-invest.  And make bad investments.  Even speculate.  What Austrians call malinvestments.  But there was no shift from consumption to investment.  Savings haven’t increased.  In fact, with all those new loans on the books the banks see a shift in the other direction.  Because they have loaned out more money while the savings rate of their depositors did not change.  Which produced on their books a reduction in the net savings rate.  Leaving them more dangerously leveraged than before the credit expansion.  Also, those lower interest rates also decrease the interest rate on savings accounts.  Discouraging people from saving their money.  Which further reduces the savings rate of depositors.  Finally, those lower interest rates reduce the income stream on their loans.  Leaving them even more dangerously leveraged.  Putting them at risk of financial collapse should many of their loans go bad.

Keynesian Economics is more about Power whereas the Austrian School is more about Economics

These artificially low interest rates fuel malinvestment and speculation.  Cheap credit has everyone, flush with borrowed funds, bidding up prices (real estate, construction, machinery, raw material, etc.).  This alters the natural order of things.  The automatic pricing mechanism of the free market.  And reallocates resources to these higher prices.  Away from where the market would have otherwise directed them.  Creating great shortages and high prices in some areas.  And great surpluses of stuff no one wants to buy at any price in other areas.  Sort of like those Soviet stores full of stuff no one wanted to buy while people stood in lines for hours to buy toilet paper and soap.  (But not quite that bad.)  Then comes the day when all those investments don’t produce any returns.  Which leaves these businesses, investors and speculators with a lot of debt with no income stream to pay for it.  They drove up prices.  Created great asset bubbles.  Overbuilt their capacity.  Bought assets at such high prices that they’ll never realize a gain from them.  They know what’s coming next.  And in some darkened office someone pours a glass of scotch and murmurs, “My God, what have we done?”

The central bank may try to delay this day of reckoning.  By keeping interest rates low.  But that only allows asset bubbles to get bigger.  Making the inevitable correction more painful.  But eventually the central bank has to step in and raise interest rates.  Because all of that ‘bidding up of prices’ finally makes its way down to the consumer level.  And sparks off some nasty inflation.  So rates go up.  Credit becomes more expensive.  Often leaving businesses and speculators to try and refinance bad debt at higher rates.  Debt that has no income stream to pay for it.  Either forcing business to cut costs elsewhere.  Or file bankruptcy.  Which ripples through the banking system.  Causing a lot of those highly leveraged banks to fail with them.  Thus making the resulting recession far more painful and more long-lasting than necessary.  Thanks to Keynesian economics.  At least, according to the Austrian school.  And much of the last century of history.

The Austrian school believes the market should determine interest rates.  Not central bankers.  They’re not big fans of fractional reserve banking, either.  Which only empowers central bankers to cause all of their mischief.  Which is why Keynesians don’t like Austrians.  Because Keynesians, and politicians, like that power.  For they believe that they are smarter than the people making economic exchanges.  Smarter than the market.  And they just love having control over all of that money.  Which comes in pretty handy when playing politics.  Which is ultimately the goal of Keynesian economics.  Whereas the Austrian school is more about economics.

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Keynesian Economics

Posted by PITHOCRATES - February 20th, 2012

Economics 101

John Maynard Keynes said if the People aren’t Buying then the Government Should Be

Keynesian economics is pretty complex.  So is the CliffsNotes version.  So this will be the in-a-nutshell version.  Keynesian economics basically says, in a nut shell, that markets are stupid.  Because markets are full of stupid people.  If we leave people to buy and sell as they please we will continue to suffer recession after recession.  Because market failures give us the business cycle.  Which are nice on the boom side.  But suck on the bust side.  The recession side.  So smart people got together and said, “Hey, we’re smart people.  We can save these stupid people from themselves.  Just put a few of us smart people into government and give us control over the economy.  Do that and recessions will be a thing of the past.”

Well, that’s the kind of thing governments love to hear.  “Control over the economy?” they said.  “We would love to take control of the economy.  And we would love to control the stupid people, too.  Just tell us how to do it and our smart people will work with your smart people and we will make the world a better place.”  And John Maynard Keynes told them exactly what to do.  And by exactly I mean exactly.  He transformed economics into mathematical equations.  And they all pretty much centered on doing one thing.  Moving the demand curve.  (A downward sloping graph showing the relationship between prices and demand for stuff; higher the price the lower the demand and vice versa).

In macroeconomics (i.e., the ‘big picture’ of the national economy), Keynes said all our troubles come from people not buying enough stuff.  That they aren’t consuming enough.  And when consumption falls we get recessions.  Because aggregate demand falls.  Aggregate demand being all the people put together in the economy out there demanding stuff to buy.  And this is where government steps in.  By picking up the slack in personal consumption.  Keynes said if the people aren’t buying then the government should be.  We call this spending ‘stimulus’.  Governments pass stimulus bills to shift the demand curve to the right.  A shift to the right means more demand and more economic activity.  Instead of less.  Do this and we avoid a recession.  Which the market would have entered if left to market forces.  But not anymore.  Not with smart people interfering with market forces.  And eliminating the recession side of the business cycle.

Keynesians prefer Deficit Spending and Playing with the Money Supply to Stimulate the Economy

Oh, it all sounds good.  Almost too good to be true.  And, as it turns out, it is too good to be true.  Because economics isn’t mathematical.  It’s not a set of equations.  It’s people entering into trades with each other.  And this is where Keynesian economics goes wrong.  People don’t enter into economic exchanges with each other to exchange money.  They only use money to make their economic exchanges easier.  Money is just a temporary storage of value.  Of their human capital.  Their personal talent that provides them business profits.  Investment profits.  Or a paycheck.  Money makes it easier to go shopping with the proceeds of your human capital.  So we don’t have to barter.  Exchange the things we make for the things we want.  Imagine a shoemaker trying to barter for a TV set.  By trading shoes for a TV.  Which won’t go well if the TV maker doesn’t want any shoes.  So you can see the limitation in the barter system.   But when the shoemaker uses money to buy a TV it doesn’t change the fundamental fact that he is still trading his shoemaking ability for that TV.  He’s just using money as a temporary storage of his shoemaking ability.

We are traders.  And we trade things.  Or services.  We trade value created by our human capital.  From skill we learned in school.  Or through experience.  Like working in a skilled trade under the guidance of a skilled journeyperson or master tradesperson.  This is economic activity.  Real economic activity.  People getting together to trade their human capital.  Or in Keynesian terms, on both sides of the equation for these economic exchanges is human capital.  Which is why demand-side economic stimulus doesn’t work.  Because it mistakes money for human capital.  One has value.  The other doesn’t.  And when you replace one side of the equation with something that doesn’t have value (i.e., money) you cannot exchange it for something that has value (human capital) without a loss somewhere else in the economy.  In other words to engage in economic exchanges you have to bring something to the table to trade.  Skill or ability.  Not just money.  If you bring someone else’s skill or ability (i.e., their earned money) to the table you’re not creating economic activity.  You’re just transferring economic activity to different people.  There is no net gain.  And no economic stimulus.

When government spends money to stimulate economic activity there are no new economic exchanges.  Because government spending is financed by tax revenue.  Wealth they pull out of the private sector so the public sector can spend it.  They take money from some who can’t spend it and give it to others who can now spend it.  The reduction in economic activity of the first group offsets the increase in economic activity in the second group.   So there is no net gain.  Keynesians understand this math.  Which is why they prefer deficit spending (new spending paid by borrowing rather than taxes).  And playing with the money supply.

The End Result of Government Stimulus is Higher Prices for the Same Level of Economic Activity

The reason we have recessions is because of sticky wages.  When the business cycle goes into recession all prices fall.  Except for one.  Wages.  Those sticky wages.  Because it is not easy giving people pay cuts.  Good employees may just leave and work for someone else for better pay.  So when a business can’t sell enough to maintain profitability they cut production.  And lay off workers.  Because they can’t reduce wages for everyone.  So a few people lose all of their wages.  Instead of all of the people losing all of their wages by a business doing nothing to maintain profitability.  And going out of business.

To prevent this unemployment Keynesian economics says to move the aggregate demand curve to the right.  In part by increasing government spending.  But paying for this spending with higher taxes on existing spenders is a problem.  It cancels out any new economic activity created by new spenders.  So this is where deficit spending and playing with the money supply come in.  The idea is if the government borrows money they can create economic activity.  Without causing an equal reduction in economic activity due to higher taxes.  And by playing with the money supply (i.e., interest rates) they can encourage people to borrow money to spend even if they had no prior intentions of doing so.  Hoping that low interest rates will encourage them to buy a house or a car.  (And incur dangerous levels of debt in the process).  But the fatal flaw in this is that it stimulates the money supply.  Not human capital.

This only pumps more money into the economy.  Inflates the money supply.  And depreciates the dollar.  Which increases prices.  Because a depreciated dollar can’t buy as much as it used to.  So whatever boost in economic activity we gain will soon be followed by an increase in prices.  Thus reducing economic activity.  Because of that demand curve.  That says higher prices decreases aggregate demand.  And decreases economic activity.  The end result is higher prices for the same level of economic activity.  Leaving us worse off in the long run.  If you ever heard a parent say when they were a kid you could buy a soda for a nickel this is the reason why.  Soda used to cost only a nickel.  Until all this Keynesian induced inflation shrunk the dollar and raised prices through the years.  Which is why that same soda now costs a dollar.

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The More the Government Interferes in the Economy the more they Push the Economy Underground

Posted by PITHOCRATES - February 5th, 2012

Week in Review

Is the cost of government too much?  Are the taxes, licensing, regulations, legislation, etc., proving so costly that it’s pushing the economy underground?  Yes (see World Black Market Booms by Christiane Amanpour, Matthew Drake & David Miller posted 2/1/2012 on Yahoo! News).

We all know black market goods are available all over the world, but what you may not know is that if you add up all revenue generated from un-taxed business it would equal the second largest economy of the world, behind only the United States.

Free market capitalism favors people over the state.  It allows people to come together and make mutually beneficial economic exchanges.  That they enter into voluntarily.  And when the state becomes to invasive in our lives, we apparently take our economic exchanges underground.  To escape confiscatory taxes.  And punishing regulations.  If that isn’t an indictment of the failure of Big Government I don’t know what is.  For when people are left to their own devices, they want to engage in economic exchanges without the heavy hand of government raising prices and/or influencing their decisions.  The prefer the liberty of the free market.  Not the coercion of the state.

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