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Economics Is Simple

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another old essay

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A notable feature of Mises's analysis of "interventionism" — of government intervention in the economy — is that it is fundamentally what could now be called "ecological"; for it shows that an act of intervention generates unintended consequences and difficulties, which then present the government with an alternative: either more intervention to "solve" these problems, or repeal of the whole interventionist structure.

In short, Mises shows that the market economy is a finely constructed, interrelated web; and coercive intervention at various points of the structure will create unforeseen troubles elsewhere. The logic of intervention, then, is cumulative; and so a mixed economy is unstable — always tending either toward full-scale socialism or back to a free-market economy. The American farm-price support program, as well as the New York City rent-control program, are almost textbook cases of the consequences and pitfalls of intervention.

Indeed, the American economy has virtually reached the point where the crippling taxation; the continuing inflation; the grave inefficiencies and breakdowns in such areas as urban life, transportation, education, telephone and postal service; the restrictions and shattering strikes of labor unions; and the accelerating growth of welfare dependency, all have brought about the full-scale crisis of interventionism that Mises has long foreseen.

The instability of the interventionist welfare-state system is now making fully clear the fundamental choice that confronts us between socialism on the one hand and capitalism on the other. Perhaps the most important single contribution of von Mises to the economics of intervention is also the one most grievously neglected in the present day: his analysis of money and business cycles. We are living in an age when even those economists supposedly most devoted to the free market are willing and eager to see the state monopolize and direct the issuance of money. Yet Mises has shown that

1.there is never any social or economic benefit to be conferred by an increase in the supply of money;

2.the government's intervention into the monetary system is invariably inflationary;

3.therefore, government should be separated from the monetary system, just as the free market requires that government not intervene in any other sphere of the economy.

Here Mises emphasizes that there is only one way to ensure this freedom and separation: to have a money that is also a useful commodity, one whose production is like other commodities subject to the supply and demand forces of the market. In short, that commodity money — which in practice means the full gold standard — shall replace the fiat issue of paper money by the government and its controlled banking system.[8]

Mises's brilliant theory of the business cycle is the only such theory to be integrated with the economists' general analysis of the pricing system and of capital and interest. Mises shows that the business cycle phenomenon, the recurring alternations of boom and bust with which we have become all too familiar, cannot occur in a free and unhampered market. Neither is the business cycle a mysterious series of random events to be checked and counteracted by an ever-vigilant central government. On the contrary, the business cycle is generated by government: specifically, by bank credit expansion promoted and fueled by governmental expansion of bank reserves.

The present-day "monetarists" have emphasized that this credit expansion process inflates the money supply and therefore the price level; but they have totally neglected the crucial Misesian insight that an even more damaging consequence is distortion of the whole system of prices and production.

Specifically, expansion of bank money causes an artificial lowering of the rate of interest, and an artificial and uneconomic overinvestment in capital goods: machinery, plant, industrial raw materials, and construction projects. As long as the inflationary expansion of money and bank credit continues, the unsoundness of this process is masked, and the economy can ride on the well-known euphoria of the boom; but when the bank credit expansion finally stops, and stop it must if we are to avoid a runaway inflation, then the day of reckoning will have arrived.

For without the anodyne of continuing inflation of money, the distortions and misallocations of production, the overinvestment in uneconomic capital projects, and the excessively high prices and wages in those capital goods industries become evident and obvious. It is then that the inevitable recession sets in, the recession being the reaction by which the market economy readjusts itself, liquidates unsound investments, and realigns prices and outputs of the economy so as to eliminate the unsound consequences of the boom. The recovery arrives when the readjustment has been completed.

"The Mises theory shows that business cycles are generated by the inflationary policies of government and that, once underway, the best thing that government can do is to leave the economy alone."

It is clear that the policy prescriptions stemming from the Misesian theory of the business cycle are the diametric opposite of the "post-Keynesian" policies of modern orthodox economics. If there is an inflation, the Misesian prescription is, simply, for the government to stop inflating the money supply.

When the inevitable recession occurs, in contrast to the modern view that the government should rush in to expand the money supply (the monetarists) or to engage in deficit spending (the Keynesians), the Austrians assert that the government should keep its hands off the economic system — should, in this case, allow the painful but necessary adjustment process of the recession to work itself out as quickly as possible.

At best, generating another inflation to end the recession will simply set the stage for another, and deeper, recession later on; at worst, the inflation will simply delay the adjustment process and thereby prolong the recession indefinitely, as happened tragically in the 1930s. Thus, while current orthodoxy maintains that the business cycle is caused by mysterious processes within the market economy and must be counteracted by an active government policy, the Mises theory shows that business cycles are generated by the inflationary policies of government and that, once underway, the best thing that government can do is to leave the economy alone.

In short, the Austrian doctrine is the only consistent espousal of laissez-faire; for, in contrast to other "free market" schools in economics, Mises and the Austrians would apply laissez-faire to the "macro" as well as the "micro" areas of the economy.

If interventionism is invariably calamitous and self-defeating, what of the third alternative: socialism? Here, Ludwig von Mises is acknowledged to have made his best-known contribution to economic science: his demonstration, over fifty years ago, that socialist central planning was irrational since socialism could not engage in that "economic calculation" of prices indispensable to any modern, industrialized economy.

Only a true market, based on private ownership of the means of production and on the exchange of such property titles, can establish such genuine market prices, prices which serve to allocate productive resources — land, labor, and capital — to those areas which will most efficiently satisfy the demands of consumers. But Mises showed that even if the government were willing to forget consumer desires, it could not allocate efficiently for its own ends without a market economy to set prices and costs. Mises was hailed even by socialists for being the first to raise the whole problem of rational calculation of prices in a socialist economy; but socialists and other economists erroneously assumed that Oskar Lange and others had satisfactorily solved this calculation problem in their writings of the 1930s. Actually, Mises had anticipated the Lange "solutions" and had refuted them in his original article.[9]

It is highly ironic that no sooner had the economics profession settled contentedly into the notion that Mises's charge had been refuted, than the Communist countries of Eastern Europe began to find, pragmatically and much against their will, that socialist planning was indeed unsatisfactory, especially as their economies were becoming industrialized. Beginning with Yugoslavia's breakaway from state planning in 1952, the countries of Eastern Europe have been heading with astonishing rapidity away from socialist planning and toward free markets, a price system, profit-and-loss tests for enterprises, and so on. Yugoslavia has been particularly determined in its cumulative shift toward a free market and away even from state control of investments — the last government stronghold in a socialistic economy. It is unfortunate but not surprising that, neither in the East nor in the West, has Ludwig von Mises's name been brought up as the prophet of the collapse of central planning.[10]

If it is becoming increasingly evident that the socialist economies are collapsing in the East, and, on the other hand, that interventionism is falling apart in the West, then the outlook is becoming increasingly favorable for both East and West to turn before very long to the free market and the free society. For this courageous and devoted champion of liberty, there could be no more welcome prospect in his 90th year.

But what should never be forgotten is that these events are a confirmation and a vindication of the stature of Ludwig von Mises, and of the importance of his contribution and his role. For Mises, almost single-handedly, has offered us the correct paradigm for economic theory, for social science, and for the economy itself, and it is high time that this paradigm be embraced, in all of its parts.

There is no more fitting conclusion to a tribute to Ludwig von Mises than the moving last sentences of his greatest achievement, Human Action:

The body of economic knowledge is an essential element in the structure of human civilization; it is the foundation upon which modern industrialism and all the moral, intellectual, technological, and therapeutical achievements of the last centuries have been built. It rests with men whether they will make the proper use of the rich treasure with which this knowledge provides them or whether they will leave it unused. But if they fail to take the best advantage of it and disregard its teachings and warnings, they will not annul economics; they will stamp out society and the human race.[11]

Thanks in no small measure to the life and work of Ludwig von Mises, we can realistically hope and expect that mankind will choose the path of life, liberty, and progress and will at last turn decisively away from death and despotism.

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not a fan of lincoln bill

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A Student's Guide to Economic History

[How Capitalism Saved America: The Untold History of Our Country, From the Pilgrims to the Present. By Thomas J. DiLorenzo. Crown Forum, 2004. 295 pages.]

How Capitalism Saved America

In the title of a famous essay written in 1906, Werner Sombart asked, Why Is There No Socialism in the United States? Whether one agrees with his analysis, his premise cannot be disputed: socialism has never enjoyed much of a following in America, except of course among intellectuals. In his vigorous and excellent defense of capitalism, Thomas DiLorenzo dispatches this group of what C.D. Broad called the "clever silly" with entirely appropriate concision.

His principal target lies elsewhere. Most opponents of capitalism profess to be its defenders. The market is fine, these opponents say, so long as the firm hand of government guides it. DiLorenzo is concerned to combat one particular variety of this malign species.

Throughout the course of American history since the Constitution was adopted, political groups have sought to yoke the free market to a program of economic nationalism and governmentally directed growth. Alexander Hamilton, Henry Clay, and Abraham Lincoln rank as major names in this tradition, and DiLorenzo discusses with great acuity the policies of these figures. (Readers of his earlier outstanding study, The Real Lincoln, will find here the essential background for his condemnation of that false friend of freedom.)[1]

Unfortunately, nationalist mercantilism did not die with Lincoln, and DiLorenzo shows its influence on Franklin Roosevelt, whose economic policies manifested more than a slight tinge of fascism. The opponents of capitalism, both socialists and mercantilists, ignore the fact that laissez-faire capitalism is the indispensable means to prosperity.

Why are intellectuals the glaring exception to Sombart's generalization? DiLorenzo identifies a prime motive:

Perhaps the single most important reason why the intellectual class favors socialism is that it denounces the material inequality it sees as intrinsic to a capitalist economy. The socialist intellectuals' ideal is material equality — why should some be better off financially than others? (pp. 30 – 31, emphasis in original)

DiLorenzo's response is simple and effective. The attempt to enforce equality violates human nature. The "disparities in income and standard of living in any economy reflect human nature itself … no two people are the same in terms of ambition, aptitude, intelligence, skill, and so much more" (p. 31). The natural tendency to inequality, which DiLorenzo (following Michels) terms the Iron Law of Oligarchy, by no means disappears in socialist societies. Quite the contrary, it is exacerbated, and in the countries of the Soviet bloc an elite class prospered while the masses lived in poverty.

This is of course a mild understatement. Stalin and Mao rank among the worst of the world's tyrants, a fact that DiLorenzo reminds us did not prevent Western intellectuals of great repute from fawning praise of them.

W.E.B. Du Bois … thought Stalin was a perfect gentleman who "asked for neither adulation nor vengeance. He was reasonable and conciliatory." (p. 37)

A critic of capitalism such as John Rawls might respond to our author in this way: True enough, the pursuit of equality can be carried too far, and the imperatives of human nature must always be kept in mind. But must any attempt to tame the inequalities of the market fail? Why not an egalitarian policy that respects the power of incentives? How can we ignore the philosophical arguments that mandate equality, to the greatest extent possible?

DiLorenzo does not directly address these philosophical arguments. They are not his topic, and in any case they lack merit.[2] Rather, his response would, I think, reiterate his central theme. Capitalism is an immensely productive system: if left to itself, it will generate prosperity and provide goods and services that the masses demand.

The superiority of capitalism to any alternative system admits of no rational doubt. DiLorenzo appeals in this connection to evidence from various economic freedom indexes, such as the one published by the Fraser Institute in Canada. "These indexes show a strong correlation between the degree of economic freedom in a country and economic growth" (p. 24).

The connection between prosperity and capitalism is of course no recent phenomenon. From the days when the attempts at communal production in the Jamestown and Plymouth settlements led to famine and death, episodes to which DiLorenzo devotes a chapter, a simple thesis has proved true. The market works, and interference with it does not.

In relying on the manifest facts of history, DiLorenzo has not abandoned his Austrian credentials by discarding theory for a mere recital of facts and "empirical correlations," in the style of econometrics. Quite the contrary, he explains quickly and skillfully a basic point of Austrian theory. Capitalism is, in Mises's phrase, a system of "mass production for the masses." Consumer demand determines what it will be profitable to produce, and alert entrepreneurs gain at the expense of those less able to fulfill consumers' requirements.

The historical success of capitalism is no accident. Rather, follows at once from a readily graspable but incontrovertible argument.

However, this does not stop various groups from their efforts to tinker with the market. In their foolish attempts to "improve" the only workable economic system, they inevitably make matters worse.

The struggle between one such group of "improvers" and their antagonists forms a dominant theme of pre – Civil War American history. Alexander Hamilton inaugurated a program, unfortunately highly influential, in which a powerful federal government in pursuit of its own ends distorted the choices of the market. He "favored the mercantilist policies of protectionist tariffs, taxpayer subsidies for private road- and canal-building corporations, and a government-run monetary system that could finance such patronage" (p. 73).

Hamilton faced vigorous opposition from Thomas Jefferson and his many followers, who recognized the fallacies of Hamiltonian mercantilism. As DiLorenzo points out, the Jeffersonians hammered home the connection between a strong national government and mercantilism. Probably the foremost of such Jeffersonians was John Taylor; he believed that "states' rights were an indispensable tool for opposing mercantilist policies" (p. 75).

The Hamiltonians wanted a governmentally guided economy; the Jeffersonians did not. Who was right? The answer comes as no surprise. The policy of internal improvements, promoted by Henry Clay and other proponents of his American System, failed disastrously.

Starting in the late 1830s, many states subsidized the construction of canals and railroads — and the subsidies invariably turned out to be disastrous. … The failures of government-subsidized internal improvements were so pronounced that by 1860 Missouri and Massachusetts were the only two states in the union that had not yet amended their constitutions to prohibit internal improvement subsidies. (p. 88 – 91, emphasis in original)

But is not the free market inherently unable to provide such public goods as highways? DiLorenzo expertly turns aside the elaborate models of welfare economists who argue for "market failure." In numerous cases, roads and canals were built privately. The arguments for market failure resemble the supposed proof offered by Simon Newcomb, shortly before the Wright brothers' flight, that travel by air was impossible.

The manifest mistakes of the American System did not deter Abraham Lincoln from vigorous promotion of high tariffs and even more "improvements." DiLorenzo sees this as the key to Lincoln's career. Far from being a champion of human freedom, Lincoln aimed to subordinate the states to his program of economic nationalism.

The election of Abraham Lincoln was, among other things, the triumph of mercantilism in America. The American economy has featured what might be called creeping mercantilism ever since. (pp. 44 – 45)

Franklin Roosevelt proved an able student of Lincoln and the Hamiltonians, and in his case, economic nationalism bore disturbingly close parallels with fascism. DiLorenzo notes that Roosevelt's National Recovery Act "was essentially modeled after the Italian fascist system" (p. 191). Like Mussolini, Roosevelt sought to establish boards to set prices in each of the major industries. Once more, a leading politician proved unable or unwilling to accept the truth that free-market capitalism works.

Defenders of Roosevelt will counter DiLorenzo by claiming that the Great Depression forced Roosevelt's hand. How can one argue that the free market should operate unhindered when it led to disaster in 1929 and the ensuing years?

DiLorenzo easily turns aside this pernicious myth. Following Murray Rothbard's definitive America's Great Depression, he notes that Herbert Hoover's intervention in the market prevented a natural adjustment to the collapse of the artificial credit boom of the 1920s. Hoover's efforts to keep wages high insured continued mass unemployment, and Roosevelt continued his predecessor's misguided policy. After the Supreme Court, in one of its last bouts of sanity, declared the NRA unconstitutional, the floundering president put forward one foolish scheme after another, but none was able to rescue the economy from state-created chaos.

The efforts under the NRA to cartelize the economy were ironic, in view of the fact that a principal complaint against the free market since the 1890s was that it led to control of the economy by giant monopolies, whose pricing policies harmed consumers. Only small businesses, reformers alleged, could save consumers from exploitation by John D. Rockefeller of Standard Oil and other "malefactors of great wealth" like him.

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