Booms and Busts

 

            The modern theory of the business cycle, as taught by conventional educators throughout the world, tells a story of ups and downs that naturally occur in the world of business. For this to be true, it would mean that a great number of firms and individuals nationwide have been making the wrong investments and allocation resources and labor in the wrong manner all at the same time. It would also mean that around the same time, a majority of these people wake up and realize the mistakes they’ve made. Even for this very unlikely event to be true in a dynamic, changing, and emergent economy; such an event would have to be tied to the money, or to some sort of nationwide laws, practices, or regulations that effect markets on a national scale.

            How might it be possible that so many people at the very same time make the same investment mistakes and suffer horrible losses during economic busts? The answer is hidden within the economic signals that entrepreneurs rely on to direct their capital. Besides having ridiculously harmful, cost-increasing regulations in nearly every single industry; government regulation and policies play only a small role in this signal disruption. The real fault of the government lies in the way it conducts monetary policy.  

The actions that our central bank has been taking in the last 100 years or so, that turn out to be so harmful in regards to recessions are the lowering of interest rates below what would otherwise be considered the “market price” for money. Low interest rates mean cheap access to money. In a market economy, they also mean that there has been an increase in amount of money people are saving in banks. This increase in savings signals entrepreneurs that there will be an increase in consumption in the future. Entrepreneurs, then, take out loans at the lower interest rate and invest the capital into various areas of the economy that they believe will be in high demand by consumers in the future. When government provides a false signal via low interest rates, the entrepreneurs are led to believe something that isn’t true: that people have increased their savings in hopes to consumer more in the future. The investments made tent to be focused on a specific area in the economy; i.e. real estate. Eventually, however, it becomes apparent that the increase in consumption is not going to occur and the investments made will not be as or at all profitable. This is when the crash begins. People start to liquidate their assets in an attempt to get out before they lose more money. As this happens, the price of the goods fall sharply and we are left with a recessed economy. The recession however, is not a process to be feared, but one to be trusted. The period of downed prices of certain good only means that the economy is adjusting to the previous period of mal-investment.

Unfortunately, recessions are harmful more ways than just unemployment increases.  Because investment and capital allocation takes time (especially real estate) many people spend a large amount of that time allocating resources into areas they believe will pay off in the long term. When the truth is realized and the investment turns out to be bad, people not only lose out on the investment, but on the time it took to make the investment. This is time that could’ve been spent doing other productive activities that may have paid off. The consumers suffer the same injury. False signals caused people to invest into things that consumers were not going to demand in the future. When all is said and done, we are left with entrepreneurs who have wasted time and money performing economic activities that are not needed to consumers. In the meantime, consumers are not being provided the goods and services they most urgently needed. The signals sent on behalf of the consumers were clouded by the false signals caused by the Federal Reserve and its monetary policies.

The lesson here is not to fear the crash of the market, but rather, the boom. The boom is always the cause of the recession, while the bust and the events that come along with it, are only symptoms of the boom. To stop the boom, we must constrain the expansion of money and the artificial expansion of credit. In order for this to be achieved, we must take on a system of free banking and sound money… something that cannot be achieved as long as the Federal Reserve System is in place.  

Equilibrium and Limitations of Society and Technology

There are several problems with the concept of equilibrium. In the first place, it has never been found to occur: any theory, in order to be considered valid, must hold up in the real world. Unfortunately, if this has ever happened, it rapidly shifts. The economy is in a constant state of flux, and true equilibrium will never happen. Sometimes markets get close, but they never actually get there. Furthermore, the state of equilibrium is not even desirable in the first place. Equilibrium is by definition a state of stasis, in which no progress is made because society has reached the hypothetical limit of advance. In this situation, there would be “perfect competition” which really means hundreds of different firms all offering the exact same product.

However, all improvements in human history have historically been necessitated by some sort of limitation that sparks a change in the way markets or society is structured, or results in the development of a new technology. True equilibrium would result in humanity as a whole stuck at the hunter-gatherer level: the atlatl would be the height of cutting-edge technology. But because of constant, relatively rapid advancements in technology, equilibrium is impossible to create or maintain. Furthermore, the necessity of government inherently precludes equilibrium, because it is essentially wasteful. On net, true, the advantages of the peace resulting from a well-structured government outweigh the inevitable chaos that would result if it did not exist, but it is in the nature of government to expand and interfere wherever it can. Bubbles such as the housing bubble and subprime mortgages inherently preclude equilibrium.

By advancing in order to overcome deficits in the current level of technology and/or social organization, the general standard of living improves and both the quantity and quality of products increase. Creation of agrarian societies led to greater quantities of food then had otherwise been available. Division of labor allowed for true capitalism in which markets arose and a greater amount of products were traded. Industrial farming allowed society to break the formerly inescapable Malthusian cycle of population expansion and famine. In short, equilibrium is a pipe dream, and we should not seek it out even if it were possible. By constantly improving, we create volatile periods in which markets must adjust, resulting in brief times of economic pain (the ever-increasing mechanization of modern society comes to mind), but it is ultimately worth it in the standard of living and variety of products that we enjoy.

Kickstarter and Products in the Information Age

The single greatest obstacle to the creation of a good product is information.  Specifically, disseminating the information about the product to the group most inclined to buy it has, historically, been the first thing to overcome when preparing to bring a new product to market.  However, with the advent of the information age and, especially, the site Kickstarter, that may be changing.

Kickstarter is, according to the site, “the world's largest funding platform for creative projects”: it allows uses to give a certain amount of funding to any project they wish.  The creators of the project put up a page with a certain amount of information, usually a video and/or article, and if the public likes it, they’ll fund it.  This is, quite simply, the Holy Grail of venture capitalism.  Rather than having to acquire funding from a couple of wealthy individuals, or even through their own bank accounts, a person developing a new product can use the site to acquire as much funding as they may require: so long, of course, as a sufficient number of people feel that their product is worthwhile.

Kickstarter, coupled with the internet, has the potential to allow for a veritable explosion in the variety of products entering the marketplace.  The most obvious effect has been in video games: indy game developers have used Kickstarter to great effect when it comes to funding new games.  (FTL is the most successful example of this method.)  However, Kickstarter also provides for new technology, comics, art, and more.  The internet allows the developers to spread the word to even more audiences, further drumming up support. 

In short, thanks to Kickstarter and, in the future, websites like it, we may soon see the market open up to an even greater variety of products than there are currently.  From an economic perspective, this will motivate producers to innovate even more in an effort to stay ahead, and will afford consumers more choices when deciding which products to buy.  Better yet, entrepreneurs will be able to gauge enthusiasm for a new product before they take the risk of developing it, ensuring that their efforts go towards something that the market will support rather than wasting resources on a product that no one will buy.

Free-Market Money: Can it really exist? (April Post)

Free-market Money: Can it really exist?

I’ve had many discussions with Mike, my Libertarian co-worker about the need for sound money. He reminds me time and again that our current fiat money is worthless and that through inflationary measures the Fed has brought our dollar on the verge of collapse.

Mike wholeheartedly supports the return to the Gold Standard so government cannot wantonly print additional money out of thin air like we’ve seen with QE1, QE2, and the like.

I found Hayek’s short essay on free-market money interesting but I question whether such a system can really exist.

Sure I like idea that government would be forced to have a quantity control for any commodity backed money. This isn’t to say that we would necessarily have to go back to a gold standard; we would just have to introduce money or currency that cannot be inflated at will. Hayek believes that as long as government maintains its monopoly control over money that it can inflate or manipulate currency. I don’t disagree with him on this point.

Hayek calls for the introduction of free-market money through the private sector. He seems to be adamant that any “good” money (which he really doesn’t define good) must be issued by private institutions. “Good” money it seems, can never ever come from government.

I am having a helluva time conceptualizing this. As a “Keynesian schoolboy” I have been raised to believe that money, any form of money, is a matter of social convention and social cooperation. Whether it’s dollars, salt, glass, beads, or Rai stones (which have at various times in history been used as currency and money) all money must be socially accepted to be used as money.

I cannot purchase big macs with bitcoins. I cannot pay my bills by mailing in my cache if silver bullion. I do not want to get paid in Rai stones. Because of social convention, I must use dollars. But I suppose one could argue that the government “forced” this social convention through the exercise of monopoly power over money.

Hayek writes, “…no senior banker, who understands only the present banking system, can really conceive how such a new system would work…” Well, I’m no senior banker and I’m having troubles conceiving how this new system would work. Maybe I’m being a bit too pessimistic here, but free-market money sounds great, and I’d like to see how private institutions would carry out this idea. But I question if free-market money can really exist.

 

Maybe an independent study of Austrian School banking is just the ticket...

Interest Rates, Entrepreneurs, and the Federal Reserve

QE4: (Quantitative Easing, Round 4) The Federal Reserve's policy to 'print' $85 billion every month in order to "stabilize the economy"

M2: The money supply* (in essence) that the Fed is increasing with QE

Inflation: An increase in the money supply

On October 27, 1978, the Federal Reserve Act was amended to include section 2A:

"The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." [emphasis added]

How does one "effectively promote" "maximum employment, stable prices, and moderate long-term interest rates"?

It seems as though Ben Bernanke et al look at history and see that when our economy is healthy, employment is high, interest rates are "moderate", and prices are stable. Upon observing this phenomenon, they seem inclined to believe that the healthy economy is a result of these key indicators, and therefore, believe that by forcing these indicators to be at levels which coincide with economic health throughout history, the economy will be returned to good health once again.

Austrian economists, on the other hand, view these indicators as the result, and not the cause of, economic health. By assuming this viewpoint, Austrians are forced to look deeper into the issue and again ask, "How does one "effectively promote" maximum employment, stable prices, and moderate long-term interest rates"? Their answers are often found to be in contrast to the solutions proposed by the dominant Keynesian viewpoint.

In regards to the interest rate, Austrians defend its role as an economic indicator, which operates to coordinate the activities of the entrepreneur with the intentions and desires of consumers. Basic supply and demand analysis will show that as more money is deposited into savings accounts, the incentive to save becomes diminished (the interest rate lowers). Thus, when entrepreneurs observe a low interest rate, they should recognize that 1) consumers are saving for future consumption, and 2) this is the most opportune time to start a business, as the cost of borrowing capital is low. 

Upon recognizing the real function of the interest rate, it becomes more clear that any exogenous influence on the interest rate (Federal Reserve policy esp.) degrades the quality of the interest rate as an indicator to entrepreneurs. It should be recognized that the level of manipulation of the interest rate has a direct relationship to the quality of information entrepreneurs possess to help them fulfill their function.

So, what are the implications of entrepreneurs having inaccurate information? According to Hayek and many others, malinvestment. Currently, the Fed's policy has the interest rate target at 0-.25% - which is a very low level that should be indicative of a very high level of savings. But this is not the case: personal savings rates are really near an all time low (http://research.stlouisfed.org/fred2/series/PSAVERT/). 

As entrepreneurs see these low interest rates, they may assume that the economy is healthy, people have lots of money saved, and they are ready  to consume some new products. In seeing this, they may decide to open a new business to capitalize on the perceived health of the economy. However, what they will find is that personal savings are basically non-existent, and consumers are not ready to spend any money, hence, malinvestment, which leads to further economic disease. 

In conclusion, the interest rate (and unemployment and price levels) should be recognized as spontaneous phenomenon that are the result of, and an indication of, economic conditions. If the interest rate is seen to be a cause of economic health, rather than its result, policy makers will try to 'fix' the interest rate at levels that they have observed coinciding with economic health. As we have observed already, tampering with these emergent signals will lead to the further degradation of the economy and prosperity in general.  

Fair or Foul Tax System

Earlier this year in the Washington Post it was reported that Republican governors were moving aggressively “to cut personal and corporate income taxes, including proposals that would increase reliance on state sales taxes, setting up ambitious experiments in tax reform that could shape what is possible on a national level.”  I think this could make the federal tax system more simple and efficient.  I can see the incentives for the governors to explore this avenue because it would be easier to take advantage of the improving economy and the gradual rebound in revenues.  “In Louisiana, Gov. Bobby Jindal is pushing to repeal the state’s personal and corporate income taxes and make up the lost revenue through higher sales taxes. Gov. Dave Heineman of Nebraska is calling for much the same thing in his state. Gov. Sam Brownback of Kansas wants to keep in place what was supposed to be a temporary increase in the state sales tax to help pay for his plan to lower and eventually end his state’s income tax.”  It seems to me as if all of  these governors don’t really know what type of tax system they want or that will really help the economy grow and prosper; but a few do seem to understand and are advocating that the economy would be better off by focusing taxation on consumption rather than on income.  Taxing consumption would incentivize economic growth because it would encourage more savings and investment.  On the other hand, taxing consumption could increase inequality because it would reduce taxes for the wealthy who which spend far less of their income compared to the lower and middle class.  “The question of whether we should tax income or whether we should tax spending is really a proxy for a different debate,” said Joseph Henchman, vice president for state projects at the Tax Foundation, a conservative-leaning research organization. “Everyone agrees we’ll get more growth with consumption taxes. It’s just that some people prioritize fairness.”  After taking your classes (Power and Prosperity, Urban, Austrian and Finance) I really question the idea of fairness.  If we aren’t breaking a rule or stepping outside of regulations then I don’t think it should be a question of fairness; Fairness has the potential to be way too normative.  As we have acknowledged before, competition is a good thing and I believe taxing consumption would make the state more competitive in finding employers and high-skilled workers; furthermore taxing consumption could simplify our tax system and relieve some pressure for government spending.  Both parties have varied views on this tax system but it seems as if Republicans are pro consumption tax because they believe it is more robust thus helping them get more conservative voters; and Democrats are against it because they think it would harm education, health care and welfare programs because they think the tax system would shift the burden to the lower and middle classes.  I think taxing consumption would be a good thing for the economy, but I don’t know if we will ever be able to enact such a system because as in most cases it will create winners and losers.  It’s a matter of will more winners vote or more losers vote, who knows, the future is unknown and life if dynamic so only time will tell.

http://www.nytimes.com/2013/01/25/us/politics/republican-governors-push-taxes-on-sales-not-income.html?_r=0

Bitcoin: Possible Shortcomings

               The electronic crypto-currency known as Bitcoin is the new hot topic of debate among economists. A year ago, Bitcoin appeared to be little more than a digital novelty, the concept of a completely decentralized digital commodity that individuals all around the world would use as money completely alien to the general populous. The events of the past few months have proven differently,  with Bitcoin's sudden rise in value leading many to hail Bitcoin as the future of money. This claim is not entirely with reason. Bitcoins are superior to conventional currency in many aspects, such as imperishability,  transportability, and divisibility. However, Bitcoin falls short is two key aspects, and only time will tell if these shortcomings will prove to be Bitcoin's ultimate undoing.

                The first aspect Bitcoin falls short in is  ease of use. Few businesses, either digital or brick-and-mortar, accept Bitcoins as payment for goods and services. While that number is starting to increase, current Bitcoin users must rely on digital trading houses, which charge a fee for each transaction, to convert Bitcoins into local currency. Due to the decentralized nature of the Bitcoin system, It is not uncommon for transfers to take an hour or more to process, and the problem will only get worse as new users, and therefore more computers, are added. With no central controlling entity with an incentive to improve the Bitcoin client in order to attract new users, current users are forced to rely  on third party development to improve the system, which can  lead to software conflicts, further decreasing the system's performance.

                The second aspect that may result in the failure of Bitcoin is its presumed inability to be counterfeited. One of the most widely known traits of Bitcoin is its 21 million "coin" cap. The system is purportedly programmed to never pass this limit, ensuring that Bitcoins will never inflate. However,  with this critical task left entirely to the system, and with no governing entity ever vigilant for hackers developing new ways to ensure that the currency cannot be duplicated, it may only be a matter of time before someone finds an ingenious way around the system's safeguards and finds a way to counterfeit bitcoins. Every user has an incentive to be the first to hack Bitcoin's system, for whoever discovers it first will be able to reap a vast sum of money by simply creating and selling as many Bitcoins as possible until the currency inevitably collapses. What makes this even more attractive is the fact that, due to Bitcoin's open-sourced nature,  so long as the hackers find a way to create more Bitcoins instead of stealing, their actions will be perfectly legal.

                Despite these flaws, this does not mean that Bitcoin is a great leap forward in the development of currency. A similar system with a currency cap could be adapted to work under some form of private ownership, which would result in an individual with incentives to actively upgrade and monitor the system in order to attract more users, resulting in greater profits for the owner. So long as the owner is able to prove that he is unable to inflate the currency, the result will be a system that is, in theory, superior to Bitcoin. Such currencies are already in development, and only with time will the market process show what system consumers prefer.   

                                 

A Reflection on Rothbard's "Egalitarianism as a Revolt Against Nature" in Light of Moral and Economic Reasoning

The primary issue with Rothbard's “Egalitarianism as a Revolt Against Nature” is that the primary argument rests on a Straw Man fallacy. To wit: “This means, of course, that equality of all men—the egalitarian ideal—can only be achieved if all men are precisely uniform, precisely identical with respect to all of their attributes. The egalitarian world would necessarily be a world of horror fiction—a world of faceless and identical creatures, devoid of all individuality, variety, or special creativity.” The substance of his argument -that the philosophy of egalitarianism, when taken to its logical conclusion, is morally abhorrent- is, in fact, quite valid. However, Rothbard's reasoning, resting as it does on an inherently fallacious mechanism, requires further expounding in order to be considered a defensible theory.

Primarily, a greater understanding of egalitarianism is required. This philosophy, when carried out, is nearly indistinguishable from hardline communism. Greater equality is seldom intended to mean building the masses up. It is, rather, as C.S. Lewis put it, “democracy in the diabolical sense”: bringing society down to a level that most people are capable of, and not permitting anyone save the rulers to rise above the general limit. This may not -technically- be what egalitarian philosophy professes to desire, but all theories must be viewed in light of the real world, rather than the world of theory. And in the real world, egalitarianism has never been used as a tool for anything save “democracy” in the sense of “you have no right to be better than me”. Indeed, egalitarian movements have historically been dedicated to drumming up support by promising to plunder the wealthy, then proceeding to tear down the edifices of society and proclaim paradise in the rubble. Witness the Soviet revolution, which exterminated the Czar and the upper class of Russia, along with anyone suspected of supporting them. Far from leading to paradise on Earth, this led to mass shortages, famines, and economic devastation.

Furthermore, egalitarianism is morally abhorrent in the lights of Kantianism, Natural Law theory, Utilitarianism, and Virtue Ethics alike. Rothbard has already detailed at length the shortcomings of egalitarian philosophy when compared to Natural Law theory, so I feel little need to launch into any further examination. “The intuitive recognition that men are not uniform, that the species, mankind, is uniquely characterized by a high degree of variety, diversity, differentiation; in short, inequality. An egalitarian society can only hope to achieve its goals by totalitarian methods of coercion; and, even here, we all believe and hope the human spirit of individual man will rise up and thwart any such attempts to achieve an ant-heap world... we recognize that such a world and such attempts are profoundly antihuman; being antihuman in the deepest sense, the egalitarian goal is, therefore, evil and any attempts in the direction of such a goal must be considered evil as well.”

Utilitarianism, in fact, would be the theory one would suspect of having the most in common with egalitarianism. However, even though there is no higher measure of morality than the greatest pleasure for the greatest number under this theory, egalitarianism is inherently antithetical to the philosophy of Utilitarianism. The means by which Man has raised himself from tribal hunter-gatherer societies to the modern industrial age is innovation. Egalitarianism would stifle this innovation that has brought so many benefits to humanity. Rather than plundering the able in order to sustain a brief period of orgiastic delight, it is in the best interests of Mankind to build up innovators so that the rest of society may enjoy the fruits of their labors.

Virtue Ethics and Kantianism, with their emphasis on treating humans as beings with inherent dignity, must of necessity react to egalitarianism with repulsion. It is abhorrent to reward those who have made something of themselves by looting all that they have created in a vainglorious and vain aggrandizement of some redistributionist ideal. Utopia does not, in fact, justify the means, all the more so when this utopia will never be achieved and attempting to do so will lead to nothing but suffering in the short term and ruin in the long term.

Finally, egalitarianism is futile in the economic sense. As I stated in my brief reflection on Utilitarianism above, the celebration of innovation and risk-taking has raised Man to the state he currently enjoys. To act as the ancient Greek despot did and cut down anyone who rises above the general mass is to commit economic suicide. Punish those who attempt to create and raise themselves above the rest, and you get stagnation at best. At worst, you get ruin and collapse. Witness the ruin of every redistributionist state ever attempted. The indolent decline to make any particular exertion, knowing full well that they are protected from the consequences of their laziness and stupidity. Meanwhile, the industrious have little motivation to work any harder than the rest: after all, any excess wealth that they create will be siphoned off in order to uphold the status quo. Only through innovation and, indeed, empire-building (in the economic and industrial sense of the word) can a society enjoy a greater measure of wealth.

Why Handicapping and Egalitarianism are Upsetting

“You play to win the game”, a famous quote by Herm Edwards the retired NFL coach. Is life not also a game? Are individuals not meant to compete to strive to be better than, and beat our counterparts? The reading about egalitarianism seems to indicate that liberals and particularly those following some kind of ethical agenda would rather participate on a level playing field. This prompts the question as to what equality in this sense actually entails. Individuals are inherently born onto different playing fields and thus do not experience the same life chances and cannot possibly compete in life equally. Individuals are born with and or into different body types, cognitive and physical capabilities, geographical regions, religions, wealthy or poor families, or areas with political strife. It is therefore impossible, inconceivable, and uncompassionate to level the playing field of life for all.

“Mankind, is uniquely characterized by a high degree of variety, diversity, differentiation; in short, inequality. An egalitarian society can only hope to achieve its goals by totalitarian methods of coercion; and, even here, we all believe and hope the human spirit of individual man will rise up and thwart any such attempts to achieve an ant-heap world” (Rothbard)

One sport, golf, attempts to level the playing field for players of all abilities to participate. In no other sport is there a system that allows beginners and experts to compete against each other on the same day under the same playing conditions. The handicap system allows a beginner player to compare himself to an experienced player by effectively decreasing the beginners’ score and effectively increasing the score of the experienced player. In theory if both golfers perform to their ability on a given day then they should shoot the same effective score. The problem is that this system hardly ever performs the way it is intended. One player might perform extraordinarily well on the day the two players compete. Life’s bounces might favor one player over another on that day. Perhaps individuals will find a way to take advantage of the system to increase their chances of winning. Ultimately one player will discover a way to gain advantage through the system so that he can win without actually improving his ability to play the game. Ultimately neither competitor will be better off in the long run. This is the result of interference with competition.

            When in sport or life has there ever existed a competition in which one party was handicapped simply to allow the other could compete? What is the purpose of competition if not to discover the better participant? The redistribution of wealth through government policies seems to mimic a handicapping system in which the force attempts to level the playing field. Strokes are collected from the wealthy via taxation and government force and redistributed arbitrarily. Is this a form of compassion, to disadvantage one in order to give advantage to another? Neither party will benefit in the long run. Handicapping, and the redistribution of wealth is a form of pity. Only through uninhibited competition and the free market process is there compassion. You play to win the game, and the real winner is only discovered through competition free of oppressive interference. 

"Let it Be" Money

Money is a curious thing. It is a medium of exchange that represents some store of value. However nearly all money that we know of today does not represent any actual commodity on earth. Nearly all governments operate under a fiat money system. The word fiat is of Latin origin and literally “let it be done”.  Printed government notes do not represent any ownership of anything but are merely accepted as money. The value of printed money is based on the “belief that those who print it will continue to have the power to do so”. It is strange to think that a piece of paper is money and valuable simply because we believe that it is worth something.

            One wonders what the world would be like if tomorrow everyone in the United States stopped believing in the dollar. After all it is just a piece of paper. What if tomorrow everyone decided that we would judge wealth by the amount of water one possesses. This would be intriguing because water is an actual commodity that people will perish without. It would certainly be interesting to watch utility companies turn into banks and issue out notes that corresponded to the amount of water that an individual had stored at the facility. But of course that wouldn’t not work because the rain from the sky would inflate the system and then government force would prohibit the drilling, harvesting or other collection of rain, well water, or other forms of natural precipitation. Unfortunately we don’t know what good money is or could be because government has a monopoly on the coining of money. “To put it into the hands of an institution which is protected against competition, which can force us to accept the money, which is subject to incessant political pressure, such an authority will not ever again give us good money” (Hayek). Regardless of what is good money it is certainly interesting to think of a world without money just as it is to continue living in this world where we are told that a piece of paper has value just because it does.

http://www.youtube.com/watch?v=w2tKg3E53DM