If the U.S. was on a Gold Standard there would NOT have been a Financial Crisis in 2007

Posted by PITHOCRATES - June 9th, 2013

Week in Review

Counterfeiting money is against the law.  We all know this.  But do we understand why?  Today’s money is just fiat money.  The Federal Reserve prints it and simply says it is money.  So why is it okay for them to print money but not for anyone else?  Because the amount of money in circulation matters.

The goods and services that make up our economy grow at a given rate.  You hear numbers like GDP of 2%, 3% or more.  In China they had GDP numbers in excess of 8%.  The goods and services in our economy are what have value.  Not the money.  It just temporarily holds the value of these goods and services as they change hands in the economy.  So the amount of money in circulation should be close to the value of goods and services in the economy.  Think of a balancing scale.  Where on the one side you have the value of all goods and services in the economy.  And on the other you have the amount of money in circulation.  If you increase the amount of money on the one side it doesn’t increase the amount of goods and services on the other side.  But it still must balance.  So as we increase the amount of money in circulation the value of each dollar must fall to keep the scale in balance.

Now when we put our money into the bank for our retirement we don’t want the value of those individual dollars grow less over time.  Because that would reduce the purchasing power of our money in the bank.  Making for an uncomfortable retirement.  This is why we want a stable dollar.  One that won’t depreciate away the value of our retirement savings, our investments or the homes we live in.  We’d prefer these to increase in value.  But we can stomach if they just hold their value.  For awhile, perhaps.  But we cannot tolerate it when they lose their value.  Because when they do years of our hard work just goes ‘poof’ and disappears.  Leaving us to work longer and harder to make up for these losses.  Perhaps delaying our retirements.  Perhaps having to work until the day we die.  So we want a stable currency.  Like the gold standard gave us (see Advance Look: What The New Gold Standard Will Look Like by Steve Forbes posted 5/8/2013 on Forbes).

The financial crisis that began in 2007 would never have happened had the Federal Reserve kept the value of the dollar stable. A housing bubble of the proportions that unfolded–not to mention bubbles in commodities and farmland–would not have been possible with a stable dollar. The Fed has also created a unique bubble this time: bonds. It hasn’t popped yet (nor has the farmland bubble), but it will.

The American dollar was linked to gold from the time of George Washington until the early 1970s. If the world’s people are to realize their full economic potential, relinking the dollar to gold is essential. Without it we will experience more debilitating financial disasters and economic stagnation.

What should a new gold standard look like? Representative Ted Poe (R-Tex.) has introduced an original and practical version. Unlike in days of old we don’t need piles of the yellow metal for a new standard to operate. Under Poe’s plan–an approach I have long favored–the dollar would be fixed to gold at a specific price. For argument’s sake let’s say the peg is $1,300. If the price of gold were to go above that, the Federal Reserve would sell bonds from its portfolio, thereby removing dollars from the economy to maintain the $1,300 level. Conversely, if the gold price were to drop below $1,300, the Fed would “print” new money by buying bonds, thereby injecting cash into the banking system.

Yes, the subprime mortgage crisis and the Great Recession would not have happened if the Federal Reserve kept the dollar stable.  Instead, they kept printing and putting more money into circulation.  Why?  To keep interest rates low.  To encourage more and more people to buy a house.  Even people who weren’t planning to buy a house.  Even people who couldn’t afford to buy a house.  Until, that is, subprime lending took off.  Because of those low interest rates.  With all of these people added to the housing market who otherwise would not have been there (because of the Federal Reserve’s monetary policies of printing money to keep interest rates artificially low) the demand for new houses exploded.  As people tried to buy these before others could house prices soared.  Creating a great housing bubble.  Houses worth far greater than they should have been.  And when the bubble burst those housing prices fell back to earth.  Often well below the value of the outstanding balance of the mortgage on the house.  Leaving people underwater in their mortgages.  And when the Great Recession took hold a lot of two-income families went to one-income.  And had a mortgage payment far greater than a single earner could afford to pay.

So that’s how that mess came about.  Because the Federal Reserve devalued the dollar to stimulate the housing market (and any other market of big-ticket items that required borrowed money).  If we re-link the dollar to gold things like this couldn’t happen anymore.  For if it would put a short leash on the Federal Reserve and their ability to print dollars.  How?  As they print more dollars the value of the dollar falls.  Causing the value of gold priced in dollars to rise.  So they would have to stop printing money to keep the value of gold priced in dollars from rising beyond the established gold price.  Or they would have to remove dollars from circulation to decreases the value of gold priced in dollars back down to the established price.  Thereby giving us a stable currency.  And stable housing prices.  For having a stable currency limits the size of bubbles the Federal Reserve can make.

But governments love to print money.  Because they love to spend money.  As well as manipulate it.  For example, depreciating the dollar makes our exports cheaper.  But those export sales help fewer people than the depreciated dollar harms.  But helping a large exporter may result in a large campaign contribution.  Which helps the politicians.  You see, a stable dollar helps everyone but the politicians and their friends.  For printing money helps Wall Street, K Street (where the lobbyists are in Washington DC) and Pennsylvania Avenue.  While hurting Main Street.  The very people the politicians work for.



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Economic Stimulus

Posted by PITHOCRATES - November 5th, 2012

Economics 101

Prices match Supply to Demand letting Suppliers know when to bring more Goods and Services to Market

There is a natural ebb and flow to the economy.  Through good times and bad.  And you can tell which way the economy is heading by prices in the market place.  When prices are rising times are typically good.  As people are gainfully employed with money to spend.  As they compete with each other for the goods and services in the market place demand rises.  Growing greater than the supply of goods and services.  So prices rise.  Because when there are fewer goods and services they are worth more money.  For those who have them to sell.  Because demand is so great people are willing to pay top dollar for them.  To get them while supplies last.  This attracts the attention of other suppliers.  Who want to cash in on those high prices.  So they bring more goods and services to market.

In time supply catches up to demand.  And passes it.  Suddenly the market has more goods and services than people are buying.  As inventories grow retailers stop buying so much from their wholesale suppliers.  Who in turn stop buying so much from their manufacturers.  Who in turn stop buying so much from their raw material suppliers.  And manufacturers and their raw material suppliers begin laying off workers.  So there are fewer people gainfully employed with money to spend.  The fewer gainfully employed buy less than the more gainfully employed.  Causing inventories to grow larger as more goods are going into them than are coming out of them.  So they start cutting prices.  To unload these inventories before people start buying even less.  Because they spent a lot of money to build those inventories.  And it costs to hold these items in warehouses and stockrooms.

And that’s the natural ebb and flow of the economy.  What economists call the business cycle.  That goes from an expanding economy to a contracting economy.  From boom to bust.  From inflation to recession.  Something normal.  And natural.  Though it could be unpleasant for those who lose their jobs.  But it’s something that must happen.  To correct prices.  You see, prices make all of this work automatically.  They match supply to demand.  Letting suppliers know when to bring more goods and services to market.  And when they’ve brought too much.  When the economy goes into recession prices fall.  Which tells suppliers that supply exceeds demand.  And that anything additional they bring to market will not sell.  As they incur costs to bring things to market this is very good information to have.  So they don’t waste money.  Leaving their businesses short of cash.  Possibly causing their businesses to fail.

Whenever we Devalue the Dollar with Inflationary Monetary Policy Prices Rise

No one likes losing their job.  Because they need income to pay their bills.  And the government doesn’t like people losing their jobs.  Because they tax those incomes to pay the government’s bills.  And unemployed people pay no income taxes.  So the government tries to tweak the economy.  At the federal level.  To extend the inflationary periods of the business cycle.  And they do that with inflationary monetary policy.  Using their monetary powers to keep interest rates below the true market interest rate.  Hoping it will encourage suppliers and consumers to keep borrowing and spending money.  Even though supply had already caught up to and passed demand.  Such that everyone that wanted to buy something could.  While every supplier that wanted to sell something couldn’t.

Some people take advantage of these lower interest rates.  Some people will remortgage their homes to lower their monthly payment.  Which will give them a little more disposable cash each month.  Which they may use to buy more stuff.  But other people will take this opportunity to buy a large house just because of the low interest rate.  As some businesses may borrow to expand their business just because of the low interest rate.  Not for unmet demand.  These actions may not help the economy.  In fact they may hurt the economy in the long-term.  When the inevitable recession comes along and they are so overextended they may not be able to pay their bills.  They may lose their house.  Or their business.  For the worst thing to have whenever you suffer a reduction in revenue or income is debt.

But there is an even worse effect of that inflationary monetary policy.  When you increase the money supply you increase the total amount of dollars in the economy.  But they’re chasing the same amount of goods and services.  Which makes each dollar worth less.  Requiring more of them to buy the same things they once did.  Which is why whenever we devalue the dollar with inflationary monetary policy prices rise.  So, yes, there may be an initial expansion of economic activity.  But some people will have inflationary expectations.  That is, they know prices will go up in the very near future.  So they won’t increase production.  Why?  While an initial burst of economic activity may draw down those bloated inventories those coming higher prices will increase business costs.  Which businesses will have to pass on in the prices of their goods.  And how do higher prices affect consumers?  They buy less.  So manufacturers are not going to expand production when price inflation is going to reduce their sales in the long run.

Cutting Taxes and Reducing Costly Regulations have Stimulated Economic Activity every time they’ve been Tried

Perhaps the worst effect of inflation is the false information those higher prices give.  When consumer demand rises so do prices.  And it’s a signal to suppliers to bring more goods and services to market.  But when prices rise because of a depreciated dollar and NOT due to higher consumer demand, some may bring more goods and services to market when there is no demand for it.  So you have rising prices.  And expanding production.  Producing more goods than the market is demanding.  Creating a bubble.  Adding a lot of stuff to the market place at very inflated prices.  That no one is buying.  Then the bubble bursts.  And recession sets in.  As businesses lay off workers to adjust supply to meet actual demand.  And those inflated prices fall back to market values.  The higher inflationary monetary policy pushed those prices up the farther they have to fall.  And the more painful the recession will be.

You see, inflationary monetary policy interferes with the natural ebb and flow of the economy.  And the automatic price mechanism that matches supply to demand.  By trying to expand the inflationary side of the business cycle, and contract the recessionary side, governments make recessions longer.  And more painful.  Which is why Keynesian stimulus policies (lowering interests rates and deficit spending) don’t stimulate long-term economic activity.  Yet it is what most governments turn to whenever the economy slows. While there is another way to stimulate economic activity.  One that is not so popular with most governments.  Across the board tax cuts on business and personal incomes.  And reducing costly regulations on businesses.  These make a more business-friendly environment.  Encouraging businesses to expand and hire people.  Because these actions will have a positive impact on a business’ long-term outlook.  And with consumers having more disposable income (thanks to the cuts in personal income tax rates) businesses know there will be a market of any increase in production.

So there you have two ways to stimulate economic activity.  One way that works (tax cuts and reducing costly business regulations).  And one that doesn’t (lowering interest rates and deficit spending).  So why is the one that doesn’t work chosen by most governments over the one that does?  Because governments like to spend money.  It’s how they build constituencies.  By giving generous benefits to voters.  But to do that they need tax revenue.  Lots of tax revenue.  Produced by increasing tax rates as often as they can.  So they cannot stand the thought of cutting taxes.  Ever.  Which is why they always choose inflationary policies over tax cuts.   Even though those policies fail to stimulate economic activity.  As proven throughout the era of Keynesian economics.  While cutting taxes and reducing costly regulations have stimulated economic activity every time they’ve been tried.



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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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FT125: “Welfare states fail because economic systems based on slavery don’t create enough stuff.” -Old Pithy

Posted by PITHOCRATES - July 6th, 2012

Fundamental Truth

In the Barter System the Only Way to Get Something you Wanted was to create Something of Value Yourself

What’s more important?  Money?  Or stuff?  Stuff, of course.  Because people work to earn money to buy stuff.  They don’t work just for the money.  Because you can’t eat money.  You can’t drink money.  You can’t smoke money.  You can drive money.  You can’t watch or listen to money.  You can’t live in money.  You can’t surf the Internet with money.  No.  The only thing money is good for is buying stuff.  It’s the stuff we buy that makes our lives more enjoyable.  Having money helps.  But it is only a means to an end.  That end being stuff.  And someone has to make that stuff.  For if no one does then all the money in the world is worthless.

Early economies were barter economies.  People traded stuff.  Stuff they created, dug up, grew, manufactured, etc.  Instead of working to earn money to buy stuff they created stuff and traded it for other stuff.  So the only way to get something you wanted was to create something of value yourself.  Money didn’t change this.  Money just made trading with other people more efficient.  By being a temporary storage of wealth.  Because the barter system had a serious flaw.  High search costs. 

It took time to bring two people together to trade their stuff.  If a toolmaker wanted a pottery vase he had to find a potter who wanted a tool the toolmaker made.  This could take awhile.  Hence the high search costs.  Because while these people were seeking each other out they couldn’t make anything else of value.  With money, though, you could accept money in trade.  And then go and trade that money for what you wanted.  This greatly reduced search costs.  Because all you had to do was find the things you wanted.  And trade your temporary storage of wealth (i.e., money) for them.  Allowing them to spend more time creating value.  And less time searching.

The North won the American Civil War because the North practiced Free Market Capitalism while the South Didn’t

Advances in agriculture allowed larger and larger food surpluses.  Which, in turn, allowed more and more people to do something other than farm.  This unleashed human capital.  Allowed people to think about other things.  Create new things.  And improve existing things.  This created a middle class of artisans.  Craftspeople.  The people that created goods and services and brought them to the market place.  Creating the complex economy.  These people became entrepreneurs.  They efficiently used resources and sold things in the market place the people were demanding.  Not out of the goodness of their hearts.  But because they were pursuing profits.

This is free market capitalism.  The economic system that ushered in the modern world.  Free people thinking freely.  Creating.  Bringing their bold new ideas into reality.  Giving us the steam engine.  The railroad.  Machine tools.  Electric power.  The assembly line.  Free market capitalism brought us these things and improved our standard of living.  Because they were free to enter the market place.  And make profits.  Providing a powerful incentive to make the world a better place for everyone else.  Because when they took risks and worked hard to make the world a better place they could get rich in the process.

This is why the North won the American Civil War.  Because the North practiced free market capitalism.  While the South did not.  Their economy was a slave economy.  Instead of an expanding middle class working and contributing to the economy they had an expanding slave population.  That didn’t contribute to the economy.  They worked in the fields.  With all the proceeds from their labors going to a few plantation owners.  Slaves in general didn’t tinker or bring new things to market to enrich their masters.  For they had no incentive to do so.  They did have an incentive to do as they were told and work the fields.  To avoid punishment.  And they had no wages to spend in the market.  So there was less demand for manufactured goods in the South (in some states of the Deep South slaves made up to a third to half of the population).  So there was less manufacturing in the South.  Far less.  This is why the North exploded in manufacturing.  Entrepreneurs could bring things to market.  And the manufacturing workers earned wages they could use to buy those things.  As well as mass-produce the implements of war.  Unlike they could in the South.  Because of the economic superiority of the North it was just a matter of time before the South was overwhelmed.  And lost. 

When the Roman Empire turned into a Welfare State they had to Force People to Make Stuff Against their Will

Governments can print money.  They can tax people.  They can borrow money.  But the one thing they can’t do is create stuff.  If they could create stuff (i.e., economic activity) simply by printing money then the South would have matched the North in economic output.  But they did not.  Which is why they ultimately lost the war.  Because they could print Confederate dollars.  But that didn’t make muskets, bullets, canon, shoes, food, ships, steam locomotives or railroad track.  Creative people had to make these things first before the Confederate government could procure them.  Which is why the government didn’t procure them.  Because no one made them.

This is why governments just can’t print money and give it to the people.  They could.  But it would be pointless.  Let’s say they gave everyone $100,000 a year.  So no one would ever have to work again.  A lot of people would vote for the politician that promised that.  Of course if no one works who will create all the stuff to buy with that $100,000?  Having money is one thing.  But if there is nothing to buy with it then that money is worthless.

This is why the welfare state will ultimately fail.  As more people collect welfare benefits instead of creating stuff there will be less stuff to buy.  When supply shrinks while demand increases prices rise.  Higher prices that everyone has to pay.  People who create.  And people who don’t.  So they will raise taxes on those who work to pay for the benefits for those who don’t.  So those who don’t work can afford the higher prices, too.  Higher taxes are a great disincentive to create.  Or to become an entrepreneur.  Some may just choose the easier path.  Stop creating.  And start collecting that government money, too.  Further reducing supply and increasing demand.  Raising prices further.  Reducing overall economic activity.  And reducing the standard of living.

This happened in the Roman Empire as they kept raising taxes and debasing their coin to pay for their excessive government spending.  It got so bad that people quit their jobs because they couldn’t make any money.  Creating great shortages of goods.  And food.  So the Romans passed laws forbidding people from leaving their jobs.  Even tied people and their descendants to the land they farmed.  Which grew into European feudalism.  And Russian serfdom.  Economic systems little better than the slavery of the Deep South.  Which stunted innovation.  Lowered the standard of living.  And led to the fall of the Western Roman Empire.  But it was the only way the Romans could get the stuff they needed.  By forcing people to make it against their will.  Which is what they had to do when the Roman Empire turned into a welfare state.  And the creators quit creating.



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The Chicago School of Economics

Posted by PITHOCRATES - March 5th, 2012

Economics 101

Monetarists believe in Laissez-Faire Capitalism and Fiat Money

Keynesian economics supports hands-on government management of the economy.  Using fiscal and monetary policy to move the aggregate demand curve at will to end business cycles.  The boom bust cycles between inflation and recession.  Leaving only the inflationary boom times.   Using tax and spend fiscal policies.  Or simply printing money for government expenditures.  For in Keynesian economics consumption is key.  The more of it the better.  And when people stop buying things the government should step in and pick up the consumption slack.

The Austrian school is a more hands-off approach.  The markets should be free.  Laissez-faire capitalism.  And the business cycle should remain.  For it is a necessary part of the economy.  Part of the automatic pricing mechanism that adjusts supply to meet demand.  When people demand more prices go up.  Encouraging businesses to expand production to sell at these higher prices (inflationary expansion).  Then when supply exceeds demand businesses have excessive inventory that they can’t sell anymore at those higher prices.  So they cut their prices to sell off this excessive supply (deflationary recession).  Also, that hands-off approach means no playing with monetary policy.  Austrians prefer a gold standard to prevent central bank mischief that results in inflation.

The Chicago school of economics takes a little from each of these schools.  Like the Austrians they believe that government should take a hands-off approach in the economy.  Markets should be free with minimum government intervention.  But unlike Austrians, they hate gold.  And blame the gold standard for causing the Great Depression.  Instead, they believe in the flexibility of fiat money.  As do the Keynesians.  But with a strict monetary policy to minimize inflation (which is why proponents of this school were also called monetarists).  Unlike the Keynesians.  For monetarists believe only a government’s monetary policy can cause runaway inflation.

(This is a gross simplification of these three schools.  A more detailed and comprehensive study would be a bit overwhelming as well as extremely boring.  But you get the gist.  At least, for the point of this discussion.)

We used Gold and Silver for Money because it was Durable, Portable, Divisible, Fungible, Scarce, Etc.

At the heart of the difference between these schools is money.  So a refresher course on money is in order.  Money stores wealth temporarily.  When we create something of value (a good or a service) we can use that value to trade for something we want.  We used to barter with other creative people who made value of their own.  But as the economy got more complex it took more and more time to find people to trade with.  You had to find someone who had what you wanted who also wanted what you had.  If you baked bread and wanted shoes you had to find a shoemaker who wanted bread.  Not impossible.  But it took a lot of time to find these people to trade with.

Then someone had a brilliant idea.  They figured they could trade their good or service NOT for something THEY wanted but something OTHER people would want.  Such as tobacco.  Whiskey.  Or grain.  These things were valuable.  Other people would want them.  So they could easily trade their good or service for one of these things.  And then later trade it for what they wanted.  And money was born.  For various reasons (durable, portable, divisible, fungible, scarce, etc.) we chose gold and silver as our money of choice.  Due to the inconvenience and danger of carrying these precious metals around, though, we stored our precious metals in a vault and used ‘receipts’ of that deposit as currency.  And the gold standard was born.

To understand the gold standard think of a balance scale.  The kind where you put weights on one side to balance the load on the other.  When the scale balances the weight of the load equals the sum of the weights needed to make the scale balance.  Now imagine a scale like this where the VALUE of all goods and services (created by talented people) are on one side.  And all the precious metal in the gold standard are on the other.  These must be in balance.  And the sum of our currency must equal the amount of precious metal.  (Because they are ‘receipts’ for all that gold and silver we have locked up someplace.)  This prevents the government from creating inflation.  If you want to issue more money you have to put more precious metal onto the scale.  You just can’t print money.  For when you do and you don’t increase the amount of precious metal on the scale you depreciate the currency.  Because more of it equals the same amount of precious metal.  For more currency to equal the same amount of precious metal then each unit of currency has to be worth less.  And when each unit is worth less it takes more of them to buy the same things they bought before.  Thus raising prices.  If a government prints more currency without adding more precious metals on the scale they increase the value of that precious metal when MEASURED in that currency.  It becomes worth more.  In other words, you can trade that precious metal for more of that depreciated currency than before they depreciated it.  You do this too much and eventually people will prefer the precious metal over the currency.  They’ll lose faith in the currency.  And when that happens the economy collapses.  As people move back towards a barter system.

Milton Friedman wanted the Responsibility of the Gold Standard without Gold’s Constraint on increasing the Money Supply

A healthy economy needs a stable currency.  One that people don’t lose faith in.  Imagine trying to shop without money.  Instead, taking things to trade for the groceries you need.  Not very efficient.  So we need a stable currency.  And the gold standard gives us that.  However, the thing that makes gold or silver a stable currency, its scarcity, creates a liability.  Let’s go back to that balance scale.  To the side that contains the value of all goods and services.  Let’s say it increases.  But the precious metal on the other side doesn’t.  Which means the value of that precious metal increases.  The currency must equal the value of that precious metal.  So the value of the currency increases.  And prices fall.  It takes less of it to buy the same things it bought before.  Not a bad thing for consumers.  But it plays havoc with those who borrowed money before this appreciation.  Because they now have to repay money that is worth more than when what is was worth when they borrowed it.  Which hurt farmers during the 1920s.  Who borrowed a lot of money to mechanize their farms.  Which helped to greatly increase farm yields.  And increased food supplies while demand remained unchanged.  Which, of course, lowered farm prices.  The supply increased on the scale.  But the amount of gold didn’t.  Thus increasing the value of the gold.  And the currency.  Making prices fall.  Kicking off the deflationary spiral of the Great Depression.  Or so say the monetarists.

Now the monetarists wanted to get rid of the gold supply.  The Keynesians did, too.  But they wanted to do it so they could print and spend money.  Which they did during the Seventies.  Creating both a high unemployment rate and a high inflation rate.  Something that wasn’t supposed to happen in Keynesian economics.  For their solution to fix unemployment was to use inflation to stimulate aggregate demand in the economy.  Thus reducing unemployment.  But when they did this during the Seventies it didn’t work.  The Keynesians were befuddled.  But not the monetarists.  Who understood that the expansion of the money supply (printing money to spend) was responsible for that inflation.  People understood this, too.  And had rational expectations of how that Keynesian policy was going to end.  Higher prices.  So they raised prices before the stimulus could impact unemployment.  To stay ahead of the coming inflation.  So the Keynesian stimulus did nothing to reduce unemployment.  It just caused runaway inflation.  And raised consumer prices.  Which, in turn, decreased economic activity.  And further increased unemployment.

Perhaps the most well known economist in the Chicago school was Milton Friedman.  Who wanted the responsibility of the gold standard.  But without gold’s constraint on increasing the money supply to meet demand.  The key to monetarism.  To increase the money supply to match the growth in the economy.  To keep that scale balanced.  But without gold.  Instead, putting the money supply directly on the scale.  Printing fiat money as needed.  Great power.  But with great power comes great responsibility.  And if you abuse that power (as in printing money irresponsibly) the consequences of that abuse will be swift.  Thanks to the rational expectations of the people.  Another tenet of the Chicago school.



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Government Bonds, Deficits, Debt, Interest and Inflation

Posted by PITHOCRATES - January 16th, 2012

Economics 101

Unlike Corporate Borrowing, Government Borrowing does not Translate into Consumer Goods and Services

When corporations need large sums of money to finance their businesses they issue stocks and bonds.  Investors respond by buying their stocks and bonds.  By loaning the business their money they are investing into these businesses.  Giving them capital to create more things to sell.  Thus stimulating the economy.  Because this investment translates into more consumer goods and services.  That consumers will ultimately buy.

When they offer these goods and services at prices consumers will pay the business does well.  As do the consumers.  Who are able to use their money to buy stuff they want.  So consumers do well.  Corporations do well.  And the investors do well.  For a corporation doing well maintains the value of their investments.  Everyone wins.  Unlike when the government enters the bond market.  For when they do there are some winners and, unfortunately, some losers.

Governments issue bonds when they spend more money than they collect in taxes.  They borrow instead of raising taxes because they know raising taxes reduces economic activity.  Which they want to avoid.  Because less economic activity means less tax revenue.  Which would make the original problem worse.  So like a corporation they have a financing need.  Unlike a corporation, though, the money they borrow will not translate into more consumer goods and services.  They will spend it inefficiently.  Reward political friends.  But mostly they will just pay for past spending.  In mature countries deficits and debt have grown so large that some governments are even borrowing to pay the interest on their debt.

Investors like Government Bonds because Government has the Power to Tax

When the government sells bonds it raises the borrowing costs for businesses.  Because their corporate bonds have to compete with these government bonds.  Corporations, then, pay a higher interest rate on their bonds to attract investors away from the government bonds.  Interest is a cost of business.  Which they add to the sales price of their goods and services.  Meaning the consumer ultimately pays these higher interest costs.  Worse, if a corporation can’t get financing at a reasonable interest rate they may not borrow.  Which means they won’t grow their business.  Or create new jobs.

As government debt grows they sell more and more bonds.  Normally not a problem for investors.  Because investors like government bonds.  (What we call sovereign debt.  Because it is the debt of sovereign states.)  Because government has the power to tax.  So investors feel confident that they will get their interest payments.  And that they will get back their principal.  Because the government can always raise taxes to service this debt.  And raise further funds to redeem their bonds.

But there is a downside for investors.  Too much government debt makes them nervous.  Because there is something governments can do that businesses can’t.  Governments can print money.  And there is the fear that if a government’s debt is so great and they have to pay higher and higher interest rates on their sovereign debt to attract investors that they may just start printing money.  Inflate the money supply.  By printing money to pay investors.  Sounds good if you don’t understand the consequences of printing money.  But ‘inflating the money supply’ is another way of saying inflation.  Where you have more dollars chasing the same amount of goods and services.

When Corporations Fail and go Bankrupt they don’t Increase Consumer Prices or Cause Inflation

Think of it this way.  The existing value of all available goods and services equals the amount of money in circulation.  When you increase the money supply it doesn’t change the amount of goods and services in the economy.  But it still must equal the amount of money in circulation.  So the dollar must now be worth less.  Because more of them still add up to the same value of goods and services.  That is, by printing more money they depreciate the dollar.  Make it worth less.  And if the dollar is worth less it will take more of them to buy the same things.  Causing consumer prices to rise.

Worse, inflation reduces the value of bonds.  When they depreciate the dollar the money locked into these long-term investments shrink in value.  And when people get their money back they can’t buy as much with it as they could before they bought these long-term investments.  Meaning they lost purchasing power while the government had their money.  Which gives investors a negative return on their investment.  And if a person invested their retirement into these bonds they will have less purchasing power in their retirement.  Because a depreciated dollar shrinks their savings.  And increases consumer prices.  So retirees are especially hard hit by inflation.

So excessive government borrowing raises consumer prices.  By making corporations compete for investment capital.  And by causing inflation.  Whereas excessive corporate borrowing does not.  They either provide goods and services at prices consumers willingly pay.  Or they fail and go bankrupt.  Hurting no one but their private investors.  And their employees who lose their jobs.  Sad, but at least their failure does not increase consumer prices.  Or cause inflation.



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They Just Don’t Make Villains like George W. Bush Anymore

Posted by PITHOCRATES - October 6th, 2010

It’s Getting Harder to Lie These Days

The angry Left could not draw as many people to their rally in Washington as Glenn Beck did.  Why?  Byron York explains in Why Big Labor couldn’t match Glenn Beck’s rally in a Washington Examiner 10/4/2010 column.  He says Big Labor is “shrinking, aging and divided.”  No big whoop here.  I mean, the days of Big Labor are gone.  Thanks to free trade, consumers no longer have to be their bitch.  For example, once upon a time we had to buy the pieces of crap that the Big Three were selling.  Because they were the only caterer in town.  But thanks to competition from the Japanese imports, the consumers got a little more respect from the Big Three.  They no longer take us for granted.  And they’re building quality again.  Why?  Because someone else was.  That’s the beautiful thing about competition.  It makes everything better.

Included in this column is this disturbing fact:

In January, the Labor Department reported that for the first time in history, there are more union members in the public sector (7.9 million) than there are in the private sector (7.4 million). That’s despite the fact that there are five times more workers in the private sector than in federal, state, and local governments. In percentage terms, just 7.2 percent of private-sector workers belong to a union, while 37.4 percent of public-sector workers are unionized.

Think about this.  The private sector pays for its union pay and benefits with the revenue from the goods and services they sell. Competition for these goods and services provides a restraint on those union pay and benefits.  The taxpayer finances the public sector.  There is no competition for what they do.  And no restraint whatsoever on their pay and benefits.  So is it surprising that there are more union members in the public sector?

That said, the private sector still outnumbers the public sector.  For now, at least.  Yes there is a ruling elite.  And an aristocratic base (college professors, the mainstream media, unions and government workers) that supports them in exchange for their special favors. But the numbers are against them.  When times are bad, the masses will be heard.  And we heard them at Beck’s rally.  Not at the “One Nation Working Together” rally.  Where their silence was deafening.

Here’s a Thought; Try to Stand for Something

The ads for the Democrats this campaign season are interesting for what they don’t say.  They don’t trump their votes for Obamacare, financial reform, Cap and Trade, etc.  No.  The Democrats are not running on their achievements.  Just as they never campaign for higher taxes and more regulation.  Because, unless you’re a public sector union employee, you are just not for higher taxes and more regulation.  So they don’t run ads about their achievements or their policy agendas.  They just attack their opponents.  Dig up some dirt.  Or fabricate it.  Anything but run on their own record or policy agenda.

Of course, such a campaign strategy is difficult when you have the White House, the Senate and the House.  In the good old days there was George W. Bush.  Democrat enemy #1.  With him in the White House, you never had to campaign on your own record.  Or commit to a position.  Whenever asked about a position you just attacked Bush.  Life was simpler then.  Like York wrote:

Finally, the rally lacked a villain. Back in the days of George W. Bush, merely saying the president’s name could elicit angry boos over and over and over again. Every problem in every part of American life could be attributed to Bush and his gang. Now, with a Democratic president and Congress, speakers can denounce Republicans all they want, but everyone knows who is running the U.S. government. That knowledge took a little of the edge off all those denunciations.

Bush has been gone coming up on 2 years now.  And things are worse now under total Democrat rule.  The Democrats have no choice.  They’ll have to be accountable for their actions.  And this is the reason why the Left couldn’t match the Glen Beck rally.  They can no longer blame George W. Bush.  And where’s the fun in that? 

The mess we’re in is their mess.  We know it.  And they know it.  And they’re beginning to know that we know it.  Which makes the lie that much harder to sell.



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LESSONS LEARNED #19: “Philosophical debates can be effective but character assassination is more expedient, especially when no one agrees with your philosophy.” -Old Pithy

Posted by PITHOCRATES - June 24th, 2010

THOMAS JEFFERSON HATED Alexander Hamilton.  So much so he hired Philip Freneau as a translator in his State Department in George Washington’s administration.  You see, Jefferson did not like confrontation.  So he needed a way to slander Hamilton, his policies and the Washington administration without getting his own hands dirty.  And that was what Freneau was supposed to do with the money he earned while working in the State Department.  Publish a newspaper (National Gazette) and attack Hamilton, his policies and the Washington administration.  Papers then were partisan.  More so than today.  Then, lies and libel were tools of the trade.  And they knew how to dig up the dirt.  Or make it up. 

Another scandalmonger, James Callender, was slinging dirt for Jefferson.  And he hit pay dirt.  Mr. and Mrs. Reynolds of Philadelphia had a lucrative business.  They were blackmailing Alexander Hamilton.  Mr. Reynolds had his wife seduce Hamilton.  Which she did.  And did well.  They had an affair.  And Mr. Reynolds then blackmailed him.  Jefferson pounced.  Or, rather, Callender did.  To keep Jefferson’s hands clean.  Hamilton, Callender said, was using his position at the Treasury Department for personal gain.  He was using public funds to pay the blackmailer.  They found no proof of this.  And they did look for it.  Hard.  But when they came up empty, Jefferson said that it just proved what a good thief Hamilton was.  He was so good that he didn’t leave any traces of his treachery behind.

Of course, when you lie down with dogs, you get up with fleas.  And Jefferson’s association with Callender would come back and bite him in the ass.  In a big way.  Upset because Jefferson didn’t appropriately compensate him for all his loyal dirt slinging (he wanted the postmaster’s job in Richmond), he publicized the Sally Hemings rumors.  And after breaking the true story of the Hamilton affair, many would believe this scoop.  That Jefferson was having an affair with one of his slaves.  It was a dark cloud that would forever hang over Jefferson.  And his legacy.

Hamilton admitted to his affair.  Jefferson admitted to no affair.  Hamilton would never hold public office again and would later die in a duel with Jefferson’s one-time toady, Aaron Burr.  This duel resulted because Hamilton was doing whatever he could to keep the amoral and unscrupulous Burr from public office (in this case, it was the governorship of New York).  When the election of 1800 resulted in a tie between Jefferson and Burr, Hamilton urged the House to vote for Jefferson, his archenemy.   Despite what had appeared in the press, Hamilton did have morals and scruples.  Unlike some.  Speaking of which, Jefferson would go on to serve 2 terms as president.  And all of that angst about Hamiltonian policies?  They all went out the window with the Louisiana Purchase (which was unconstitutional, Big Government and Big Finance).

RONALD REAGAN WAS routinely called old, senile and out of touch by the entertainment community, the media and his political foes.  But he bested Mikhail Gorbachev and the Soviet Union, something Jimmy Carter never did.  He said ‘no’ at Reykjavik because he told the American people that he wouldn’t give up the Strategic Defense Initiative (SDI).  He knew the Soviet Union was bleeding.  Communism was a farce.  It inhibited human capital.  And impoverished her people.  SDI may have been science fiction in the 1980s, but capitalism wasn’t.  It could do it all.  Including SDI.  The Soviet Union was on the ropes and Reagan would give no quarter.  The days of living in fear of the mushroom cloud were over.  And capitalism would deliver the knockout punch.

Reaganomics, of course, made this all possible.  Supply-side economics.  Which follows the Austrian school.  Say’s Law.  ‘Supply creates demand’.  You don’t stimulate the economy by taxing one group of people so another group can spend.  You stimulate it by creating incentives for risk takers to take risks.  And when they do, they create jobs.  And wealth.

Tax and spend is a failed Keynesian, zero-sum economic policy.  When you take from the earners and give to the non-earners, we just transfer purchasing power.  We don’t create it.  For some to spend more, others must spend less.  Hence, zero-sum.  The net some of goods and services people are purchasing remains the same.  Different people are just doing the purchasing.

When Apple invented the Macintosh personal computer (PC), few were demanding a PC with a graphical user interface (GUI).  But Apple was innovative.  They created something they thought the people would want.  And they did.  They took a risk.  And the Macintosh with its mouse and GUI took off.  Apple manufacturing increased and added jobs.  Retail outlets for the Macintosh expanded and created jobs.  Software firms hired more engineers to write code.  And other firms hired more people to engineer and manufacture PC accessories.  There was a net increase in jobs and wealth.  Just as Say’s Law predicts.  Supply-side economics works.

Of course, the Left hates Reagan and attacked Reaganomics with a vengeance.  They attacked Reagan for being pro-rich.  For not caring about the poor.  And they revised history.  They say the only thing the Reagan tax cuts gave us were record deficits.  Of course, what those tax cuts gave us were record tax receipts.  The government never collected more money.  The House of Representatives (who spends the money), awash in cash, just spent that money faster than the treasury collected it.  The record shows Reaganomics worked.  Lower tax rates spurred economic activity.  More activity generated more jobs and more personal wealth.  Which resulted in more people paying more taxes.  More people paying taxes at a lower rate equaled more tax revenue in the aggregate.  It works.  And it works every time people try it. 

Because Reaganomics worked and showed the Left’s policies were failures, they had to attack Reagan.  To discredit him.  They had to destroy the man.  Except when they’re running for elected office.  Then they strive to show how much more Reagan-like they are than their conservative opponents.  Because they know Reaganomics worked.  And they know that we know Reaganomics worked.

GEORGE W. BUSH was routinely called an ‘idiot’ by the entertainment community, the media and his political foes.  Yet this ‘idiot’ seems to have outwitted the elite of the liberal Left time and time again.  I mean, if their policies were winning, they would be no reason to have attacked Bush in the first place.  The Left hated him with such vitriol that they said he blew up the Twin Towers on 9/11 as a justification for invading Iraq for her oil.  It was Big Oil’s lust for profit, after all, that was driving this Texan’s Big Oil policies.  And taking Iraq’s oil would increase Big Oil’s sales and give her even more obscene profits.

If Bush was an idiot, he must have been an idiot genius to come up with a plan like that.  Then again, gasoline prices crept to $4/gallon following the Iraq War.  Had all that oil gone on the market according to plan, that wouldn’t have happened.  Unless the plan was to keep that oil OFF of the market, thus, by rules of supply and demand, the price of oil (and the gasoline we make from it) would go up thus enriching Big Oil through higher prices resulting from a lower sales volume.  My god, what evil genius.  For an idiot.  Of course, gas taxes, numerous summer gas blends (required by the government’s environmental policies), an aging and over-taxed pipeline infrastructure and insufficient refinery capacity (the government’s environmental policies make it too punishing even to consider building a new refinery) to meet increasing demand (soaring in India and China) had nothing to do with the rise in gas prices.

IS THE POLITICAL Left evil?  Probably not.  Just amoral.  They have an agenda.  They survive on political spoils and patronage.  Old time politics.  Enrich themselves through cronyism.  If tribute is paid they’ll extend favorable treatment.  If tribute is not paid, they will release their wrath via hostile regulation, litigation, Congressional investigation and punitive taxation.  Just like they did to Big Tobacco (and, no, it wasn’t about our health.  They could have just made tobacco illegal.  But they didn’t.  Why?  It just brings in way too much money to the government.  Via sin taxes.  And federal lawsuits.  And with it being addictive, it’s a frickin cash piñata for them.)

They know few agree with their philosophy.  But they don’t care.  It’s not about national prosperity.  It’s about power.  And they want it.  That’s why they can’t debate the issues.  They know they can’t win.  So they attack the messenger.  Not the message.  If you don’t believe that, you can ask Abraham Lincoln, Ronald Reagan, George W. Bush, Sarah Palin and just about any other Republican.  Well, you can’t ask Lincoln or Reagan.  But you can guess what they would say.



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