The tariff was the funding source for most of government for about a century.
Once upon a time there was no federal income tax. No estate tax. No gift tax. No payroll tax. No capital gains tax. And no corporate tax. Taxes we take for granted today didn’t exist a century or so ago. The country was a lot leaner back then. People kept most of their money. And took care of their families.
The federal government used to fund everything thing they did with tariffs. A tax on imports. Paid in ports. As ships unloaded their goods. Far away from most people. And few people complained. Our first excise tax was a different story. A 7 cent per gallon of whiskey incited the Whiskey Rebellion. After fighting the Revolutionary War to escape the oppressive taxation policies of Great Britain the people were in no mood for a new tax. The whiskey tax lasted for about a decade. Then they repealed it.
This left tariffs as the funding source for most of government for about a century. But even that grew controversial. And began the divisions between North and South. The North protected its industry with protective tariffs on iron products, textiles (wool and cotton) and agricultural goods. Shipped from the more industrialized Britain. Which Britain responded to with tariffs of their own. On cotton and other agricultural products grown in the South. So the more the North protected their industries the more difficult it made for the South to export their raw goods.
In 1913 the progressives reintroduced the income tax and taxed the rich at 1%.
This wasn’t the only difference of opinion the North and South had. And their differences resulted in war. The North was able to win the American Civil War with its expansive industry. But the war devastated the country. Especially the South. Which lost about 8.6% of her population. To get an idea of what an 8.6% population decline is consider this. That percentage of the current U.S. population is approximately 27 million. So the losses the South suffered were similar to what the Soviets lost on the Eastern Front during World War II.
The South may have lost more of its population. But the North suffered nearly the same number of war dead. She just had a larger population to begin with. To run all of that industry that won the war. America’s first modern war was a costly one. And one that President Lincoln had to turn to a new source of revenue. The federal income tax. Which taxed the rich. At 3%. Then it taxed the super rich at 5%. But after they paid down the war debt they repealed America’s first income tax.
Then came the progressives. And their taxes. In 1913 they reintroduced an income tax. Taxing the rich at 1%. And the super rich at 6%. To fund an expanding federal government. Then came World War I. To fund the war they increased the tax rate on the rich to 15%. And the super rich at 77%. The top marginal rate fell during the Twenties. But FDR raised it back up during the Great Depression. Until it reached 94%. Where for every dollar they earned in and above the top income bracket they got to keep only 6 cents.
Few would be able to write a check on tax day to pay their full tax bill.
Then came all the other taxes. And they just kept coming. Our tax bill grew to staggering amounts. Which posed a problem for the taxing authorities. As people just didn’t keep that kind of money around. They worked. They raised their families. And what little they had left they put into the bank for their retirement. Making it very difficult for them to pay their tax bill when it came. Especially when it was 30% or more of their entire income. So what to do?
The Founding Fathers created a nation out of a tax rebellion. And then when that nation levied its first excise tax they got a little rebellion of their own. Being opposed to taxes is part of the American DNA. So the taxing authorities had to somehow hide the large amount of taxes we were paying. That is, they had to reduce the transparency of these taxes. For if you don’t know what you’re paying in taxes you really can’t get mad at paying high taxes.
Enter the withholding tax. The greatest sin government ever perpetrated against the people. For it takes our money before we ever get it. Conditioning us to accept ‘net’ pay as the norm. And making ‘gross’ pay some meaningless payroll jargon. Because you can’t spend ‘gross’ pay. You can only spend ‘net’ pay. Which is the only pay people care about. Making it not only easier to hide the soaring amount of taxes people were paying. But because it’s so easy to hide what we’re paying they could raise those taxes to confiscatory heights. Because we never have that money in our hands. We never see it. It goes from our employer to the taxing authorities. Which is the only way they could collect these soaring amounts. For few would be able to write a check on tax day to pay their full tax bill. As people just don’t keep that kind of money around.
Tags: excise tax, federal income tax, gross pay, imports, income tax, net pay, North, rebellion, rich, South, tariff, tax, tax bill, taxes, taxing authorities, whiskey, withholding, withholding tax
Week in Review
Money is a temporary storage of value. We created money to make trade easier. We once bartered. We looked for people to trade with. But trying to find someone with something you wanted (say, a bottle of wine) that wanted what you had (say olive oil) could take a lot of time. Time that could be better spent making wine or olive oil. So the longer it took to search to find someone to trade with the more it cost in lost wine and olive oil production. Which is why we call this looking for people to trade goods with ‘search costs’.
Money changed that. Winemakers could sell their wine for money. And take that money to the supermarket and buy olive oil. And the olive oil maker could do likewise. Greatly increasing the efficiency of the market. There is a very important point here. Money facilitated trade between people who created value. Creating something of value is key. Because if people were just given money without producing anything of value they couldn’t trade that money for anything. For if people didn’t create things of value to buy what good was that money?
Today, thanks to Keynesian economics, governments everywhere believe they can create economic activity with money. And use their monetary powers to try and manipulate things in the economy to favor them. And one of their favorite things to do is to devalue their money. Make it worth less. So governments that borrow a lot of money can repay that money later with devalued money. Money that is worth less. So they are in effect paying back less than they borrowed. And governments love doing that. Of course, people who loan money are none too keen with this. Because they are getting less back than they loaned out originally. And there is another reason why governments love to devalue their money. Especially if they have a large export economy.
Before anyone can buy from another country they have to exchange their money first. And the more money they get in exchange the more they can buy from the exporting country. This is the same reason why you can enjoy a five-star vacation in a tropical resort in some foreign country for about $25. I’m exaggerating here but the point is that if you vacation in a country with a very devalued currency your money will buy a lot there. But the problem with making your exports cheap by devaluing your currency is that it has a down side. For a country to buy imports they, too, first have to exchange their currency. And when they exchange it for a much stronger currency it takes a lot more of it to buy those imports. Which is why when you devalue your currency you raise prices. Because it takes more of a devalued currency to buy things that a stronger currency can buy. Something the good people in Japan are currently experiencing under Abenomics (see Japan Risks Public Souring on Abenomics as Prices Surge by Toru Fujioka and Masahiro Hidaka posted 4/14/2014 on Bloomberg).
Prime Minister Shinzo Abe’s bid to vault Japan out of 15 years of deflation risks losing public support by spurring too much inflation too quickly as companies add extra price increases to this month’s sales-tax bump.
Businesses from Suntory Beverage and Food Ltd. to beef bowl chain Yoshinoya Holdings Co. have raised costs more than the 3 percentage point levy increase. This month’s inflation rate could be 3.5 percent, the fastest since 1982, according to Yoshiki Shinke, the most accurate forecaster of Japan’s economy for two years running in data compiled by Bloomberg…
“Households are already seeing their real incomes eroding and it will get worse with faster inflation,” said Taro Saito, director of economic research at NLI Research Institute, who says he’s seen prices of Chinese food and coffee rising more than the sales levy. “Consumer spending will weaken and a rebound in the economy will lack strength, putting Abe in a difficult position…”
Abe’s attack on deflation — spearheaded by unprecedented easing by the central bank — has helped weaken the yen by 23 percent against the dollar over the past year and a half, boosting the cost of imported goods and energy for Japanese companies.
Japan is an island nation with few raw materials. They have to import a lot. Including much of their energy. Especially since shutting down their nuclear reactors. Japan has a lot of manufacturing. But that manufacturing needs raw materials. And energy. Which are more costly with a devalued yen. Increasing their costs. Which they, of course, have to pay for when they sell their products. So their higher costs increase the prices their customers pay. Leaving the people of Japan with less money to buy their other household goods that are also rising in price. Which is why economies with high rates of inflation go into recession. As the recession will correct those high prices. With, of course, deflation.
Keynesians all think they can manipulate the market place to their favor by playing with monetary policy. But they are losing sight of a fundamental concept in a free market economy. Money doesn’t have value. It only holds value temporarily. It’s the things the factories produce that have value. And whenever you make it more difficult (i.e., raise their costs by devaluing the currency) for them to create value they will create less value. And the economy as a whole will suffer.
Tags: Abenomics, barter, currency, deflation, devalue, devalue their money, devaluing, devaluing your currency, energy, export, imports, inflation, Japan, Keynesian, market, money, prices, raise prices, raw materials, recession, search, search costs, temporary storage of value, trade, value
Week in Review
The Keynesians were applauding Shinzō Abe’s economic plans for Japan. To end the never-ending deflationary spiral they’ve been in since the late Nineties. His Abenomics included all the things Keynesians love to do. And want to do in the United States. Expand the money supply through inflationary monetary policy. Devalue the yen to make their exports cheaper. Lower interest rates into negative territory. Quantitative easing. And lots of government spending. The kinds of things that just makes a Keynesian’s heart go pitter pat.
They kicked off Abenomics in 2013. And how are things about a year later? Not good (see Japan’s deficit hits record as economic growth slows posted 3/9/2014 on BBC News Business).
Japan’s current account deficit widened to a record 1.5tn yen ($15bn; £8.7bn) in January, the largest since records began in 1985.
In further bad news, the country’s economic growth figures were also revised downwards…
The sluggish growth and growing deficit come just before a planned sales tax increase, scheduled to take effect in April.
They did weaken the yen. Making it worth less than other currencies so those currencies could get more yen when they exchanged their currencies to buy those Japanese exports. Of course, when Japanese exchanged their yen for those other currencies they got less of those other currencies in return. Requiring more yen to buy those now more expensive imports. Thus increasing their trade deficit.
Japan is an island with a lot of people. They have to import a lot of their food, energy and natural resources as they have little on their island. So the weaker yen just made everything more expensive in Japan. Which, of course, lowered GDP. As those higher prices reduced the amount of buying their consumers could do.
Japan’s greatest problem is her aging population. And they have just about the oldest population in the world. As the youth have slammed the brakes on having children. So you have massive waves of people leaving the workforce the government is supporting in retirement. And fewer people entering the workforce to pay the taxes that support those retirees. Which, of course, forces higher tax rates on those remaining in the workforce. Further reducing the amount of buying their consumers can do. And no amount of Abenomics can change that.
Abenomics did not deliver what the Keynesians thought it would. Because Keynesian economics (aka demand-side economics) just doesn’t work. If it did Japan never would have had a Lost Decade to begin with. For it was Keynesian economics that gave Japan that asset price bubble in the first place. Which burst and deflated into the Lost Decade.
What Japan needs is a return to classical economic principles. Focusing more on the supply side. Lower tax rates and reduce regulation. Let the market set interest rates. Restore the policies that introduced ‘Made in Japan’ to the world. They need to make their capitalism more laissez-faire. If they do they can create the kind of economic activity that just might be able to support the generation who created the ‘Made in Japan’ label in their retirement. But you must have robust economic activity. So robust that lower tax rates can produce greater tax revenue. The supply-side economics way.
Tags: Abenomics, aging population, Consumers, currencies, deficit, exports, government spending, imports, interest rates, Japan, Japanese exports, Keynesian, Keynesian economics, lost decade, quantitative easing, retirees, Supply-side economics, taxes, trade deficit, workforce, yen
Ford brought the Price of Cars down and Paid his Workers more without Tariff Protection
Andrew Carnegie grew a steel empire in the late 19th century. With technological innovation. He made the steel industry better. Making steel better. Less costly. And more plentiful. Carnegie’s steel built America’s skylines. Allowing our buildings to reach the sky. And Carnegie brought the price of steel down without tariff protection.
John D. Rockefeller saved the whales. By making kerosene cheap and plentiful. Replacing whale oil pretty much forever. Then found a use for another refined petroleum product. Something they once threw away. Gasoline. Which turned out to be a great automotive fuel. It’s so great that we use it still today. Rockefeller made gasoline so cheap and plentiful that he put the competition out of business. He was making gasoline so cheap that his competition went to the government to break up Standard Oil. So his competition didn’t have to sell at his low prices. And Rockefeller made gasoline so inexpensive and so plentiful without tariff protection.
Henry Ford built cars on the first moving assembly line. Greatly bringing the cost of the car down. Auto factories have fixed costs that they recover in the price of the car. The more cars a factory can make in a day allows them to distribute those fixed costs over more cars. Bringing the cost of the car down. Allowing Henry Ford to do the unprecedented and pay his workers $5 a day. Allowing his workers to buy the cars they assembled. And Ford brought the price of cars down and paid his workers more without tariff protection.
George Westinghouse decreased the Cost of Electric Power without Tariff Protection
George Westinghouse gave us AC power. Thanks to his brilliant engineer. Nikola Tesla. Who battled his former employer, Thomas Edison, in the Current Wars. Edison wanted to wire the country with his DC power. Putting his DC generators throughout American cities. While Westinghouse and Tesla wanted to build fewer plants and send their AC power over greater distances. Greatly decreasing the cost of electric power. Westinghouse won the Current Wars. And Westinghouse did that without tariff protection.
After losing out on a military contract for a large military transport jet Boeing regrouped and took their failed design and converted it into a jet airliner. The Boeing 747. Which dominated long-haul routes. Having the range to go almost anywhere without refueling. And being able to pack so many people into a single airplane that the cost per person to fly was affordable to almost anyone that wanted to fly. And Boeing did this without tariff protection.
Bill Gates became a billionaire thanks to his software. Beginning with DOS. Then Windows. He dominated the PC operating system market. And saw the potential of the Internet. Bundling his browser program, Internet Explorer, with his operating system. Giving it away for free. Consumers loved it. But his competition didn’t. As they saw a fall in sales for their Internet browser programs. With some of their past customers preferring to use the free Internet Explorer instead of buying another program. Making IE the most popular Internet browser on the market. And Gates did this without tariff protection.
Tariff Protection cost American Industries Years of Innovation and Cost Cutting Efficiencies
Carnegie Steel became U.S. Steel. Which grew to be the nation’s largest steel company. Carnegie had opposed unions to keep the cost of his steel down. U.S. Steel had a contentious relationship with labor. During the Great Depression U.S. Steel unionized. But there was little love between labor and management. There were a lot of strikes. And a lot of costly union contracts. Which raised the price of U.S. manufactured steel. Opening the door for less costly foreign imports. Which poured into the country. Taking a lot of business away from domestic steel makers. Making it more difficult to honor those costly union contracts. Which led the U.S. steel producers to ask the government for tariff protection. To raise the price of the imported steel so steel consumers would not have a less costly alternative.
During World War II FDR was printing so much money to pay for both the New Deal and the war the FDR administration was worried about inflation. So they put ceilings on what employers could pay their employees. With jobs paying the same it was difficult to attract the best employees. Because you couldn’t offer more pay. So General Motors started offering benefits. Health care. And pensions. Agreeing to very generous union contracts. Raising the price of cars. Which wasn’t a problem until the imports hit our shores. Then those union contracts became difficult to honor. Which led the U.S. auto makers to ask the government for tariff protection. To raise the price of those imported cars so Americans would not have a less costly alternative.
These two industries received their tariffs. And other government protections. Allowing them to continue with business as usual. Even though business as usual no longer worked. So while the foreign steel producers and auto makers advanced their industries to further increase quality and lower their costs the protected U.S. companies did not. Because they didn’t have to. For thanks to the government they didn’t have to please their customers. As the government simply forced people to be their customers. For awhile, at least. The foreign products became better and better such that the tariff protection couldn’t make the higher quality imports costly enough to keep them less attractive than the inferior American goods. With a lot of people even paying more for the better quality imports. Losing years of innovation and cost cutting efficiencies due to their tariff protection these American industries that once dominated the world became shells of their former selves. With General Motors and Chrysler having to ask the government for a bailout because of the health care and pension costs bankrupting them. Something Carnegie, Rockefeller, Ford, Westinghouse, Boeing or Gates never had to ask.
Tags: AC power, Boeing, business as usual, car, Carnegie, Current Wars, efficiencies, electric power, FDR, Ford, gasoline, Gates, General Motors, imports, innovation, Internet browser, Internet Explorer, jet, Rockefeller, steel, tariff, tariff protection, Tesla, U.S. Steel, union contracts, unions, Westinghouse
Week in Review
Today the political left attacks capitalism as being unfair. And mean. Whereas they laud government intervention into the free market. To level the playing field. And to redistribute income. To help those who can’t be as successful as others. They support unions. And oppose free trade. Because free trade lowers prices for consumers. By breaking up monopolies. And giving them choice. Free trade is an essential element of capitalism. But the fight to make people’s lives better with free trade wasn’t easy. As people who got rich with government-protected high prices opposed free trade (see Why did The Economist favour free trade? by C.R. posted 9/6/2013 on The Economist).
IN NINETEENTH century Europe and America, debates over whether tariffs or free trade produced the most economic growth dominated the political scene. Up until the early 1840s, protection appeared to be winning the argument. In Britain, high tariffs were imposed on agricultural imports in 1819, by legislation known as the Corn Laws. The ideas of Friedrich List, a German economist who argued that tariffs boosted industrial development through the protection of infant industries, were gaining ground, particularly in the United States. One Pennsylvanian legislator even joked in 1833 that the dictionary definition of man should be changed to “an animal that makes tariff speeches” so frequently were they heard.
Against this atmosphere, James Wilson founded The Economist in 1843 to campaign for free trade. His first target was to repeal the Corns Laws in Britain. He argued:
They are, in fact, laws passed by the seller to compel the buyer to give him more for his article than it is worth. They are laws enacted by the noble shopkeepers who rule us, to compel the nation to deal at their shop alone.”
The UAW got very generous contracts with the Big Three during the Fifties and the Sixties. Raising the price of cars. Which wasn’t a problem when they were the only ones making cars. But then came the imports. Which told the people how much more they were paying than these articles were worth. And started buying the imports. As they did those generous pay and benefit packages became more difficult to pay. So the Big Three lobbied for tariffs on those less costly imports. And got them. Raising the price of the imports. Forcing Americans to deal with the Big Three alone. And buy their more costly cars.
More people bought cars than made them, though. And the people who made the cars were better paid than most Americans. So these tariffs forced poorer people to spend more on a car leaving them less for their families. So richer people could have more. This is what tariffs do. They allow fewer people to have more. While more people have to do with less. So fewer buy more. While more buy less. Because there are more people who buy cars than make them these tariffs, then, reduce economic activity. And because the Big Three didn’t have to figure out how to give more for less to their customers they didn’t. Giving their customers ‘rust buckets’ in the Seventies. Something else that tariffs do. Lead to inferior goods. Because if the government forces people to buy from you then the quality of what you sell doesn’t matter.
Wilson believed that protectionism caused “war among the material interests of the world”, in other words, war between nations and classes. A high tariff regime was no longer economically “productive”; Britain was stuck in an economic depression in the early 1840s. In contrast, free trade produced “abundance and employment”. It was appropriate for Britain’s economy where “a large proportion of the population and property depended on commerce and industry alone”. On the other hand, List’s ideas about protection were dismissed as unnecessary “swaddling clothes” for a mature economy, such as Britain’s.
The Economist’s early views on free trade were strongly influenced by the classical economists Adam Smith and David Ricardo, as Ruth Dudley Edwards, a historian, has pointed out. Wilson, like Smith, realised that trade was a two way exchange. Countries needed to “increase imports to increase exports” to boost economic growth. Consumers, Smith argued in the Wealth of Nations, should buy products from where they were cheapest. All protection did was create monopolies, which were “a great enemy to good management”. Ricardo took Smith’s ideas further, arguing that all countries benefit from free trade by producing what they were best at relative to other countries.
That’s what the Big Three wanted. A monopoly on cars sold in America. And there is only one way to get one. The government has to create them. Hence the Big Three’s request for tariff protection.
David Ricardo’s comparative advantage said nations should make what they can make best and trade for those things they can’t. For example, if two countries can both make one thing but one can do so at lower costs they can make more of them for the same costs. Giving them a larger surplus to trade for other things. While the other nation will consume more resources to build the same quantity leaving less to make the other things they need. While having fewer things available for export. So if you try to make things you can’t make efficiently you end up consuming more resources to have less. Whereas the nation that makes only what it can make best ends up consuming fewer resources that are then available to make other things. And they have more things to trade. Leading to a higher standard of living. And if their trading partners do likewise they, too, experience a higher standard of living.
Free trade leads to greater economic activity. Which made Britain wealthy. Allowing them to extend their empire for another 70 years or so. Despite the warnings of the rich landowners who said repealing the Corn Laws would cause harm. Instead, repealing the Corn Laws led to greater economic activity. And less costly food. Allowing people to feed their families more easily. The only harm suffered was to the profits of the big landowners. Who lost their monopoly. And could no longer charge more than their food was worth.
Tags: Adam Smith, Big Three, Britain, capitalism, Corns Laws, David Ricardo, exports, free trade, imports, monopoly, protectionism, standard of living, surplus, tariffs, The Economist, trade
The Gold Exchange Standard provided Stability for International Trade
Congress created the Federal Reserve System (the Fed) with the passage of the Federal Reserve Act in 1913. They created the Fed because of some recent bad depressions and financial panics. Which they were going to make a thing of the past with the Fed. It had three basic responsibilities. Maximize employment. Stabilize prices. And optimize interest rates. With the government managing these things depressions and financial panics weren’t going to happen on the Fed’s watch.
The worst depression and financial panic of all time happened on the Fed’s watch. The Great Depression. From 1930. Until World War II. A lost decade. A period that saw the worst banking crises. And the greatest monetary contraction in U.S. history. And this after passing the Federal Reserve Act to prevent any such things from happening. So why did this happen? Why did a normal recession turn into the Great Depression? Because of government intervention into the economy. Such as the Smoot-Hawley Tariff Act that triggered the great selloff and stock market crash. And some really poor monetary policy. As well as bad fiscal policy.
At the time the U.S. was on a gold exchange standard. Paper currency backed by gold. And exchangeable for gold. The amount of currency in circulation depended upon the amount of gold on deposit. The Federal Reserve Act required a gold reserve for notes in circulation similar to fractional reserve banking. Only instead of keeping paper bills in your vault you had to keep gold. Which provided stability for international trade. But left the domestic money supply, and interest rates, at the whim of the economy. For the only way to lower interest rates to encourage borrowing was to increase the amount of gold on deposit. For with more gold on hand you can increase the money supply. Which lowered interest rates. That encouraged people to borrow money to expand their businesses and buy things. Thus creating economic activity. At least in theory.
The Fed contracted the Money Supply even while there was a Positive Gold Flow into the Country
The gold standard worked well for a century or so. Especially in the era of free trade. Because it moved trade deficits and trade surpluses towards zero. Giving no nation a long-term advantage in trade. Consider two trading partners. One has increasing exports. The other increasing imports. Why? Because the exporter has lower prices than the importer. As goods flow to the importer gold flows to the exporter to pay for those exports. The expansion of the local money supply inflates the local currency and raises prices in the exporter country. Back in the importer country the money supply contracts and lowers prices. So people start buying more from the once importing nation. Thus reversing the flow of goods and gold. These flows reverse over and over keeping the trade deficit (or surplus) trending towards zero. Automatically. With no outside intervention required.
Banknotes in circulation, though, required outside intervention. Because gold isn’t in circulation. So central bankers have to follow some rules to make this function as a gold standard. As gold flows into their country (from having a trade surplus) they have to expand their money supply by putting more bills into circulation. To do what gold did automatically. Increase prices. By maintaining the reserve requirement (by increasing the money supply by the amount the gold deposits increased) they also maintain the fixed exchange rate. An inflow of gold inflates your currency and an outflow of gold deflates your currency. When central banks maintain this mechanism with their monetary policy currencies remain relatively constant in value. Giving no price advantage to any one nation. Thus keeping trade fair.
After the stock market crash in 1929 and the failure of the Bank of the United States in New York failed in 1930 the great monetary contraction began. As more banks failed the money they created via fractional reserve banking disappeared. And the money supply shrank. And what did the Fed do? Increased interest rates. Making it harder than ever to borrow money. And harder than ever for banks to stay in business as businesses couldn’t refinance their loans and defaulted. The Fed did this because it was their professional opinion that sufficient credit was available and that adding liquidity then would only make it harder to do when the markets really needed additional credit. So they contracted the money supply. Even while there was a positive gold flow into the country.
The Gold Standard works Great when all of your Trading Partners use it and they Follow the Rules
Those in the New York Federal Reserve Bank wanted to increase the money supply. The Federal Reserve Board in Washington disagreed. Saying again that sufficient credit was available in the market. Meanwhile people lost faith in the banking system. Rushed to get their money out of their bank before it, too, failed. Causing bank runs. And more bank failures. With these banks went the money they created via fractional reserve banking. Further deflating the money supply. And lowering prices. Which was the wrong thing to happen with a rising gold supply.
Well, that didn’t last. France went on the gold standard with a devalued franc. So they, too, began to accumulate gold. For they wanted to become a great banking center like London and New York. But these gold flows weren’t operating per the rules of a gold exchange. Gold was flowing generally in one direction. To those countries hoarding gold. And countries that were accumulating gold weren’t inflating their money supplies to reverse these flows. So nations began to abandon the gold exchange standard. Britain first. Then every other nation but the U.S.
Now the gold standard works great. But only when all of your trading partners are using it. And they follow the rules. Even during the great contraction of the money supply the Fed raised interest rates to support the gold exchange. Which by then was a lost cause. But they tried to make the dollar strong and appealing to hold. So people would hold dollars instead of their gold. This just further damaged the U.S. economy, though. And further weakened the banking system. While only accelerating the outflow of gold. As nations feared the U.S. would devalue their currency they rushed to exchange their dollars for gold. And did so until FDR abandoned the gold exchange standard, too, in 1933. But it didn’t end the Great Depression. Which had about another decade to go.
Tags: bank failures, banking crises, banking system, banknotes, central bankers, credit, depressions, exchange rate, exports, Fed, Federal Reserve Act, Federal Reserve System, financial panics, fractional reserve banking, gold, gold exchange standard, gold standard, Great Depression, great monetary contraction, imports, interest rates, international trade, monetary contraction, money supply, New York, prices, reserve requirement, the Fed, trade deficit, trade surplus
The Roaring Twenties gave us Automobiles, Electric Power, Radio, Movies, Telephones and Air travel
In 1921 there were 9 million automobile registrations. That jumped to 23 million by 1929. An increase of 156%. That’s a lot more cars on the roads. In the Roaring Twenties we made cars out of steel, paint and glass. Inside we fitted them with lumber, cotton and leather. We put rubber tires on them. And filled their fuel tanks with gasoline. So this surge in car ownership created a surge in all of these industries. Extraction of raw materials. Factories and manufacturing plants to build the equipment to extract those raw materials. As well as the machinery to build these automobile components. And the moving assembly lines in assembly plants to assemble these automobiles. The plants, warehouses and automobile dealers created a surge in the construction industry. And all the industries that fed the construction industry. Including the housing industry to house all these gainfully employed workers.
And this was just the auto industry. Which wasn’t the only industry that was booming during the Roaring Twenties. Thanks to the hands-off government policies of the administrations of Warren G. Harding and Calvin Coolidge businesses introduced us to the modern world. Electric power came into its own. By 1929 about 80% of all installed horsepower was electrical. And it entered our homes. Electric lighting and electric appliances. Vacuum cleaners. Washing machines. Refrigerators. All of this required even more raw material extraction from the ground. More manufacturing equipment and plants. More wholesale and retail construction. And more housing to house all of these workers earning a healthy paycheck.
And there was more. The Roaring Twenties gave us broadcast radio in our electric-powered homes. Free entertainment, sports broadcasts and news. Paid for by the new industry of advertising. Competing with radio was another growing industry. Motion pictures. That by the end of the Roaring Twenties were talkies. And speaking of talking there was a lot of that on the new telephone. In our homes. Interconnecting all of these industries was ship, rail and truck transportation. Even air travel took off during the Twenties. More raw material extraction. More equipment. More manufacturing. More construction. And jobs. More and more jobs. The hands-off government policies of the Harding and Coolidge administrations created the great Bull Market of the Twenties. Explosive economic activity. Real economic growth. Creating low-cost consumer goods to modernize America. Increase her productivity. Making her the dominant economic power in the world. The Europeans were so worried about America’s economic prowess that they met in 1927 at the International Economic Conference in Geneva to discuss the American problem. And how they were going to compete with the American economic juggernaut. Because the free market capitalism of the New World was leaving the Old World in the dust.
Herbert Hoover was a Republican in Name Only that FDR once Admired but Calvin Coolidge Despised
This was real economic growth. It was not speculation. This wasn’t artificially low interest rates creating an asset bubble. Working Americans bought homes and cars. And furnishings. Businesses produced these to meet that demand. They had growing sales. And growing profits. Which increased their stock prices. Investors wanted to own their stocks because these companies were making money. And with the world modernizing these stock prices weren’t going anywhere but up in the foreseeable future. Unless something changed the business environment. Well, something did.
Despite the roaring economy Calvin Coolidge did not run for a second term. Which was a pity. For his successor, Herbert Hoover, was a Republican in name only. He was a big time progressive. Who wanted to use the power of government to make the world perfect. A devout believer in the benevolence of Big Government. He added about 2,000 bureaucrats to the Department of Commerce. FDR at one time admired him (before he ran against him for president). Coolidge despised him. Under Hoover the federal government intruded into the private sector. His economics were Keynesian. He, too, worshipped at the altar of demand. He believed high wages were the key to prosperity. For people with more money buy more. And all that buying created demand for businesses to meet. Even during a recession he believed wages should not fall. Despite the fact that’s what recessions do on the back side of the business cycle. Lower prices and wages. And lay off people.
By the Twenties American farmers were mechanizing their farms. Allowing them to grow more food than ever before. Agriculture prices fell. At first this wasn’t a problem as there were export markets for their bumper crops. Thanks to a war-devastated Europe. But eventually the European soldiers returned to the farm. And the Europeans didn’t need the American food anymore. Even places tariffs on U.S. imports to their countries to help their farmers get back on their feet. Add in a bad winter that killed livestock. Some bad insect infestation in the summer. Add all this together and you had the beginning of the great farm crisis. Debt defaults. Bank failures. And the contraction of the money supply. Which the Federal Reserve (the Fed) did not step in to compensate for by expanding the money supply. Which was sort of their purpose for being in existence. As there was less money to borrow business could longer borrow to continue their growth. Because of the time factor in the stages of production to expand production required borrowing money. To make matters worse the Fed was actually pulling more money out of circulation. Because they looked at the rising stock prices and concluded that speculators were borrowing money to invest in the stock market. Thus inflating stock prices. But it wasn’t speculators running up those prices. It was an economic boom that was running up those stock prices. Until the government put a stop to that, at least.
Bad Government Policy didn’t Create the Roaring Twenties but Bad Government Policy ended Them
The Smoot-Hawley Tariff was close to becoming law in the fall of 1929. It was moving through committees on its way to becoming law. This tariff would raise the tax on all imports by about 30%. The idea was to protect domestic supplies and manufacturers. But even in 1929 it was a global economy. A lot of imports entered the stages of production. Which meant costs would be increasing throughout the stages of productions. Greatly increasing the input costs of all those businesses enjoying those high stock prices. Which would raise their prices (to cover those higher input costs). Reducing their sales. And slashing their profits. Add this to the contracting money supply and it painted a very bleak picture for business.
With demand sure to fall due to a massive new tariff that was about to become law businesses cut back. To get rid of what was about to become excess capacity. For they were smart. And understood what affected their businesses. And you know who else were smart? Investors. Who looked at this tariff and saw a locomotive engineer about to slam on the brakes. And if Congress passed this into law after 1928 Coolidge wasn’t going to be there to veto the law. So they all came to the same conclusions. The bull market was coming to an end. And they wanted to sell their stock to lock in their stock gains. Which caused the great sell-off of 1929. And the stock market crash. Starting the Great Depression.
People still debate the cause of the Great Depression. A popular argument is that greedy investors caused it by speculating in the stock market. Or that greedy businesses out-produced demand. But the economics of the Roaring Twenties don’t support this. This wasn’t people buying big houses because interest rates were low. This was the electrification of America. Cars. Telephones. Radio. Movies. Air travel. This was broad and real economic growth. Bad government policy didn’t create it. But bad government policy ended them. And it was the expectations of even worse government policies that yanked the rug out from underneath the economy. By causing a business contraction and stock market sell-off. Much like Obamacare is doing to businesses today. Scaring the bejesus out of them. For they have no idea what their future costs will be under Obamacare. So they are doing their best to prepare for it. By not expanding their businesses. By not hiring anyone. And sitting on their cash. To prepare for the worst. Much like businesses did in 1928. Which explains why the Great Recession lingers on.
Tags: 1929, air travel, automobile, Bull Market, bumper crops, Business, businesses, Calvin Coolidge, cars, construction, Coolidge, economic boom, electric power, extraction of raw materials, factories, farm, farmers, FDR, Federal Reserve, Great Depression, hands-off government policies, Harding, Herbert Hoover, imports, Keynesian, machinery, manufacturing plants, money supply, Obamacare, profits, radio, real economic growth, recession, Roaring Twenties, sales, Smoot-Hawley Tariff, speculators, stages of production, stock market, stock market crash, stock market sell-off, stock prices, tariffs, telephone
The New Economic Reality of Farming was that we needed Fewer Farmers in the Age of Mechanization
The Roaring Twenties was a decade of solid, real economic growth. The world modernized during the Twenties. Electric power, telephone, radio, motion pictures, air travel, etc. So much of what we take for granted today became a reality during the Roaring Twenties. But there was a downside. Farmers borrowed money to mechanize their farms. As farms mechanized they produced great crop yields. Bringing bumper crops to market. There was so much food brought to market that prices plummeted. Reducing farm incomes so much that they couldn’t service the debt they incurred to mechanize their farms. They defaulted. Causing banks to fail.
By the late Twenties all the European farmers who fought in World War I were back on the farm. And were feeding Europe again. So not only were the Americans producing bumper crops they were losing a large export market. Forcing farm prices down further. There were simply more farmers than the economy was demanding thanks to the new efficiencies in farming. But because there were so many farmers they were an important political constituency. They were still casting a lot of votes. So the politicians stepped in. With a complete disregard to economic principles. And tried to help the farmers. With rent-seeking policies.
The farmers were hurting. So they wanted to transfer some wealth from the masses to the farmers. As in rent-seeking. As opposed to profit-seeking. Instead of creating wealth (profit-seeking) they were transferring wealth (rent-seeking). And they did this with price supports. They raised the price of their crops above market value. Forcing Americans to make sacrifices in their lives so they could afford to pay higher food prices to help the farmers. So the farmers wouldn’t have to adjust to the new economic reality of farming. We need fewer farmers in the age of mechanization. But it just didn’t end with higher prices. The government would buy excess food grown by these ‘too many farmers’ and destroy it. Or pay farmers NOT to grow food. Then they took it up a notch. And slapped tariffs on imported food. Further raising the price of food.
In an Effort to raise Farming Prices the Rent-Seekers caused the Great Deflation of the Great Depression
Food tariffs were just one part of the Smoot-Hawley Tariff Act. This act pretty much raised the tariff on everything the U.S. imported. Greatly increasing the cost of all imports. To protect the domestic producers from cheap foreign competition. But there was a problem with increasing the cost of all imports. It increased the price of whatever we built with those imports. So much so that when they were discussing this act in Congress businesses across America knew the boom of the Twenties would end. As did investors investing in these companies. So even before the bill became law it caused a huge stock selloff. Which led to the stock market crash of 1929.
At first the higher prices helped American businesses. Their revenue increased. Everyone thought the tariff act was a success. But as prices went up costs went up throughout the manufacturing pipeline. Prices grew so high that people stopped buying. Inventories accumulated so they cut production. And then laid people off en masse. Causing a great recession. Then further rent-seeking solutions (more governmental intervention into the free market) turned that recession into the Great Depression. What started out as a problem for overly efficient farmers turned into a national crisis. In an effort to raise farming prices they caused the great deflation of the Great Depression. As prices fell so did revenues. Making it very difficult to service debt. More people defaulted on their debt. And more banks failed.
When the Smoot-Hawley Tariff Act became law our trading partners answered in kind. Leading to a great trade war. So on top of everything else what limited export markets we had shut down as well. As the trade barriers went up economic activity decreased. David Ricardo’s Comparative Advantage worked in reverse. Increasing opportunity costs. When international markets closed less efficient domestic industries took their place. Pulling resources from more efficient uses. Raising the cost of those resources. Adding these cost increases on top of the tariffs. Which further increased prices. And further lowered economic activity. Adding further woe onto the Great Depression.
The Medallion System dates back to the Medieval Guilds and Restricts Entry into the Cabbie Market
As the Great Depression languished on few people filled the streets of New York City (NYC). At least few people with money who had to go places. There were more cabs than people needed. Supply exceeded demand. Putting a downward pressure on taxi fares. And increasing the time a cabbie had to work to earn some decent money. Usually the market steps in and corrects such a situation. Forcing some cabbies out of the cabbie business. But not in NYC. There they used the power of government to address this surplus of supply. And introduced the medallion system.
This was the kind of rent seeking that dated back to those medieval guilds. The medallion restricted entry into the cabbie market. By limiting the number of cabs in NYC. Every cab (at least those who can pick up passengers who hail a cab at the curb) must have a medallion permanently affixed to their cab. Which they must purchase from the city. Or transfer from another cab. Currently, if you want to drive a taxi cab in NYC you better have some deep pockets. Or have the kind of credit that lets you get a very large mortgage. For the medallion system exists to this day. And that medallion may cost you close to a half million dollars.
If you ever wondered why it sometimes takes so long to hail a cab in NYC this is the reason. Rent-seeking. As in the medallion system. Which works just like tariffs. Reducing supply. And increasing prices for consumers. So the rent-seekers can use the power of government to transfer wealth. Instead of using innovation to create wealth. And bringing that wealth to the market place to trade. Instead they choose to take more wealth from the market place than they bring to it. With the help of government. And their rent-seeking policies. Thus reducing overall wealth in the economy. Which reduces economic activity. And does nothing to help lift an economy out of recession. Or out of a Great Depression.
Tags: banks, bumper crops, cabbie, cabs, create wealth, crop yields, debt, deflation, economic activity, economic growth, farmers, farms, great deflation, great deflation of the Great Depression, Great Depression, higher prices, imports, incomes, mechanization, medallion, medallion system, NYC, prices, recession, rent-seeking, Roaring Twenties, Smoot-Hawley Tariff, tariffs, Taxi, transfer wealth, transferring wealth, Twenties, wealth
Mercantilism gave Britain the Royal Navy which Ushered in the Pax Britannica
Great Britain had a rough go of it at the end of the 18th century. They lost their American colonies in the American Revolutionary War. A war that started over the issue of taxation to pay for the previous Seven Years’ War. So instead of securing new revenue to pay down old debt they incurred new debt. The French Revolution closed out the century. Causing concern for some in Britain that their monarchy may be the next to fall. It didn’t. For the constitutional monarchy and representative government in Britain was a long cry from the absolute monarchy that they had in France. So revolution did not come to Britain. But war did. As the French expanded their revolution into a European war. Pulling the British back into war with their old enemy.
With a large conscripted French Army and the concept of total war France made total war. Napoleon Bonaparte won a lot of battles. Conquered much of Europe. Even marched back and conquered Paris. Proclaimed himself emperor of France. And continued waging war. Including an ill-conceived invasion of Russia. Which marked the beginning of the end for Napoleon. And the French Empire. Weakened from war France saw her old nemesis, Great Britain, rise as the first superpower since the Roman Empire. And like the Romans’ Pax Romana Britain entered a century of peace. Pax Britannica.
The reason the British could do this was because of their mercantile past. They set up colonies and international trade networks. And they used the proceeds from that lucrative trade to finance the greatest naval power then in the world. The Royal Navy. And the Royal Navy would help keep the peace in the Pax Britannica. She became the world’s policeman. Making the world safe for trade. Especially on the high seas. But then something interesting happened. She broke from her mercantile past. Because they saw the shortcomings of mercantilism. One of which produced wealthy landowners at the expense of a hungry population.
When the British repealed the Corn Laws in 1846 Food Prices fell and the Standard of Living Rose
The British Corn Laws were a series of laws protecting those who grew cereal crops. The stuff we grow that has edible grains. Corn, rice, wheat, barley, etc. What we call staple crops as they form the basic sustenance of humans everywhere. We grow these in greater abundance than all other foods. And when you look at the grain size you come to one realization. It takes a lot of land to grow these crops. And who owns large tracts of land? The landowning aristocracy. A small group of people with a lot of wealth. And a lot of political influence. Hence the Corn Laws.
The Corn Laws were legislation with one goal. To prevent the British people from buying less expensive food. By either forbidding any importation of cheaper grains until the domestic price had reached a certain price level. Or adding tariffs to the less expensive imports so the landowners could still sell their grains at higher prices. Thus preserving their wealth. And they made specious arguments about how lower-priced food was actually bad for the people. For it was just a way for manufacturers to maximize their profits. For if food was cheaper they could pay their workers less. Being the greedy bastards that they were. So the only fair thing to do was to keep food prices high. To keep the living wage high. To force manufacturers to pay their workers more. You see, the only way to help the poor and middle class was to let the wealthy landowners become even wealthier. By keeping the price of the food they sold high.
Opposition grew to the Corn Laws. People studied the works of their fellow countrymen. Adam Smith and David Hume (both Scottish). And the Englishman David Ricardo. All great economists and thinkers. Who were all proponents of free trade. Ricardo’s Comparative Advantage basically proved the case of free trade over the protectionism of mercantilism. Eventually the political power of the landowners could not overcome the economic arguments. Or a famine in Ireland. And, in 1846, they repealed the Corn Laws and adopted free trade. Food prices fell. Leaving people with more disposable income. To purchase the goods the Industrial Revolution was making. Increasing their standard of living. While small famers had to leave their farms being unable to farm efficiently enough to pay their bills at the prevailing prices.
The Success of NAFTA proves David Ricardo’s Comparative Advantage
Mercantilists and other opponents to free trade like to point at the human costs. Small farmers losing their farm. Just so they can preserve some semblance of privilege to protect the high prices in their industry. But it was becoming more and more difficult to make the argument that the masses were better off paying higher prices. Because they’re not. Lower consumer prices increase the standard of living for everyone. Higher living standards create healthier living conditions. And reduces child mortality. For the greatest killer of children in the world is poverty.
The British were both a military and an economic superpower during the 19th century. But someone was chasing her. The Untied States. Who was feeling her economic oats. Her economy would catch up and surpass the British. Making it the mightiest economic power of all time. How did this happen? Two words. Free trade. The United States was the largest free trade zone in the world. The economic advantages of all those states trading with each other freely across their state borders made Europe stand up and take notice. And in response created treaties that ultimately led to the European Union and the Eurozone. To replicate the large free trade zone of the United States.
Back across the Atlantic the Americans, Canadians and the Mexicans took it up a notch. And created the North American Free Trade Agreement. NAFTA. Extending the free trade that existed in each of their countries across their international borders. The mercantilist fought against this. Because protectionism, restrictions and tariffs helped the privileged few protect the high prices in their industry. In America they talked about a great sucking sound as all American jobs went to low-wage Mexico. Some manufacturers did move to Mexico. Primarily because like the small farmers in Britain after the repeal of the Corn Laws they could no longer sell at prices to meet all of their costs. But it was not as the mercantilists predicted. Yes, imports increased. In 2010 they were up 235% from pre-NAFTA 1993. But exports were up, too. Some 190% for the same period. Proving Ricardo’s Comparative Advantage. By focusing on what we do best and trading for everything else all countries do better.
Tags: Britain, British, comparative advantage, consumer prices, Corn Laws, crops, David Ricardo, economic, Europe, European Union, expensive food, exports, farmers, food, food prices, France, free trade, free trade zone, French, French Revolution, grain, Great Britain, imports, international trade, landowners, manufacturers, mercantile, mercantilism, Mexico, NAFTA, Napoleon, Pax Britannica, political power, prices, privilege, protectionism, Ricardo, Royal Navy, standard of living, superpower, tariffs, trade, Untied States, wealth, wealthy landowners
As long as Imports equal Exports the Balance in the Trade Account is Zero and there is no Trade Deficit or Surplus
Imagine two wine shops in an affluent suburb. Let’s call one Fine Wines. And the other The Wine Shoppe. They both feature a wide selection of wines from around the world. And each specializes in wines from a specific region. So they sell much of the same wines. But some of the most exclusive and most expensive wines can only be found at one store or the other. Now wine retailers typically have a loyal clientele. There is a relationship between proprietor and customer. To enhance the wine drinking experience. So proprietors will cater to their customers to keep them as customers. And provide whatever wine they wish. Even if they don’t stock it. Or don’t have a normal purchasing channel to the wine they wish to buy.
Both stores have similar relationships with their clientele. And they share something else in common. The wines one seller doesn’t sell the other seller sells. Which produces a special relationship between these two stores. They buy and sell wines from each other as needed to meet the needs of their customers. So customers at either store can purchase any wine they sell in both stores. Allowing each store to maintain their special proprietor-customer relationship. Without losing customers to the other store.
Most of the time the value of the wine they buy and sell from each other in these inter-store sales net out. Sometimes one store owes the other. And vice versa. But it usually isn’t much. And the stores take turns owing each other. The overall cost for this inter-store trade is negligible. And pleases customers at both stores. So maintaining this trade is a win-win. With no negative impact on either store’s business. As long as ‘imports’ equal ‘exports’. And the balance in this ‘trade account’ is kept close to zero. So they continue to ‘trade’ bottles of wine. Without exchanging any money. Most of the time, that is. Until a trade deficit develops.
If the Currency is Backed by Gold the only way to create new Dollars is to put more Gold into the Vault
Let’s say for whatever reason Fine Wines runs a trade deficit. Fine Wines sells more of The Wine Shoppe wines than The Wine Shoppe sells of theirs. Which means Fine Wines imports more from The Wine Shoppe than they export to The Wine Shoppe. Creating the trade deficit. They’re not trading bottles for bottles anymore. Fine Wines delivers one case of wine to The Wine Shoppe and returns with 3 cases. And now has an outstanding balance owed to The Wine Shoppe. Which they must settle by sending money to The Wine Shoppe. If sales continue like this Fine Wines will become a net importer and run chronic trade deficits. While The Wine Shoppe will become a net exporter. And have a running trade surplus.
If the clientele of Fine Wines keeps buying the imported wine from The Wine Shoppe instead of the ‘domestic’ Fine Wines, Fine Wines will have cash problems. Because they owe their distributors for the wine they bought and stocked. But when they sell The Wine Shoppe’s wine it doesn’t bring any cash into their store. Because Fine Wines has to give that money to The Wine Shoppe. For it was, after all, The Wine Shoppe’s wine that Fine Wines sold. That they sold as a courtesy to their customers. To keep them loyal customers. So a portion of their total sales doesn’t even count as income (income = total sales – imports). And if Fine Wines divides their income by the total number of bottles they sold they see a sad truth. The impact of those imports has lowered the average price per bottle of wine. This price deflation will make it very difficult to pay the bills they incurred before this deflation. As they are now selling wine at lower prices than they paid for it from their distributors.
And that’s similar to how the gold standard works. We back the money in circulation (i.e., the money supply) by gold. Which we lock away in some vault. To increase the money supply you need to increase the gold supply. To decrease the money supply you need to decrease the gold supply. This makes it very difficult for governments to be irresponsible and print money. Because if the currency is backed by gold the only way to create new dollars is to put more gold into that vault. Ergo, responsible government spending. And an automatic mechanism to fix trade deficits.
Fixed Exchange Rates based on Gold made International Trade Simple and Fair
This is where our wine stores example comes in. If a government runs a trade deficit under the gold standard gold moves between countries. Just like money did between the two wine stores. And a net exporter of gold (a net importer of goods paying for the resulting trade deficit with gold) will see a reduction in price levels. Just like Fine Wines did. (And the net importer of gold will see the opposite). But here’s what else happens. Those lower prices now make the importer more cost competitive. (And the higher prices make the exporter less competitive). Because people prefer buying less expensive things. So the net importer’s sales increase thanks to lower prices. While the net exporter’s sales decrease because of higher prices. Moving the balance in the trade account back towards zero. Where it will always try to be under normal market conditions.
This built-in responsibility didn’t stop governments from misbehaving, though. And some have printed more money than they had the gold reserves to back it. For governments like to spend money. Especially when they’re trying to buy votes. So they have turned on those printing presses at times. And increased the money supply. Without putting more gold into the vault. The result? A larger money supply backed by the same amount of gold? It depreciated the currency by inflating the money supply. Which can be a problem when the money is backed by gold. Especially when you have an exchange rate based on gold.
To buy goods from a foreign country you first exchanged your currency for theirs. Because you buy foreign goods in the foreign currency. And you based this exchange rate on gold. And fixed each currency to an amount of gold. Which made this currency exchange simple. And fair. Unless someone was depreciating their currency by printing it without putting more gold into the vault. But if they did other nations would find out. And stop exchanging their currency for the depreciated currency which would buy less. They, instead, exchanged the foreign currency they had for gold instead. So they could buy more. Exchanging a depreciated currency at an exchange rate based on a non-depreciated currency. Leaving the nation with a swollen money supply full of a depreciated currency. And no gold. Giving the nation runaway inflation. And a crashed economy. A very strong incentive not to depreciate your currency while on a gold standard.
Tags: backed by gold, currency, deflation, depreciated currency, exchange rate, exports, foreign currency, gold, gold reserves, gold standard, imports, inflation, money, money supply, net exporter, net importer, price deflation, price levels, prices, print money, trade, trade account, trade deficit, trade surplus, vault
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