Keynesian Economics

Posted by PITHOCRATES - October 14th, 2013

Economics 101

(Originally published February 20th, 2012)

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

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

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

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

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

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

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

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

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

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

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

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

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The Communists in Japan are targeting Young People to help them Transform Japan into an Oppressive Communist State

Posted by PITHOCRATES - August 10th, 2013

Week in Review

The former Soviet Union, the People’s Republic of China (back in the days of Mao), North Vietnam, North Korea and Cuba all have great police states.  Not to keep people out of their countries.  But to prevent the people inside their countries from escaping to the capitalist West. Why?  Life was better in the capitalist West than in the communist East.  Where nations in the capitalist West didn’t need a secret police to keep their people from escaping.  But needed strong immigration controls to keep their countries from being overwhelmed by refugees trying to escape to their lands.  Yet despite this history of communist failures there are still communist parties in countries trying to attract voters.  Preferably the ones who don’t know about that history of failure (see Communist Party makes a comeback … in Japan by Gavin Blair, The Christian Science Monitor, posted 8/5/2013 on Yahoo! News).

Founded in 1922, the JCP is the oldest political party in Japan, and has enjoyed constant representation in parliament for longer than any other. But until recently, its image was one of older activists and it struggled to attract younger voters.

July’s elections were the first in Japan where online campaigning was permitted, and it was the JCP that is widely seen as having made best use of it. As well as savvy leveraging of social networks and video streaming platforms, the party created a series of online mascot characters that addressed individual issues such as the planned consumption tax hike, shady business practices, the heavy US military presence on Okinawa, and constitutional change.

“We were able to use the Net to reach out to younger people, many of whom don’t read newspapers or watch TV much. Through the characters, we could communicate issues simply and appeal to young voters,” says party spokesperson Toshio Ueki, who reports that the characters’ webpages got 1.5 million hits in the weeks before the poll.

Sound familiar?  That’s how President Obama won election twice.  By reaching out to younger people.  The people who probably know the least about economics.  And history.  That’s how people who want to change a country do it.  By getting people who don’t have the foggiest idea about what happened in the world in the last century or so.  Who simply don’t know of what people tried.  And what has failed.  With communism pretty much at the top of the list of things NOT to do based on past history.

If we did take power, the JCP wouldn’t try to implement a Communist economy immediately. It would require huge changes and we would seek the support of the people for each step,” Kira says. “And we would want to use the best parts of the current economic system, too.”

Japan is pretty close geographically to some of the great communist failures.  The former Soviet Union.  The People’s Republic of China (PRC) back in the days of Mao.  Vietnam.  And, of course, North Korea.  Places that have all gotten better with a move away from communism and towards capitalism.  Except North Korea.  Which is pretty much unchanged.  And the former Soviet Union.  Which is no more.  But the biggest part of the Soviet Union lives on.  Russia.  Which had moved towards capitalism.  But now is drifting back a bit.

History has shown where there is unfettered free markets life is better.  For this is the direction of all immigration.  From countries with highly fettered markets to countries with less fettered markets.  Older people know this.  People who read history know this.  Or lived it.  People who understand classical economics know this.  But young people?  They haven’t a clue.  Which is why all candidates who want to expand the power of the state over the people target young people.  For with them all they have to do is to promise more stuff and more freedom.  Even if they promise to deliver these with policies that have throughout history done anything but.

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Farming, Food Surplus, Artisans, Trade, Barter, Search Costs, Money, Precious Metals, Pound, Dollar and Gold Standard

Posted by PITHOCRATES - October 9th, 2012

History 101

Food Surpluses allowed Everything that followed in the Modern Age

Humans were hunters and gatherers first.  When the environment ruled supreme.  Then something happened.  Humans began to think more.  And started to push back against their environment.  First with tools.  Then with fire.  Bringing people closer together.  Eventually settling down in civilizations.  When the human race embarked on a new path.  A path that would eventually usher in the modern age we enjoy today.  We stopped hunting and gathering.  And began farming.

Throughout history life has been precarious.  Due to the uncertainty of the food supply.  Especially when the environment ruled our lives.  That changed with farming.  When we started taking control of our environment.  We domesticated animals.  And learned how to grow food.  Which lead to perhaps the most important human advancement.  The one thing that allowed everything that followed in the modern age.   Food surpluses.  Which made life less precarious.  And a whole lot more enjoyable.

Producing more food than we needed allowed us to store food to get us through long winters and seasons with poor harvests.  But more importantly it freed people.  Not everyone had to farm.  Some could do other things.  Think about other things.  And build other things.  Artisans arose.  They built things to make our lives easier.  More enjoyable.  And when these talented artisans and farmers met other talented artisans and farmers they traded the products of all their labors.  In markets.  That became cities.  Enriching each other’s lives.  By allowing them to trade for food.  For things that made life easier.  And for things that made life more enjoyable.

We settled on using Precious Metals (Gold and Silver) for Money for they were Everything Money Should Be

As civilizations advanced artisans made a wider variety of things.  Putting a lot of goods into the market place.  Unfortunately, it made trading more difficult.  Because while you saw what you wanted the person who had it may not want what you had to offer in trade.  So what do you do?  You look for someone else that has that same thing.  And will trade for what you have.  And when the second person doesn’t want to trade for what you have you look for a third person.  Then a fourth.  Then a fifth.  Until you find someone who wants to trade for what you have.

This is the barter system.  Trading goods for goods.  And as you can see it has high search costs to find someone to trade with.  Time that people could better spend making more things to trade.  What they needed was a temporary storage of value.  Something people could trade their things for.  And those people could then use that temporary storage they received in trade to later trade for something they wanted.   We call this ‘something’ money.

We have used many things for money.  Some things better than others.  In time we learned that the best things to use for money had to have a few characteristics.  It had to be scarce.  A rock didn’t make good money because why would anyone trade for it when you could just pick one up from the ground?  It had to be indestructible and hold its value.  A slab of bacon had value because bacon is delicious.  But if you held on to it too long it could grow rancid, losing all the value it once held.  Or you could eat it.  Which would also remove its value.  It had to be divisible.  A live pig removed the problem of bacon growing rancid.  However, it was hard making change with live pigs.  Which is why we settled on using precious metals (gold and silver) for money.  For they were everything money should be.

The Key to Economic Activity is People with Creative Talent to make Things to Trade

Money came first.  Then government monetary systems.  Traders were using gold and silver long before nations established their own money.  And when they did they based them on weights of these precious metals.  The British pound sterling represented one Saxon pound of silver.  The U.S. dollar came from the Spanish dollar.  Which traces back to 16th century Bohemia.  To the St. Joachim Valley.  Where they minted private silver coins.  The Joachimsthaler.  Where the ‘thaler’ (which translated to valley) in Joachimsthaler became dollar.  The German mark and the French franc came into being as weights of precious metals.  People either traded silver or gold coins.  Or paper notes that represented silver or gold.

We used silver first as the basis for national currencies.  Then with new gold discoveries in the United States, Australia and South Africa gold became the precious metal of choice.  Using precious metals simplified trade by providing sound money.  And it also made foreign exchange easy.  For when the British made their pound represent 1/4 of an ounce of gold and the Americans made their dollar represent 1/20 of an ounce of gold the exchange rate was easy to calculate.  The British pound had 5 times as much gold in it than the U.S. dollar.  So the exchange rate was simply 5 U.S. dollars for every British pound.  Which made international trade easy.  And fair.  Because everything was priced in weights of gold.

The pure gold standard, then, was part of the natural evolution of money.  The state did not create it.  It does not require an act of legislation.  Or political decree.  The pure gold standard existed before the state.  And states based their currencies on the monetary system that already existed.  Using weights of precious metals as money.  That is, a pure gold standard.  Central banks and fiat money are only recent inventions of the state.  And bad ones at that.  For the thousands of years that preceded the last hundred years or so there were only traders mutually agreeing to trade their goods for precious metals.  Using these precious metals as a temporary storage of wealth.  To temporarily hold the value of the things they made.  So the key to economic activity is people with creative talent to make things to trade.  And a sound money like gold and silver to facilitate that trade.  Not a central bank.  Or monetary policy.

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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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Tax Cuts, Gold Standard, Roaring Twenties, Great Depression, New Deal, Great Society, Stagflation, Ronald Reagan and Class Warfare

Posted by PITHOCRATES - February 28th, 2012

History 101

The Twenties saw one of the Greatest Explosions in Economic Growth in History despite being on a Gold Standard 

There is a duality in economics.  There is Keynesian economics.  And the Austrian School.  The Keynesians believe in central banking.  Forcing interest rates below market rates.  Purposely creating a permanent but ‘manageable’ inflation rate.  And other government interventions into markets.  The Austrians believe in a strong currency.  Even bringing back the gold standard.  Letting the markets set interest rates.  Are against purposely creating inflation.  And oppose government intervention into markets.  So these two schools are sort of the Yin and Yang of economics.  The dark and the light.  The wrong and the right.  The Keynesian and the Austrian.

So it’s not surprising to see periods of history where these two schools bump up against each other.  As we transition from good economic times to bad economic times.  And vice versa.  When politicians change policies for political reasons.  Or when politicians change policies for economic reasons.  When the Keynesians are out of power and want to get back into power.  Or the Keynesians are in power, have destroyed the economy and the electorate wants to throw them out.  Starting shortly after World War I.  When John Maynard Keynes’ ideas came to light.  Economic policies that used smart people and an active, benevolent government.  Exactly what Woodward Wilson and his progressives were looking for.  Who wanted to quantify human behavior and improve it.  With an activist and scientific government.  To bless the United States with their brilliance again now that the war was over.  And return to the new enlightened way.  Helping people everywhere to be better citizens.  And fixing all the ‘faults’ of free market capitalism.

But the progressives lost the 1920 election.  The voters favoring Warren Harding’s message to return to normalcy.  And rejecting the progressives and their new scientific ways of government.  They wanted jobs.  And that’s what Harding gave them.  By cutting taxes.  Thanks to the advice of his brilliant treasury secretary.  Andrew Mellon.  And getting out of the way of businesses.  When he died Calvin Coolidge continued his policies.  And the Twenties roared.  It was one of the greatest explosions in economic growth in history.  Where credit was plentiful.  Despite being on a gold standard.  As the United States electrified.  And modernized.  Electric power.  Telephones.  Radio.  Electric appliances.  Movies.  Even on the farm.  Where mechanization provided bountiful harvests and inexpensive food.  The Roaring Twenties were great times for consumers.  The average American.  Thanks to minimal governmental interference into the free market.  And capitalism.  But, alas, that wouldn’t last.

Ronald Reagan won in a Landslide based on an Economic Platform that was Austrian to the Core 

It was the mechanization of the farm that began the process that lead to the Great Depression.  The average American benefited greatly from those low food prices.  But not the farmers who went into debt to mechanize their farms.  And when those European World War I soldiers traded their rifles for plows the American farmers lost some valuable export markets.  Farmers were struggling with low prices.  And heavy debt.  Some defaulted on their debt.  Causing bank failures in the farming regions.  Which soon spread throughout the banking system.  And when president Hoover came to office he was going to help the farmers.  For Hoover, though a Republican, was a progressive.  He brought back activist government.  He interfered with the free market.  To fix these problems.  Price supports for farmers to import tariffs.  Raising costs for businesses.  And prices for consumers.  Then the Smoot-Hawley Tariff launched an all out trade war.  Crashing the economy.  And giving us the Great Depression.

The 1930s was a lost decade.  FDR’s New Deal policies increased the size of government.  And their reach into the free market.  Which prolonged the Great Depression.  But nothing they tried worked.  Despite trying their progressive brilliance for some ten years.  It took World War II to pull the United States out of the Depression.  When the government at last allowed businesses to pursue profits again.  And got out of their way.  This surge in economic activity continued after the war and through the Fifties.  And into the Sixties.  With none other than JFK cutting taxes in a very Austrian way.  Yes, Kennedy was an adherent to the Austrian school.  But LBJ wasn’t.  And when he took over things changed.  The progressives were back.  Calling themselves liberals now.  And instead of the New Deal they gave us the Great Society.  Which grew the government even larger than the New Deal did.  And the Great Society spent the money.  Along with putting a man on the moon and the Vietnam War, government spending exploded.  The Keynesians were hitting their prime.  For once they could do all of the great things they always said they could.  And in the process fix a ‘broken’ free market system.  Finally having brilliant people in all the right places in government.  Making brilliant policies to help people live better lives.

And then came the Seventies.  The government was spending so much that they turned to the printing presses.  Because they could.  Thanks to central banking.  Even if it was hamstrung by gold.  You see, at that time the dollar was convertible into gold.  And with the Americans printing so much money and depreciating the dollar countries holding U.S. dollars said, “Screw that.”  And converted their dollars into gold.  That great sucking sound they heard in the Seventies was the sound of U.S. gold reserves getting sucked out of the country.  Well, even though the Keynesians hated gold they didn’t want to see all their gold reserves disappearing.  So Nixon did something very Keynesian.  And decoupled the dollar from gold.  Freeing the government at last to spend as irresponsibly as the Keynesians wanted.  And spend they did.  Turning the printing presses on high.  Depreciating the dollar ever more and causing double digit inflation.  Worse, all that Keynesian spending did nothing for the economy.  There was high unemployment as well as inflation.  An unusual phenomenon as you typically had one or the other.  Not both.  But this was stagflation.  A Keynesian phenomenon.  And you measured how bad it was by adding the unemployment rate to the inflation rate.  Giving you the misery index.  And the misery was pretty high during the Keynesian Seventies.  It was so miserable that they joked about it on Saturday Night Live.  With Dan Aykroyd impersonating Jimmy Carter.  Joking about high nice it would be to own a $400 suit.  And how nice it was just to make a phone call to get the printing presses to print more money.  The people thought Aykroyd’s Carter was funny.  But they didn’t care for the real one all that much.  And made him a one term president.  As Ronald Reagan won in a landslide.  Based on an economic platform that was Austrian to the core.  Including a promise to return responsibility to government spending by reinstating a gold standard.  (Which was a political ‘bridge too far’.)

The Electorate paying Federal Income Taxes fell from 80% when Reagan was in Office to about 50% by 2009 

The Eighties were so prosperous that the Keynesians, liberals and progressives derisively call them the decade of greed.  They tried everything within their power to rewrite history.  Calling the exploding economic activity ‘trickle down’ economics.  But the figures don’t lie.  Despite the liars figuring.  The inflation rate fell.  Interest rates fell.  The unemployment rate fell.  And despite the cuts in tax rates the government was never richer.  Tax revenue collected under the reduced rates nearly doubled.  But there was little cutting in government spending.  Flush with all that cash they kept spending.  In part to rebuild the military to win the Cold War.  Which Reagan won.  But all the social spending continued, too.  Which led to some record deficits.  Not the trillion dollar deficits of the Obama administration.  But large nevertheless.  Which provided the meme to explain away the prosperity of the Eighties.  “But at what cost?” being the common refrain.  They talk about the deficits.  But very conveniently leave out that part of how tax revenues doubled at the reduced tax rates.

Well, as time passed the Keynesians got back into government.  In the late Nineties as they kept interest rates low again to stimulate the economy.  Creating the dot-com bubble.  And the early 2000s recession.  George W. Bush cut taxes.  Brought the economy out of recession.  But then the Keynesians went back to playing with those interest rates.  Kept them artificially low.  Creating a great housing bubble.  And the Subprime Mortgage Crisis.

Keynesian economics have failed throughout the last century of trying.  And taxpayers clearly saw this along the way.  Voting for Austrian policies every time economic policy mattered.  Especially after another failure of Keynesian policy.  Every time their policies failed, though, the Keynesians had an excuse.  Supply shocks.  Liquidity traps.  Something.  It was always something that caused their policies to fail.  But it was never the policies themselves.  Despite Mellon, Harding, Coolidge, Kennedy and Reagan proving otherwise.  So they had to try something else.  And they did.  Class warfare.  They transferred the tax burden to the wealthier.  Reduced the number of people paying federal income taxes.  And gave ever more generous government benefits.  This took the failed ideology out of the equation.  Making it easier to win elections.  For when Reagan was in office more than 80% of the electorate were taxpayers.  And Austrian economics won at the polls.  The Nineties ended with only about 65% of the electorate paying federal income taxes.  By 2009 that number shrunk to about only half of the electorate.  Which gave the tax and spend Keynesians an edge over responsible-governing Austrians.  Because people who don’t pay income taxes will vote for policies to increase taxes on those who do.  Not because of concern over economic policy.  But just to get free stuff.  Something Keynesians learned well.  When at first you fail just buy votes.  And then you can continue your failed policies to your heart’s content.

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Keynesian Economics

Posted by PITHOCRATES - February 20th, 2012

Economics 101

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

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

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

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

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

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

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

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

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

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

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

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

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Stocks and Bonds

Posted by PITHOCRATES - January 9th, 2012

Economics 101

When Companies grow their Capital Requirements grow beyond a Bank’s Lending Ability

We note a civilization as being modern when it has vigorous economic activity.  Advanced economies around the world all have the same things.  Grocery stores.  Clothing stores.  Electronic stores.  Appliance stores.  Coffee shops and restaurants.  Factories and manufacturing plants.  And lots and lots of jobs.  Where people are trading their human capital for a paycheck.  So they can take their earnings and engage in economic activity at these stores, coffee shops and restaurants.

To buy things off of shelves in these stores things have to be on those shelves first.  Which means selling things requires spending money before you earn money.  Businesses use trade credit.  Such as accounts payable.  Where a supplier will give them supplies and send them an invoice typically payable in 30-90 days.  They will establish a credit line at their bank.  Where they will borrow from when they need cash.  And will repay as they collect cash (such as when their customers pay their accounts payable).  And take out loans to finance specific things such as a delivery van or restaurant equipment.

Businesses depend on their bank for most of their credit needs.  But when companies grow so do their capital requirements.  Where capital is large amounts of money pooled together to purchase property, buildings, machinery, etc.  Amounts so great that it exceeds a bank’s ability to loan.  So these businesses have to turn to other types of financing.  To the equity and debt markets.

Investors Invest in Corporations by Buying their Stocks and Bonds

Equity and debt markets mean stocks and bonds.  Where we use stocks for equity financing.  And bonds for debt financing.  Stocks and bonds allow a corporation to spread their large financing needs over numerous people.  Investors.  Who invest in corporations by buying their stocks and bonds.

When a business ‘goes public’ they are selling stock in their company for the first time.  We call this the initial public offering (IPO).  If the company has a very promising future this will bring in a windfall of capital.  As investors are anxious to get in on the ground floor of the next big thing.  To be a part of the next Microsoft.  Or Apple.  This is when a lot of entrepreneurs get rich.  When they are in fact the next big thing.  And if they are, then people who bought stock in their IPO can sell it on the secondary market.  Where investors trade stocks with other investors.  By buying low and selling high.  Hopefully.  If they do they get rich.  Because the greater a company’s profits the greater its value and the higher its stock price.  And when a company takes off they can sell their stock at a much higher price than they paid for it in the IPO.

When a corporation needs to borrow more than their bank can loan and doesn’t want to issue new stock they can sell bonds.  Which breaks up a very large amount into smaller amounts that investors can buy.  Typically each individual corporate bond has a face value of $1000.  (So a ten million dollar ‘loan’ would consist of selling ten thousand $1,000 bonds).  Like a loan a corporation pays interest on their bonds.  But not to a bank.  They pay interest to the investors who purchased their bonds.  Who can hold the bonds to maturity and collect interest.  Or they can trade them like stock shares.  (Changes in the interest rates and/or corporate financial strength can change the market value of these bonds.)  When a bond reaches maturity (say in 20 years) the company redeems their bonds from the current bondholders.  Hopefully with the new profits the bond issue helped to bring into the corporation.  Or they just issue new bonds to raise the money to redeem the older bonds.

A Company Usually has a Mix of Equity and Debt Financing that Balances all the Pros and Cons of Each

There are pros and cons to both equity and debt financing.  Selling stock transfers ownership of the company.  Sell enough so that someone can own more than 50% and that someone can replace the board of directors.  Who in turn can replace the CEO and the other corporate officers.  Even the business founder.  This is the big drawback of going public.  Founders can lose control of their company.

Stocks don’t pay interest.  So they are less threatening during bad economic times.  As business owners, stock shareholders are there for the long haul.  During the good times they may expect to collect dividends (like an interest payment).  During bad times they will wait it out while the company suspends dividend payments.  Or, if they lose confidence, they’ll try and sell their stock.  Even at a loss.  To prevent a future greater loss.  Especially if the corporation goes bankrupt.  Because stockholders are last in line during any bankruptcy proceedings.  And usually by the time they pay off creditors there is nothing left for the shareholders.  This is the price for the chance to earn big profits.  The possibility to lose everything they’ve invested.

Bonds are different.  First of all, there is no transfer of ownership.  But there is a contractual obligation to make scheduled interest payments.  And if they fail to make these payments the bondholders can force the company into bankruptcy proceedings.  Where a corporation’s assets can be liquidated to pay their creditors.  Including their bondholders.  Which, of course, often means the end of the corporation.  Or a major restructuring that few in management enjoy.

Stockholders don’t like seeing their share value diluted from issuing too many shares.  Bondholders don’t like to see excessive debt that threatens the corporation’s ability to service their debt.  So a company usually has a mix of equity and debt financing that balances the pros and cons of each.  A financing strategy that has been working for centuries.  That allows the advanced civilized world we take all too much for granted today.  From jetliners.  To smartphones.  To that new car smell.  For none of these would be possible without the capital that only the equity and debt markets can raise.

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The iPhone is Impressive but the Plough is a True Technological Wonder

Posted by PITHOCRATES - October 19th, 2011

Technology 101

The Plough allowed us to Grow more Food in Virtually any Soil giving us more Free Time to Think

The iPhone is an amazing piece of technology.  Whenever a new one comes out lines form with anxious people clamoring to get the new phone.  Steve Jobs was a brilliant entrepreneur.  He knew how to give the people what they wanted.  But he had some help along the way.

What made the iPhone possible?  Was it touch-screen LCD technology?  A little.  Was it the miniaturization of integrated circuits?  Well, that helped no doubt.  How about the transistor?  This was big.  It opened the door to the integrated circuits.  But it took something before that.  Vacuum tubes?  What the transistor replaced?  No.  Was it wireless radio transmission?  Antenna technology?  The development of electromagnetic field and wave theory?  No.  You have to go further back.  Even before the genius of Nikola Tesla (electrical engineer, inventor and father of AC power).  The telephone?  The telegraph?  The printing press?  No.  All necessary steps on the road to the iPhone.  But none of these are the prime mover that set things in motion to make the iPhone possible.  To find this prime mover you have to go way back.  To the dawn of civilization.  To the one piece of technology that changed everything.  The plough.

The first civilizations sprung up on the fertile banks of the great rivers.  The Hwang-Ho.  The Indus.  The Nile.  The Tigris.  And the Euphrates.  Where the flooding of these rivers made the soil nutrient-rich.  And easy to work.  The masses could scratch it with a stick.  Sow their seeds.  And pray to their gods for a bountiful harvest.  The plough changed that.  It let us grow food in virtually any soil.  And the work of a few could do the same of the masses in those river valleys.  This produced two things.  A food surplus.  And spare time.  Everyone in a society no longer had to farm.  They could do other things.  And think.

The Plough gave rise to Artisans, the Free Market Economy and a Middle Class

It all started here.  The plough unleashed the human mind.  It transformed us from working machines at the mercy of our environment.  To masters of our environment.  Where we transformed our environment to better serve us.

This gave rise to artisans.  Blacksmiths.  Tanners.  Cobblers.  Inventors.  Entrepreneurs.  What we call the rise of a middle class.  These people didn’t have to grow food.  Because they could trade for food.  With the things they created.  And like the farmers, they created surpluses.

We traded this surplus of food and artisan goods in markets.  The free market economy was born.  These markets became cities.  As the economy grew capital formation grew.  Banking and finance.  The joint-stock company.  The corporation.  Capitalism.  Which eventually gave us Steve Jobs.  And the iPhone.

The Plough put us in Control of our Environment, Reduced Famine and Improved the Quality of Life

None of this would have happened without the plough.  Because before the plough everyone grew food.  And lived at the mercy of their environment.  Where famine would devastate civilizations because of a bad growing season.  But the plough gave us food surpluses.  That let us live through a bad growing season.  And allowed a middle class to continue to grow.  Improving the quality of life for the first time in history.

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LESSONS LEARNED #25: “War is costly. Peace, too.” -Old Pithy

Posted by PITHOCRATES - August 5th, 2010

AT THE HEIGHT of the Roman Empire, the empire reached from North Africa to Britannia (England), from Hispania (Spain) to Mesopotamia (approximately modern day Iraq).  When Roman power ruled the civilized world, there was peace.  The Pax Romana (Roman Peace).  The Romans built empire through conquest.  And Rome grew rich with the spoils of conquest.  For awhile, peace was only those quiet intervals between growth and conquest.  But with secure borders, a uniform government, a rule of law, a stable currency, bustling trade & markets and a military to be the world’s policeman, peace broke out.  For some 200 years.

Life was good for the Roman citizen.  As well as for those living in the empire.  The Romans modernized the provinces they conquered.  Made life better.  Even for the conquered people.  Although there were those who hated being subjugated by a foreign power.

Reg: They bled us white, the bastards. They’ve taken everything we had. And not just from us! From our fathers, and from our father’s fathers.

Loretta: And from our father’s father’s fathers.

Reg: Yeah.

Loretta: And from our father’s father’s father’s fathers.

Reg: Yeah, all right Stan, don’t belabor the point. And what have they ever given us in return?

Revolutionary I: The aqueduct?

Reg: What?

Revolutionary I: The aqueduct.

Reg: Oh. Yeah, yeah, they did give us that, ah, that’s true, yeah.

Revolutionary II: And the sanitation.

Loretta: Oh, yeah, the sanitation, Reg. Remember what the city used to be like.

Reg: Yeah, all right, I’ll grant you the aqueduct and sanitation, the two things the Romans have done.

Matthias: And the roads.

Reg: Oh, yeah, obviously the roads. I mean the roads go without saying, don’t they? But apart from the sanitation, the aqueduct, and the roads…

Revolutionary III: Irrigation.

Revolutionary I: Medicine.

Revolutionary IV: Education.

Reg: Yeah, yeah, all right, fair enough.

Revolutionary V: And the wine.

All revolutionaries except Reg: Oh, yeah! Right!

Rogers: Yeah! Yeah, that’s something we’d really miss Reg, if the Romans left. Huh.

Revolutionary VI: Public bathes.

Loretta: And it’s safe to walk in the streets at night now, Reg.

Rogers: Yeah, they certainly know how to keep order. Let’s face it; they’re the only ones who could in a place like this.

All revolutionaries except Reg: Hahaha…all right…

Reg: All right, but apart from the sanitation, the medicine, education, wine, public order, irrigation, roads, the fresh-water system and public health, what have the Romans ever done for us?

Revolutionary I: Brought peace?

Reg: Oh, peace! Shut up!

(From Monty Python’s The Life of Brian, 1979.)

Maintaining a peaceful empire is costly.  As people got more accustomed to peace and plenty, they began to complain about taxes.  Citizens refused to volunteer to serve in the Roman Legions maintaining that peace.  Barbarians began to serve in the Legions.  Some rose to command them.  Some Roman commanders came from the very people they were fighting in the border regions.  Soon Rome would rely on mercenaries (hired soldiers) to defend their borders.  All of this cost the empire.  It had to pay more and more to maintain the loyalty of the military.  Ditto for the huge bureaucracy administrating the empire.  And they lost control.  Trouble on the borders and economic collapse ended the peace.  And, ultimately, the empire.  The civilized world broke down and collapsed.  And barbarian leaders on the borders, hungry for conquest, attacked.  Plunging the former Roman provinces into war and instability.

RISING FROM THE ashes of the Roman Empire were the seeds of new empires.  And the ground that proved most fertile was the northern limit of the old empire.  England.

England started to assert herself with the growth of her navy.  With her borders secured, a uniform government, a rule of law, a stable currency, bustling trade & markets and a military to be the world’s policeman, peace broke out.  Again.  For about a hundred years.  During the Industrial Revolution.  After the defeat of Napoleon. 

Imperial Britain stretched across the globe.  The sun never set on the British Empire.  And wherever she went, she brought the rule of law, modernity, a sound economy and political stability.  Her old colonial possessions went on to be some of the richest, most prosperous and peaceful nations in the world.  India.  Australia.  New Zealand.  South Africa.  Canada.  And, of course, the United States of America.  She achieved her century of peace (Pax Britannia) by a balance of power.  She maintained peace by intervening in disputes, often on the side of the weaker nation.  She prevented stronger, aggressive nations from threatening her weaker neighbors.   And she provided a safe environment for the weaker nation to live peacefully in the shadows of stronger, more aggressive neighbors.

For a hundred years Britannia kept the peace.  In large part due to her Royal Navy, the most powerful and potent navy at the time.  If you ate any imported food or used any imported goods, it was thanks to the Royal Navy that kept the world’s sea lanes safe.  But this peace came with a price.  The rise of nationalism, the quest of new empires to establish their own overseas colonies and a change in the balance of power in Europe with the rise of Germany added to that price.  And then a shot fired in Sarajevo by a Serbian terrorist ignited a tinderbox.  The assassination of Archduke Franz Ferdinand by Gavrilo Princip started World War I.  The most bloody and expensive war at the time, it bankrupted Great Britain and ended her empire.  And left the world a less safe place. 

From the ashes of World War I rose new leaders with aspirations of world conquest.  Fascist Italy led by Benito Mussolini.  Nazi Germany led by Adolf Hitler.  Communist Russia led by Joseph Stalin.  Imperial Japan led by Hideki Tojo.  And the nation that led the victors in World War II would, by default, become the new world power.  The new world policeman.  The United States of America.

SO WHAT HAPPENED during the inter-war years that led to World War II?  War exhausted Britain and France.  Neither had the stomach for another war.  Britain continued to rely on the Royal Navy for protection (as an island nation, sea power is indispensable).  France built fixed fortifications (the Maginot Line).  Both were primarily defensive strategies. 

In America, General Billy Mitchell demonstrated the vulnerability of battleships to air power by sinking a battleship with an airplane (greatly flustering the naval high command).  Colonel George S. Patton developed an armored doctrine for an unenthused army and eventually transferred back to the horse cavalry.  Meanwhile, Imperial Japan was building aircraft carriers.  And Nazi Germany, Fascist Italy and Communist Russia developed air and armored doctrine while fighting in the Spanish Civil War.

Fascist Italy attacked Ethiopia in 1935 to rebuild the Roman Empire and make the Mediterranean Sea a Roman lake once again.  Nazi Germany launched World War II in 1939 by an armored assault on Poland with tactical air support.  Poland resisted with horse cavalry.  And lost.  Imperial Japan attacked Pearl Harbor in 1941 to destroy American naval power in the Pacific.  They did a lot of damage.  But the American carriers, their prime objective, were at sea.  They would eventually meet those carriers later at the Battle of Midway.  Where they would lose four of their best carriers and many of their best aviators.  This tipped the balance of power in the Pacific to the Americans.

America was ill-prepared for war.  But American industry, the Arsenal of Democracy, ramped up and built the planes, tanks, guns, rifles and ships that would win the war.   It would come with a heavy price tag.  Global wars typically do.  Had there been a balance of power that would have checked the territorial ambitions of the aggressor nations, it would have been a different story.  Of course, having the power is one thing.  How you use it is another. 

France had more tanks than Germany before the outbreak of hostilities.  But the Nazis quickly overran France.  Why?  Doctrine.  France’s doctrine was to hide behind the security of the Maginot Line.  It was a defensive-only strategy.  She developed no armored doctrine.  The lesson they learned from World War I was that armies killed themselves attacking fixed defenses.  Germany, too, learned that lesson.  So their doctrine called for going around fixed defenses with fast-moving armor spearheads with tactical air support (i.e., blitzkrieg).  Formidable though the Maginot Line was, it could not attack.  And if the Nazis didn’t attack it, it did nothing but concentrate men and firepower away from the battle.

WHEN WE PULLED out of South Vietnam, we agreed to use American air power if North Vietnam violated the terms of the treaty ending that war.  Watergate changed all of that.  Even though JFK got us into Vietnam, it became Nixon’s war.  And a vindictive Congress wouldn’t have anything more to do with it.  The North tested the American will.  Saw that there was none.   Attacked.  And overran South Vietnam.  The message was clear to tyrants.  America will quit in the long run.  Especially after a large loss of life.

Other ‘retreats’ would reinforce this perception.  Especially in the Arab world.  The withdrawal from Lebanon after the bombing of the Marines’ barracks.  The withdrawal from Somalia after the Somalis dragged dead American troops through the streets of Mogadishu.  The Arab world even saw the victory in Desert Storm as a retreat.  The anti-American Arab world said that our invasion was about oil.  That what we really wanted was to topple Saddam Hussein and take his oil.  It was just another Christian Crusade into holy Islamic lands.  When we didn’t do that, the Arab world saw it as another American retreat.  That America didn’t have the will to endure a bloody battle to conquer Iraq. 

So some in the Arab world would test America.  Al Qaeda.  Headed by Osama bin Laden.  They started small and became more daring.  World Trade Center bombing.  Tanzanian Embassy bombing.  Kenyan Embassy bombing.  Khobar Towers bombing.  The USS Cole attack.  And they paid little for these attacks.  America didn’t fight back.  But their luck ran out on September 11, 2001.  Because America finally fought back.

PUBLIC ENEMY NUMBER one, Osama bin Laden, belonged to the conservative Sunni sect of Islam called Wahhabi.  They have a large following in Saudi Arabia.  The Wahhabi have a delicate relationship with the Saudi Royal family.  They disapprove of the Western displays of wealth in the House of Saud. 

Al-Qaeda was a shadowy enemy.  We confronted them in the mountains of Afghanistan where the Taliban gave them a safe sanctuary.  We attacked.  Knocked the Taliban from power.  Drove al-Qaeda underground.  But we could not stop their funding.

Wahhabi money from Saudi Arabia financed 9/11.  And the money continued to flow.  The Saudis would not intervene on behalf of America.  They feared any crackdown on the Wahhabi could unleash a civil war.  So America needed leverage to get Saudi cooperation.  And they found it in an old nemesis, Saddam Hussein. 

A Sunni minority ruled Iraq.  The Saudis did not like Saddam Hussein.  However, they liked the balance of power he offered to Iran.  Iran was Shiite.  As much as the Saudis did not like Saddam, they disliked Shiite Iran more.  This was the American lever.

After some diplomatic gymnastics, the invasion of Iraq was set.  The Saudis thought we were bluffing.  They didn’t believe we would invade Iraq.  Never in a million years.  If we didn’t do it in Desert Storm when we had the force in place to do it and didn’t, there was no way the Americans would amass another coalition and redeploy forces to the region again.  Especially because America doesn’t like long, drawn out, bloody wars.  Which an invasion of Iraq would surely be.

They asked us to remove our forces from the Saudi bases.  We did.  Now they were getting nervous.  That was the political game.  Make some noise to show the Arab world you weren’t an American toady.  But, secretly, you want those American forces to remain.  That American presence did provide security.  And stability.  After the invasion of Kuwait, it sure looked like Saudi Arabia would be next.  It was only that large American force in the desert that changed that inevitability. 

The Americans invaded.  And conquered.  Now the Saudis had a vested interest in helping the Americans.  They needed them to be successful in Iraq.  To contain Iran.  The lever worked.  The Saudis stemmed the flow of Wahhabi money to al-Qaeda.  The invasion of Iraq proved to be one of the most effective battles in the war on terrorism.  

HISTORY HAS SHOWN that a balance of power can lead to peace.  It has also shown that a superpower can enforce a larger peace.  But it also has shown that there is good and bad when it comes to power.  The Romans could be cruel, but so were most in that time.  The road to empire, after all, started out simply as a quest to provide a buffer between Rome and the hostile barbarians on her borders.  Rome, then, expanded in pursuit of peace.  (Initially, at least.)  And then used her power to maintain peace.

Many view Great Britain as the successor to the Roman Empire.  And many view America as the successor to the British Empire.  These powers share many things (rule of law, an advanced civilization, political stability, etc.).  Perhaps the greatest, though, is a powerful military.  And how it was/is used.  As a powerful deterrent to an aggressor nation.  To protect trade routes.  To maintain peace.  Malign these empires/nations all you will, but the greatest periods of world peace were due to their military power.  And their will to use that military power.  Expensive as that was.  Is.

So, yes, wars are costly.  Peace, too.  Sometimes, though, we must fight wars.  But we can avoid a lot of them.  By a peace-time military force that acts as a deterrent.  Because there are bad guys out there.  Who only respect one thing.  And it isn’t diplomacy.  Often the only thing preventing them from waging a cruel war of conquest is a potent military and a willing leader to use it.  If a tyrant knows he will face a military consequence for acting, he may not act.  When he knows that consequence will be devastating, he will not act.  But if he knows a nation hasn’t the military power or the will to use military power, he will act.  Just as Hitler did.  As Mussolini did.  As Tojo did.  And as Osama bin Laden did.

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