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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Division of Labor

Posted by PITHOCRATES - November 4th, 2013

Economics 101

(Originally published October 24th, 2011)

The Division of Labor gives us our Houses, Food, Cars, Televisions, Smartphones, Laptops and the Internet

We can’t do everything ourselves.  It’s not efficient.  And most times not even possible.  We don’t build our own houses.  Grow our own food.  Build our own cars.  Manufacture our own high-definition televisions.  Smartphones.  Laptops.  And we don’t build our own Internet.  No.  Instead, people everywhere across the economy specialize in one thing (i.e., work for a living).  And together these specialists fit into the big economic picture.  Which gives us our houses, food, cars, televisions, smartphones, laptops and the Internet.

It started with the most basic division of labor.  Prehistoric women raised their young.  While prehistoric man hunted.  Which was necessary for the propagation of the species.  And us.  For if they all hunted and no one nursed the young the young would have died.  And with them the species of man.  For there was no formula back then.

The next great leap forward on the civilization timeline was the indispensible plough.  The prime mover of civilization.  With the food problem managed, famines were more the exception than the rule.  And with fewer people needed to produce a food surplus, people could do other things.  And they did.

The Division of Labor let us Create Surpluses in Food, Ploughs, Shoes, Tools, Harnesses, Etc.

The division of labor gave rise to artisans.  The first skilled trades.  Made possible by a food surplus.  As other people grew the food the artisans made the tools and crafts the farmers used.  They specialized in plough making and designed and built better and better ploughs.  Lots of them.  Shoemakers made shoes.  Lots of them.  Metal workers made tools.  Lots of them.  Leatherworkers made harnesses.  Lots of them.  See the pattern?

The food surplus gave us surpluses in ploughs, shoes, tools, harnesses, etc.  The division of labor let us create these surpluses.  Specialists made continual improvements in their areas of specialization.  Producing better things.  And more of them.  Which led to another key to the advanced civilization.  Trade.

The shoemaker didn’t have to grow food.  He could trade shoes for food.  Ditto for the plough maker.  The metal worker.  The leatherworker.  And the farmers didn’t have to make any of these things because they could trade food for them.  So we became traders.  We created the market.  And traders took their goods and/or services to these markets to trade for other goods and/or services.  First by foot.  Then by animal.  Then by boat.  Then by train.  Then by truck.  Then by airplane.  Artisans (i.e., workers) traded their specialization for the product and/or services of another’s specialization.  Then.  And now.

The Division of Labor made the Complex Simple and our Lives Rather Comfortable and Fun

The division of labor gave rise to the artisan.  The skilled trade worker.  The middle class.  People who can specialize in one thing.  And trade that one thing for the other things he or she wants.  Whether it be a skilled blacksmith hammering out farming tools.  A tool and die maker working in a factory.  An accountant.  Or a software engineer.  We have a skill.  Our human capital.  And we trade that skill to get the other things we’re not skilled in.  The end result is a modern, bustling, free market economy.  An advanced civilization.  And a high standard of living.

All thanks to the division of labor.  Which made the complex simple.  And our lives rather comfortable.  And fun.  Unlike prehistoric man.  Who knew of no such things as iPhones.  Indoor flush toilets.  Movie theaters.  Or restaurants.  No, he didn’t do much other than survive.  Which was no easy thing.  But he did.  And for that we are grateful.

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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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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - September 17th, 2013

History 101

(Originally published June 11th, 2013)

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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FT186: “Liberals are so bad at economics because they had no one in their lives to undo the bad education they got.” —Old Pithy

Posted by PITHOCRATES - September 6th, 2013

Fundamental Truth

Minimum-Wage Workers in Fast-Food and at Wal-Mart want a Living Wage for their Minimum-Wage Jobs

Wal-Mart workers are now demanding a living wage.  (Or people hired to protest the company the left loves to attack.)  Awhile back it was the fast-food workers demanding a doubling of the minimum wage.  So they could have a living wage.  Because they can’t raise their families with a minimum wage job.  So they want a pay rate beyond the pay rate of a minimum wage job.

So how much is earning $15/hour?  Well, if you work full-time and get the usual (2 weeks of vacation and holiday pay) that comes to 2080 (40 hours/week X 52 weeks/year) payroll hours a year.  At $15/hour that comes to $31,200 annually.  Which is the ‘living wage’ the fast-food workers want.  And no wonder.  According to the Bureau of Labor Statistics (see May 2012 National Occupational Employment and Wage Estimates) here are some other jobs that pay around $31,200 annually with what they do as noted by the Bureau of Labor Statistics:

Medical Assistants (Perform administrative and certain clinical duties under the direction of a physician. Administrative duties may include scheduling appointments, maintaining medical records, billing, and coding information for insurance purposes. Clinical duties may include taking and recording vital signs and medical histories, preparing patients for examination, drawing blood, and administering medications as directed by physician).  Medical Equipment Preparers (Prepare, sterilize, install, or clean laboratory or healthcare equipment. May perform routine laboratory tasks and operate or inspect equipment).  Ophthalmic Laboratory Technicians (Cut, grind, and polish eyeglasses, contact lenses, or other precision optical elements. Assemble and mount lenses into frames or process other optical elements. Includes precision lens polishers or grinders, centerer-edgers, and lens mounters).  Pesticide Handlers, Sprayers, and Applicators, Vegetation (Mix or apply pesticides, herbicides, fungicides, or insecticides through sprays, dusts, vapors, soil incorporation, or chemical application on trees, shrubs, lawns, or botanical crops. Usually requires specific training and State or Federal certification).  Pharmacy Technicians (Prepare medications under the direction of a pharmacist. May measure, mix, count out, label, and record amounts and dosages of medications according to prescription orders).  Phlebotomists (Draw blood for tests, transfusions, donations, or research. May explain the procedure to patients and assist in the recovery of patients with adverse reactions).  And Substitute Teachers (Teach students in a public or private school when the regular teacher is unavailable).

Some have worked Two or More Fast-Food/Retail Jobs so they could get the Education and Skills for a Higher-Paying Job

These are not entry-level jobs.  You just can’t walk in when you’re still a high school student, fill out an application and expect to get hired in any of these jobs.  They all take training/education beyond high school.  And require a license or certification.  Which requires an investment of time and money to get.  Usually including night school at the least.  And more often at least 2 years of college.  None of which is required for a minimum wage job.

So it’s no wonder people with minimum wage jobs want a pay rate that is beyond their skill-set.  Who wouldn’t?  Wouldn’t you want to get that higher pay without putting in that schooling?  That investment of time and money?  Things you probably can’t even do if you’re raising a family on a minimum wage job.  Or two.  But does that mean we should just pay these people more?  Would that be fair to the Medical Assistants, Medical Equipment Preparers, Ophthalmic Laboratory Technicians, Pesticide Handlers, Sprayers, and Applicators, Vegetation, Pharmacy Technicians, Phlebotomists and Substitute Teachers?

No.  It wouldn’t be fair to them.  For they would have made great sacrifices in their life to get those better paying jobs.  Because that is how you get a better-paying job.  In fact, some may have worked two or more fast-food/retail (such as Wal-Mart) jobs so they could get the education and skills these jobs required.  A lot of people working in fast-food/retail today may be doing the same thing.  For fast-food and retail offer two great things that allow these people to acquire these skills.  They will hire people without any skills (i.e., entry-level workers).  And fast-food and retail have many working schedules available.  Allowing single-parents to work when they have other arrangements for their children (school, daycare, parents, etc.).

The Hippies of the Sixties became Professors and then Moved on to Write the Curriculum

Instead of protesting fast-food and Wal-Mart we should be happy that at least someone in this horrible economy is actually hiring people when so few others are.  As President Obama’s economic policies have made such an anti-business environment.  The economy is so bad that just this past month another 516,000 have left the labor force (see Table A-1. Employment status of the civilian population by sex and age).  Which is the only reason why the unemployment rate fell.  Because of discouraged workers who couldn’t find a job just quit looking for a job.  But the government puts a positive spin on this by lauding the 169,000 new jobs the economy created.  Saying it’s further proof that President Obama’s economic policies are working.  Despite 516,000 who quit looking for jobs that are just not there.

If people are unhappy with their low-paying jobs in fast-food and retail they should be more upset about this economic destruction being waged by the Obama administration.  Which is the reason why fast-food and retail are the only businesses hiring today.  But there is no outrage.  Why?  Because most don’t understand economics.  And there is a reason why most people don’t.  It’s because of our education system.  Which the left has taken over.  Who write a curriculum that teaches students that capitalism and profits are unfair and bad while government and income redistribution so the rich pay their fair share is good.  And just.

A professor at Michigan State is the latest professor to illustrate the indoctrination of our young going on at our public schools and colleges.  Parents had to deal with their kids coming home from high school to hear how they were killing the polar bears because they drive cars.  But when these kids go to college this is the kind of stuff they encounter on a daily basis.  And he’s not the worst offender.  The worst offenders are those who don’t say outrageous things.  But who do it more subtly.  A smile, a smirk, a condescending remark—things that tell a young impressionable mind out from under their parents’ control for the first time that their parents were wrong.  Unless their parents were liberal.  They will believe almost anything these professors say.  Because they are very smart and must know far more than their parents.  And they treat these kids like adults.  And there is nothing that high school/college kids want more.  To be grown up.  It’s why they smoke cigarettes.  And have sex.  Because that’s what grownups do.

So is it any wonder that people have a poor understanding of economics?  Ever since the hippies of the Sixties couldn’t change the country from the outside they became professors to change it from the inside.  And then moved on to write the curriculum.  These people who hated capitalism.  And admired communism.  Which is why so many of them lived in communes in the Sixties.  These are the people writing the curriculum for our children.  Making sure our education system creates like-minded people.  To keep them voting Democrat until wisdom and experience opens their eyes.  And undoes the bad education they got.  This is why people think that it’s fair to pay minimum wage workers the same as Medical Assistants, Medical Equipment Preparers, Ophthalmic Laboratory Technicians, Pesticide Handlers, Sprayers, and Applicators, Vegetation, Pharmacy Technicians, Phlebotomists and Substitute Teachers.  Just to see how pervasive this indoctrination of our children is—and why people keep voting for those who keep trying the failed economic policies of the past—we should put a webcam in every classroom and lecture hall.  So parents—and the rest of America—can see the liberal dogma being fed to the young.  Making them think, and vote, the way they do.  Then we’ll know whether these are isolated incidences.  Or that it is in fact pervasive.  Explaining why so many people today have no understanding of economics.  That minimum-wage jobs are entry-level jobs.  And that if you want to raise a family you probably shouldn’t be voting Democrat.  Whose policies are making the only available jobs in this horrible economy those entry-level jobs.

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Communism, Karl Marx, Marxism, Surplus Labor and the Labor theory of Value

Posted by PITHOCRATES - August 20th, 2013

History 101

(Originally published December 13, 2011)

Some would call Putting Profits before People Heaven if they had Lived in the Caring Hell of Communism

No ideology killed more people than communism.  In total numbers.  Such as Joseph Stalin in the Soviet Union.  Or Mao Tse-tung in the People’s Republic of China.  Or as a percentage of population.  Where Pol Pot’s Cambodian genocide holds this honor alone.  These communist leaders killed their people directly for political purposes.  Or starved them to death because of agrarian reforms that produced famines.  All in the name of freeing their people from the horrors of capitalism.

Heaven and hell.  That’s how a defector who escaped communism and made it to capitalism would describe what it’s like to live under each system.  Capitalism would be heaven.  And communism would be hell.  The problem with communism was that it didn’t work.  Economically.  People lived in want of the basic staples of life.  And often went hungry.  When they didn’t starve to death by yet another famine.  And if they complained or spoke out against the system they risked torture.  Or they simply just disappeared.  Banished to a work camp.  A reeducation camp.  Or killed.  So it’s no surprise that people trapped in these countries tried to escape.  Which is why communist states were oppressive police states.  To prevent people from escaping their horrible lives.

And yet to this day some people still hold up communism as the ideal socioeconomic system.  The one that cares about the people.  The one that puts people before profits.  Unlike capitalism.  Which puts profits before people.  Of course some would call putting profits before people heaven.  Especially if they had lived in the caring hell of communism.

Communism as an Economic System is an Utter and Abject Failure

Those who champion communism don’t blame the ideology.  They say it’s the people.  The few who use the ideology for personal gain.  And by few they mean basically everyone.  But if everyone is doing it it’s not the people.  It’s the ideology.  And it goes back to its utter and abject failure as an economic system.

Communism goes back to Karl Marx.  The guy that coauthored the Communist Manifesto in 1848.  And from which we get the terms Marxism.  And Marxist.  To describe varying forms of communism.  And communists.  He’s the guy who said that capitalism exploited the working man.  Those with money (capital) who owned factories, the industrial bourgeoisie, charged more for their goods than they paid their workers to make those goods.  Because Marx believed the value of any good was the labor that made it (the labor theory of value), this excess value (profit) was a labor surplus.  And belonged to the worker.  So he encouraged class conflict.  For the proletariat (the working class) to rise up and take over the means of production from those who owned it.  These middle class capitalists.  The industrial bourgeoisie.  And establish a dictatorship of the proletariat.  So the bourgeois capitalist pig-dogs couldn’t exploit the proletariat any more.  And everyone would then live happily ever after.

But no one ever did.  Like in capitalism.  Where happiness abounds.  Because, in capitalism, the market determines prices.  Not some bureaucrat counting up labor inputs through the manufacturing process.  From the mining of resources.  To the final assembly.  Which can make things very expensive.  And, worse, unwanted by the people.  Because when the market sets the price and assigns value, the market tells people what to make.  Normally when something is a hot seller it tells manufacturers to make more of it.  To cash in on those high prices.  So they do.  And people tend to buy this surge in products.  But when the market isn’t setting the price and assigning value, the market can’t tell people what to make.  So a bureaucrat must.  Which is what happens in communism.  Bureaucrats decide everything.  From what to make.  To the allocation of resources.  To the selling price.  And the things they decide to make are rarely what the people want.  Explaining why stores in communist countries were full of stuff no one wanted to buy.  And why people had to stand hours in line to get the things they did.  Or paid more on the black market.  Which is why communism as an economic system is an utter and abject failure.  And why people wanted to escape it.  Their only obstacle being that brutal and oppressive police state.  Which was necessary because if everyone left that wanted to the communist leaders wouldn’t have anyone to provide for them.

There are no Such Things as Market Failures under Capitalism

Communism was one of the worst man-made tragedies to ever befall man.  Karl Marx was wrong.  And his asinine theories killed tens of millions of people.  People enjoy life and prosper under capitalism.  Under communism they set records for genocide.  Why?  Because the communist economic model is an utter and abject failure.

The struggle between communism and capitalism was an economic one.  And pitted the market against bureaucrats who thought they were smarter than the market.  But it turned out they weren’t.  Not by a long shot.  And despite this history people are constantly talking about market failures and the evils of capitalism.  Much like Joseph Stalin, Mao Tse-tung and Pol Pot.  But for them it was never about the economics.  It was about the power.  Much like it is today.  Because there are no such things as market failures under capitalism.  It’s the bureaucrats who fail.  Not the markets.  At least, based on all recorded history.

Markets fail only when they aren’t free.  They fail when bureaucrats insert themselves into the economic process.  Via regulatory policy.  Or high taxes.  When they try to shape market forces to a political end.  And when they do it is capitalism no more.  It’s crony capitalism.  Or worse.

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Saving, Investing and the Paradox of Thrift

Posted by PITHOCRATES - August 12th, 2013

Economics 101

(Originally published August 27th, 2012)

Healthy Sales can Support just about any Bad Decision a Business Owner Makes

“Industry, Perseverance, & Frugality, make Fortune yield.”  Benjamin Franklin (1744).  He also said, “A penny saved is a penny earned.”  Franklin was a self-made man.  He started with little.  And through industry, perseverance and frugality he became rich and successful.  He lived the American dream.  Which was having the liberty to work hard and succeed.  And to keep the proceeds of his labors.  Which he saved.  And all those pennies he saved up allowed him to invest in his business.  Which grew and created more wealth.

Frugality.  And saving.  Two keys to success.  Especially in business.  For the business that starts out by renting a large office in a prestigious building with new furniture is typically the business that fails.  Healthy sales can support just about any bad decision a business owner makes.  While falling sales quickly show the folly of not being frugal.  Most businesses fail because of poor sales revenue.  The less frugal you’ve been the greater the bills you have to pay with those falling sales. Which speeds up the failing process.  Insolvency.  And bankruptcy.  Teaching the important lesson that you should never take sales for granted.  The importance of being frugal.  And the value of saving your pennies.

Saving and frugality also hold true in our personal lives.  Especially when we start buying things.  Like big houses.  And expensive cars.  As a new household starting out with husband and wife gainfully employed the money is good.  The money is plentiful.  And the money can be intoxicating.  Because it can buy nice things.  And if we are not frugal and we do not save for a rainy day we are in for a rude awakening when that rainy day comes.  For if that two income household suddenly becomes a one income household it will become very difficult to pay the bills.  Giving them a quick lesson in the wisdom of being frugal.  And of saving your pennies.

The Money People borrow to Invest is the Same Money that Others have Saved

Being frugal lets us save money.  The less we spend the more we can put in the bank.  What we’re doing is this.  We’re sacrificing short-term consumption for long-term consumption.  Instead of blowing our money on going to the movies, eating out and taking a lot of vacations, we’re putting that money into the bank.  To use as a down payment on a house later.  To save for a dream vacation later.  To put in an in-the-ground pool later.  What we’re doing is pushing our consumption out later in time.  So when we do spend these savings later they won’t make it difficult to pay our bills.  Even if the two incomes become only one.

Sound advice.  Then again, Benjamin Franklin was a wise man.  And a lot of people took his advice.  For America grew into a wealthy nation.  Where entrepreneurs saved their money to build their businesses.  Large savings allowed them to borrow large sums of money.  As bank loans often required a sizeable down payment.  So being frugal and saving money allowed these entrepreneurs to borrow large sums of money from banks.  Money that was in the bank available to loan thanks to other people being frugal.  And saving their money.

To invest requires money.  But few have that kind of money available.  So they use what they have as a down payment and borrow the balance of what they need.  The balance of what they need comes from other people’s savings.  Via a bank loan.  This is very important.  The money people borrow to invest is the same money that others have saved.  Which means that investments are savings.  And that people can only invest as much as people save.  So for businesses to expand and for the economy to grow we need people to save their money.  To be frugal.  The more they save instead of spending the greater amount of investment capital is available.  And the greater the economy can grow.

The Paradox of Thrift states that Being Frugal and Saving Money Destroys the Economy

Once upon a time this was widely accepted economics.  And countries grew wealthy that had high savings rates.  Then along came a man named John Maynard Keynes.  Who gave the world a whole new kind of economic thought.   That said spending was everything.  Consumption was key.  Not savings.  Renouncing centuries of capitalism.  And the wise advice of Benjamin Franklin.  In a consumption-centered economy people saving their money is bad.  Because money people saved isn’t out there generating economic activity by buying stuff.  Keynes said savings were nothing more than a leak of economic activity.  Wasted money that leaks out of the economy and does nothing beneficial.  Even when people and/or businesses are being frugal and saving money to avoid bankruptcy.

In the Keynesian world when people save they don’t spend.  And when they don’t spend then businesses can’t sell.  If businesses aren’t selling as much as they once were they will cut back.  Lay people off.  As more businesses suffer these reductions in their sales revenue overall GDP falls.  Giving us recessions.  This is the paradox of thrift.  Which states that by doing the seemingly right thing (being frugal and saving money) you are actually destroying the economy.  Of course this is nonsense.  For it ignores the other half of saving.  Investing.  As a business does to increase productivity.  To make more for less.  So they can sell more for less.  Allowing people to buy more for less.  And it assumes that a higher savings rate can only come with a corresponding reduction in consumption.  Which is not always the case.  A person can get a raise.  And if they are satisfied by their current level of consumption they may save their additional income rather than increasing their consumption further.

Many people get a raise every year.  Which allows them to more easily pay their bills.  Pay down their credit cards.  Even to save for a large purchase later.  Which is good responsible behavior.  The kind that Benjamin Franklin would approve of.  But not Keynesian economists.  Or governments.  Who embrace Keynesian economics with a passion.  Because it gives them a leading role.  When people aren’t spending enough money guess who should step in and pick up that spending slack?  Government.  So is it any wonder why governments embrace this new kind of economic thought?  It justifies excessive government spending.  Which is just the kind of thing people go into government for.  Sadly, though, their government spending rarely (if ever) pulls a nation out of a recession.  For government spending doesn’t replicate what has historically created strong economic growth.  A high savings rate.  That encourages investment higher up in the stages of production.  Where that investment creates jobs.  Not at the end of the stages of production.  Where government spending creates only inflation.  Deficits.  And higher debt.  All things that are a drag on economic activity.

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Banks, Keynes, Subprime Mortgage Crisis and Great Recession

Posted by PITHOCRATES - June 11th, 2013

History 101

Bringing Borrowers and Lenders Together is a very Important Function of our Banks

Borrowers like low interest rates.  Savers (i.e., lenders) like high interest rates.  People who put money into the bank want to earn a high interest rate.  People who want to buy a house want a low interest rate.  As the interest rate will determine the price of the house they can buy.  Borrowers and lenders meet at banks.  Bankers offer a high enough interest rate to attract lenders (i.e., depositors).  But not too high to discourage borrowers.

This is the essence of the banking system.  And capital formation.  Alexander Hamilton said that money in people’s pockets was just money.  But when the people came together and deposited their money into a bank that money became capital.  Large sums of money a business could borrow to build a factory.  Which creates economic activity.  And jobs.  The United States became the world’s number one economic power with the capital formation of its banking system.  For a sound banking system is required for any advanced economy.  As it allows the rise of a middle class.  By providing investment capital for entrepreneurs.  And middle class jobs in the businesses they build.

So bringing borrowers and lenders together is a very important function of our banks.  And bankers have the heavy burden of determining saving rates.  And lending rates.  As well as determining the credit risk of potential borrowers.  Savers deposit their money to earn one rate.  So the bank can loan it out at another rate.  A rate that will pay depositors interest.  As well as cover the few loans that borrowers can’t pay back.  Which is why bankers have to be very careful to who they loan money to.

Keynesians make Recessions worse by Keeping Interest Rates low, Preventing a Correction from Happening

John Maynard Keynes changed this system of banking that made the United States the world’s number one economic power.  We call his economic theories Keynesian economics.  One of the changes from the classical school of economics we used to make the United States the world’s number one economic power was the manipulation of interest rates.  Instead of leaving this to free market forces in the banking system Keynesians said government should have that power.  And they took it.  Printing money to make more available to lend.  Thus bringing down interest rates.

And why did they want to bring down interest rates?  To stimulate economic activity.  At least, that was their goal.  To stimulate economic activity to pull us out of a recession.  To even eliminate recessions all together.  To eliminate the normal expansion and contraction of the economy.  By manipulating interest rates to continually expand the economy.  To accept a small amount of permanent inflation.  In exchange for a constantly expanding economy.  And permanent job creation.  That was the Keynesian intention.  But did it work?

No.  Since the Keynesians took over the economy we’ve had the Great Depression, the stagflation and misery of the Seventies, the savings and loans crisis of the Eighties, the irrational exuberance and the dot-com bubble crash of the Nineties, the subprime mortgage crisis and the Great Recession.  All of these were caused by the Keynesian manipulation of interest rates.  And the resulting recessions were made worse by trying to keep interest rates low to pull the economy out of recession.  Preventing the correction from happening.  Allowing these artificially low interest rates to cause even more damage.

The Government’s manipulation of Interest Rates gave us the Subprime Mortgage Crisis and the Great Recession

My friend’s father complained about the low interest rates during the Clinton administration.  For the savings rate offered by banks was next to nothing.  With the Federal Reserve printing so much money the banks didn’t need to attract depositors with high savings rates.  Worse for these savers was the inflation caused by printing all of this money eroded the purchasing power of their savings.  So they couldn’t earn anything on their savings.  And what savings they had bought less and less over time.  But mortgages were cheap.  And people were rushing to the banks to get a mortgage before those rates started rising again.

This was an interruption of normal market forces.  It changed people’s behavior.  People who were not even planning to buy a house were moved by those low interest rates to enter the housing market.  Then President Clinton pushed other people into the housing market with his Policy Statement on Discrimination in Lending.  Getting people who were not even planning to buy a house AND who could not even afford to buy a house to enter the housing market.  Those artificially low interest rates pulled so many people into the housing market that this increased demand for houses started raising house prices.  A lot.  But it didn’t matter.  Not with those low interest rates.  Subprime lending.  Pressure by the Clinton administration to qualify the unqualified for mortgages.  And Fannie May and Freddie Mac buying those risky subprime mortgages from the banks, freeing them up to make more risky mortgages.  This scorching demand pushed housing prices into the stratosphere.

A correction was long overdue.  But the Federal Reserve kept pushing that correction off by keeping interest rates artificially low.  But eventually inflation started to appear from all that money creation.  And the Federal Reserve had no choice but to raise interest rates to tamp out that inflation.  But when they did it caused a big problem for those with subprime mortgages.  Those who had adjustable rate mortgages (ARMs).  For when interest rates went up so did their mortgage payments.  Beyond their ability to pay them.  So they defaulted on their mortgages.  A lot of them.  Which caused an even bigger problem.  All those mortgages Fannie Mae and Freddie Mac bought?  They sold them to Wall Street.  Who chopped them up into collateralized debt obligations.  Financial instruments backed by historically the safest of all investments.  The home mortgage.  Only these weren’t your father’s mortgage.  These were risky subprime mortgages.  But they sold them to unsuspecting investors as high yield and low-risk investments.  And when people started defaulting on their mortgages these investments became worthless.  Which spread the financial crisis around the world.  On top of all of this the housing bubble burst.  And those house prices fell back down from the stratosphere.  Leaving many homeowners with mortgages greater than the corrected value of their house.

It was the government’s manipulation of interest rates that gave us the subprime mortgage crisis.  The Great Recession.  And the worst recovery since that following the Great Depression.  All the result of Keynesian economics.  And the foolhardy belief that you can make recessions a thing of the past.

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Rational Choice Theory

Posted by PITHOCRATES - June 10th, 2013

Economics 101

Trying to Predict which Choice People will Choose is Difficult

People.  They’re the worst.  A joke on Seinfeld.  But so true in economics.

People look out for their best interests.  Everything they do that they have power to do they do to improve their station in life.  When they buy gas they choose the station with the lowest price.  When they get a mortgage they go to the lender with the lowest borrowing costs.  When they go shopping they go to the store with the best sales.  Most of the time.

Some nights people may stop at a pizzeria on the way home from work.  Take the food home.  And scarf it down in front of the television.  Sometimes people may go out to dinner at an expensive restaurant.  Enjoying a fine dining experience.  At a fancy restaurant.  Taking their time.  Savoring every course.  A fine wine.  A decadent dessert.  Two very different choices.  Takeout pizza.  And a fine dining experience.  Trying to predict which choice people will choose is difficult.  Especially when the same people may choose one option one night.  Then the other option on another night.

You can’t reduce People’s Decision-Making Process down to a Mathematical Equation

Choice.  What will we choose when given choice?  That is the million dollar question.  For being able to predict how human beings will choose will make the one who can predict choice very wealthy.  Stores would know exactly what to sell.  Investors would always know what stocks to buy.  And television executives would only put television shows on air the people will love.  But stores often have huge sales to unload merchandise that isn’t selling.  Investors lose money in the stock market.  And every fall television executives bring a slew of new shows to air.  Most of which will be off the air by next season.

Yes, people are rational.  And they typically choose to maximize their utility.  That is, getting the most bang for their buck.  But they are human.  They think.  A lot.  And when they consider everything before making a choice they may choose what to others is irrational.  Even if it’s not to them.  That’s the problem with people.  You can’t reduce their decision-making process down to a mathematical equation.  But economists try.  As do politicians.

But their efforts rarely get the people to do what they want.  During a recession they will implement policy to change people’s decision-making process.  They’ll expand the money supply to lower interest rates.  To encourage people to borrow money and buy things.  Like houses.  And cars.  Even if they weren’t even thinking about buying a house or a car.  The hope is that if these people start buying things they weren’t previously going to buy it will generate economic activity.  And pull the country out of recession.

Left to their own Devices the People will make the Best Decisions

But it rarely works.  If it ever works.  A recession is like a cold.  You can take a lot of over-the-counter cold medicine to ease your discomforts.  But you can’t cure it.  You just have to let it run its course.  So it is with a recession.  A recession is a correction.  Prices correct to market values.  And supply corrects to match demand.  Suppliers cut back on production.  And lay people off.  This is the painful part of a recession.  People losing their jobs.  But they have to.  Because there are too many people producing more than others are buying.  But once the recession runs its course the economy can start growing again.  And business will start hiring again.

Trying to prevent this correction with low interest rates will only delay the correction.  Worse, it will encourage people into irrational behavior.  Such as borrowing money to buy a house during a correction.  Getting a mortgage that will soon be worth more than the value of the house.  Once the correction resets housing prices to market values.  While some people make these irrational decisions others make rational decisions.  Refusing to increase production or to hire more people when the government floods the market with cheap money.  Because they know that it will at best delay the correction.  So they won’t act as the government hoped they would.  Leaving the economy in recession.  So it can run its course.  Like the common cold.

Because recessions must run their course the government should not intervene.  They should not try to influence the decision-making process of the people.  For left to their own devices the people will make the best decisions.  Which is why countries with free market economies have healthier economies than countries with managed economies.  And why when the government does not intervene in the economy recessions are shorter and less painful.  Because the correction that must happen happens.  In the shortest time possible.  But when government intervenes we get things like the Great Depression.  And the Great Recession.

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FT167: “When we lived more austerely there was no need for painful austerity to cure a bloated government.” —Old Pithy

Posted by PITHOCRATES - April 26th, 2013

Fundamental Truth

Wise Men in Governments can Do Anything but Pay for their Nanny States

Economics changed in the early Twentieth Century.  America once again had a central bank.  Progressives were expanding the role of government.  And a new economist entered the scene that the progressives just loved.  For he was a macroeconomist who said government should have an active role in the economy.  A role where government tweaked the economy to make it better.  Stronger.  While avoiding the painful corrections on the downside of a business cycle.  Something laissez-faire capitalism caused.  And could not prevent.  But if wise men in government had the power to tweak the private sector economy they could.  At least this is what the progressives and Keynesian economists thought.

That economist was, of course, John Maynard Keynes.  Who rewrote the book on economics.  And what really excited the progressives was the chapter on spending an economy out of a recession.  Now there were two ways to increase spending in an economy.  You can cut tax rates so consumers have bigger paychecks.  Or the government can spend money that they borrow or print.  The former doesn’t need any government intervention into the private sector economy.  While the latter requires those wise men in government to reach deep into that economy.  Guess which way governments choose to increase spending.  Here’s a hint.  It ain’t the one where they just sit on the sidelines.

Governments changed in the Twentieth Century.  Socialism swept through Europe.  And left social democracies in its wake.  Not quite socialism.  But pretty close.  It was the rise of the nanny state.  Cradle to grave government benefits.  A lot of free stuff.  Including pensions.  Health care.  College educations.  And a lot of government jobs in ever expanding government bureaucracies.  Where wise men in government made everything better for the people living in these nanny states.  And armed with their new Keynesian economic policies there was nothing they couldn’t do.  Except pay for their nanny states.

According to John Maynard Keynes raising Tax Rates reduces New Economic Activity

The problem with a nanny state is things change.  People have fewer babies.  Health care and medicines improve.  Increasing lifespans.  You put this together and you get an aging population.  The death knell of a nanny state.  For when those wise men in government set up all of those generous government benefits they assumed things would continue the way they were.  People would continue to have the same amount of babies.  And we would continue to die just about the time we retired.  Giving us an expanding population of new workers entering the workforce.  While fewer people left the workforce and quickly died.  So the tax base would grow.  And always be larger than those consuming those taxes.  In other words, a Ponzi scheme.

But then change came.  With the Sixties came birth control and abortion.  And we all of a sudden started having fewer babies.  While at the same time advances in medicine was increasing our lifespans.  Which flipped the pyramid upside down.  Fewer people were entering the workforce than were leaving it.  And those leaving it were living a lot longer into retirement.  Consuming record amounts of tax money.  More than the tax base could provide.  Leading to deficit spending.  And growing national debt.

Now remember those two ways to increase spending in the economy?  You either cut tax rates.  Or the government borrows and spends.  So if cutting tax rates will generate new economic activity (i.e., new spending in the economy) what will a tax increase do?  It will decrease spending in the economy.  And reduce new economic activity.  Which caused a problem for these nanny states with aging populations.  As the price tag on their nanny state benefits eventually grew greater than their tax revenue’s ability to pay for it.  So they increased tax rates.  Which reduced economic activity.  And with less economic activity to tax their increase in tax rates actually decreased tax revenue.  Forcing them to run greater deficits.  Which added to their national debts.  Increasing the interest they paid on their debt.  Which left less money to pay for those generous benefits.

President Obama’s Non-Defense Spending caused a Huge Spike in the National Debt not seen since World War II

It’s a vicious cycle.  And eventually you reach a tipping point.  As debts grow larger some start to question the ability of a government to ever repay their debt.  Making it risky to loan them any more money.  Which forces these countries with huge debts to pay higher interest rates on their government bonds.  Which leaves less money to pay for those generous benefits.  While their populations continue to age.  Taking you to that tipping point.  Like many countries in the Eurozone who could no longer borrow money to pay for their nanny states.  Who had to turn to the European Union, the European Central Bank and the International Monetary Fund for emergency loans.  Which did provide those emergency loans.  Under the condition that they cut spending.  Money in exchange for austerity.  Something that just galls those Keynesian economists.  For despite all of their financial woes coming from having too much debt they still believe these governments should spend their way out of their recessions.  And never mind about the deficits.  Or their burgeoning debts.

But these Keynesians are missing a very important and obvious point.  The problem these nations have is due to their inability to borrow money.  Which means they would NOT have a problem if they didn’t need to borrow money.  So austerity will work.  Because it will decrease the amount of money they need to borrow.  Allowing their tax revenue to pay for their spending needs.  Without excessive tax rates that reduce economic activity.  Making the nanny state the source of all their problems.  For had these nations never became social democracies in the first place they never would have had crushing debt levels that cause sovereign debt crises.  But they did.  And their populations aged.  Making it a matter of time before their Ponzi schemes failed.  Something no nation with a growing nanny state and an aging population can avoid.  Even the United States.  Who kept true to their limited government roots for about 100 years.   Then came the progressives.  The central bank.  And Keynesian economics.  Putting the Americans on the same path as the Europeans (see US Federal Debt As Percent Of GDP).

Debt as Percent of GDP and Wars R2

With the end of the Revolutionary War they diligently paid down their war debt.  Which was pretty much the entire federal debt then.  As the federal government was as limited as it could get.  Then came the War of 1812 and the debt grew.  After the war it fell to virtually nothing.  Then it soared to pay for the Civil War.  Which changed the country.  The country was bigger.  Connected by a transcontinental railroad.  And other internal improvements.  Which prevented the debt from falling back down to pre-war levels.  Then it shot up to pay for World War I.  After WWI the Roaring Twenties replaced progressivism and quickly brought the debt down again.  Then Herbert Hoover brought back progressivism and killed the Roaring Twenties.  FDR turned a bad recession into the Great Depression.  By following all of that Keynesian advice to spend the nation out of recession.  From the man himself.  Keynes.  The massive deficit spending of the New Deal raised the debt higher than it was during World War I.  Changing the country again.  Introducing a state pension.  Social Security.  A Ponzi scheme that would struggle once the population started aging.

Then came World War II and the federal debt soared to its highest levels.  After the war a long decline in the debt followed.  At the end of that decline was the Vietnam War.  And LBJ’s Great Society.  Which arrested the fall in the debt.  Its lowest point since the Great Depression.  Which was about as large as the debt during the Civil War and World War I.  Showing the growth in non-defense spending.  Then came Reagan’s surge in defense spending to win the Cold War.  Once the Americans won the Cold War the debt began to fall again.  Until the Islamist terrorist attacks on 9/11.  Halting the fall in the debt as the War on Terror replaced the Cold War.  Then came the Great Recession.  And President Obama.  Whose non-defense spending caused a huge spike in the national debt.  Taking it to a level not seen since World War II.  When an entire world was at war.  But this debt is not from defense spending.  It’s from an expanded nanny state.  As President Obama takes America into the direction of European socialism.  And unsustainable spending.  Which can end in only but one way.  Austerity.  Painful austerity.  Not like the discomfort of the sequester cuts that only were cuts in the rate of future growth.  But real cuts.  Like in Greece.

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