The Fiscal Cliff and the Whole Context

These days we are swamped with TV and internet coverage of the fiscal cliff scheduled to occur on January 1st. What the cliff amounts to is a reduction in government deficit spending, which in itself is a good thing. But, since the deficit would still be astoundingly and disastrously large, the cliff isn’t as big a deal as one would wish. That the “cuts” are in fact just reductions in the rate of spending increases and not reductions in spending, it is clear that the whole thing is mostly a sham (e.g., see).

On the other hand, since the reduction in the deficit would be mostly tax hikes, the pain would fall on the productive population. In the context of the economy, it is spending that needs to be reduced. An increase in taxes would be an additional drag on the economy, increase the rate of the decline of our standard of living, and enhance the movement toward destruction of rights and the importance of the individual in our society. What happens with the fiscal cliff could hasten the slide toward a fate like Greece or Spain. We really don’t want that to happen. Of the options that Obama seems to accept, i.e., no deal or higher tax on high incomes levels and no spending cuts, I find it hard to choose. There is some indication that BO wants a limited increase in taxes and increases in spending, which could be worse.

But the fiscal cliff is just part of the problem: the hoopla over the “fiscal cliff” provides a smoke screen covering additional pending disasters for our economy, namely, the beginning of the implementing of ObamaCare taxes and regulations, and the coming tidal wave of Dodd-Frank and other anti-business regulations.

Quite possibly the impact of Dodd-Frank will dwarf the fiscal-cliff. It has already drastically restructured parts of the financial community. There are many regulations still to be issued from Dodd-Frank (many are already late) and they all are intended on reducing the range of options of a financial institution, which will lower its profitability, more tightly limit its decision making capability, and reduce its ability to fund American production.

ObamaCare has many elements (some still little known) that will be instituted in 2013 that will raise business costs, lower employment, and cause further problems with health insurance and medical costs. All of these together, including whatever nonsense ends up as the “solution” to the fiscal cliff, will mean slower growth, or possibly recession for the US economy (which won’t be good for the world economy either).

Think what that will mean for the federal deficit and budget.

We have seen many projections as to when the federal revenue will equal the sum of interest payments on debt, Social Security, and Medicare, in other words, severe problems with funding the government and retaining the appearance of the safety of government debt. If you look closely at each, I expect that you will see that the assumptions include some growth in the US economy and that there will be a significant number of people paying the Social Security and Medicare taxes. But, with four more years of BO and the total number of people employed remaining low (as opposed to actually producing; and as opposed to the unemployment figures that are meaningless), tax revenue, including FICA, is not going to grow while the interest on federal debt, even at today’s absurdly low levels, Social Security and Medicare demands will grow rapidly. The only way to pay for defense and the astounding number of programs the federal government supports, is to constantly grow the deficit. It is also possible that Obama will try to raise taxes, but that may be too obviously destructive for today’s population.

The federal deficit will be the tipping point, but the real cause of death for our economy is the restrictions on doing business and producing. The arguments about spending and deficits need to begin including emphatic emphasis on the disaster of regulation.

For us, the unwilling and resisting passengers on this train into the tunnel of death, it means that we need to arrange our thinking to prepare personally and philosophically. I will leave to you the personal preparations (I am thinking about a potential blog post on this topic.)

Philosophically, we need to emphatically tell anyone we can that the coming mess is not the result of capitalism or selfishness (maybe we can equate blaming the Jews in Germany after WW1 with blaming capitalists). That is in addition to the stuff we are already doing, e.g., focusing on helping ARI and other similar activities and aiming at the destructive educational system we have.

And now for a final comment that is going to be a theme for me:

Understanding the Objectivist philosophical method is vital to anyone concerned about his freedom, as well as his life in general, of course. Recently I have been getting my own intense reminder. I have been reading Understanding Objectivism and The DIM Hypothesis. I want to emphatically recommend these books. If you want to understand an individual’s mental functioning, UO is the book to read. It is also helpful in leading up to the other one. To better understand the trends and conflicts in our own situation here in the US, The DIM Hypothesis is absolutely necessary. It is very philosophical. But philosophy matters, and our conflicts today are philosophical. For your own sake, read them.

Basic Economics: Savings Accounts

Looking at the modern relationships between interest rates, taxes, and price inflation, I have wondered why anyone would put money into savings accounts or buy bonds, especially U.S. government bonds. A savings account, earning 1.6% (The top rate offered by my credit union recently.), after taxes of say 20% and price inflation of 2% gives you a guaranteed annual loss of 0.72%! The situation for bonds isn’t that much better, if at all. For someone with a higher income, with higher tax rates, the loss is substantially greater .

On the other hand, I know that savings accounts have historically been the primary savings vehicle in the U.S. I know from 100 Voices that Ayn Rand held her money from the sales of her novels in savings accounts. What is the difference between then, even as late as the 1970s and the 1990s, which is when I first realized the problem.

In thinking about this issue, one of the first things I saw is that interest rates have been declining as a trend since the spike in 1990. At that time I had a mortgage at 10.75%. The decline in interest rates since then has been the consequence of the Fed’s view that below market interest rates on loans encourages consumption and business activity and that if they don’t have the economic activity that they want, they decide they should lower rates more. Each round of recession and boom and financial crisis over the last twenty plus years has seen the Fed pushing short-term interest rates lower and lower. Today, the short-term rates are about as low as then can go. The rate the Fed controls directly, the rate it charges banks to borrow overnight funds for their Fed “reserves” (deposits) is zero to 0.25%. (Some recent auctions of German government short-term bonds have seen negative interest rates.) And, for the third time since 2009, they are trying to lower medium and long-term rates with “quantitative easing.”

So, first, the problem I am seeing is a very recent event. What are some of the consequences?

First there is the complete disassociation of savings and capital. The creation and use of capital is a vitally important activity in an economy. The creation and use of capital causes prosperity, not to mention the survival of our population. A population as large as ours cannot survive (or occur) without industrialization. Just to maintain industrialization requires capital. Economies either grow or contract. There is no equilibrium.

Over the last twenty years the number of households that have ownership in corporations, i.e., own stocks, has gone up significantly. One major reason is that people recognize that they have to have a more rapid growth in their retirement savings than can be provided by bank savings accounts. The need is two fold. With taxes and other restraints on creating wealth, they are not able to save enough. And then, price inflation has a double impact in that not only will it make the process of saving enough difficult, but it will also make the amount the retiree needs to live increase significantly and unpredictably. Even a 2% price inflation rate is a danger. That means that in just twenty years, a retiree would need 25% more cash for the same standard of living. Since many retirees live longer than that in retirement, and the percentage of people with such long lives is growing, the impact of even small amounts of price inflation is significant and ignored by the government planners. Bernanke has recently remarked that the effect of the Fed’s goal of 2% price inflation on retirees is unimportant in policy decisions.

You might think that a higher percentage of stockownerships is good for the economy. I’m not so sure. I was, but my view is changing. There is a difference between creating capital and owning existing capital. Saving and putting your money directly into a new or growing business is creating capital. Buying a stock from another owner is not.

Consider what should happen when you put your money into a bank savings account. (I am going to ignore the consumer loans and the loans to business for normal business activities.) Businesses come to banks for the purpose of borrowing money to start a new business or grow their existing company. This is the direct application of capital, i.e., new productive activity. Here we also see the division of labor at work. The person who saved the capital is engaged in his own profession or job and by saving, he is putting money into the hands of the banker whose profession is apprising risk and opportunity in expanding production. Then there are the businessmen who compete for funds by presenting their plans and expectations of profit.

The normal person does not have the expertise to appraise business opportunities. (Although in a rational culture he would have a better understand of the reality of business activity than people do today.) This is true in the case where people already know something about the industry. Some financial writers have advised investors to place their money in industries in which they are familiar. It isn’t a bad idea, but it does not address the additional need to be able to appraise the financial, managerial, and competitive strength of a company. Correctly understanding the context for investing is difficult enough for the professional, especially in today’s complex economy. For those who do not have the relevant education, experience or time, the prospects are very poor. No wonder everyone is so hopped up on the gambling metaphor for investing.

The need for non-professional investors to put their savings into asset markets is part of the make-up of the two recent booms: tech stocks and residential real estate. Without the amateur investor, both booms would have been less dramatic. Note that many of these investors lost lots of money, right along side the so-called professionals. This is over and above the normal losses that the non-professional investor tends to lose in the normal course of events. Some professionals use the activity of the individual investor as a contra indicator. If individual investors are buying, the reasoning goes, it is time to sell. Every study that I have seen clearly concludes that the non-professional consistently looses money investing in asset markets.

Then, over the last twelve years, as I have indicated in a previous post, the equity markets have failed to bring positive returns. Comparing equal dollars of purchasing power, today’s Dow (without including dividends or taxes) is 20% to 25% below the level at the end of the tech stock boom.

In fact, the only asset class that has shown consistent positive returns in the last decade is long-term bonds. But that brings us back to the beginning point, the Fed’s push to lower interest rates, because the reason long-term bonds have shown a gain is that interest rates keep falling. When interest rates begin to go up, watch out. Look at the returns of the bondholders of Greece, Spain, and Italy. When the interest rates on these dead bonds moved from less than 3% to near 6% or more, bond holders lost about 50% of their capital on the secondary market. To me, even 6% or 7% doesn’t seem very high when I wonder if the bonds will be repaid, or repaid with money worth anything.

There are surely lots of other consequences of the Fed’s disastrous decisions. Many are clearly visible, including the continued recession we are suffering through. (Officially the recession ended, but the psychology is still that of a recession, the unemployment level is that of a recession, and the government is doing all it can to keep us there, just like it did in the 1930s.) But the consequences that I have discussed are the ones I have recently added to my list.

But then there is the important question: Is the use of savings accounts by people who aren’t financial professionals a good thing in a laissez-faire economy and how?

The first thing to realize is that in a laissez-faire economy prices and wages tend to fall over time, which is the consequence of having a money immune from government manipulation. Prices fall faster than wages so that there is a continuous raise in the standard of living. That means that the dollar you place in a savings account will have a greater purchasing power over time even without consideration of interest paid.

The second important issue is the level of what is called the ordinary interest rate. That is the amount of return required for a person to delay consumption. This interest rate does not include consideration of risk, etc. I have seen suggestions that the rate of ordinary interest tends to be around 1%. That is, the normal person would be willing to put off spending $100 if in one year they had $101, assuming a laissez-faire economy. Other issues, such as the supply of physical capital (one market where supply does play a role in price) and risk factors, increase the interest rate within different market contexts.

So, if a savings account offered 2% interest, it was a great deal. The same is true for bonds issued by businesses. Saving for retirement would require much less of a struggle, later medical bills would be less of a problem, and our standard of living would continue to raise and we could have the flying car (see, my avatar means something – what we have lost due to government interference!).

Then, money placed into savings accounts was then loaned by banks to businesses who were credit worthy and had the best available plans for additional profits. Savings, that is capital, was accumulated and placed in the service of wealth creation, capitalism. That is basic banking.

I think much of the concern and fuss over fractional banking is based upon the view that banks are warehouses rather than institutions involved in the accumulation of capital. In the modern world, even ignoring the stupid, forced level of interest rates required by welfare state banking theory, savings have been diverted from banks and their major source of funds are demand deposits.

While unused demand deposits, and the goods represented by that money, are a kind of unintentional savings, real savings involves conscious decision and results in the funds being placed accordingly. When real savings is placed into profitable enterprise, and market rates of interest paid, investing and profit making activity would actually be a less risky activity.

With the manipulation of the money supply, the extensive regulation of the financial community, and the control of interest rates, none of the prices for savings or the factors of production reflect any part of the reality of business activity, market opportunities, or costs (not to mention political pull). Who knows what can or will happen when no facts are available for reason to evaluate.

So my conclusion is that in a laissez-faire economy, placing your money in savings accounts and buying bonds (of businesses) is a sane and personally beneficial decision.

In our economy, the government has pretty much taken way sane and beneficial opportunities. If you accept the idea that one should know what one is doing, then probably 90% of the investing public is acting irrationally. They do not understand the world as it currently functions, including the existing markets and the impact of government regulations and manipulations. Yes, I think that is true of many of my readers. Sorry.

Personal Responsibility

Recently, Don Watkins, in a blog posting (I can’t find the specific post for some reason, but it was on http://capitalism.aynrand.org/, which is very good), referenced an article arguing that anyone who tries can succeed, at least to some level. This article was written recently and not one hundred years ago. Now, I don’t disagree with its basic sentiment. I especially agree that one should take responsibility for one’s welfare and future. Further, I emphatically agree that we live in a world where it is possible to make our own way, metaphysically speaking. But, as I read the article, I kept wanting to ask the author if he’d been paying any attention to what has been happening in our economy and culture now, and for the last one hundred years.

I know why Dr. Watkins referred to the article. It is rare to find anyone who is willing to say anything good about personal responsibility today. Any such sentiment needs to be encouraged. But, in fact the article is wrong in its application to today’s America. Personal responsibility is not encouraged. Personal success is often disparaged (not by business people, but certainly within the culture). Most important, the government has been actively attacking personal success and making it more difficult for a long time.

I think that it is difficult to succeed today and becoming more so. I think that the article should have had some important provisos. I mean, haven’t we been saying that it matters what the government does? Haven’t we been arguing that man needs to have certain conditions to succeed and that the U.S. government has been moving away from those conditions.

Now, in order to make sense of the issue of personal responsibility in our context certain basic notions have to be made plain. Most important, and thus first, is that if man’s life is the standard of value, the actions by individuals based upon their own understandings and judgment is the only way in which human survival is achieved and prosperity or progress, in any rational sense, occurs. It isn’t the action, or the amount of effort, or the “work” done that is the cause of success, but the use of reason and the resulting ideas, and their correspondence with the real world. Nor does good reasoning guarantee success. A rational man can fail, even in a rational or free environment.

But, we are not living within a rational environment. We are living within an advanced welfare state with millions of regulations, probably a million regulators, and an endless number of imposed government costs of doing business. In business after business, the risk of failing to meet some idiotic government regulation or expense has become greater and greater. Starting a business was always risky. Small businesses have always failed at very high rates.

And then there is the issue of what our personal responsibility is.

Some guy on facebook told me that people on Social Security were deadbeats, and we shouldn’t care what happens to them. But after nearly one hundred years of regulation of the financial sector, the chances that most Americans can save sufficiently for retiring, at nearly any age (not to mention the costs of health care after fifty plus years of government interference in the medical industry), is nearing zero (see my blog post). Many people, if not most, who are dependant upon government retirement money are victims.

Most importantly, the facebook guy had the cause and effect backwards. While it is true that there are some people who duck personal responsibility, at least in America that percentage is a minority. It is also true that some people are misled by the claim that their forced savings by the Social Security tax, for example, does lead to some level of personal protection at retirement. Neither type of group explains the large numbers of people who end up dependent upon Social Security.

What does explain those figures is the consequences of government actions in the economy. Just to point the finger at one element (out of a list of hundreds), look at the disconnection between savings and capital entailed in the policies of the Federal Reserve Board. The Fed thinks that the economy works best with an annual increase of price levels at two percent. This means that in just ten years, a dollar loses well over twenty percent of its purchasing power. At the same time, the Fed has driven interest rates down to very low levels. The interest rate offered by the standard savings account will not allow the saver to keep up with price inflation, especially after income taxes. To try to make ones savings work and grow, people have been forced to become investment professionals. However, the Fed’s policies have resulted in asset booms that have in fact left Americans with considerably less wealth.

The facebook guy is blaming the victim for the consequences of government actions.

Ayn Rand didn’t write about this issue directly. But she was asked about it. One response is on point. She was asked about unemployment insurance. The questioner clearly expected that Miss Rand would condemn the person taking the government money, but she didn’t. She said, “Government controls create unemployment. No matter what happens to your employer, if you are out of work today, why should you protect him and starve? There cannot be individual responsibility for something that is the government’s fault. In any situation where the government creates a hardship that pushes you into a position of martyrdom, you are morally justified to take advantage of whatever money is offered to you, provided you don’t spread the kind of ideas that created the trouble.” (Ayn Rand Answers, p. 124) (Note that Ayn Rand kept her wealth earned from her writing in savings accounts.)

Fundamentally, we are not individually responsible for the consequences of government actions. Nor can we hold other individuals responsible by demanding that they suffer when they are victims. In a society that is attacking the innocent, we are now in a lifeboat context, and the rules of morality apply differently. Condemning the victim, the innocent, is joining the government. It is corrupt. It is evading the cause. It makes finding the correct solution nearly impossible.

If we tell someone who can’t find a job because of government interference, say minimum wage laws or restrictions starting a new business, that he isn’t taking personal responsibility, we are doing the liberal’s job. We need to be telling him that he, too, is a victim. If he is to have a future he needs to live within capitalism.

If we then tell someone who wasn’t able to save for retirement and sees the cost of living and their medical expenses rising beyond reach that they didn’t take personal responsibility, we are doing the liberal’s job. We need to be telling him that he, too, is a victim. That if he is to be able to live, and even enjoy his old age, he needs to live within capitalism.

If we then tell someone who is poor and uneducated that they are failing to take personal responsibility, just because they are poor and uneducated, we are doing the liberal’s job. We need to be telling him that if he does not want to remain poor and if he wants an education of any kind, he needs to live within capitalism.

The only other option besides capitalism is a declining economy and ultimately depression and perhaps the collapse of civilization.

Let’s keep the cause and effect clear. Let’s not advocate policies that will further harm the victims. For example, declaring that we must first stop the entitlement programs before we have a functioning economy (meaning one that can create wealth) only means that we are telling people that they will have to suffer without hope. Yes, there will be some suffering in any event. But telling anyone that will have to suffer is only justified if we are moving toward capitalism, which means a free economy. So first we have to liberate the economy. Then we can cut the entitlements. But if we don’t begin with freeing the economy, we will only add suffering without the possibility of a prosperous future.

My Predictions

Although I originally began this blog with the idea of keeping track of inflation and potential results for prices and prosperity in general, I haven’t engaged in prediction. My focus has been on commentary. We are, however, at a point that offers some interesting prospects for the future and I though it might be interesting and possibly helpful to suggest a possible set of outcomes.

Specifically, at this point in late 2012 the governments in the major economies have either implemented or are poised to implement some massive monetary flooding, which they call “easing.” The U.S. Federal Reserve officials have announced an open ended $40B a month scheme that will continue until either employment begins increasing or the end of time, whichever comes first. In Europe, the European Central Bank is ready to create unlimited amounts of money, claiming that it has to reduce the spread in government bond prices (between Spain and Italy, who have had to pay high interest rates, and Germany’s very low rates). China is expected to begin more “easing” in that it is currently seeing a much deeper and more significant drop in economic activity than the government seemed to expect. Apparently they thought that they were a separate, insulated entity. In response, just as any Western mixed economy government would do, the Chinese are moving toward spending newly made-up money. Japan has just begun its own easing program and England began theirs a few months ago. There is a great orgy of money creation in progress.

Those countries with “strong” currencies are also involved. They really don’t want to see their competitive position undercut by having other currencies diving in comparative cost, making their own products much more expensive on the world market. One example is that Switzerland’s central bank been buying euros for several months to keep their currency in line. As has been said by others, there is something akin to the arms race growing where every country inflates their currency in competition with the others. This process could also lead to protectionism, with higher tariffs and import controls.

As long as our economic problems are seen as the consequences of low consumption or low demand (and demand is seen as just money and not production related), we can always expect that the government response will be to create more money. There is some fear of the new money increasing consumer prices beyond a certain level (generally at an annual rate of 2% - some poison is good for you apparently). This concern is an interesting hold over from a point where government economists had a closer contact with reality. But there is little concern about the prospects for unacceptable levels of price inflation. It is the case that the upward pressure on prices from constant increases in the money supply tends to be less when production levels are low.

Consequently, we can expect that we will soon see a lot more money being created and put into the larger, more industrialized economies and interest rate will remain extremely low.

The amount of money that actually comes into the U.S. economy is a question for which I have no good answer. There is certainly some, but not as much as you might think when you hear the Fed brag about its easing. The money created by the Fed for QE1 and QE2 is mostly still sitting at the Fed in the deposit accounts for member banks receiving 0.25% a year.

 

The money supply has continued to grow, but the pace is not as fast as one might expect.

 

You can see in the graph that the average dollar amount of growth every year has been somewhat consistent. That means that the percentage rate of growth is falling. To just keep the constant percentage rate, this graph would need to show a much larger constantly increasing dollar amount, as the total grew each year.

As a result, consumer prices have moved upward modestly in the last few years (by comparison) and asset prices are mixed (housing downward and equities upward, but less than the CPI). Only bond prices have moved upward, as the Fed has moved to force down long-term interest rates as well as short-term. Long-term rates are very low, especially considering the need for capital in our economy. There is no connection today between savings, investment, interest rates, and the capital markets.

In these conditions, I wonder what the Fed believes that more “quantitative easing” or lower interest rates, could achieve. They talk about lowering unemployment as if the problem is that jobs are not being created for of financial reasons. Here we have an excellent example of theoretical, rationalist thinking that doesn’t consider even the possibility of looking at the real world. At present, there is no connection between the interest rate (including the supply of money) and investment/growth decisions. For a business, the difference between 3% and 2.5% on a long-term, profitable investment is insignificant. The real question for businesses is whether the project could be profitable. Some companies have invested when they have cash on hand. Many are considering a merger or acquisition, which doesn’t add to our productive capacity (although it might improve efficiency). But U.S. companies see no justification in future profitability to make the investment needed to put over two million people to work. The Fed and the Government, and Romney and the Republicans just don’t see that.

Another upcoming set of events in the U.S that could have a negative impact on our economy is the end of the Bush tax cuts and the spending cuts required by law. These events, both scheduled for January 1, 2013, won’t improve the capital and investment situation, although the rate of growth of government debt will slow some. At least in the short-term, if the tax cuts do end and the rate of spending slows, the immediate result will be a drag on the U.S. economy.

I am not convinced that the supposed mandatory cuts in spending are particularly important economically. Some people try to make this situation seem cataclysmic by quoting a cut of over a trillion dollars. That is fraud, since that is a ten-year number. As is always the case with government cuts, they are loaded mostly into the latter years. I think that the 2013 number is closer to $69B, which is for the full year. When you are talking about a multi-trillion budget and a deficit of over a trillion dollars, sixty-nine billion is an accounting error.

But saying “cuts” is intended to be misleading. The Congress didn’t pass a cut in spending. They authorized a reduction in the expected growth of spending. It was a cut from what they thought current laws would require the government would spend. There is not going to be a cut in spending. Let me repeat: These are not cuts in spending but small reductions in the growth of spending. Even so, there may be some companies that will feel an impact in their expected revenue from government contracts. But, economically, compared to the total level of spending and the prospect of more “easing”, big deal.

Combined, the tax cut, possible cuts in the growth of spending, and the Fed’s money flood, mean that there will be less money in people’s pocketbooks, but more, potentially, in the banking system. Remember that the way the Fed’s money gets into the economy is via bank loans. If the banks continue to maintain their stricter standards there is not going to be a significant increase in bank loans. In fact, the current trend is for lower corporate profits, meaning that businesses will be less credit worthy than before (and stock prices should decline, instead of booming). In addition, ever since the beginning of the “Great Recession,” bank regulators have been constantly checking on the “quality” of bank loans. Unless regulators are willing to loosen the strings, banks aren’t taking any riskier loans. I don’t see much of the Fed’s new money getting into the economy. That is not to say that there won’t be an effect. As in the past, there is a tendency to some money to find its way into assets.

In addition, the final Dodd-Frank regulations have yet to appear and the costly ObamaCare provisions are coming into effect. All businesses, but especially banks, are legitimately confident that their costs will increase significantly and their range of action considerably curtailed. Startup businesses have declined. dramatically. For the economic/cultural pessimist, there is much support in the U.S.

In Europe, the central bank is being pushed into acting because the market for Spanish and Italian government bonds demands much higher returns to compensate for higher risk. Personally, I think that there is no uncertainty. Neither Spain nor Italy will be able to repay their bonds in the coming years. (I equate being given worthless money with not being paid.). So the higher rates are certainly justified. But enough of the euro country governments don’t like that. The higher rates mean that Spain and Italy would have to face their insolvency soon, which would be a big problem for the other euro government countries. So the euro block is pushing the central bank to create money to avoid reality. In this case the money will go directly into government spending and will have very negative consequences. Not the least consequence will be a lessening of the pressure on Spain and Italy to solve their problems. (Spain is expected to need the euro bank bailout. No one is currently talking about Italy, but its economy is heading the same direction.) By creating money to buy government bonds the European Central Bank is defaulting on the loans by directly creating inflation and thus reducing the purchasing power of the money that bought the bonds. Everyone in Europe is ignoring that fact. In addition, there will be a lot of upward pressure on prices and everyone will feel the cost. But, most of all, the importance of freeing their economies and being fiscally responsible can be evaded. The ultimate result will be greater disasters.

I expect that China’s new money will be similar to earlier efforts, which went primarily into government owned and controlled businesses, shrinking the portion of the economy that is private. It may also be more of a “consumption” orientation, which will mean less of a push in industrialization, and a move toward Western ideas of a consumer driven economy. That government decision would necessarily reduce the growth rate even without the normal consequences of asset booms and busts.

If more “easing” won’t help solve the unemployment problem (who cares about actual production?) and thus won’t help with economic activity, what will it do?

Well, the U.S. economy isn’t going to grow much, if at all. In fact, it could contract. If the new money just sits at the Fed as before, we needn’t worry about hyperinflation. The money supply will grow, but not significantly faster than before, although those numbers should be watched carefully.

I heard someone point out that since the first “easing” the Dow has risen 4000 points and since the second “easing” nearly 3000. I am sure that the Dow and other indexes will raise some more. The Dow has already gone up a few hundred points since the Fed announcement. What would a push by the Fed be without a serious increase in asset prices? Commodity prices could also rise. Some are saying that industrial commodities, such as copper, will not because industrial production is tending to fall. But the money being created will go somewhere. You just need to keep an eye out to see where that is.

So, if you want to put your money somewhere, based upon recent history, there you are! Just be careful about your timing and don’t lose perspective about the causes of the asset price rise and its duration. Be ready to short.

Of course, economic events are really harder to predict than that, especially in a controlled economy. Something will happen that we don’t foresee and things will happen differently than we expect. One thing we do know, whatever happens, it’s unlikely to be good.

Long-term, the consequence of all of this “easing” is to probably bring the day of reckoning closer, possibly by years. With unemployment staying down, Social Security and Medicare spending will continue to widen the gap between tax income and spending. The demands upon the Treasury will increase, meaning more debt. The low levels of production will mean that wealth is not being created and our personal wealth and standard of living will continue to fall.

I think that money can be made from the chaos and misallocation of resources. You just have to pick your method based upon the circumstances and pay attention to the situation.


P.S. I just listened to Yaron Brook on the Mike Slater show (via a notification from Lassiez-Faire). He says so much of what I just mentioned. I really did work it out before. But he says it well.

Austerity versus Growth in Europe

In my last post I discussed the immediate lesson we could learn from the “austerity” programs occurring in Europe today. In this post I want to talk about some of the events in Europe and suggest some future results.

No doubt my readers aren’t really taken in by the emphatic declaration by European socialist politicians that the government planning must include growth, and not just reductions of government spending, otherwise known as “austerity.” All of this is government speak, that is, none of these terms mean what they rationally means when it comes out of the mouth of the European politician or bureaucrats. It reminds me of Clinton’s first term, when someone convinced Bill that investment was a vital element in the economy. For the next year or so every government initiative that Clinton proposed was called an investment. Every action that the European politician wants to take will be called a growth program.

We should know that the Europeans do not know and go out of their way to evade what it is that causes increases in production and wealth. In their minds the cause of all that is good is the government. They do not understand why their economies aren’t performing as they want them to. They don’t understand that all of their laws have cut down economic activity. In the way of what they are calling reforms they have done very little to make actual growth possible. I read somewhere recently that Greek bureaucrats require an overwhelming amount of stuff form someone applying for a business license, including a stool sample. On the episode of “No Reservations” filmed in Lisbon, I leaned that Portuguese agriculture was forced to stop profitable farming in several crops by EU protectionist regulations (protecting the French and Italians). The number of regulations and interference in business in Europe on the EU, country, and state level is many times what it is in the U.S. None of this is being addressed. What has been “reformed” to some small degree in a few countries is a few regulations that made it impossible to fire someone. There is probably more, but minor, and unreported in the general media.

Austerity has been the watchword in Europe recently. Let’s be clear on what that means. It means that the national government’s budget deficit has to be kept below a certain percentage of the country’s GDP, on the order of three percent, according to the recently passed EU law. It doesn’t actually mean that a surplus has to be achieved or that the country’s government debt has to be reduced. It only means that the debt can’t grow at more than a certain rate, which is deemed to be a level that an economy can comfortably service (which probably assumes interest rates kept artificially low). If a country was actually productive, keeping government spending to that level might not pose much of a problem, until the economy wasn’t productive any more. However, for different reasons in each country, with the exception of Germany and the smaller northern euro zone countries, they have been spending much more and driven their debts much higher (Italy’s debt wasn’t that high, but its deficit was, driving interest rates higher). Since their economies are very dependent upon government spending, when the spending slowed the economy began to contract, people’s income dropped, and greater numbers became unemployed. People became unhappy.

Within this context it makes sense to want to see the economy grow. Economic growth would create more jobs and ultimately move the economy to prosperity. Growth basically comes from letting people produce and seek higher income and wealth. That is not what the European politician calling for growth has in mind. He still sees the government as the prime mover. He wants to increase government activity and government spending. He wants to move away from austerity toward what was going on before this mess. He wants to pretend that the mess doesn’t exist. He wants that favorite of all government boondoggles and fountain of spoils, infrastructure projects. But building a bridge is not growth. (BO wants to fix schools and put in wiring for the internet.) So far, the programs that I have heard proposed will not cause economic growth.

The populations in Europe are apparently supporting these “pro-growth,” socialist politicians. France just elected one. Greece will at least come close to pushing out the politicians who voted in austerity. The Greek alternative is someone who wants to renege on the country’s sworn commitments. Spain is trying, but failing to reign in its spending and the population is angry about the results of that attempt. And in a recent German state election, a couple of socialist parties opposed to austerity won a solid election against the person leading Europe away from government spending, the German PM. Even one of the most emphatic pro-austerity governments in northern Europe, the Netherlands, has announced that it isn’t able to keep its spending below the required cap. They are going to have new elections soon and may become an over-spender.

We are faced with the amazing scenario in which the leading, European, social welfare, big party politicians are trying to keep their countries from going into bankruptcy, which is to say that they are at least paying attention, and the voting public is rejecting them and voting in complete, not just partial, idiots. Who would have expected the politicians to show some responsibility?

Why isn’t it working? Why can’t the politicians convince the public to go along with the “austerity?” There are two reasons. First, the public has been taught for years, by their parents, their schools, their churches, and their politicians that the government is the fount of all that is good and that private enterprise is evil. They believe that the government can just make things up and provide them with the long life of leisure and pleasure that they have been promised. They just don’t understand why things should change now.

One wonderful example of that is the apparent conflicting poll results in Greece. According to polls taken after the last election and the realization that no government could be formed from the relative strength of the parties, the Greek public wants to put into power a person who will reject all of the agreements connected to the bailout that result in “austerity” (the polls have fluctuated as to who is leading). On the other hand, the Greeks by a large majority want to keep the euro, which they would have to give up if they elect the guy they seem to like.

Then, you ask, why do the Greeks want to stay in the euro zone? Again there are two answers, a bad one and a better one. The bad reason is that the Greek prosperity of the last decade began with their entrance to the euro zone. Having the same currency as the Germans, the Greeks were able to borrow to support the government’s crazy spending at very low rates. Their wages climbed to become thirty percent higher than German wages. They think the euro lays golden eggs!

The second, better reason for wanting the euro is that the common currency does facilitate trade. If governments behaved at all sensibly, a common currency in open trading blocs is an excellent idea. The problem in Europe is that each country insisted on having certain protections. It isn’t actually a free market but a highly controlled one. Really, the common market, the EU, is an illusion.

Getting back to the initial discussion, the second reason why the voters want to reject the “austerity” candidates is that “austerity” as a government program is a failure. It is a failure because all it is doing is collapsing their economies. As I have implied above and in my last post, their economies have insufficient capacity for the readjustment of prices and wages and to move assets into productive endeavors. In short, their economies are not capitalistic but controlled.

We have seen the European politicians struggling for an extended period of time to cope with their problem. We have seen several announcements that they have taken major steps and that things would be better only to see the exact same problem continue: concern by lenders that they aren’t going to be paid back. Hundreds of billions of euros have been given or committed to several different countries. The European Central Bank injected nearly one trillion euros into the banking system in loans at 1% interest which resulted in almost no new commercial lending and about five months of better terms for loans in Spain and Italy. The collapse of inter-bank lending, which was supposedly the justification for the loans, has continued to be a problem. Interest rates controlled by the European Central Bank continue to be near 1% and yet the entire bloc is heading into recession, including Germany. Nothing that has been done has dented their problems. Covered them over for a short period of time, perhaps, but done nothing to move the European Community toward growth and prosperity.

The voters do not understand the importance of capitalism, but they do see that with “austerity” their prospects are very poor. Jobs of all kinds are disappearing, wealth is leaving the country when it can, and no one has the leeway to do anything about it. There appears to be a fatalism about their daily lives. They foresee nothing good happening in the foreseeable future. Unfortunately, that is what happens when you give government all the power.

So we see that Europe seems to be faced with the alternative of severe recession with “austerity” with no real way out and going back to the government spending that got them into trouble in the first place. Surely, this problem will be blamed on capitalism and politicians who want to have greater control will be successful. Ignorance of capitalism will lead to contraction, probably bankruptcy, and further reduction of freedom. The effects of decades of social welfare state policies will become obvious.

I am not one for disaster scenarios. When people write about upcoming collapse of our economy I tend to yawn. Yet very bad things are happening. Greece is in a depression, although no one else is willing to say so. Spain isn’t that far away from a depression and they haven’t even gotten to the bottom yet. Neither of those countries are particularly large and so far they have had friends who have been able to keep them afloat. Then we must realize that Italy and France are tittering. Italy has set a course that will keep it going for a while, but France has just rejected “austerity” and has already begun new commitments for ongoing spending. Their choice seems to have been made. It isn’t good. I suggest we all reread The Ominous Parallels by Leonard Peikoff to get an idea of what could happen.

So, then the question becomes, what are we going to do? We don’t want to live through the same thing here. Obviously, in order to avoid it people will have to learn what capitalism is, in some detail. I think that many people are willing to listen. ARI has several good programs and books that do that. Let’s help them. The more voices explaining capitalism the better.

The Immediate Important Lesson From Europe

We can learn many lessons from what is happening in Europe and what will be happening over the next decade or two. We will see in very explicit detail that democracy is at root a destructive system as it attempts to consume very productive asset it can get its hands on. We shall see that borrowing to spend and consume is inherently a dead-end. We shall see again that government controls do not stop destructive behavior and that few know what good behavior is then. Etc.

But we are now witnessing something that I didn’t expect. We are seeing how not to achieve a turn around in an economy. “Austerity” is a failed program.

Okay, first let’s consider what “austerity” is. It is not actually austerity. The term was first picked up from the context of an over-indebted person. If he wanted to get out of his situation, without going back on his word to pay those people who lent him money, he had to reduce his spending and pay off his debts. Then he would be financially healthy and could begin building wealth.

So, the idea went, governments could reduce their spending, too. Except they failed to remember two different aspects of the individual’s context: first, that the individual had to continue to work, i.e., produce. Production is still the key. Second, they failed to remember that the individual had to spend less than his income. Governments regard “austerity” as merely spending less than they were or perhaps spending less than they were planning, although still increasing their spending. I haven’t seen any of the European governments talking about a budget surplus and paying off their debt.

But, the most important lesson to be learned is the first: Production is the key. What I mean is that just spending less in those countries has no positive effect on the economy, only less of a negative effect. What has a positive effect is the creation of goods and services, i.e., production. Those countries aren’t producing more. Actually, since they have grown the government so much, less spending translates immediately into less purchases and a constriction of business. Business has been forced to depend upon government spending. When that spending disappears, businesses do less business, are less profitable and tend to fail. That is what we are seeing across Europe, especially in the countries with the worst situations.

Those economies haven’t gotten to where they are because of the government spending by itself. The major cause of the poor performance of those economies is government controls. Controls limit what businessmen can do and their ability to produce. Government controls are the lid on man’s productive capacity.

As long as the government controls the economy, and the European Union has a staggering level of controls, those economies are going to suffer. In fact, what we see today is the simultaneous reduction of government spending with the increase in numbers and degree of control. We see tighter and tighter restrictions being placed on business and finance, further weakening their ability to produce while the governments are trying to at least slow the rate of their indebtedness. It won’t work.

This is a lesson for us all. We need to realize that as bad as the debt situation is, and as bad as it can get, and that by itself debt can destroy our economy, that it is not the primary issue and should not be our primary target. At least it shouldn’t be.

We must also recognize that if we only talk about debt and the need to reduce spending as our immediate objective we will not succeed in moving any society towards our viewpoint. They see what “austerity” achieves. No one should want any part of that, including us.

No, our focus should be on production. Our campaign should be to unleash the productive abilities of the United States, to reverse governmental economic controls. to free our businessmen. Freedom. That should be our program.

I do not want for a minute for you to think that I am the originator of this insight. As in most all of my understanding of the world, I learned this from Ayn Rand. She did not write about this issue, but she was asked about it more than once in public forums. It is to our benefit that we can read today what she said in response to those questions in Ayn Rand Answers, pages 46-50. Also look at her answer regarding unemployment benefits on page 124. She isn’t in favor of government spending or any activity that isn’t directly protecting individual rights. She wants to stop inappropriate government spending. But she recognizes that what must be done first is to free the economy. Without that first step, and giving it the time to begin producing (probably shorter than we might think), we will see our economy contract just as the European economies are.

My position in this article isn’t new, but I hadn’t realized until recently that the European “austerity” program was exactly that being proposed by my critics. These are the people who argue that the US government spending had to be stopped as soon as possible. The immediate target of these proponents of “austerity” was Social Security and unemployment benefits. I responded that what would happen is just a lot of misery and the destruction of legitimate business, which is just what is happening in Europe, especially Greece and Spain. If “austerity” were begun in the US today, the results might not be as bad. But no good would be achieved as long as government controls were kept in place.

The only direct, economic destructive element of government spending is that it soaks up savings, which is needed for business investment. But the economy can find capital when it has potential profits in sight. We would learn that finding capital would not be an issue. Today, the drag on the US economy isn’t a lack of capital. Banks will tell you that they have plenty to lend. Businesses have plenty of money to invest if they chose. (I am not really conflating fiat money with capital.) Companies could find capital today if they were confident in the future. With all of the proposed additional controls and the fear of BO’s plans for our future, they are wise to avoid the crazy risk inherent in our political situation. And thus the economy stalls. It isn’t the deficit they are afraid of, but government force.

It might be argued that the correct approach to cutting spending would include some advanced warning. Perhaps people should be given a year or two to get their lives in order in preparation for changes in government spending. Yet, that still doesn’t address the underlying problem. If there isn’t sufficient economic activity, sufficient investment, sufficient production, sufficient productive jobs, advanced warning would provide no benefit. There are no economic alternatives to prepare with. Advanced warning only is beneficial if the person affected has alternatives to what he is currently relying upon.

At this point the response that I receive is that I am evading the moral issue of the theft of the property of those who are paying the taxes (either direct or indirect from the borrowing and inflation). It is wrong, I am told, for the theft to continue. It should be stopped immediately.

Aside from the fact that Ayn Rand did not advance this point when she had the chance, and aside from the fact that I am not disagreeing with either the immorality of the taxes or the spending, and aside from the fact that I vehemently argue that the spending and borrowing has to stop, and aside from the fact that I recognize the moral hazard from the dependency upon government spending, I reject the argument that the morality requires us to act without considering the immediate consequences and how very bad ones can be avoided.

I would argue that Objectivist morality is fundamentally a morality of consequences, that is, of causes and effects, of ends and means. If implementing a moral decision means the destruction of those who are the intended beneficiaries, the innocent and the productive in this case, then there is something wrong with the reasoning. And destruction of the productive and innocent is definitely a result of “austerity.” It isn’t just the person receiving the government handout who is suffering but the entire economy, the productive and innocent. Real, honest businesses are going under. People who made rational decisions within the context of their country are loosing all they possess. It is these people who a morality of self-interest and the social-economic system of capitalism is suppose to protect. It is they who should flourish. “Austerity” is destroying their lives as thoroughly as socialism itself. Therefore, “austerity” is the wrong approach.

While government spending upon anything but the protection of individual rights is automatically a violation of rights and a move toward the destruction of those rights, the spending itself isn’t a major catastrophe, in the sense of the immediate, economic consequences. Just as with a household, it isn’t the spending per se, it is the spending in relation to the income, which means the economy’s production. If the spending is higher than the production allows (not even considering the savings necessary to increase production), then there will be problems. That is true for either a household or a business or a government. It is worse when the overspending is for unproductive consumption, which is always true of governmental spending. “Infrastructure” is consumption. Something constructed by the government might sit there for a while, like a bridge, but it is not paying its own way and replacing itself, as a business investment would, is consumption.

Of course, governmental spending is often accompanied by restrictions on the population because the government wants to keep its monopoly, i.e., only the government can build roads, etc. If there was competition, the incompetence of the government would be clearly demonstrated. Look at the U.S. Post Office.

No, government spending isn’t the cause of a country’s economy failing to grow.

On the other hand, the best any of the commentators that I have read have made only the slight suggestions that regulation has any effect on production and prosperity. It is recognized that regulation has a cost in time and money, but not on an economy’s ability to produce and grow. This is a complete blind spot. I attribute this lack of knowledge to the general rationalist trend found in economics and business schools. Looking at how things actually work is not an acceptable practice. At least at one point in time efficiency studies were all the rage. If there are still such studies they most likely don’t question government mandated business practices. They just treat regulations as acts of nature.

However, the point is that government regulation is treated as just a part of life and is not questioned and its consequences are not considered. This last point is true in a wider scale than you probably realize. Few look to see if the supposed good consequence of government regulation actually happened. No follow up studies are done to evaluate the success of the regulation. Those consequences are assumed and bragged about but never proved or evaluated. Recently, I received an email from Ending Big Government, the website set up by Yaron Brook and Don Watkins in connection with their new book, Free Market Revolution: How Ayn Rand’s Ideas Can End Big Government. This email was entitled “Story about Stories” in which people who were impacted by government regulations explained what was happening (See here). This is a great idea. The consequences of regulations have to be concretized for people. They have to see in detail that regulation is destructive in order to understand that it has to be stopped. For example, people don’t know how extensive, intrusive, expensive, and anti-productive the FDA regulation is. These details need to be made public. The media won’t do it. The Republicans won’t do it. Who will?

So, let me suggest that you continue to watch Europe attempt to practice “austerity” and how they go into recessions. I think that Spain is already in a depression, or will be soon. Greece certainly is. Think about the consequences as the government just spending less. Think about why their economies can’t seem to grow. What is stopping them?

Next week I hope to finish up a post that will be more specific about Europe and the backlash against “austerity.” I think that we will see another lesson there as well.

Comments on Richard Salsman Review of Objective Economics by Northrup Buechner

Richard Salsman wrote an extensive review of Dr. Northrup Buechner’s book, Objective Economics: How Ayn Rand’s Philosophy Changes Everything about Economics (OE) that appeared in the recent issue of The Objectivist Standard, Vol. 7, No. 1.

Salsman doesn’t like what is in Objective Economics – any of it. He says, “That which is true in the book is not new, while that which is new in it is not true.” (SR 10)

The review, which goes on for ten pages, comments upon many different aspects of the book. In fact, the approximately 50 paragraphs contain almost as many different points. One might think that the review is offered for people with a background in academic economics, however it is offered in a journal with a broad audience.

It might have served Salsman’s purpose better if he had selected a couple issues and focused on explaining his positions and how he differed from Buechner. Taking my own advise, instead of plodding through all of Salsman’s comments, I will restrict myself to only a few points.

Buechner’s focus is on the development of his own theory and its underlying justification, but Salsman doesn’t state what Buechner’s theory is or how he proves it. Salsman’s review ignores 90% of Buechner’s book, its theme, and its purpose.

Salsman is very upset that Buechner rejects a lot of “contemporary, academic economics.” (SR, 1) Salsman thinks that modern economics has improved significantly over the last decades – Buechner doesn’t. Buechner explicitly rejects the venerable theory of the law of supply and demand as a true theory of economic prices and proceeds to create his own, which he calls The Theory of Objective Price (Chapter 8, OE). Since Salsman insists on the importance of the law of supply and demand, I will start there.

Salsman says on page 2, “in crucial areas [Buechner] strips modern economics of its more rational doctrines… the law of supply and demand….” (Salsman mentions several other “rational doctrines”). Page 3: “Modern economics does have a theory of objective prices (i.e., the law of supply and demand)….” Page 5: “But Buechner insists that there is only a law of demand, and, strictly speaking, no law of supply – hence no unified law of supply and demand. Buechner disintegrates this law, insisting that supply somehow is less crucial than demand, which is equivalent to insisting that one side of a coin is less important to the whole than the other.” And: “…the law of supply and demand is one of the more magnificent, integrative achievements in the history of economics.” Salsman then goes on to quote John Locke and Jean-Baptiste Say who say that the law of supply and demand is important. Page 7: “Since at least Alfred Marshal, economists have said that prices are determined jointly and equally by supply and demand, that our desires coupled with our purchasing power (supply) (sic) entail our demand for goods and services whose attributes yield utility (satisfaction) for us, and that profit-seeking supplier try to offer products with utility-yielding features. In [Alfred] Marshall’s famous metaphor, it takes both blades of the scissors (supply and demand) to cut the paper (establish price). …this depiction captures the relational aspect of the economic valuer and what is economically valued, of mind and reality, of consciousness and existence. This is the essence of a valid theory of objective economic value.” (Italics in original; SR, 7) The quotations are only the spots where Salsman uses the term “the law of supply and demand”.

But in spite of all of these statements, Salsman does not tell you what the law of supply and demand is, what it does, or how it is proved. You might say that this is a review and not a place proof. Nevertheless, when he is denying that Buechner has proved his theory, Salsman should at least say something about the law’s proof. It is as if Salsman regards the law as self-evident. He should tell you where you can find a full discussion and a proof. Actually, I have never seen a proof. At best you can find descriptions, which is what you find in Adam Smith’s initial discussion.

For references purposes, here is what Wikipedia says this about this law:

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.
The four basic laws of supply and demand are:
5. If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
6. If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
7. If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
8. If supply decreases and demand remains unchanged, then it leads to higher equilibrium price and lower quantity.

This is total demand and total supply, not just what is in front of you in the grocery store and not just what a certain manufacturer produces, but everything. Thus, the idea is that, generally, prices move according to changes in the total supply and total demand. This happens regardless of the knowledge or understanding of any or all of the participants in the market. Not every theorist holds that the changes in price are immediate or worldwide at any particular time or situation. Actually, these issues are rarely covered or acknowledged. The forces of the market are considered impersonal and unaffected by individuals or individual firms.

The point in the law of supply and demand is not that there has to be a supply, which seems to be Salsman’s thought in places, but that the amount of total supply directly affects the price. You can see something like that in certain auction markets or produce markets in which the product moves swiftly from the field to the store. The immediate supply of limes, for example, immediately affects the price. Gasoline prices also closely follow the international supply. But that is misleading since the international price, or what is called the Light Sweet Crude Oil priced in the Oklahoma market reflects the oil that is offered at that time at that market of that quality and not the total supply.

I want to point out two things about the law of supply and demand. First, it has no mechanism for explaining the prices of new products. And not just new products for which there is no demand, but no knowledge of it in the marketplace. We have seen hundreds of new products offered in the past decades that no one has thought of before and for which there was no demand. In order to get a demand people had to be educated (one of the functions of a sales force). Yet when these products reached the consumer, they had prices.

Salsman says, “…Buechner finds the first method [of how prices are set] ubiquitous [the method in which someone sets the price], even though it entails the oxymoron of solo price determination, in direct defiance of the basic fact that every price is an exchange ratio and that it takes (at least) two people to arrive at a price.” (SR, 5) That is obviously not the case. It does take two people for an exchange to take place. But in our every day experience, including what we read in the papers, etc., prices are set by individuals all the time.

Consider the initial public offering of the stock in a company that is going public. The price is set by the owners, with advice from experts in the equity markets. The stock is sold and immediately goes on to the secondary market, the stock exchange, and then the price fluctuates. On what we call the secondary market for stocks, price is set not by the total demand or the total supply, but the marginal supply and demand, that is the number of shares supplied at that time and the demanded at that time. If the numbers, the shares and prices, do not balance, a “market maker” steps in and either holds them or fills from his own account.

When I was a general manager of a small retail chain and responsible for setting our prices, I used a standard markup. I didn’t go into the shop and bargain. I didn’t do a survey. Sometimes, if we had gotten a good deal on an item, I would use a higher markup. I set prices. I practiced solo price determination. Buechner stresses that the businessman tends to have significant experience in his market. He knows his customers, his total costs, and his competitors and then uses his judgment to set a price that will in the long term maximize his profits. Certainly he could adjust the price if he doesn’t get the result he wants. But still, in any circumstance, the price is set by the actions of a human consciousness.

Consider what someone does who wants to buy something. The buyer, whether he is a consumer or the purchasing agent for a company, goes to the source of the product and asks what the price is. Price is not some disembodied thing, but a real concrete that is known by the seller or the person who facilitates the transaction (broker, market maker, etc.). The market may be such that the buyer may bargain or negotiate a different price, but starts with what the seller has decided. If there is a negotiation, the seller has to agree to the final price. Price is not a separate thing from the actions and decisions, conscious decisions, of the people involved in the transaction.

What is your experience? If Salsman, and by extension modern economics, is right, we should all experience influence on prices daily. Salsman is wrong, there is no such “basic fact.”

Second, the law of supply and demand as a determinate of price does not have a mechanism to explain how prices change. It says that when the total supply or total demand changes the price changes. How? Exactly how does that happen. What concrete steps does the total supply impact the market price? Buechner’s explanation is that businessmen keeps informed about his market. When conditions change, demand changes for example, in order for the price to change some businessman has to decide to change his price. He does not consider total supply. He considers his costs, his profits, and his competitors and then he makes a decision. There are no other actors but human beings who are the producers who are buying and selling. There are no disembodied forces.

But Salsman is interested in defending not just the law of supply and demand, but “contemporary, academic economics.” (SR, 1)

I wonder why. As an academic discipline, economics in the last century has been impacted by the same influences as every other academic pursuit and aspect of our culture. The Twentieth Century was the century of nihilism (except for Ayn Rand). It was the century of constant attacks on civilization, reason, man’s rights, everything we hold dear. It is the century that produced the slow disintegration that we see in theoretical physics, for example, as described in David Harriman’s The Logical Leap. It is the century that has seen the growth of American government without interruption regardless of which political party was in power. It was the century that has seen the nearly complete disintegration of all art forms. We do live in a wasteland, again except for Ayn Rand and her followers. Yet, Salsman wants us to understand that economics is mostly solid.

Buechner does comment on this issue, “The philosophical overview of my book is this: Modern economics is the product of modern philosophy. Since on every important issue, Objectivism is the opposite of modern philosophy, Objectivism changes everything about economics. This includes economics’ method, the conception of the economy, the meaning of competition, the concepts of supply and demand, the theory of price, the role of scarcity, and the theory of aggregate production. Overall, as the result of all the preceding, Objectivism confirms the practicality of capitalism.” (OE, 3)

At the beginning of his review, Salsman lists several influences that he credits with the positive intellectual results in economics, i.e., Austrian economics, Supply-side economics, monetarism, rational expectations, and public choice (and he includes all of their Nobel Prize winners!) (SR, 1). Yet none of these people are advocates or practitioners of reason, induction, rational self-interest, or even of introspection. None of these influences are advocates of laissez-faire capitalism. All that Salsman offers to support his contention is that economics has improved is that some contemporary, academic economists are willing to consider less regulated markets rather than government activity in certain circumstances. Certainly that is better than being an outright socialist. But Salsman’s favored economists do not understand or accept the absolute necessity of individual rights and the use of reason for the survival of man as man.

In fact, these people are the appeasers of the progressives and leftists who wish to destroy capitalism and freedom. They need to be swept aside. Ultimately, Salsman’s favored economists are not valid alternatives for the Objectivist. (Go listen to Yaron Brook’s talk, “Why Bad Economics Won’t Go Away”)

What is vitally important in considering economics, and any science studying some aspect of man, is the initial view the science takes of what a man is and what is the proper method of studying the subject. You will find in Buechner explicit answers to both questions. Salsman does not address the first issue at all. He makes only minor references to induction and objectivity. Salsman declares, “Moreover, contrary to his pledge to proceed inductively, Buechner’s alternative theories are not proved inductively….” (SR, 2) Salsman does not tell you Buechner’s method of induction or why Salsman believes it to be invalid, or even that Buechner does have a method. For that matter, Salsman does not tell you what a valid method of induction within economics might be or where to find it. This vital issue is ignored and replaced with repeated statements about the law of supply and demand and “contemporary, academic economics.”

At points it seems that Salsman dislikes this book sufficiently to make amazing claims, amazing to someone who has read Objective Economics. Amazing in that the book does not say what is being claimed. I want to show you examples of Salsman’s criticisms that seem to me to be incomprehensible. I will limit myself to two examples. The one I am offering first comes in a very confusing paragraph (SR, 6), Salsman argues “…, on Buechner’s own account, even in the normal case no general theory of price, objective or otherwise, can hold.” (Italics in original) Salsman sites pages 283, 277, and 278. I’m sorry, that is wrong. These pages come from Appendix A, “The Theory of Price in Modern Economics: A Critique,” in which Buechner has placed his discussion of modern economics’ theory of supply and demand. It is Buechner’s conclusion that the entire modern theory is wrong, and founded on concepts with no relation to reality. The quotations Salsman used are clearly about modern theory and not Buechner’s. Buechner presents his own theory in Chapter 8, pages 139 to 152. Buechner states unequivocally that he holds his theory to apply to all exchanges within an economy.

But Salsman also says that “[Buechner] contends that his theory of objective price-setting is valid and applicable only in that unique context, and (by implication not in the mixed economy.” (Italics in original) Salsman quotes Buechner, “The general context in which my theory applies is laissez-faire capitalism, this political-economic system”…”defines the surrounding conditions” for the theory. (SR, 4; OE, 16; the formulation here is how Salsman wrote it) But, at the end of that two page section, Buechner says, “In fact, the study of economics has to begin, and always has begun, with the assumption, more or less fuzzy, that men are free to act on their best rational judgment. It is not possible to begin with a system in which the government initiates physical force, intervening, regulating, controlling, and usurping countless details of economic activity and then ask a question such as “Why do prices rise?””
Buechner continues, “One has to begin by seeing how capitalism would work when there are no government controls or regulations. Once that is clear, it is possible to project government action or regulation and consider how it changes the free market result. But first one has to have the free market result. That is what I provide in this book.”

How did Salsman fail to see that statement?

The second example is Salsman’s reference to Leonard Peikoff’s Objectivism: The Philosophy of Ayn Rand (OPAR). Salsman suggests that “The best account of how Ayn Rand’s philosophy undergirds and further integrates economics – including the objectivity …of the law of supply and demand” you should read chapter 11 (Capitalism). (SR, 10) Well, yes, of course you should. But chapter 11 doesn’t help Salsman. There is no attempt to establish economic laws in that chapter. Dr. Peikoff is not an economists and doesn’t attempt to be.

Dr. Peikoff first discusses the relation between philosophy and economics. What is interesting in this context is that Dr. Peikoff’s discussion closely approximates what Buechner had to say (OE, 18-19). Salsman castigates Buechner because the book has no ethical argument for capitalism. (SR, 3) Peikoff and Buechner see that there is a division of intellectual labor. Apparently Salsman doesn’t. Buechner says, “In the preceding discussion, I have made no attempt to give the moral justification for laissez-faire capitalism. In particular, I have not defined man’s rights nor explained why men have rights. I have not explained what is wrong with the initiation of physical force and why it is only such force that violates men’s rights. I have not tried to argue that capitalism is the ideal social system, though I believe it is. Proving these things is the responsibility of political philosophy, not economics. Here, I have been concerned only to identify what laissez-faire is. That it should exist is another subject.” (OE, 18-19)

Peikoff also affirms that, “The dominant view today is that economic value (like every other kind) is not objective, but arbitrary. Monopolists or other “exploiter,” subjectivists claim, charge any amount they feel like charging….” (OPAR, 399) Buechner uses the concept of objectivity throughout the book, and identifies errors involving the subjective and intrinsic. Salsman denies that modern economics is stuck with the subjective and criticizes Buechner for saying so. (SR, 3)

What Peikoff has to say about the law of supply and demand isn’t very helpful either. “The economic value of goods and services is their price (this term subsumes all forms of price, including wages, rents, and interest rates); and prices on a free market are determined by the law of supply and demand. Men create products and offer them for sale; this is supply. Other men offer their own products in exchange; this is demand. “Supply” and “demand,” therefore, are two perspectives on a single fact: a man’s supply is his demand; it is his only means of demanding another man’s supply. The market price of a product is determined by the conjunction of two evaluations, i.e., by the voluntary agreement of sellers and buyers. If sellers decide to charge a thousand dollars for a barrel of flour because they feel “greed,” there will be no buyers….” (OPAR, 399). This is hardly a ringing endorsement of the economic theory that total supply and total demand converge to establish and change prices. It is the philosophical point that demand is not a floating governmental creation. It is also the point that an exchange occurs when both the buyer and the seller decide the price to be good for them individually. That Dr. Peikoff (or Ayn Rand, in her own writing) did not go out and personally evaluate the theory of price that is the law of supply and demand is not an endorsement.

Even more disappointing is the lack of discussion of Buechner’s understanding of objectivity and his application of that understanding to the actions of the producer (businessman), buyer, and economist. In his discussion of a businessman’s attempt to calculate his cost of production, Buechner says, “Objectivity is an issue of method. There is no way to determine the objectivity of a result other than by looking at the method by which that result was reached. If the method is based on facts, if it reflects a rational attempt to grasp reality, if nothing relevant is deleted or evaded, and nothing extraneous is introduced, then the resulting unit cost is objective.” (OE, 83)

Buechner also focuses on production and the producer as the driving force in an industrial economy (See, e.g., “Producer sovereignty?, OE, 204). In discussing capital goods and factors of production he says, “The original factor of production is the reasoning human mind. In the fundamental sense, there is no other factor.” (OE, 153) It is for this reason that Buechner holds that businessmen do not consider supply when setting their prices. Supply is what they create and control. That is what a businessman, an industrialist, a producer does.

What Salsman’s review amounts to is a ringing endorsement of “contemporary, academic economics” (SR, 1) and an attempt to stop you from reading Objective Economics without mentioning what is in the book. It is disappointing.

Inflation Update: First Quarter, 2012

I have been writing this since the turn of the year. It has been subdivided already several times. A couple parts have appeared as other posts and several pages are just sitting around in this file, orphaned! I have again divided it so that I can get something out and the length will not evoke cursing. This section is my inflation update. Maybe some of the rest will appear in the future.

I realized recently that my most “favorite” group that constantly announced the coming of hyperinflation has only made one such announcement in the last several months, and that one was somewhat less frantic than normal. (Recently, they have been touting stocks.) In their last prophascy of doom, they did touch on issues that are important, but since they have only one economic note, hyperinflation, they don’t consider other, equally nasty, potentials, of which there are several. But apparently, hyperinflation is not the immediate threat they have often claimed. They haven’t said why they have changed their tune.

Yet, there is plenty of good reasons to be concerned about inflation in the next few years. For the fun of it, let’s divide up the issue into two separate (but certainly related) questions:

If by inflation you are asking about the money supply and its impact on asset prices and the economy: just look at the stock market! There is plenty of made up money sitting around that comes out and bids up assets when given even a glimmer of hope. True, company profits are healthy. My question is about the source of those profits. Is it just savings from leaner operations, or is it return on growing business. I fear that it is the former, which means little for future economic improvement. What reasons do we have to suggest that businesses are investing in the anticipation of growth?

There is new, made-up money floating around, for example, our balance of payments for last year was again a large deficit, perhaps smaller that in 2007, but still large. That means that a lot of electronic dollars left the country, billions of them ($110B in the third quarter, 2011; $124.7B in the second quarter, 2011), and didn’t return, won’t return (for those dollars to come back other currencies would have to be better than the dollar, and that isn’t happening). At the same time, notice that our money supply did not shrink by hundreds of billions. Think about this. We sent over $400B dollars out of the country last year, and didn’t notice it. Where did it come from? (Hint: International trade is done entirely on credit!)

The money supply within the country, in the broad measure that I use, MZM, shows the resumption in the upward trend continuing. The graph available, and widely used, is hard to read and the current trend is still only a few of months old. So what it means is unclear. What appears to be the situation at this point is that the increase is on the same growth line as before the meltdown. But since the base is larger, the growth will have less impact. Think of the difference it means to you to have a $10,000 raise when your income was $30,000 vs. $200,000. So, an additional $100B means more when the money supply was $1T in the 80s vs. today’s nearly $11T. The rate of growth in the money supply would need to be a lot steeper to be really important. The growth we see isn’t good, mind you, just not frightening.

Another important measure of the money supply is new loans made by banks. This is the method by which the Fed puts money into the economy. The Fed has been trying to push new made-up money into the economy since 2007 with little success. Recently, however, loans are beginning to increase again. Just new loans would not be an issue. After all, business needs credit, and amount would fluctuate over time. Further, with the deep recession, the amount of loans would have declined. A healthy economy would need credit to grow. If that new credit reflected new savings we would be seeing real growth soon. Of course, it doesn’t. Savings is being sucked into the Federal deficit. So, the growth of bank loans tends to indicate new made-up money being pumped into the economy, which could lead to another round of asset price inflation. The recent upward trend of new bank loans is worrisome, and needs to be watched. Again, the graph is too small to give good detail, but the slant of the upward movement isn’t too steep.

We are still sitting on a time bomb. If you look at the reserves (deposits) of banks who are members of the Federal Reserve (nearly all banks), you see that the amount of reserves they have is amazingly high. This is the Bernanke plan. Notice the last big jump to about $1.8T. That was QE2. That is to say that much of the massive amounts of money that Bernanke and his gang pushed into the economy is actually just still sitting at the Fed. It really didn’t do much except keep interest rates at stupidly low levels. It did help push commodity prices up, which is another type of asset boom. Does anyone believe that the interest rates actually reflect any element of the real economy? Low interest rates have not sparked new investment. They have merely given an unearned bonus to holders of federal debt and kept BO thinking that his deficits don’t really cost anything.

The time bomb will be the consequence when banks begin to think that they should move those reserves to their banks and expand their loan portfolios. Then we have a real inflation as the money supply explodes (once put into the economy, under current rules, each dollar moved from the reserve could become ten, or the $1.8T of excess reserves could become an additional $18T (our current money supply using MZM is almost $11T). The Fed actually knows that is a bad thing. When they first expanded the reserves with QE1 in 2008, there was a lot of talk about what they would do to sop up the excess reserves, which were then about $1T. That talk has completely disappeared as the economy failed to improve. But the problem remains and has gotten bigger. If the economy begins to grow the Fed will have to do something. Any action the Fed takes to sop up that money will raise interest rates, perhaps dramatically, and that would put a lid on the economy. That would also send interest rates up around the world and make things in Europe much worse. So ignored everywhere right now is this time bomb that will go off if the economy does begin to grow.

If you are thinking of prices as an indication of your cost of living (quality of products is often forgotten), the news is mixed. For example, the costs of health care and health care insurance is going to continue to skyrocket, especially if the quality of care is considered. (This increase in cost is only partly due to ObamaCare. Wait until that really begins to kick in!) Government interference in healthcare has never lowered cost or improved care. It has only made people feel like they were getting something for nothing.

Gas prices have risen, and will remain at higher levels until various international issues have been resolved. The last few years the pressure on prices has been due to new demand from countries that actually were developing. The current problem is due to the threatened supply because of Iran’s level of irrationality, Iran being a major oil producer. Again, the West’s willingness to allow its technology and industriousness to be hijacked by local warlords and savages becomes the source of economic shocks.

(The problems with higher food commodity prices that we had a while ago have abated, mostly due to higher crop results, e.g., the end of the draught in Russia. There are countries that are still seeing lower supply and thus more expensive food supplies. Most of these countries have governments who are controlling the markets. I can’t help but wonder if their problems are due to their governments inability to continue to subsidize food distribution.)

Reports from some U.S. food processors report that they have had to raise their prices from between 5% and 7% in the last year. No doubt we will see some upward movement in prices and no upward movement is good. Even price inflation rates of 2% are damaging. But there is no indication on the horizon that we are moving toward hyperinflation.

I just read another of Peter Schiff’s monologues. Among other things, he claims that price inflation is running at 10% (He just said inflation, but I assume he meant prices, in his writing he often switches back and forth.). He and others have constantly asserted that the CPI has been politically corrupted and that actual prices increases have run much higher. I do think that the CPI has been manipulated in many ways, and a lot of it was politically motivated, at least implicitly. But I have a problem with rates of price increases much higher than a few percent. Why? Let’s say that prices were going up at the rate of 7% a year, which is in the ballpark of many such claims. That would mean that prices today would be double what they were ten years ago (rule of 72, see below). Is that your experience? It isn’t mine. Some have argued with some justification that the quality level in many products has improved at the same or nearly the same price and that lots of technology prices have dropped. As I suggest in my review and comments of his books, I think Schiff often shoots from the hip, which I don’t find admirable. He has been right on some important things, but I’m not sure that it was because of good insight or just accident.

I did say that the situation is mixed, didn’t I. What I meant is that the news is that mixed in with the reports that prices are generally drifting upward are some reports of some really bad spots. In December, I would have said that foodstuff commodities prices had dropped, but the thinking that loosening of credit in China and Europe was going to stimulate demand has run them back up a little.

As I see it, the problem that could most affect us immediately is a financial crisis brought about by the European governments. The finance ministers in Europe are saying that they aren’t sure that this bailout will succeed. The Greeks have shown that they fail to live up to their promises, and curse others when that is pointed out. The other tottering European economies are very dependent upon low interest rates and the availability of massive amounts of made-up money. Remember, the euro zone’s long-term plan is a “fire wall” of several hundred billion euros. Where is that money going to come from?

So, my expectations for the next year or so is that our economy will continue to totter along. If unemployment moves up, or people become to understand the figures that are before them, we could see a big pull back in equities and consumption slow. That would lead to QE3 and more of a mess.

Prices will continue to inch up. Commodities will continue to have upward pressure. Basically, we will have more of the same.

There are two other considerations to watch for: The implimentation of the new rules for banks and derivatives and the actions that BO might take in anticipation of the election latter this year. Neither of these will be good for us and will be inflationary.

Having said that I should also say how reliable I regard my expectations. (Do you notice that nearly all of today’s prognosticators never look at how they did in the past?) Reliability of economic predictions is dependent upon two separate issues: One – how reality oriented is the analysis; Two – lack of omniscience. There is also one other point to keep in mind, good economic events require rationality, at least to some extent, and productivity. As good economic events are in short supply, for obvious reasons, the question is then how far off on the down side are my comments. I noted the areas that I thought that we could have major problems. There could be problems coming that I, or anyone, has not noticed. The most recent example, aside from people missing what is under their noses (the residential real mortgage meltdown), is 9/11. Another major terrorist strike could upset everything, and we would have a hard time recovering, too. So, I have tried to cover the economic bases that I can spot. But there could be others. Just keep on your toes.



P.S. I just read an article about investments in Turkish companies by venture capitalists, Now I don’t know how true the article was, although it did make Turkey sound like a much better place than I would have imagined. What I thought was so amazing about the article was that it didn’t mention the Turkish government or nationalized companies once! (Except to imply that the government wasn’t an issue!)