Some Thoughts on Supply-side Economics

 Richard M. Ebeling (03/02/2010)

When Keynes‘s General Theory was published in 1936 there was no reason to believe that it would soon serve as the framework for 40 years of economic theory and policy. Almost to a man, every important economist of that era condemned the book and its message as confused, inconsistent and dangerous.

Joseph Schumpeter compared Keynes‘s proposals with the types of economic policies pursued by France’s Louis XV, which led to the bloodshed of the French Revolution.1 Friedrich Hayek angrily insisted that Keynes was asking us to abandon 200 years of economic theory and return to the crude and naive idea that somehow the more money you create the wealthier you become.2

And Kenneth Boulding declared that

Mr. Keynes’ economics of surprise, like Hitler’s, may be admirable in producing spectacular immediate success. But we need Puritan economists like Dr. Hayek to point out the future penalties of spendthrift pleasures and to dangle us over the hellfire of the long run.3

Yet, by 1946, only ten years after the appearance of The General Theory, all that had changed. Keynesian economics had swept the field and those who refused to accept the new vision were considered as out of date and antiquated as those who still believed that the sun revolved around the earth.

Paul Samuelson could prayerfully give thanks that Keynesian system had given economists, “a Gospel, a Scripture, a Prophet.”4 And Gottfried Haberler, who had once been one of Ludwig von Mises‘s most promising students in the 1920s and early 1930s, could insist that, “Only a dullard or a narrow minded fanatic could fail to be moved to admiration by Keynes‘ genius.”5

Promising price stability, Keynesian monetary policy produced 30 years of ever worsening inflation; pledging an era of full employment, Keynesian contra cyclical manipulations created severe fluctuations and distortions in employment and output, particularly in the last ten years; and assuring the public that the secret to ever greater investment and productivity lies in the government’s fiscal ability to stimulate aggregate demand, the last 20 years has seen productivity increases falling rapidly and capital investment become ever more erratic.

With such a widening margin between promise and performance, a revolt against the Keynesian system was inevitable. The first step in this revolution was the rediscovery of the quantity theory of money. Both Austrian and Chicago economists hammered away at the public and their fellow economists that a prolonged and accelerating rise in prices could never happen without an ever increasing expansion of the supply of money and credit.

How successfully has this truth been learned? James Meade, a leading British Keynesian and Nobel Laureate, gave a lecture in Vienna last year in which he said that a “system of uncontrolled [trade union] monopoly power” combined with a “Keynesian governmental undertaking that, whatever happens to the level of money wages, demand will be stimulated sufficiently to avoid any General Unemployment,” has created a “set of institutions which might well have been expressly designed to set in motion and maintain [a] process of explosive inflation.”6

When one of the leading intellectual advocates of the British Welfare State and the Keynesian system begins to show such grave doubts, we can hope that the era of naive but highly dangerous rationalizations for monetary expansion may be coming to an end.

Another major blow against the Keynesian paradigm is now being leveled by those who call themselves the “supply-side” economists.

Pointing to the low rate of savings in the United States (approximately 3 percent), and the low rate of (real) investment and productivity increases, the “supply-siders” have lifted from a bookshelf long neglected by the Keynesians, the old 19th century classical works that had so cogently argued that only that which has been produced can be consumed and only that which has been saved is available to be invested. With great articulation they have helped bring back to Say’s Law the respect it always deserved and should never have been denied.

All exchange has as its purpose the fulfillment of human wants and desires. We offer to trade something we possess for something held by another because we believe that that which the other person presently has title to would give us greater satisfaction than that which we presently own. Yet, unless we have been the beneficiary of a magnanimous gift giver, the only way to acquire what we want is first to produce or participate in the production of something that other individuals might possibly desire.

That too much of one thing and too little of another might be produced is almost inevitable in a world where the future is uncertain and present productivity must be guided by anticipations of future wants. But through the process of profit and loss, incentives are always being created for producers to supply greater quantities of some goods and less of others. Thus, while a perfect balancing of supply and demand may never exist at any moment in time, that is the tendency that is always at work in the system.

The “supply-side” economists have not only repeated these arguments, but have also attempted to analyze under what conditions it is worthwhile to trade or not to trade, work or not to work, and save or not to save. Individuals, they point out, must compare the relative advantages of doing one thing rather than another, and the alternative that offers the highest anticipated gain will be the one chosen.

In the market place, relative advantages come to be expressed in terms of prices. We enter the supermarket and, given our income, we allocate our expenditures so as to maximize utility or achieve the highest level of satisfaction possible.

If the relative prices of some goods change, we reevaluate our estimations of them and most people will tend to buy a relatively smaller amount of the products that have risen in price and a relatively larger amount of those that have gone down in price. Relative prices, and any changes in them therefore, influence and guide the allocation of income on the part of consumers and the allocation of production on the part of producers.

The same tools of analysis, the “supply-siders” argue, can also be applied to a study of fiscal policy. Tax rates, for example, represent some of the relative prices that an individual has to take into consideration when making a decision.

If an individual is considering working additional hours or is contemplating a new investment or a new device for improving productivity, he must compare the additional revenue or gain that he would receive from carrying out this plan with the additional costs — including taxes — involved.

Thus, “supply-siders” conclude, progressively rising marginal tax rates that take a greater and greater proportion of one’s income will tend to dissuade work, create incentives to move into barter or cash transactions that can avoid the leering eye of the tax collector, and diminish the incentive for saving and investment.

How could work, productivity, saving, investment and greater division of labor be stimulated? By lowering the marginal tax rates, so that at every level of income the proportion remaining in the hands of workers and producers would be larger. Then the relative cost of making a work or saving or investing decision would have fallen and these activities over time would probably be expanded.7

Now, if the “supply-side” argument was left at that, the main thrust of their argument could be considered unobjectionable in its general outline, with few grounds for major disagreement. They would have only more or less supplied the basic tools of price theory to some aspects of fiscal policy.8

An additional ingredient in the tool kit of some “supply-side” theoreticians, however, is the concept of the “Laffer Curve,” named after Arthur Laffer, a USC economist.

Laffer argues that there are two possible tax rates that will generate the same level of government revenue. If taxes are zero, government revenue is zero and the people retain 100 percent of their income. If taxes are l00 percent, government revenue would again be zero because, Laffer says, nobody would bother to work if they were not allowed to keep any of what they had earned and produced.

If the rate of taxation is lowered from l00 percent, individuals would have an incentive to work, since they could now keep some of what they had produced and government revenue would rise from zero to some positive number. Every lowering of the tax rate would continue to induce more and productivity, with greater government revenue besides.

Greater government revenue, that is, until some point at which any further lowering of the tax rate would, in fact, generate less of a government take rather than more. Hence, the “Laffer Curve.”

What, then, is the goal to which economists and politicians should direct their efforts? In The Way The World Works, Jude Wanniski, one of the leading gurus of the “supply-side” school of economics, gives as an answer, the discovery of the actual shape of the “Laffer Curve.”

That part of “The Curve” at which government revenue is maximized should be pinpointed and fiscal policy implemented to assure that the economy is moved to that point without further delay.9

The obvious question is, how do we ever find out the actual shape of “The Curve” and where we are on it?

If, for sake of the argument, we accept that such a “Curve” exists somewhere out there, it is important to realize that it would be nothing more than the cumulative subjective estimations of a multitude of individuals about the relative advantages of work vs. leisure, consumption vs. savings, etc.

“The Curve” would be no more fixed or stable than the expectations and preferences of the individuals in a particular community. Changes in people’s valuations, revisions in expectations about the political, social or economic climate and new discoveries of cost-saving production techniques would all work to make any hypothecated “Laffer Curve,” a shifting, shadowy entity whose position and shape would be as fluid and erratic as the imaginative minds of the individuals who comprise the elements living under “The Curve.”

But even more important than the theoretical difficulties of determining the position and shape of “The Curve” is the assumption that the goal of fiscal policy should be the maximizing of governmental revenues.

The primary trade-off is not seen as that between income kept and income seized via taxation from the public. That analysis is incidental to the main purpose of discovering the tax structure that generates the most revenues for the state coffers, i.e., the incentive structure that entices and induces the slaves to produce the output that assures the maximum booty for the slave-masters and their lackey underlings.

Indeed, the in-fighting and emotional hysteria in Congress over the Kemp-Roth Bill is nothing more than the politicians and the special interests arguing over whether the proposed tax cut will or will not supply the government with ever greater sums to dole out to the friends and favorites of the political court.10

“Supply-side Economics,” as it has developed over the last few years and as it is usually presented when its case is being made, is not a vehicle for diminishing the size of government or expanding the economic liberty of the general public.

Having reached a dead-end in attempts to stimulate the economy on the side of “aggregate demand,” the macroeconomic manipulators have now discovered there is a new set of economic equations that can be massaged on the “aggregate supply” side as well.

Already the economic model builders are busy at work revising their equations and adding more variables. Michael Evans, the designer of two of the leading Keynesian econometric models, has changed over to the “supply-side” school. Having opened a new economic forecasting business, he is designing a new “supply-side” model and is already estimating how much of a percentage cut in tax rates will produce what percentage increase in savings and work effort.11

And after having slowly been shown the light, the economic forecasters working for Congress are licking their chops calculating what tax levers should be pulled, and by how much, to generate revenue and production where the government considers it worthwhile.

Rather than a means for freeing the economy from the fiscal tax burdens of the state, “supply-side” economics may very well serve as the vehicle for what in France has long been called “indicative planning.” Instead of directly ordering the movement of labor and resources from one area of the economy to another, indicative planning operates through a system of tax incentives and subsidy programs to entice business enterprises into certain parts of France and into certain lines of production that the government considers “socially desirable.”12

Supply-side economics could open the door for systematic government manipulation of tax rates as a means to assure the “socially desirable” level of saving and investment and the “socially desirable” combination of work and leisure.

Just as the old Keynesian macroeconomics has been a mechanism for distorting the economy through “aggregate demand” tools, the new “supply-side” macroeconomics will almost certainly result in economic distortions through the use of “aggregate supply” tools.

Tax cuts and lowering of tax rates are desirable. But they are desirable because they would allow those who have earned the income the right to keep and spend it as they see fit. Would savings and investment be greater if personal and corporate tax levels were lower? Probably they would, since existing fiscal actions have set up disincentives for both activities.

But individuals, themselves, should be left free to decide how much to work or not and how much to consume and save. And equally important, entrepreneurial and business activities should be free from regulations and fiscal gimmickry so production can be organized and resources can be allocated to reflect the preferences and desires of income earners in their role as consumers.

There is no “socially desirable” level of work or of saving and investment other than what individuals freely choose as desirable. And unless the case for “supply-side” economic reform is modified to reflect an argument for individual freedom, it may very well serve as a means for even greater state control over the economy and not less.

  • 1.Joseph A. Schumpeter, “Review of The General Theory of Employment, Interest and Money by John Maynard Keynes,” Journal of the American Statistical Association (Dec., 1936), p. 794.
  • 2.Friedrich A. Hayek, The Pure Theory of Capital (London: MacMillan & CO., Ltd., 1941), pp. 409-410.
  • 3.Kenneth E. Boulding, “Review of The Pure Theory of Capital by Friedrich A. Hayek,” Journal of Politcal Economy (Feb., 1942), p. 131.
  • 4.Paul Samuelson, “The General Theory”, in The New Economics, ed. by Seymour E. Harris (New York: Alfred A. Knopf, 1946), p. 147.
  • 5.Gottfried Haberler, “The General Theory,” in The New Economics, ibid., p. 161.
  • 6.James E. Meade, “Stagflation in The United Kingdom,” Atlantic Economic Journal (Dec., 1979). p. 6.
  • 7.Jack Kemp, An American Renaissance: A Strategy for the 1980’s (New York: Harper & Row, 1979), pp.32-76.
  • 8.See Murray N. Rothbard, Power and Market: Government and the Economy (Menlo Park: Institute for Humane Studies, 1970) pp. 63-123, who draws similar conclusions, though with important qualifications.
  • 9.Jude Wanniski, The Way the World Works (New York: Simon and Schuster, 1978), pp. 97-1 15.
  • 10.Arthur B. Laffer & Jan P. Seymour, eds., The Economics of the Tax Revolt (New York: Harcourt Brace Jovanovich: 1979), pp. 45-68.
  • 11.Michael E. Evans, “The Bankruptcy of Keynesian Econometric Models,” Challenge Magazine (Jan.-Fep.., 1980) pp. 13-19.
  • 12.Vera Lutz, Central Planning for the Market Economy, An Analysis of the French Theory and Experience (London: Longmans, Green and Co. Ltd., 1969).

“The Lessons of the 1920–21 Depression” by J. T. Salerno Pace University

The Forgotten Depression is a narrative history of the depression of 1920–21. Although it is informed by a very definite theory—the Austrian business cycle theory—it is not a standard work in applied economics. It does not first present the theory in a rigorous formulation and then move on to apply the theory by adducing pertinent qualitative facts and statistical data to explain a complex historical event such as a depression. It instead proceeds by way of anecdotes and contemporary media accounts, liberally seasoned with telling quotations from politicians, policy makers, economists, business leaders, and other contemporary observers of the unfolding depression. Data on money, prices, and production are inserted at crucial points to keep the reader abreast of the economy’s precipitous decline, but they do not dominate and weigh down the story. James Grant, a masterful stylist, effectively weaves these disparate elements into a seamless and compelling narrative that never flags in pace or wanders off track. The book should appeal to a wide variety of readers, from college students and business professionals to academic economists and policy makers.

By proceeding anecdotally, Grant gives the reader an intimate “feel” for the intellectual milieu prevailing at the time, offering a bracing immersion into an economic paradigm unimaginably alien to contemporary thinking about business cycles. It is for this reason that the book is especially valuable for academic economists whatever their theoretical bent or policy predilections. Grant conveys to the reader a clear understanding of a policy for curing depressions that was nearly universally prescribed in the era before macroeconomic concepts and formulas fastened themselves upon the minds of economists and media opinion molders. This policy is today derisively referred to as “liquidationist.”

To understand the liquidationist position, one must first grasp its foundational concepts and assumptions. In the world of the early 1920s so richly portrayed by Grant, there was no national macroeconomic entity with which economic theory and policy were concerned: “As far as the political-economic mind of 1920 was concerned, there was no ‘U.S. economy.’ And as the economic totality was yet unimagined, so too was the government’s role in directing, managing and stimulating it” (p. 128; see also p. 67). Economists—with a few notable exceptions—did not think of the “price level” as a unitary statistical construct or worry overmuch about its fluctuations. Nor did they try to calculate “aggregate demand” or total spending or even consider either relevant to economic performance. Indeed, for most economists, the core of the market economy was the interdependent system of money prices, including wage and interest rates. Money prices were seen as the foundation for the calculations of revenues, costs, profits, and asset values upon which entrepreneurs based their resource-allocation decisions. Furthermore, it was widely recognized that money prices were in constant flux as they coordinated economic activities in the face of ceaseless change in consumer tastes, business organization, technology, population, labor skills, and so on. As Grant aptly and incisively expresses his theme in the preface, “The hero of my narrative is the price mechanism” (p. 2).

The favorable view of liquidation as a cure for depression thus arose naturally out of the belief that the price mechanism, when left undisturbed, benignly adapts resource allocation and production to the underlying economic realities. As Grant points out, to liquidate, as the term was used at the time, simply meant “to throw on the market” (p. 172). In this sense, “liquidating” labor, inventories, farms, and businesses was a call to allow the price system to operate to discover the configuration of wages, prices, and asset values appropriate to the reemployment of idle resources in the production of goods most urgently demanded by consumers. If this price adjustment incidentally resulted in deflation, then so be it. In lieu of the fictitious concept of a unitary price level, inert and resistant to movement, money prices were conceived as naturally and fluidly (but not instantly) moving up and down like a swarm of bees in flight. The fact that the “price swarm” might be ascending or descending would not inhibit and, indeed, might be required to facilitate necessary changes in the relative positions of money prices. (The metaphor of a “price swarm” wasn’t coined until 1942 by Arthur W. Marget in The Theory of Prices: A Re-examination of the Central Problems of Monetary Theory, 2 vols. [New York: Kelley, 1966, pp. 2:330–36], but it aptly describes the earlier classical-liquidationist view of the value of money.) Deflation presented no special problem because the classical view of the value of money still prevailed. In this view, money’s value was simply the unaveraged array of money prices inverted to reveal the alternative quantities of each good or service that exchanged for the money unit—for example, the dollar. Money prices fluctuated freely, so then must the value of money, which was determined in the same integral market process.

Grant’s judicious choice of quotations shows how pervasive and deeply ingrained was the view that the only sure cure for the depression was deflation and liquidation of overblown resource and asset prices. Here are some examples.

Benjamin Strong, the governor of the Federal Reserve Bank of New York, foresaw the need for deflation and liquidation at the height of the postwar boom in 1919, writing that an anticipated change in Federal Reserve Board and Treasury policy “will insure during the next year or two a very considerable liquidation of our banking position . . . and a considerable decline in the price level” (qtd. on p. 92). The Berkeley economist Adolph C. Miller, a member of the Federal Reserve Board, opined in 1919, “Where there has been inflation, there must follow a deflation, as a necessary condition of economic health,” although Miller doubted that this deflation could and would be done (qtd. on pp. 94–95). Another member of the board and concurrently the comptroller of the currency, John Skelton Williams, in early 1921 viewed the global collapse of commodity prices as “inevitable” and welcomed the day when “the private citizen is able to acquire, at the expenditure of a dollar of his hard-earned money, something approximating the quantity and quality which that dollar commanded in prewar times” (qtd. on p. 118). As Grant concludes, the entire Federal Reserve Board was in remarkable agreement: “A continuing, drastic and perhaps violent rollback in prices, and therefore in wages, was the way forward” (p. 118).

The Federal Reserve Bank of Boston identified “two important conditions precedent to the laying of enduring foundations for the future stability of business, namely, liquidation and deflation … and an increasingly satisfactory banking situation with reserves augmented and loans decreasing [i.e., bank credit contraction]” (p. 120). A. Barton Hepburn, a former comptroller of the currency, also declared for bank-credit contraction and price deflation in 1920, lamenting, “The people of the country have by no means realized as yet the necessity for economy, liquidation of loans and curtailment in the use of credits. We will never be able to bring about the desired deflation until the general extravagance is curtailed” (qtd. on p. 98).

Even some prominent academic economists took up the case for deflation. Professor Edward W. Kemmerer of Princeton University, a leading monetary theorist, vigorously exhorted an audience of bankers in mid-1920, “We must have contraction. . . . We can’t go ahead with our business and make much progress . . . until we get substantial contraction” (qtd. on p. 125 n.).

Politicians also joined the chorus calling for deflation. In his inaugural address in March 1921, President Warren G. Harding perceptively declaimed in its favor, “The economic mechanism is intricate and its parts interdependent, and has suffered the shocks and jars incident to abnormal demands, credit inflations, and price upheavals. . . . Prices must reflect the receding fever of war activities. . . . We must face a condition of grim reality, charge off our losses and start afresh [i.e., liquidate]. It is the oldest lesson of civilization” (qtd. on pp. 135–36).

There was no fear among contemporary observers that, as current macroeconomic jargon would put it, “aggregate supply curves” would shift slowly and painfully to the right because entrepreneurs’ and workers’ expectations would adjust very slowly to the new reality. For liquidationists, in contrast, deflation would proceed very rapidly because bankers, investors, entrepreneurs, and consumers expected it to do so. And they expected it to do so because the intellectual paradigm and the monetary policy regime fostered such expectations. Even though the Fed was up and running, it did not yet see its task as preventing money prices from adjusting to changed conditions of money supply and demand.

Contemporary economic observers also did not fret about the modern specter of a runaway deflationary spiral that might result from plunging prices stoking expectations of further declines in prices and inducing consumers and entrepreneurs to delay purchases into the indefinite future. The reasons they ignored such an eventuality were obvious. First, such an event had never been experienced previously under the gold standard. Second, according to the liquidationist view, credit contraction and deflation was the most expeditious method for realigning money prices and costs, in particular wage rates. It was well understood that capitalists and entrepreneurs did not react to some abstract price level but to actual or expected price margins. Deflation under a freely operating price mechanism did not just lower the height of the price swarm but also deftly reconfigured it so that price margins expanded to the point where entrepreneurial pessimism and malaise gave way to optimism and energetic risk taking.

The liquidationist policy was criticized at the time by a small but notable group of economists, foremost among them Irving Fisher, John Maynard Keynes, and the Swede Gustav Cassel. These economists formulated what came to be known as the “stabilizationist position,” according to which maintaining a constant price level was the necessary and sufficient condition for ridding the economy of business cycles, especially depression and unemployment. For these economists, deflation was “a cruel and colossal blunder” (p. 123). Cassel denied that gradual deflation was possible and foretold that the Fed would not be able to control the rate of descent of prices or the level to which they would tumble. Writing two years after the 1920–21 depression had already ended, Keynes claimed that deflation would induce “everyone in business to go out of business for the time being” and “everyone who is contemplating expenditure to postpone orders so long as he can” (qtd. on p. 124).

In any event, as Grant demonstrates, the liquidationists proved to be correct. Cassel’s dire warning that deflation, once unleashed, would become unhinged from economic fundamentals was not substantiated. And Keynes’s dire assessment of the effect of deflation was proved false two years before he wrote it down. During the depression, total spending or nominal gross national product (GNP) tumbled by 24 percent from $91.5 billion in 1920 to $69.6 billion in 1921, and real GNP shrank by 9 percent. As Grant puts it, there was a “perpendicular plunge in commodity prices,” which never before had “fallen so far and so fast” (p. 182). Both farm prices and wholesale prices plummeted by more than one-third in 1921. Unemployment reached 15.3 percent in 1921. But despite “the breakneck rate of decline” of prices—or rather because of it—the liquidation process came naturally to an end, and prices reached a finite bottom beginning in March 1921. Contrary to Cassel and Keynes, deflation did not continue indefinitely or bring about a cessation of all economic activities and business expenditures. In fact, the U.S. economy entered a remarkably strong and rapid recovery in 1921 (pp. 186–90).

Paradoxically, in the immediate aftermath of its greatest triumph, the liquidationist position was completely discredited and placed beyond the pale of rational discourse. By the mid-1920s, the early Fisher–Keynes macroeconomics of price-level stabilization swept the field in the English-speaking world. Under the sway of this sophisticated brand of monetary crankism, policy makers and politicians deliberately disabled the price mechanism and ensured that less than a decade later a garden-variety recession would be transformed into the tragedy of the Great Depression.

La importancia (creciente) del liberalismo. Algunos libros.

Lista de libros (por Miguel Anxo Bastos)

  1. Mañana el capitalismo, Henri Lepage
  2. La gran ilusión, Norman Angell
  3. Libertad o igualdadKuehnelt Leddihn
  4. El milagro Europeo, Eric Jones
  5. Los orígenes del capitalismoJean Baechler
  6. Derecho legislación y libertad (vol. I, II y III), F.A. Hayek (vol. II, “El espejismo de la justicia social”)
  7. Fundamentos de la libertad, F.A. Hayek
  8. Precios y producción, F.A. Hayek
  9. El capitalismo del pentágono, Seymour Neymar
  10. El manantial, Any Rand
  11. El Estado, Anthony de Jasay
  12. Teoría e Historia, Ludwig von Mises
  13. Socialismo, cálculo económico y función empresarialJesús Huerta de Soto
  14. Auge y decadencia de las grandes potencias, Paul Kennedy
  15. Crítica del intervencionismo, Ludwig von Mises
  16. La envidia igualitaria, Gonzalo Fernández de la Mora
  17. Los errores de la nueva ciencia económica, Henry Hazlitt
  18. Teoría positiva del capital, Eugen von Böhm-Bawerk

Bonus Tracks (en construcción)

  1. La increíble maquina de hacer pan, R.W. Grant
  2. La economía en una lección, Henry Hazlitt
  3. El corazón invisible, Russ Roberts
  4. Un mundo feliz, Aldous Huxley
  5. El mundo de ayer, Stefan Zweig
  6. La miseria del historicismo, Karl Popper
  7. El cisne negro, Nassim N. Taleb
  8. La antropología del capitalismo, Rafael Termes
  9. Gobierno omnipotente, Ludwig von Mises
  10. Dinero, crédito bancario y ciclos económicos, Jesús Huerta de Soto
  11. Historia bancaria de los Estados Unidos, Murray N. Rothbard
  12. Falacias económicas, F. Bastiat
  13. Camino de servidumbre, F.A. Hayek
  14. Antifrágil, Nassim N. Taleb
  15. The Man versus the State, Herbert Spencer
  16. EnsayosMontagne
  17. Civilización, Niall Ferguson
  18. The Cash Nexus, Niall Ferguson
  19. El capital humano, Gary Becker
  20. Capitalismo y libertad, Milton Freedman
  21. Las culturas fracasadas, José Antonio Marina
  22. La fatal arrogancia: los errores del socialismo, F.A. Hayek
  23. The Nature of the Firm, Ronald Coase
  24. The Rational Optimist, Matt Ridley
  25. The Tipping Point, Malcolm Galdwell
  26. The Wisdow of the CrowdsJames Surowiecki
  27. The Commanding Heights, Daniel Yergin y Joseph Stanislaw
  28. Meditaciones, Marco Aurelio
  29. Sobre la brevedad de la vida y la felicidad, Séneca
  30. Cartas a su hijo, Lord Chesterfield
  31. La Mediterránea y los bárbaros del Norte, Luis Racionero
  32. On Human Nature, David Hume
  33. Teoría de los sentimientos morales, Adam Smith
  34. La sociedad abierta y sus enemigos, Karl Popper
  35. The Bourgeois Virtues, Dierdre N. McCloskey
  36. Institutions, Institutional Change and Economic Performance, Douglass North
  37. The Coming of Post-Industrial Society, Daniel Bell
  38. Proceso al Estado, Lorenzo Bernaldo de Quirós
  39. The Great Escape, Angus Deaton
  40. The Tyranny of Experts, Bill Easterly
  41. Governing the Commons, Elinor Ostrom
  42. Thinking Fast and Slow, Daniel Kahneman
  43. A Conflict of Visions, Thomas Sowell
  44. The Counter-Revolution of Science, F.A. Hayek
  45. Individualism and Economic Order, F.A. Hayek
  46. Institutional Foundations of Impersonal Exchange, Benito Arruñada
  47. Adapt, Tim Harford
  48. The Liar’s Poker, Michael Lewis
  49. The Intelligent Investor, Benjamin Graham
  50. Why Nations Fail, Daron Acemoglu y James Robinson
  51. Economic Facts and Fallacies, Thomas Sowell
  52. Knowledge and Decisions, Thomas Sowell
  53. The Theory of Free Banking: Money Supply under Competitive Note Issue, George Selgin
  54. El antiguo régimen y la revolución, Alexis de Tocqueville
  55. El criterio, Jaime Balmes
  56. Reflections on the Revolution in France, Edmund Burke
  57. Good Money, George Selgin
  58. The Great Depression, Murray N. Rothbard
  59. La conquista de la pobreza, Peter T. Bauer
  60. La teoría de la eficiencia dinámica, Jesús Huerta de Soto
  61. Discovery and the Capitalist Process, Israel Kirzner
  62. Bienestar social y mecanismos de mercado, Joaquín Trigo
  63. Competition and Entrepreneurship, Israel Kirzner
  64. Discovery and the Capitalist Process, Israel Kirzner
  65. Las primeras burbujas especulativas, Douglas E. French
  66. Método de las ciencias sociales, Carl Menger
  67. Ensayos políticos, David Hume
  68. La libertad y la ley, Bruno Leoni
  69. Principios de un orden social liberal, F.A. Hayek
  70. Los enemigos del comercio, Antonio Escohotado

Just a Game by Bill Gross

If only Fed Governors and Presidents understood a little bit more about Monopoly, and a tad less about outdated historical models such as the Taylor Rule and the Phillips Curve, then our economy and its future prospects might be a little better off. That is not to say that Monopoly can illuminate all of the problems of our current economic stagnation. Brexit and a growing Populist movement clearly point out that the possibility of de-globalization (less trade, immigration and economic growth) is playing a part. And too, structural elements long ago advanced in my New Normal thesis in 2009 have a significant role as well: aging demographics, too much debt, and technological advances including job-threatening robotization are significantly responsible for 2% peak U.S. real GDP as opposed to 4-5% only a decade ago. But all of these elements are but properties on a larger economic landscape best typified by a Monopoly board. In that game, capitalists travel around the board, buying up properties, paying rent, and importantly passing “Go” and collecting $200 each and every time. And it’s the $200 of cash (which in the economic scheme of things represents new “credit”) that is responsible for the ongoing health of our finance-based economy. Without new credit, economic growth moves in reverse and individual player “bankruptcies” become more probable.

But let’s start back at the beginning when the bank hands out cash, and each player begins to roll the dice. The bank – which critically is not the central bank but the private banking system– hands out $1,500 to each player. The object is to buy good real estate at a cheap price and to develop properties with houses and hotels. But the player must have a cash reserve in case she lands on other properties and pays rent. So at some point, the process of economic development represented by the building of houses and hotels slows down. You can’t just keep buying houses if you expect to pay other players rent. You’ll need cash or “credit”, and you’ve spent much of your $1,500 buying properties.

To some extent, growth for all the players in general can continue but at a slower pace – the economy slows down due to a more levered position for each player but still grows because of the $200 that each receives as he passes Go. But here’s the rub. In Monopoly, the $200 of credit creation never changes. It’s always $200. If the rules or the system allowed for an increase to $400 or say $1,000, then players could keep on building and the economy keep growing without the possibility of a cash or credit squeeze. But it doesn’t. The rules which fix the passing “Go” amount at $200 ensure at some point the breakdown of a player who hasn’t purchased “well” or reserved enough cash. Bankruptcies begin. The Monopoly game, which at the start was so exciting as $1,500 and $200 a pass made for asset accumulation and economic growth, now turns sullen and competitive: Dog eat dog with the survival of many of the players on the board at risk.

All right. So how is this relevant to today’s finance-based economy? Hasn’t the Fed printed $4 trillion of new money and the same with the BOJ and ECB? Haven’t they effectively increased the $200 “pass go” amount by more than enough to keep the game going? Not really. Because in today’s modern day economy, central banks are really the “community chest”, not the banker. They have lots and lots of money available but only if the private system – the economy’s real bankers – decide to use it and expand “credit”. If banks don’t lend, either because of risk to them or an unwillingness of corporations and individuals to borrow money, then credit growth doesn’t increase.The system still generates $200 per player per round trip roll of the dice, but it’s not enough to keep real GDP at the same pace and to prevent some companies/households from going bankrupt.

The system still generates $200 per player per round trip roll of the dice, but it’s not enough to keep real GDP at the same pace.

That is what’s happening today and has been happening for the past few years. As shown in Chart I, credit growth which has averaged 9% a year since the beginning of this century barely reaches 4% annualized in most quarters now. And why isn’t that enough? Well the proof’s in the pudding or the annualized GDP numbers both here and abroad. A highly levered economic system is dependent on credit creation for its stability and longevity, and now it is growing sub-optimally. Yes, those structural elements mentioned previously are part of the explanation. But credit is the oil that lubes the system, the straw that stirs the drink, and when the private system (not the central bank) fails to generate sufficient credit growth, then real economic growth stalls and even goes in reverse.*

Chart I: Annualized U.S. Credit Growth

Chart I: Annualized U.S. Credit Growth

Source: Federal Reserve, Bloomberg.

  • To elaborate just slightly, total credit, unlike standard “money supply” definitions include all credit or debt from households, businesses, government, and finance-based sources. It now totals a staggering $62 trillion in contrast to M1/M2 totals which approximate $13 trillion at best.

Now many readers may be familiar with the axiomatic formula of (“M V = PT”), which in plain English means money supply X the velocity of money = PT or Gross Domestic Product (permit me the simplicity for sake of brevity). In other words, money supply or “credit” growth is not the only determinant of GDP but the velocity of that money or credit is important too. It’s like the grocery store business. Turnover of inventory is critical to profits and in this case, turnover of credit is critical to GDP and GDP growth. Without elaboration, because this may be getting a little drawn out, velocity of credit is enhanced by lower and lower interest rates. Thus, over the past 5-6 years post-Lehman, as the private system has created insufficient credit growth, the lower and lower interest rates have increased velocity and therefore increased GDP, although weakly. Now, however with yields at near zero and negative on $10 trillion of global government credit, the contribution of velocity to GDP growth is coming to an end and may even be creating negative growth as I’ve argued for the last several years. Our credit-based financial system is sputtering, and risk assets are reflecting that reality even if most players (including central banks) have little clue as to how the game is played. Ask Janet Yellen for instance what affects the velocity of credit or even how much credit there is in the system and her hesitant answer may not satisfy you. They don’t believe in Monopoly as the functional model for the modern day financial system. They believe in Taylor and Phillips and warn of future inflation as we approach “full employment”. They worship false idols.

Money supply or “credit” growth is not the only determinant of GDP but the velocity of that money or credit is important too.

To be fair, the fiscal side of our current system has been nonexistent. We’re not all dead, but Keynes certainly is. Until governments can spend money and replace the animal spirits lacking in the private sector, then the Monopoly board and meager credit growth shrinks as a future deflationary weapon. But investors should not hope unrealistically for deficit spending any time soon. To me, that means at best, a ceiling on risk asset prices (stocks, high yield bonds, private equity, real estate) and at worst, minus signs at year’s end that force investors to abandon hope for future returns compared to historic examples. Worry for now about the return “of” your money, not the return “on” it. Our Monopoly-based economy requires credit creation and if it stays low, the future losers will grow in number.

What is the morality of debt?

E. Hadas via Reuters (27/10/2011)

Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts – for example government borrowing in the euro zone and the U.S. – the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?

Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.

But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans that do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.

Libertarians, believers in the right of individual to make their own decisions, have another contribution to the moral discussion. They point out that loans are freely agreed contracts that should be honored. Both sides should understand the possible consequences of their free choices. Borrowers should repay, even if that requires making sacrifices, and creditors who make bad lending decisions should suffer losses.

In the euro zone, some libertarians (and most Germans) consider the borrowers’ obligations to be paramount. The governments of Greece and the other over-extended nations can and should repay all their agreed debts. The citizens just have to work harder and pay more taxes.

Other libertarians take the opposite moral line. Losses are the just punishment for the foolish creditors. And the Aristotelian logic may justify forgiveness. The lent money has mostly been spent unproductively, so the borrowers now have few gains to share with the lenders. The original loans turned out to be unjustly generous to the debtors, but the terms have become unjustly harsh.

Which side has the stronger moral logic? Forgiveness looks right for Greece, where the debts are particularly high and the government and economy are particularly inept. For the rest, it is a closer call.

Turn to the U.S. government, which is building up its own substantial debt pile. The American moral debate on the practice is as old as George Washington, who warned that such debts “ungenerously throw upon posterity the burden which we ourselves ought to bear.” Today, the National Research Council writes of “an unfair and crushing burden on future generations.”

Foreign debts are particularly crushing. Citizens get to spend now on consumption and investment but are obliged to repay foreigners later, with interest. This deferment has produced $4.5 trillion of foreign debt in the U.S., 30 percent of one year’s GDP. That is far less than Greece’s full year of GDP, but enough to worry about.

If the U.S. authorities were committed to full repayment of these foreign debts, they would strive to keep the dollar’s value constant and to avoid inflation. That way, the foreigners would receive not just the contracted dollars but the full agreed economic value. While American authorities may care in theory, they are not concerned enough to refrain from loose monetary policy, which pushes the dollar down.

In this case, pro-repayment libertarians have right on their side. The largest and one of the richest economies in the world – and the issuer of the global reserve currency – is honor-bound to make good on its debts. While the creditors should have noticed that the country was becoming less responsible, their neglect does not excuse American indifference.

For purely domestic U.S. government borrowing, Aristotelian scrutiny is more appropriate. Do the ultimate borrowers, the mostly poor beneficiaries of federal programs, gain enough from these loans to justify the higher taxes that will be needed later to repay the mostly rich lenders? There is no obvious answer to that question, but it is well worth asking.

More generally, philosophical arguments ratify what practical experience teaches. Lenders should be wary about lending to governments. The choice to borrow rather than to raise funds through taxes is usually a sign of political weakness. When the time comes to repay, governments may be unable or unwilling to persuade the people that the sanctity of contracts is a principle worth protecting.

Also, the proceeds of loans to such governments are likely to be spent foolishly. Then full repayment will fail the Aristotelian test of justice. The rioters in Athens may know little about the Ancient Greek philosopher’s doctrine on lending, but they could be protesting in his name.

La economía moral de la deuda

R. Skidelsky (21/10/2014)

Cada colapso económico viene de la mano de una demanda de condonación de deuda. Los ingresos necesarios para saldar préstamos se han evaporado y los activos presentados como garantía han perdido valor. Los acreedores reclaman lo suyo; los deudores piden ayuda a gritos.

Consideremos Strike Debt, un descendiente del movimiento Occupy, que se autodefine como “un movimiento nacional de opositores a la deuda que lucha por la justicia económica y la libertad democrática”. Su sitio web sostiene que, “como consecuencia de los salarios estancados, el desempleo sistémico y los recortes en los servicios públicos”, se está obligando a la gente a endeudarse para obtener las necesidades más básicas de la vida, lo que la lleva a “depositar su futuro en manos de los bancos”.

Una de las iniciativas de Strike Debt, “Rolling Jubilee” (Jubileo Permanente), financiada a través de donaciones populares en Internet, compra y cancela deuda en un proceso que llama “resistencia colectiva a la deuda”. El progreso del grupo ha sido impresionante: lleva recaudados más de 700.000 dólares hasta la fecha y canceló deuda por un valor de casi 18.600 millones de dólares”.

La existencia de un mercado de deuda secundario es lo que le permite a Rolling Jubilee comprar deuda a tan bajo costo. Las instituciones financieras que dudan de la capacidad de sus prestatarios para saldar sus deudas venden la deuda a terceros a precios bajísimos, muchas veces de hasta cinco centavos por dólar. Los compradores luego intentan ganar dinero rescatando parte o la totalidad de la deuda de los prestatarios. Sallie Mae, una entidad crediticia que otorga préstamos a estudiantes en Estados Unidos, admitió que vende deuda reempaquetada por hasta 15 centavos por dólar.

Para llamar la atención ante las prácticas muchas veces perversas de las agencias de cobro de deuda, Rolling Jubilee recientemente canceló deuda estudiantil de 2.761 estudiantes de Everest College, una escuela con fines de lucro cuya empresa matriz, Corinthian Colleges, está siendo demandada por el gobierno de Estados Unidos por otorgar préstamos predatorios. La cartera de préstamos de Everest College estaba valuada en casi 3,9 millones de dólares. Rolling Jubilee la compró en 106.709,48 dólares, o casi tres centavos por cada dólar.

Pero eso es una gota en el océano. Sólo en Estados Unidos, los alumnos deben más de 1 billón de dólares, o aproximadamente el 6% del PIB. Y la población estudiantil es apenas uno de los muchos grupos sociales que viven endeudados.

Por cierto, en todo el mundo, la crisis económica de 2008-2009 aumentó la carga de la deuda privada y pública por igual -al punto de que la distinción público-privado se volvió borrosa-. En un discurso reciente en Chicago, el presidente irlandés, Michael D. Higgins, explicó de qué manera la deuda privada se convirtió en deuda soberana: “Como consecuencia de la necesidad de pedir prestado dinero para financiar el gasto actual y, por sobre todo, como resultado de la amplia garantía extendida a los activos y pasivos de los principales bancos irlandeses, la deuda general del gobierno de Irlanda aumentó del 25% del PIB en 2007 al 124% en 2013”.

El objetivo del gobierno irlandés, por supuesto, era salvar al sistema bancario. Pero la consecuencia no intencionada del rescate fue destrozar la confianza en la solvencia del gobierno. En la eurozona, Irlanda, Grecia, Portugal y Chipre tuvieron que reestructurar su deuda soberana para evitar un incumplimiento de pago rotundo. Los crecientes ratios deuda/PIB empañan la política fiscal, y se convirtieron en la principal justificación para la implementación de las políticas de austeridad que prolongaron la crisis.

Nada de esto es nuevo. El conflicto entre acreedores y deudores ha sido la sustancia de la política desde los tiempos babilonios. La ortodoxia siempre ha defendido los derechos sagrados del acreedor; la necesidad política frecuentemente exigió el perdón para el deudor. Cuál es el lado ganador en determinada situación depende de la magnitud de la aflicción del deudor y la fuerza de las coaliciones opositoras de acreedores y deudores.

La moralidad siempre ha sido la moneda intelectual de estos conflictos. Los acreedores, al afirmar su derecho a cobrar la totalidad de la deuda, históricamente han creado todos los obstáculos legales y políticos posibles para el default, insistiendo con sanciones duras -embargo de ingresos, por ejemplo, y, en situaciones extremas, cárcel o hasta esclavitud- por la imposibilidad de los prestatarios de honrar sus obligaciones de deuda. Siempre se pretendió que los gobiernos que incurren en deuda en guerras costosas aparten “fondos de amortización” anuales para poder saldarla.

La moralidad, sin embargo, no siempre estuvo enteramente del lado del acreedor. En idioma griego del Nuevo Testamento, deuda significa “pecado”. Pero, aunque pueda ser pecaminoso endeudarse, Mateo 6:12 respalda la absolución: “perdónanos nuestras deudas, así como nosotros perdonamos a nuestros deudores”. La resistencia social generalizada a los reclamos de los acreedores sobre la propiedad de los deudores por no pagar implicó que rara vez se llevara la “ejecución” al extremo.

La posición de los deudores se vio aún más fortalecida por la prohibición de la usura -cobrar un interés irracionalmente alto por el dinero-. Los topes a las tasas de interés fueron abolidos en Gran Bretaña recién en 1835; las tasas casi cero de los bancos centrales prevalecientes desde 2009 son un ejemplo actual de los esfuerzos por proteger a los prestatarios.

La verdad de la cuestión, como señala David Graeber en su majestuoso Deuda: los primeros 5.000 años, es que esa relación entre acreedor y deudor no encarna ninguna ley de hierro de moralidad; más bien, es una relación social que siempre debe ser negociada. Cuando la precisión cuantitativa y una estrategia inflexible frente a las obligaciones de deuda son la regla, lo que sobreviene de inmediato es el conflicto y la penuria.

En un esfuerzo por frenar las crisis de deuda recurrentes, las sociedades tradicionales abrazaron la “Ley de Jubileo”, un borrón y cuenta nueva ceremonial. “La Ley de Jubileo”, escribe Graeber, “estipulaba que todas las deudas se cancelaran automáticamente ‘en el año del Shabat’ (es decir, después de que hubieran pasado siete años) y que todos los que languidecieran en cautiverio debido a esas deudas fueran liberados”. Rolling Jubilee es un recordatorio oportuno de la continua relevancia de una de las leyes más antiguas de la vida social.

La moraleja del cuento no es, como aconsejó Polonio a su hijo Laertes, “no seas ni prestatario ni prestador”. Sin ambos, tal vez la humanidad todavía estaría viviendo en cavernas. Necesitamos, más bien, limitar la oferta y la demanda de crédito a lo que la economía es capaz de producir. Cómo lograrlo y al mismo tiempo mantener la libertad de empresa es uno de los grandes interrogantes sin resolver de la economía política.

The Nonexistent “Social Costs” of a Gold Standard System

Nathan Lewis via Forbes

One of the odd notions that has come down through the years is that a gold standard system has “social costs.” It does not. It creates a profit.

Of course, it does take effort to dig gold out of the ground. However, gold production never ceased after the end of the world gold standard in 1971. Roughly half of all the gold ever mined, in all of history, has been mined after 1971. Annual production today is the highest in history, and about double what it was in 1970. People seem happy to continue paying those “costs.”

If one is to use gold coins, then someone needs to pay for this gold. Who pays? Is it “everyone”? The government? Taxpayers? Who?

Let’s say an economy uses gold coins only. There is no paper money. (For simplicity, we will also assume no banks.) Someone works all week and gets a one-ounce gold coin in payment on Friday. The person has “paid” for this coin with a week’s worth of work.

Now, let’s have an economy with no gold coins, just paper banknotes linked to gold. Let’s say there’s a banknote worth one ounce of gold. (The U.S. $20 banknote, before 1933, was worth about 0.97 of an ounce of gold.) Someone works all week, and gets a banknote worth one ounce of gold in payment on Friday.

The “cost“ to the person of the gold coin and the banknote are the same. One week of work.

The government is in much the same situation. Whether its taxes are paid in coinage or in banknotes, the outcome is about the same.

The difference is at the currency issuer – the producer of the banknotes, which would be a central bank today. Let’s say that the currency issuer has a “100% reserve” system. For every banknote, there is an equivalent amount of gold in a vault.

This situation is not much different than where gold coinage was used exclusively. The amount of gold is the same.

Now, let’s say that the currency issuer has a 20% reserve, which was a typical level among private currency issuers in the U.S. during the 19th century. The other 80% of reserves consists of interest-bearing debt. Today, that would most likely be government bonds.

The amount of gold used by the monetary system has now fallen by 80%, replaced by interest-bearing bonds. The interest income from the bonds produces a profit for the currency issuer.

If you had a floating fiat paper currency, with no gold at all, the “cost” of the money would still be the same – a week’s worth of work. However, the assets of the currency issuer could be 100% interest-bearing debt.

Thus, we see that the “cost” of the money is the same in all cases – a week’s worth of work. The question is the “profit.” In a 100% bullion reserve system, there is no profit. However, with a 20% reserve system, there is quite a bit of profit. This profit accrues entirely to the currency issuer – today, a central bank.

We can also see that the profit enjoyed by the currency issuer doesn’t really change much, from a 20% bullion reserve/80% debt gold standard system and a 100%-debt system. The difference is only the 20% portion. The other 80% is identical. (In practice, today’s central banks still hold gold bullion reserves.) So, the gold standard system’s profitability is actually much the same as the floating fiat system’s profitability.

Some economists – including David Ricardo, in 1817 – have suggested ways of operating a gold standard system with no gold bullion reserves at all. The “gold exchange standards”, or currency-board systems, common in the 20th century, were one example of this. They are “100% debt” systems.

I suggest that you shouldn’t be too concerned about maximizing the profitability of central banks. They can look after it well enough themselves.

Concern yourself with the quality of the currency. For nearly two centuries, 1789 to 1971, the U.S. embraced the principle of gold-based money, and became the world’s economic superpower. Money was simple, stable, reliable and predictable. Despite short-term setbacks, the middle class grew steadily wealthier, generation after generation.

Today’s economists talk a big talk, but in the past forty-five years of floating currencies, have they ever been able to produce that kind of result? Mostly, they just bounce from one crisis to another, blowing bubbles along the way and leaving a train of wreckage in their wake. Have they learned anything? They seem to have gotten pretty good at “kicking the can”, avoiding a minor crisis with further distortions that lead to a bigger crisis later.

I think that there will eventually be a big enough crisis that people say: “Enough is enough. You’ve had your chance. Now it is time for you to go.” But before then, we will have to know what we will replace them with.