"Most people are in arrested development and cannot use logic." Jacob.
"Competition and capitalism are hated to-day because of their tendency to destroy poverty and privilege." William Hutt
"America is unique in that our economy is totally dependent on global charity." Peter Schiff

Tuesday, May 31, 2011

Some Consequences of the Easy Lesson

In our previous post, we explained what a business cycle really is. It's not our own invention, it's the standard Austrian explanation. To sum up:

Step 0. Tons of money is lent to people who can never pay it back.
Step 1. All that money is spent. This is the boom.
Step 2. Eventually the time comes to repay all those loans, and they aren't repaid. Consequences ensue. This is the bust.

Here are a few corollaries of the above:

1. Marx is cheering us on from his grave. We have discovered what eluded him, the cause of business cycles.

2. Then he thinks again, and boos us from his grave. Because obviously, Step 0, the cause of the whole cycle, is not by any means inherent to capitalism. We have shown that capitalism is not at all doomed to suffer business cycles, which Marx doesn't like hearing.

3. Now that we understand the reasons for business cycles, we also understand how to deal with them.

If you remember, last post we said you could create your personal miniature business cycle by maxing out your credit cards beyond any hope to repay. Spend the money, you have your boom. Suffer when the card companies come after you, that's your bust.

OK then, how do you deal with your bust?  Let's consider a few options.
  •  Borrow more money to repay the card companies. This is what Greece and the other troubled countries in Europe tried. But just as you will have a hard time finding new money at reasonable rates now you have been exposed as a bad risk, so too they cannot find anyone who trusts them anymore.
  • Steal the money to repay. If it's a govt who is deeply in debt, this is called raising taxes.
  • Get a thug to steal for you and give you the money. This is called "creating jobs" if the govt is your thug.
  • Tell the card company that something will have to be worked out. You will repay pennies on the dollar if they agree to forgive you the rest. This is called restructuring the debt. Obviously, the lenders will not agree to this if they can help it.
  • Counterfeit money and use it to repay. This is called inflation if it's a govt doing it.
  • Live on dog food under a bridge somewhere till you pay your bills. This is called an austerity program. It might work if you are tough enough, and the only one involved. But what if you are married and have a finicky wife and children who refuse to live like animals just because you are broke? Marital discontent. On a large scale it's called riots in the streets.
  •  Get a second job and work harder until you repay. This is called becoming more productive. It can be implemented on a large scale as well, but is almost never resorted to, usually because those involved have no clue how to get it done. A rare exception is China dropping Communism. 
4. Note that none of these measures will prevent you from maxing out your credit cards again, first chance you get. So too, none of these measures will prevent the next business cycle from happening.

What will? Remember in our last post we asked three unanswered questions [so far]. Where did the borrowers, the lenders, and the money all come from in such vast quantities? If we know where they came from, we may know how to get rid of them.

Time for a break

    Recessions in one easy lesson.

    Much has been written about business cycles. Marx thought Capitalism is doomed because of them, that they are an inherent part of the capitalist system that will cause it to self destruct.

    Of course, he never explained why they are an inherent part of the system, or what makes them happen, but everyone believed him. It's now commonly accepted by the mainstream that deep down in the innards of capitalism, so deep it cannot be exposed to logical explanation, and so deep it cannot possibly be eradicated, lies that deadly virus, the mystery cause of booms and busts.

    And you, dear reader, are about to enter a secret society. You are about to become one of the select few who knows what exactly causes business cycles.

    You can in fact create your own personal version of a business cycle right now in your own life. It's very simple. Max out all your credit cards, far beyond what you can possibly ever repay. Spend it all extravagantly. Do this month after month, for as long as you can get away with. That's the boom. Lots of fun, no?

    One day the credit card companies come after you. They want their money, and they want it now. Sadly, you cannot repay, ever. You lose everything. That's the bust.

    That's what a business cycle is, on a grand scale.
    The whole country borrows lots of money it cannot possibly repay = boom.
    The time comes to repay, and the country suffers the consequences of being unable to repay = bust.

    Note that there are three elements in this scenario, money, borrowers, and lenders. The lenders [usually banks] lend the money to the borrowers [=deadbeats], who don't pay it back.

    And it's not enough to have only one or two deadbeats. In order for the whole economy to be affected, to have a real business cycle, we must have these loans happen over and over, with huge amounts of money involved.

    That being the case, we have to ask the same question about each element. Where did he come from?

    1. Where did all the money come from that was lent to these deadbeats? It doesn't grow on trees.
    2. Where did the banks come from? By which I mean, why did the banks make these doomed loans in the first place? Don't they want their money back?
    3. Where did the deadbeats come from in such large numbers? Aren't most people responsible?

    OK guys. This post grows long. Time for a break. BTW, I'd love some feedback.

    Monday, May 30, 2011

    Deflation. The Good, the Bad, and the Ugly.

    Just finished Henry Hazlitt's remarkable book, The Inflation Crisis and How to Resolve It. [Get it free here].

    All in all, he thinks deflation is either good or at worst harmless. For example:
    When the stock of money is not increased, falling
    prices are a normal result of increased production and economic
    progress. They need not bring recession, because the falling prices
    are themselves the result of falling production costs. Real profit
    margins are not reduced. Money wage-rates may not increase, but
    real wages will increase because the same money will buy more.
    Falling prices with continued or rising prosperity have occurred
    frequently in our history.

    But every once in a while he mentions 'devastating deflation". Like here [emphasis mine]:
    If the world, or at least this country, ever returns to its senses,
    and decides to reestablish a gold standard, the fractional reserve
    system ought to be abandoned. If by some miracle the U.S. gov-
    ernment were to make this decision tomorrow, it could not of
    course wipe out the already existing supply of fiduciary money
    and credit, or any substantial part of it, without bringing on a
    devastating and needless deflation

    Or here:
    As long as we were operating on a fractional-reserve gold standard,
    any attempt to return to a pure, or 100 percent, gold standard
    would have involved a devastating deflation, a ruinous fall of

    Here he calls a fall in prices a problem and a mistake [emphasis mine]:
    When the First World War ended, some of the belligerents went
    back to the gold standard. England again is the outstanding ex-
    ample of the problems of doing this and of the mistakes that were
    . Resumption of gold payments was undertaken at the prewar
    rate for the pound in 1925. But two greatly changed circumstances
    were overlooked. First, there had been an enormous expansion
    meanwhile in the issuance of British currency and credit, that is,
    in the amount of paper promises that people might want to convert
    into gold. And second, as a result of that, prices had risen substan-
    tially. If in 1925 the currency had been made convertible only at
    a correspondingly higher "price" for gold, the resumption of gold
    payments might have worked. But the resumption at the old rate
    made gold too much of a bargain, and forced a contraction of
    British credit and a fall in prices

    So what gives? Is inflation good, bad, ugly, or maybe even devastating?
    The answer lurks in his other book, What You Should Know About Inflation.

    Here's the quote, emphasis mine:

    "The case of Great Britain is clear. It had gone off gold
    in World War I. The pound had dropped from a gold
    parity of $4.86 to a low of $3.18 in February 1920, and had
    returned in late 1924 to approximately 10 per cent below the
    gold parity. But wholesale prices in Britain in 1924 were
    still 70 per cent above their prewar level.

    The British Government decided to resume the gold standard at the old
    par in 1925. The result was a steady fall in wholesale prices
    over the next seven years from an index number of 171.1
    (1913 equals 100) in January 1925 to 99.2 in September 1931,
    the month in which England abandoned the gold standard.

    As the British all during this period were unwilling to make
    corresponding cuts in retail prices and wage rates, the result
    was falling exports, stagnation, and unemployment.

    And it was the gold standard itself, not the false rate (or the in-
    ternal inflexibility of wages), that got the blame."

    So there you have it. Bottom line: Deflation [=decrease in amount of paper flying around, or if there is a gold standard, the rise of the value of the currency in terms of gold] is not in an of itself a bad thing. Lower prices are not a bad thing, nor are lower wages, if prices of everything go down.

    The trouble with deflation happens when it is induced from the outside, with something like reintroducing the gold standard [without taking appropriate steps, as Hazlitt details in the book]. Even then all it does is lead to lower prices of everything, and that is not necessarily bad either.

    The real horror of deflation happens when people are then unwilling to make
    corresponding cuts in retail prices and wage rates. This of course, results  in stagnation, and unemployment.

    [I left out "falling exports" in my summary, because I don't really get what's wrong with falling exports. Maybe he means that other countries are unwilling to trade, which is of course, a bad thing].

    Why Mr Hyde can be defeated.

    For who Mr Hyde is, see my first post.
    As Dr Rubin explains in his masterpiece, we are born as Dr Jeckyl. Mr Hyde is something created later in life. In other words, he is not the real us. Because of this, his grip on us is weaker than Jeckyl's.

    Jeckyl, the source of our goodness and creativity and happiness, is who we really are. He can be silenced, intimidated, cowed, but he is always there. Hyde, on the other hand may shout and take control and bully, but he is ultimately a stranger who has intruded himself into our thoughts and feelings. He doesn't really belong there. That being so, he can be evicted.

    Dr Rubin compares him to a house of cards. He can be blown away eventually. 

    Next post we finally get to cases. How to actually evict the guy.

    The Dangers of Deflation?

    Let's discuss this article, The dangers of Deflation, by Ken Little of about.com. Note the cool facial hair and intellectual looking glasses in his photo. Obviously he knows what he's talking about right?

    And here are his credentials:
    Ken Little is the author of 12 books on investing and personal finance topics. He has also served as technical editor for two other personal finance books. Ken has spent many years writing about complex financial topics in a manner that is informative and entertaining.
    Ken has served as the Business Editor of a major daily newspaper and Vice President of Marketing for a large financial services company, and has completed many assignments as a free-lance editor and writer. In addition to being a personal finance author, Ken was the chief financial writer for a large mutual fund and consultant to several large financial services companies.

    A search will show that his opinion is the mainstream one held by every govt official from the Prez on down. I chose Mr Little because he writes clearly, and came up first in a search for "dangers of deflation".
    We are going to rearrange the article a bit, first quoting the sections on inflation then on deflation.

    As always, he gets the italic font, my comments in normal type.

    First we do inflation. Writes Mr Little:

    Inflation is often defined as too much money chasing too few goods and services. The result is rapidly rising prices.
    One wonders where did this "too much money" come from all of a sudden? Did it grow on a tree? My Poppa told me that just doesn't happen. Do you know the answer, Mr. Little?

    Also, where did this shortage of "too few goods and service" come from? Was there a tsunami and nuclear accident that did it, like in Japan recently? Is that what happened to the USA?

    May as well cut to the chase. Mr Little, as is common in the non Austrian world, has his eyes on the symptoms. Too much money, too few goods and services, no attempt to figure out why that happened. Which of course means it will keep on happening until we fix the root cause of the problems, not band aid them over.

    An Austrian would say the too much money did indeed grow on a tree. It's new paper money printed by the Treasury, or new digital money "printed" by the Federal Reserve Bank, that is causing the inflation.

    As for the too few goods and services, there is a cute little fairy tale you will hear on TV about this. It's all China's fault. Those upstarts had the nerve to get rich and powerful, and now they can afford to eat real food instead of rice, drive in cars instead of walk barefoot,and their larger more developed economy is gobbling up the goodies. That's why there is less for us.

    But it's just not true. If they are wealthier, it is not because they printed more yuan. Otherwise Zimbabwe would be the richest nation on Earth. They are richer because they figured out how to produce more than they used to. [And it wasn't rocket science. They merely made their economy freer than it used to be. That's all it took]. Once they produce more, they have more to use and more to trade with. That's how they are wealthier.

    What does all that mean for us? That China's new economic position is not causing less goods and services to exist for everyone, but more. And we all know this. Our houses are full of Chinese stuff.

    The Austrian answer to why there are too few goods and services is because businesses are being punished for producing them. They are taxed and regulated to the point where it is too costly.

    So much for inflation. Now let's see Mr Little on deflation.
    Deflation, the deep and persistent,  drop in prices is a more dangerous threat to the economy than inflation.
    Good intro, summarizing his position. we await the proofs of this statement, and Mr Little will not disappoint.

    Cutting government spending to reduce deficits is normally a good thing.

    However, the U.S. economy is in danger of slipping into a deflationary cycle and reduced government spending will not, in the short term, be replaced by increased spending from the private sector.
    Plenty of questions here. What is a deflationary cycle, why is it a bad thing, and how do you know we are in danger of "slipping into" one? We shall keep these questions in mind as we read on.

    Without a spending stimulus from somewhere, the economy could fall into a deflationary spiral that will make the 2008-09 financial crisis seem mild in comparison. Plenty of new concepts here. What is a "spending stimulus"? How does spending "stimulate" an economy? Where is the "somewhere" that the stimulus will come from? Mars? Jupiter?

    If we all agree that inflation is a bad thing, does that make deflation a good thing?
    For stock investors and the economy, both inflation and deflation are dangerous conditions.

    Deflation is usually defined as ongoing and across the board price reductions.
    That's one definition, and since it's his article we'll go with it.

    While this may seem like a good thing for consumers, deflation happens because there are fewer purchasers of goods and services, often because of a recession.

    So across the board price reductions happen because there are fewer purchasers of goods and services. Meaning less demand. For some reason, Mr Little forgot about the other determinant of price, supply.
    Not only that, he says deflation comes from recessions.

    It's time for us to see another side of the story. And indeed, right here is the key part of this whole post. It's a quote from the famous Henry Hazlitt:
    When the stock of money is not increased, falling
    prices are a normal result of increased production and economic
    progress. They need not bring recession, because the falling prices
    are themselves the result of falling production costs. Real profit
    margins are not reduced. Money wage-rates may not increase, but
    real wages will increase because the same money will buy more.
    Falling prices with continued or rising prosperity have occurred
    frequently in our history.

    So let's get things very clear here. Is Mr Little talking about a recession being a problem, and discussing ways to solve it? No, because he is saying that deflation is caused by a recession often. The recession is not under discussion now. It's low prices that worries him. They are a bad thing in and of themselves.

    Which is odd, very odd. If we are in the middle of a recession, meaning high unemployment and people are broke, the last they need is higher prices. They need lower prices. [And if we are not in the middle of a recession, then those low prices came from increased prosperity, causing no one any harm, as Henry Hazlitt explained.]

    To parallel the definition of inflation, deflation is too many goods and services chasing too few dollars. To capture those few dollars, companies must slash prices.

    Here we are getting to important questions. How did it happen that there are "too many" goods and service? Did someone leave the On button overnight in the factory by mistake? And too many for who? The world?

    Also, how did it suddenly happen that there are "too few" dollars? Did Goldfinger get into Fort Know and steal the dollar bills there instead of the gold?

    From the point of view of pure economics, there is no such thing as "too many" goods and "too few" dollars. The situation is what it is. The amount of goods is called the supply. The amount of dollars ready to spend is called the demand. Those two factors determine the price for which the market will clear, meaning all goods will be sold.

    The Law of Supply and Demand is like the Law of Gravity. You cannot outsmart gravity, and you cannot outsmart the law of supply and demand.
    Many industries operate on fairly thin profit margins, thanks in many cases, to pressure from competitors in the global market.
    Which is a good thing, of course. The consumer, meaning everyone, benefits from this.
    And I'm not sure why competitors in the global market have to be the source of competition. Why is there no competition from domestic companies? I suspect this is leading up to a sob story. Those bullies from China are offering better prices than our red blooded American industries, and the govt has to step in and help the poor dears.
    Companies don’t have to reduce prices too far before they eliminate any profit and if the trend continues, prices may drop below the cost of producing the product.
    A sane company will reduce prices only because the costs of production have gone down. Unless they made a mistake and thought there would be a market for all their products, when there isn't. Meaning they made a bad business decision, or just plain bad luck got them.

    Well, ces't la vie. Nobody guarenteed anything for me. I was never promised that I would have my job or my money forever, come what may. And that is the case with everyone who ever existed since time began.

    So I'm not sure what he's driving at. If prices go down, the consumer benefits. Normally they only go down because the producer is able to lower prices and still make money. And if prices go down because of competition, either from here or from abroad, well that's the American way; it's what made our country great. The ones who can't make money anymore find themselves other jobs where they can.

    Without any way to make up the difference, it doesn’t take long for companies to collapse.
    This is what happened in the Great Depression. Companies folded because they could not sell products for a profit.

    And why did it happen then? Who was outcompeting them? Was it China? The Soviet Union? Germany's Weimar Republic? Was anyone making cars abroad and selling them in the US? Making anything abroad and selling it in the US, for that matter?

    This whole fairy tale explanation makes no sense. Why could they sell for a profit one day before the Great Depression, but not for ten years afterwards? Because there was a Depression? And what caused the Depression? People getting fired? And why were they fired in the first place? Because companies were not able to make a profit? That's circular reasoning.

    Mr Little, though he doesn't understand the problem, thinks he has the solution. A company isn't making a profit? Stimulate it "from somewhere".

    As a side note, companies could not borrow money to stay in business because the financial markets collapsed - sound familiar?
    Because consumer demand is weakening around the globe, the fear is that overseas markets for goods will disappear.

    Consumer demand is weakening around the globe? When did you write this, Mr Little? Because commodities are all going up up up. How do you explain this?
    Stock investors can do little to protect themselves from runaway deflation.
    Runaway deflation? Where? Have you gone shopping lately?

    End of critique.
    I wrote this whole post not to refute Mr Little per se. The main reason is the revelation I got from reading that Hazlitt quote, that a company will not lower prices normally unless they will make money by lowering prices. Meaning that their production costs have lowered. In other words, somewhere along the line, someone found a way to make a cheaper mousetrap, and thus the price of mousetraps went down, and we all benefit.

    And if prices go down because of high unemployment, the key is to tackle the unemployment the right way, not tackle the low prices. Go for the jugular, for the root cause.

    Wednesday, May 25, 2011

    Nice Article at The Onion


    Here's an excerpt: 
    According to alarming new figures released Monday by the U.S. Census Bureau, the nation's population of mature adults has been pushed to the brink of extinction, with only 104 grown-ups remaining in the country today. 

    The endangered demographic, which is projected to die out completely by 2060, is reportedly distinguished from other groups by numerous unique traits, including foresight, rationality, understanding of how to obtain and pay for a mortgage, personal responsibility, and the ability to enter a store without immediately purchasing whatever items they see and desire.
    "Our grown-ups are disappearing at a much faster rate than we previously believed," said Census Bureau chief Robert M. Groves, who believes the decline in responsible adults may now be irreversible. "Unfortunately, we've only recently noticed this terrible trend, perhaps because of this group's unusual capacity to endure hardships with quiet dignity instead of whining loudly to draw attention to themselves."

    Reading it, I wondered how much of the attributes of 'grown up" I've acquired.
    There is one small economic fallacy, the assumption that having a solid 401(k) is the way to go.  

    Monday, May 23, 2011

    Does fractional reserve banking really increase total spending?

    Someone over at the Mises forums asked this.
    I know the theory is that fractional reserve banking increases total spending. But does it increase spending over time? I don't see how it can. Suppose John Smith earns 1 million dollars over his adult lifetime. If he borrows 500k and spends it when he is 18 then that means he is going to spend 500k less over the rest of his life. In other words the ability to borrow money does not increase the net amount you can spend over your lifetime. All it does is shift the time horizon. So I would think that all fractional reserve banking would do is shift the spending forward in time, not change the net amount.

    I liked my own answer so much I'm posting it here.
    Very good question. Shows an active mind.

    1. What about businesses? They don't die. What about dying with debt? It happens.

    2. Let us move aside the curtain of money and see what is happening behind the scenes. First we will talk about businesses.

    Absent FRB [=Fractional Reserve Banking], the money available to borrow comes from people saving their money and putting it in a bank. This is called under-consumption, meaning there are going to be resources that will not be consumed right now. The banks lend that money to businesses, who use it to buy those unconsumed resources to make tools etc. and increase production. With their increased production, which is hopefully a higher percent than the interest and principal they are paying on the loan, they pay off the loan. Society benefits from the increased production, since the wealth of a nation is it's goodies.

    If we introduce FRB, there is money available to people that did not get into the bank from depositors, and so does not represent underconsumption, and so there is no increased supply of resources to draw from. Thus the businesses will have to compete for the existing few resources. They have plenty of money to spend, having borrowed it from the banks, so that prices for those resources will rise. In other words, enter inflation.

    Some businesses will lose money because of this change in prices. Rather than paying off the loan with their new profits, they will go bankrupt, because there are no profits.

    So that FRB does more than shift the time horizon. It inflates the money supply, a very damaging thing.

    As for a consumer borrowing from the bank to consume, he shouldn't be there in the first place. He will have to repay that money with interest, but will not be using the borrowed money to increase his wealth. FRB allows the banks to increase their pool of suckers.

    EDIT: Not sure why, but I can't post comments. So I'll say right here that Jack's comment is spot on, and is what I meant.

    Where and Why George Orwell Got It Wrong

    I'm talking about 1984. The book has come true 99%, all over the world. The State controls our every move, uses double talk and torture and all the other things Orwell predicted It all came true down to the finest details, but for one thing, which we will get to soon.

    Orwell said that his vision of the future was not prophecy, but an extrapolation of trends he already saw existing in his time. Reading his essays, like Shooting an Elephant and others, I got the impression he was a kind hearted, very perceptive person. And no one has written a book like 1984, so rich in detail, so bleak in its vision, and yet true to the last drop.

    But he did get one thing wrong. He thought the world would be divided into three spheres of influence, constantly at war with each other. We have the constant wars, but not the three spheres of influence. How did he get everything else right and this one aspect wrong?

    I think the answer is this. Orwell knew the human heart, knew the realities of his time, but did not know economics. He was a Socialist, which to any Austrian Economist means he had no clue. Thus he did not realize that the world he had constructed contained an internal economic contradiction.

    Socialism basically means taking peoples money and spending it. Orwell correctly understood that the money taken would be spent on wars. He did not realize, however, that such a scheme cannot last forever. A Socialist country will run itself into the ground economically, and if it has large scale wars that will happen all the quicker.

    Every country in the world after he wrote the book turned Socialist to a large extent. Welfare, unions, regulations, nationalizations of industries, govt meddling, large govt payrolls, all the promises of Socialism which are exactly what impoverishes a country, took root very deeply. The most extreme case was of course Russia, then China.

    To make a long story short, they all ran out of money and thus could not afford wars and empires. All but the good ole USA, which retained economic freedom the longest. Thus it had the money to wage constant wars and have an empire, something we have with us to this very day.

    So instead of the three superpowers constantly at war which Orwell foresaw, we have one.

    What can we take away from all this? I'm pointing out a reason for optimism. The govt has us in constant warfare, and is running a police state that is more repressive daily. It gets worse and worse with no end in sight. All resistance so far has been futile.

    But there is a silver lining here. Not content to be a banana republic with a small time dictator who crushes merely his own people, the US govt has as its goal to conquer the world. And that will be their downfall. They have bitten off more than they can chew. There isn't enough money to finance such a scheme, and their economic dictatorship is hastening our bankruptcy.

    So that's our hope. Maybe they will steal all our money before they can impose a total Soviet style police state, meaning they won't be able to finance their police state.

    Friday, May 20, 2011

    Mr Hyde all around us, mwahahaha

    To find out who Mr Hyde is, click here.

    Was watching the movie Juno [not sure why]. The pregnant teen girl is telling the future Adopting Mom that sure she can touch the girl's belly, everyone does it. The baby even moves.

    Adopting Mom puts hands on girl's bloated belly and looks disappointed. She says, "I can't feel anything. It's not moving for me."

    A perfect example of her Mrs Hyde speaking. Obviously, babies don't kick around 24/7 right? And the baby doesn't know anything about Adopting Mom. It's Mom's inner Mrs Hyde telling her this insult that babies won't move for her, like she is so infertile she kills movement in another woman's baby.

    And note a very important detail here. Mom doesn't know anything about the very existence of Mrs Hyde. She thinks it is herself doing the talking and the thinking, not her inner Mrs Hyde talking. We know there are two people inside her, but she doesn't. She thinks everything going on inside her is from her real and her only self.

    Which brings us to the first step in getting rid of Hyde. Knowing when it's us talking and thinking and feeling, and when it's the Inner Critic. Obviously if you don't even know it's the enemy acting, you won't try to resist him.

    So guys and gals, you may want to take note of what you say and think and feel during the day. Anytime it's some kind of criticism, insult, put down, negative psychological insight, whatever, of yourself, take note. That's Hyde doing the talking.

    First aid: tell him to just shut up.

    Thursday, May 19, 2011

    Caplan on Public Goods

    1. In section 3.3 of "Why I Am Not an Austrian Economist" Caplan defends the concept of public goods, quoting Rothbard and rebutting him. To be specific, let us put the quote in context and see what Rothbard was talking about.
    "The call for state subsidization of external economy invest-
    ments amounts to a third line of attack on the free market, i.e.,

    that B, the potential beneficiaries, be forced to subsidize the benefactors
    A, so that the latter will produce the former’s benefits. 

    This third line is the favorite argument of economists for such proposals as
    government-aided dams or reclamations (recipients taxed to
    pay for their benefits) or compulsory schooling (the taxpayers
    will eventually benefit from others’ education), etc. The recipi-
    ents are ... being “saved” from a situation 

    in which they would not have obtained certain ben-
    efits. Since they would not have paid for them, it is difficult to
    understand exactly what they are being saved from.

    In other words, the govt decides "We know you people here want a dam, but you do not want to pay for it. So we will take your money by force, give it to a dam builder, and now you lucky people will finally have the dam you so badly wanted."

    Rothbard explains that this not a benefit to the people being forced to pay for it. Caplan quotes him:
    As for the recipients, they are being forced by the State to pay for benefits that they otherwise would not have purchased. How can we say that they "benefit"? A standard reply is that the recipients "could not" have obtained the benefit even if they wanted to buy it voluntarily. The first problem here is by what mysterious process the critics know that the recipients would have liked to purchase the "benefit." Our only way of knowing the content of preference scales is to see them revealed in concrete choices. Since the choice concretely was not to buy the benefit, there is no justification for outsiders to assert that B's preference scale was "really" different from what was revealed in his actions.

    Caplan thinks this is a ridiculous argument. He explains why:
    While the argument follows from Rothbard's utility theory, that utility theory, as previous sections argued, is seriously in error.
    Oh? And what serious error is that?

     To reiterate, contra Rothbard preferences can exist without being acted upon.
    Oh, I see. Rothbard is saying that if the people don't try and buy a dam without being forced to, it means they don't want one. And Caplan is saying, "Oh, yes they do. Maybe."

    Let us note that Caplan himself is pretty wishy washy about this point, as we have shown in this blog. Sometimes he attributes to Rothbard the thesis that preferences unacted upon do not exist; other times that they exist but we do not know what they are.

    What did Rothbard really mean? All we have to do is read what he wrote: Our only way of knowing the content of preference scales is to see them revealed in concrete choices. No two ways about it, he is saying that they exist. Moreover, he continues to say that we do know them: Since the choice concretely was not to buy the benefit, there is no justification for outsiders to assert that B's preference scale was "really" different from what was revealed in his actions. In other words, if they wanted it, they would have bought it. Not buying it means they didn't want it. Simple common sense.

    2. Caplan then says something a bit mysterious:
    Rothbard was also correct to wonder why actors refrain from bargaining to solve the public goods problem;
    The mystery is, where did Rothbard mention bargaining? He didn't. Where did he even admit that there is a public goods problem in the first place that has to be "solved"? He didn't. Reading the chapter in Man Economy and State from which Caplan took the above quote shows Rothbard denied there is such a problem. In fact Caplan admits later on that Rothbard has an "a priori rejection of the very idea of public goods."
    Bottom line, fee fi fo fum, I smell sophistry.
    More on this section in a later blog.

    Wednesday, May 18, 2011

    Mr. Hyde at the movies

    Was watching inception the other day, and there was a dialogue that caught my attention:

    Mal: But what do you believe?
    What do you feel?

    Cobb: Guilt.
    I feel guilt, Mal.
    And no matter what I do,
    no matter how hopeless I am...
    ...no matter how confused,
    that guilt is always there...
    ...reminding me of the truth.

    It just jumped out at me. Cobb is describing his Mr. Hyde. His Inner Critic is just drowning him in guilt, no matter what he does.
    In fact, come to think of it, Mal is probably his Mr Hyde. She lurks in the deepest depths of his subconscious. Her name is Mal, and a good Austrian economist knows what that means. She is out to kill him and/or to convince him to commit suicide. She prevents him from seeing his children's faces, from hitting on the young sexy girl who's with him, in  other words, from life's pleasures and feelings.

    Did the author of the screenplay know about Dr. Rubin's psychological theory? Not necessarily. A good author, knowingly or not, weaves into his story deep elements of our lives. It's why his work affects us so.

    But isn't guilt a good thing? Should you not feel bad if you sinned, did wrong, committed a crime, hurt someone, etc? Yes and no. A healthy person, realizing the error of his ways, will do what he can to patch things up, have his moment of regret, and then move on. The constant obsessing over past misdeeds is nothing but Mr Hyde speaking, finding yet another way and another excuse to destroy Jeckyl's life.

    Soon we'll talk about how to be rid of him.

    Concluding blog about Caplan and welfare economics.

    Let's cut to the chase. here's Caplan once again, at the end of his section 2.4 of "Why I Am Not an Austrian Economist"
    Throughout his career, Rothbard harshly criticized the modern neoclassical approach to welfare economics, which considers reallocations "efficient" so long as they are "potentially Pareto superior."[23] While the justice of efficiency is far from evident, this criterion of efficiency has many advantages over Rothbard's approach. 

    So it looks pretty unjust, but it's better than Rothbard's. And why?
    In particular, it actually allows one to make efficiency judgments about the real world - to judge, for example, that Communism was inefficient, or rent control is inefficient, or piracy was inefficient.

    Not sure what he means by inefficient here. If he means some artificial use of the word, like Kaldor-Hicks efficiency, or Pareto efficiency, well yes. Rothbard's approach does not measure these things. But if he means by inefficient "achieves the opposite of its intended goal", then AE has extensive literature to show the guaranteed failure of Communism and of rent control. As for piracy, do we really need complicated mathematical theories to prove it is not a viable economic system?

    More on Caplan and Welfare Economics

    We continue our discussion of what Caplan wrote in section 2.4 of  his "Why I Am Not an Austrian Economist"
    He tells us about a serious flaw in AE:
    There is however a more serious flaw in Rothbard's welfare economics - a flaw which again flows from his behaviorist insistence that only preferences demonstrated in action are real. Thus, Rothbard rejects the argument that the envy of a third party vitiates the principle that voluntary exchange increases social utility: "We cannot, however, deal with hypothetical utilities divorced from concrete action. We may, as praxeologists, deal only with utilities that we can deduce from the concrete behavior of human beings. A person's 'envy.' unembodied in action, becomes pure moonshine from a praxeological point of view... How he feels about the exchanges made by others cannot be demonstrated unless he commits an invasive act. Even if he publishes a pamphlet denouncing these exchanges, we have no ironclad proof that this is not a joke or a deliberate lie."[22]

    Truth be told, I'm also a bit sceptical about that last line of Rothbard's. I would go with an argument like this: Say Bill Gates sells a copy of Windows to Smith. Gates gets money, Smith gets a useful tool , and both benefit. Jones, who watches this transaction, is smitten with jealousy. He either wants the money, or a free copy of Windows, or both. He publishes a pamphlet denouncing exchanges. Lie detector tests show he is truly envious unto death. Jones was the breadwinner for his large family, so twenty people starve because of his demise. Has not the transaction harmed society, killing off 21 innocent bystanders?

    I would say no. It's not the transaction that killed off Jones. He would have been just as envious if Gates kept the copy of Windows and Smith kept the $100.

    One may wonder about the situation where Jones is jealous not of the money and the copy of Windows, but of the gain to each party from the transaction? After all, AE assumes both sides always benefit in a voluntary exchange. What if Jones doesn't mind if Gates keeps the Windows and Smith the money, but is envious of their improved situation after the transaction?

    We see the whole thing is getting ridiculous. If we think of the parties involved in the transaction as two people getting married, and Jones having the envy of "Either I get the pretty girl or nobody will", things become crystal clear. The bride and groom have no responsibility to Jones. The correct response to his envy is to tell him, "Deal with it." In other words, envy of an outsider to a transaction should not enter into our economic calculations in the first place.

    That's how I would deal with the question of envy. Rothbard had a different approach, to wit: Maybe he's not envious. Maybe he was lying or joking when he wrote the pamphlet. It is to this approach that Caplan slings his arrows of gentle sarcasm:
    Indeed, Rothbard could have taken this principle further. When two people sign a contract, do they actually demonstrate their preference for the terms of the contract? Perhaps they merely demonstrate their preference for signing their name on the piece of paper in front of them. There is no "ironclad proof" that the signing of one's name on a piece of paper is not a joke, or an effort to improve one's penmanship.

    That one is easy to clobber. We are talking about a normal society, where contracts are enforceable in some kind of court. So that when one signs a contract, he reveals his intent to abide by it or get sued. As opposed to writing pamphlets, which has no legal consequences.

    Caplan goes on, giving Rothbard a gently sarcastic compliment:
    Rothbard's refusal to acknowledge unobserved preferences would have to impress even B.F. Skinner. What possible reason could we have to believe that utility is "moonshine" unless expressed in concrete actions? At every moment, by introspection we are aware of preferences unrevealed by our behavior. Figuring out the mental states of other people is obviously more difficult, but that hardly shows that their mental states do not exist.

    Oh dear. Here Caplan swings in the opposite direction from what we discussed in the previous blog

    In that one, he took the nonexistent and thought it exists but is not known. Here he is doing the opposite. He is taking the unknown and pretending Rothbard was saying it does not exist. All I can say is "Tsk, tsk."

    [And by the way, even after Caplan totally misunderstood what Rothbard was saying, there was no reason for him to reject Austrian Economics. He could instead have said that he thinks Rothbard is wrong, but Mises is right. Mises admits that there are unobserved valuations, and that they are real and exist.
    Here's a quote from Mises in Theory and History, Chapter 1:

    It may happen that the judging individual considers both things or conditions envisaged as equal. He is not concerned whether there is A or B. Then his judgement of value expresses indifference. No action can result from such a neutral disposition.]

    At any rate, Caplan then delivers what I am guessing he considers the knockout punch:
    The statist could easily reverse Rothbard's objection, and claim that since there is no "ironclad proof" that third parties do not object to other people's voluntary exchanges, it is impossible to say whether that they increase social utility. Thus, Rothbard's welfare economics terminates in agnosticism about not only the benefits of intervention but the benefits of voluntary exchange. 

    Note that here he does an about face, assuming that unacted upon emotions are unknown, but that they do exist.
    The same two rebuttals mentioned in the previous blog apply here as well.Since we learn things best by repitition, I'll copy them here, suitably modified:

    It's clobbering time. I see a couple of flaws in his reasoning.
    1. Rothbard is comparing two systems. System A is always voluntary; System B always involves violence and coercion. System A always benefits the two principal parties, with unknown results to third parties; System B always harms one party, benefits the second one, and has unknown results for third parties.

    Which system is clearly the superior one? Is it not clear that System B deserves our rejection compared to A, not our agnosticism? Of course it is. What's Caplan going on about?

    2. There is a more subtle error here as well. As an example of what I mean, let me ask which is a deeper shade of green, Justice or Mercy? The answer is not "We don't know because they are both invisible". The answer is, "No scale of greenness can be applied to these concepts. They are incommensurable with respect to greenness."

    As an example for those who know a bit of math, when a mathematician is asked, which is the larger number, 1 or zero, he says 1.
    Asked which is larger, 1 or some unknown number X, he answers "Unknown."
    Which is larger, 1 or i [=the square root of minus one], he answers "They cannot be compared. The very concept of 'larger than' does not apply to these two numbers with respect to each other."

    If Rothbard was saying that Mr Smith's benefit cannot be measured against Mr Jones' loss, just as 1 and i cannot be measured against each other, then we are left with a System A that causes benefit to Smith and Jones and has unknown results for everyone else [=two things in its favor], and System B that causes Smith harm and Jones gain and unknown results for everyone else [= one thing against the system and one thing in favor of it]. Clearly, System A is the superior one. Nothing agnostic about it.

    Whew, it's gotten long. Tune in next blog for the third and final article on this topic.

    Caplan and Welfare Economics

    In section 2.4 of Why I Am Not an Austrian Economist, Caplan reveals to us that we have not understood Rothbard's politics, because we have not understood his economics either.
    He summarizes Rothbard's position:
    Rothbard went one step further by "reconstructing" welfare economics along Austrian lines. His main conclusions are simple and austere: every market transaction benefits all participants, while every act of government intervention benefits some people at the expense of others. Rothbard goes on to make a seemingly stronger claim: "If we allow ourselves to use the term 'society' to depict the pattern of all individual exchanges, then we may say that the free market 'maximizes' social utility, since everyone gains in utility."[20] This claim might be re-phrased to say simply that each voluntary exchange benefits all participants, and the free market permits the implementation of all desired voluntary exchanges.

    Sounds like govt meddling is a bad thing then, no? Not necessarily, explains Caplan:
    Strictly speaking, however, Rothbard could only claim the welfare effects of government intervention upon "social utility" are indeterminate; i.e., since the victim loses and the intervener gains, it is impossible to say anything about social utility without making a verboten interpersonal welfare comparison.

    In other words, it's true one person loses when the govt steals his property. But maybe the beneficiary of the theft feels so great from his ill gotten gain that his happiness outweighs [in some cosmic scale of things] the sadness of the victim. Since we cannot see the cosmic scale, we don't know if govt meddling in any given situation is good or bad.

    Sounds crazy, no? But wait, it gets worse. Caplan continues:
    This is an important point, because it shows that Rothbard's welfare economics provides a much weaker defense of the free market than usually assumed.
    I don't know what is "usually assumed", since Caplan provides no links where to find these usual assumptions.
    At any rate, Caplan explains why Rothbard's defense of the free market is weaker than usually assumed:

    In particular, Rothbard's own theory strips him of the ability to call any act of government "inefficient." By denying the ability to endorse state action in the name of efficiency, Rothbard also implicitly denies the ability to reject state action in the name of efficiency.

    Oh, so that's it. The govt using violence to steal and make people suffer cannot be rejected, because maybe they are being "efficient", meaning maybe they really love the results of stealing more than the victims hate it.

    Just to make sure we understand his take on Rothbard, Caplan spells it out again:
    This is no logical flaw in Rothbard's theory..., but it's political implications are rather different than commonly assumed: Rothbard's welfare criterion justifies agnosticism about - not denial of - the benefits of statism.

    In other words, if the govt, or for that matter the Mafia, kills and rapes and steals, we dare not say they have done a bad thing. Because who knows, they might have gotten more pleasure from killing and raping and stealing than the victims suffered from those acts. That's the political implication of Rothbard's theory. We dare not judge; we must remain silent agnostics.

    "Hey, don't look at me," Caplan may protest. "That's not my theory, that's Rothbard's. I'm only pointing out what he really said, as opposed to what is commonly assumed. If you don't like the political consequences of his theory, email your gripes to him, not me."

    It's clobbering time. I see a couple of flaws in his reasoning.
    1. Rothbard is comparing two systems. System A is always voluntary, System B always involves violence and coercion. System A always benefits both parties, System B always harms at least one party. System A always has a guaranteed net benefit [what Caplan calls "efficiency"], System B never has a guaranteed net benefit, and has a possible net loss.

    Which system is clearly the superior one? Is it not clear that System B deserves our rejection compared to A, not our agnosticism? Of course it is. What's Caplan going on about?

    2. There is a more subtle error here as well. Caplan is confusing the unknown with the impossible. As an example, let me ask which is a deeper shade of green, Justice or Mercy? The answer is not "We don't know because they are both invisible". The answer is, "No scale of greenness can be applied to these concepts. They are incommensurable with respect to greenness."

    As an example for those who know a bit of math, when a mathematician is asked, which is the larger number, 1 or zero, he says 1.
    Asked which is larger, 1 or some unknown number X, he answers "Unknown."
    Which is larger, 1 or i [=the square root of minus one], he answers "They cannot be compared. The very concept of 'larger than' does not apply to these two numbers with respect to each other."

    If Rothbard was saying that Mr Smith's benefit cannot be measured against Mr Jones' loss, just as 1 and i cannot be measured against each other, then we are left with a System A that causes benefit to Smith and Jones [=two things in its favor] and System B that causes Smith harm and Jones gain [= one thing against the system and one thing in favor of it]. Clearly, System A is the superior one. Nothing agnostic about it.

    [Added May 21, 2011: I found a line in Human Action by Mises which expresses exactly this idea. I think it fair to assume that Rothbard agrees. Here's the quote:
    Some economists believe that it is the task of economics to establish how
    in the whole of society the greatest possible satisfaction of all people or of
    the greatest number could be attained. They do not realize that there is no
    method which would allow us to measure the state of satisfaction attained
    by various individuals. They misconstrue the character of judgments which
    are based on the comparison between various people’s happiness.
    expressing arbitrary value judgments, they believe themselves to be estab-
    lishing facts. One may call it just to rob the rich in order to make presents
    to the poor. However, to call something fair or unfair is always a subjective
    value judgment and as such purely personal and not liable to any verification
    or falsification. Economics is not intent upon pronouncing value judgments.
    It aims at a cognition of the consequences of certain modes of acting.

    There ya go. Any comparison of two people's happiness is an "arbitrary value judgement".
    One could argue still that Mises means merely that the value is unknown. But once he says there is no method of measuring even the happiness of one individual, Occam's Razor assures us that there is incomensurability between two people].

    Caplan then lays down another whopper, but that's for our next blog.

    Thanks to you all

    I'm pleased as punch. Over 250 people have dropped in so far, from 10 different countries!
    Don't be shy about commenting, especially about what you liked.

    Tuesday, May 17, 2011

    First step in crushing Mr Hyde

    I explain who Mr Hyde is here. He is the phrase I use for our Inner Critic. [I have given him a name because it is useful to think of him as another person lurking inside us]. His mission in life is to make us miserable. All suicides, for example, do it because Mr Hyde told them to. But he doesn't just go for the home run; he will try to make us feel bad any way he can.

    So how do we stop him? We can learn something from what Mises wrote in Human Action. He says that a person will not act unless he thinks he has a chance of accomplishing what he sets out to do. If he thinks it's hopeless, he won't even try. Like the guy in the bookstore flipping through a book on optimism, then not buying it because "what's the use?"

    So there's our first step, knowing the battle can be won. We can't change all the crummy things that happen, or the dumb things we did in the past, but we can stop our Inner Critic from saying it is all our fault, that we will never do anything right, and the like.

    How do we know it can be done? From other peoples experience. Dr Rubin writes, based on decades of working with people, that Mr Hyde is like a house of cards that can be blown away [eventually], and like a salami that can be gotten rid of slice by slice. So it can be done.

    Caplan and continuity

    We continue with a superficially devastating critique of Caplan's, which seemingly hoists AE [=Austrian Economics] its own petard.
    He accuses AE of scorning the continuous when everybody else uses it, but blithely using it themselves.

    First, he quotes their rejection of it: 
    Mises and Rothbard have a final related objection to standard neoclassical utility theory: the assumption of continuity. Quoting Rothbard, "[H]uman beings act on the basis of things that are relevant to their action. The human being cannot see the infinitely small step; it therefore has no meaning to him and no relevance to his action."[16] The implications are broader than they may initially appear, because as a mathematician will tell you, you can't differentiate a function that isn't continuous. This means that if Mises and Rothbard is correct, the pervasive use of calculus in economics must be rejected in toto. 

    Then, in a dashingly brilliant stroke, he shows how the Austrians themselves use continuity in their ubiquitous supply and demand curves:
    One obvious problem arises here. Without continuous preferences, it is also highly unlikely that e.g. supply and demand can ever be equal. If you draw the supply and demand curves continuously, then they are (almost) bound to intersect. But if you draw them as a discrete set of points, supply and demand in general don't have to intersect. Thus, the argument against calculus based upon the rejection of continuity also argues against even the use of simple algebraic constructs - like intersecting supply and demand lines - that fill Rothbard's works.
    Of course, one could say that the unrealism of continuity is only minor. But this is precisely the reply that Rothbard considered and rejected: "Most writers on economics consider this assumption a harmless, but potentially very useful, fiction, and point to its great success in the field of physics... The crucial difference is that physics deals with inanimate objects that move but do not act."[19]

    You can't have it both ways, guys, explains Caplan:
    Rothbard thereby runs into a serious contradiction. If the assumption of continuity is not a harmless fiction, then it is incumbent upon him to remove all of the supply and demand intersections in his works, and to state that supply equals demand only under extremely rare conditions (for without continuous pricing, the odds that supply and demand actually intersect are very slim). This position is certainly coherent (and since Mises used no diagrams, it would be less work for him to adhere to it), but rather peculiar. Alternately, Rothbard could concede that assuming continuity rarely alters substantive results, and accept both supply and demand intersections and the use of calculus as methodologically kosher in economics.

    Dang, he really hit a home run here, it looks like. Let's see his key point once again, the one that goes for the jugular:
    Without continuous preferences, it is also highly unlikely that e.g. supply and demand can ever be equal.
    And why not, we ask? He explains for the simple minded:
    If you draw the supply and demand curves continuously, then they are (almost) bound to intersect. But if you draw them as a discrete set of points, supply and demand in general don't have to intersect.
    And indeed he repeats this argument, to make sure we get it:
    ...supply equals demand only under extremely rare conditions (for without continuous pricing, the odds that supply and demand actually intersect are very slim).

    That's his whole argument, really, that without continuous pricing, the odds that supply and demand actually intersect are very slim.

    And now it's clobbering time. I see two egregious errors Caplan is making.
    1. The first thing is to understand that supply and demand curves are not made by gathering data from the real world. There is no actual data of how many units people actually bought or sold at, say, $1 a bushel, at $2 a bushel, etc. [Doing this has inherent problems, and of course Rothbard has every right to reject it, and never uses it when discussing supply and demand]
    Not only that, the curves are not even meant to represent what happened in the real world, but rather what is going on in the minds of people. It represents what people are "willing and able" to buy and sell at various prices.  Henry Hazlitt spells this out:

    All valuation begins in the minds of individuals. We are accus-
    tomed to saying that market value is determined by supply and
    demand, and this is as true of money as of other commodities. But
    we should be careful not to interpret either supply or demand in
    purely physical terms, but rather in psychological terms.
    rises when people want something more than they did before. It
    falls when they want it less. Supply is more often thought of in a
    purely physical sense, but as an economic term it also refers to
    psychic factors. It may vary with price. At a higher price producers
    may make more of a commodity, or be ready to offer more of the
    existing stock for sale.

    Since nobody has learned to read minds yet, we see that every supply and demand curve in the world must be hypothetical. And indeed, that is what they are, teaching aids to explain hypothetical situations. They are intended to teach general principles, and most of them don't use any numbers at all.

    That being said, we can now ask ourselves, "What should a supply and demand curve look like?" The answer is of, of course "Whatever the teacher wants it to." He is using it to illustrate a situation he has made up.

    We see now the blunder Caplan has made. He is asking "Why do supply and demand curves intersect?" The answer is "Because the teacher wants them to." He claims "...without continuous pricing, the odds that supply and demand actually intersect are very slim."

    To which we reply, "Odds in which universe? The one the teacher made up? He can make up whatever he wants, choosing whatever helps him explain his point.
    "The real world? Supply and demand curves are not trying to summarize a historical event in the real world, nor to predict the numerical future of a real world." They are perfect examples of what Mises was talking about when he wrote [quoted here] that true economics principles are qualitative, not quantitative.

    Now there is one point on the whole curve that does have a basis in reality, sometimes. If we are talking about the supply and demand curve of some point in the past, say the month of January 2012, then we can sometimes gather up the data and see how much was actually  bought and sold, and at what price. Since buying and selling actually took place at some price, and a given amount was bought and a given amount was sold, we know one point on the supply and demand curve. At price X [the one that actually happened] supply Y will be given out for sale [the amount that actually was sold], and the demand will also be for Y [because that was the amount actually bought].

    So that the odds in such a case, of a supply and demand curve of a true situation in the past, has odds of 100% of intersection, whether pricing is continuous or no. Bryan, really!    

    2. That was Caplan's first mistake. His second one is his implicit assumption that the real world market usually is in equilibrium. He states that according to Rothbard "supply equals demand only under extremely rare conditions." This is, if anything, a merit, because according to AE, that is exactly the situation. Here's a line from our good friend, Wikipedia:  "...the Austrian School and Joseph Schumpeter maintained that in the short term equilibrium is never attained..." 

    Now for a thought or two about Caplan's paper in general. Most of it is over my head, so I have no idea if is right or wrong. But in the two areas I've discussed in this humble blog, the calculation problem and continuity, he has so missed the boat, I begin to wonder how much of the rest of his paper will hold up to close scrutiny.

    Monday, May 16, 2011

    More on Caplan and Socialism

    This is a continuation of my previous blog on the subject
    1. In that same section, Caplan writes:
    ...Mises repeatedly insists that economic theory gives only qualitative, not quantitative laws...For example, in Human Action, Mises tells us that:

    The impracticality of measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations. If it were only caused by technical insufficiency, at least an approximate estimation would be possible in some cases. But the main fact is that there are no constant relations. Economics is not, as ignorant positivists repeat again and again, backward because it is not "quantitative." It is not quantitative because there are no constants. Statistical figures referring to economic events are historical data. They tell us what happened in a nonrepeatable historical case.
     If so, then how could he possibly know by economic theory alone that the negative effect of the lack of economic calculation would be severe enough to make socialism infeasible? Granted, the socialist economy would suffer due to the impossibility of economic calculation; but how, on his own theory, could Mises know that this difficulty to so severe that society would collapse? 

    I assume he is asking the following. If you are a "normal" economist, up to the ears in mathematical formulas, you can plug in numbers to some formula that models a socialist economy, let the computers work out the answers, and you will find that the socialist economy will be, say, in the red 10 trillion dollars year after year. That is how you would prove that socialism is infeasible. But if you are Mises, making qualitative statements only, you may know that socialism is bad, but you cannot know HOW bad. How bad can only be measured in numbers, in dollars and cents. Maybe it loses a penny a year, for all you know, Mises. Which would certainly not make it infeasible, right?

    I can't think of any other explanation of his words that avoid making them non sequitors.
    And if that's the problem, here is the answer. Mises proves in his works that a socialist economy is, every step of the way, simply gambling. Such an economy can only decide what to do in every one of the thousands of steps of production by tossing a die with a twenty sides or more, only one of which wins. This is in contrast to a businessman, who has an automatic decision maker for him, prices. It's beyond the scope of this humble blog to go into why socialism is like that according to Mises. But that's what he claims.
    Given that assumption, you don't have to be an Einstein, or come up with numbers to know that that gambler will lose, for sure.

    Take a simple case. You go into a crap game, where two dice are rolled. If you roll a two, you win $10,000. If you roll any other of the 35 possible results, you  lose $10,000. And you play this game all day every day. Mises is saying that a socialist economy is just like that game, only with worse odds. Need he come up with numbers to show you it's a losing proposition? 

    2. Caplan then has another attack on the economics is quality, not quantity, thesis. I will quote him in italics, and add my comments in brackets to explain what he's talking about:

    The strength of this objection becomes even clearer when we consider the economic decision-making of Robinson Crusoe, alone on his island. As Mises explains, "Isolated man can easily decide whether to extend his hunting or cultivation. The processes of production he has to take into account are relatively short. The expenditure they demand and the product they afford can easily be perceived as a whole."[28] Crusoe's runs his one-man economy simply by using "calculation in kind" - mentally weighing his preferences and opportunities to make decisions. Mises concedes that this situation is conceivable, 
    [Mises just told us one guy living alone could be a successful socialist. No calc problems for him].
    adding only that this method is unworkable for a larger economy. "To suppose that a socialist community could substitute calculations in kind for calculations in terms of money is an illusion. In an economy that does not practice exchange, calculations in kind can never cover more than consumption goods. They break down completely where goods of higher order are concerned."[29]
    [But a whole community will not make it. They will have a calc problem].

    This suggests some obvious questions. Does Crusoe's one-man socialism become "impossible" when Friday shows up? Hardly. What if 100 people show up? 1000? Mises' distinction between a modern economy and Crusoe's, and why the economic calculation argument applies only to the former, again shows that Mises has underlying quantitative assumptions in spite of his strictures against them. He is making a quantitative judgment that the lack of calculation would not greatly worsen Crusoe's economy, but would devastate a modern economy. Perhaps Mises was right, but pure economic theory did not give him the answer.
    [Aha! It works for one, and for two, right? But not for a whole community, hey? Then there must be a NUMBER, yes that baby you threw out the with the bath, which is the cut off line. Caught you with your hand in the cookie jar, Ludwig, using underlying quantitative assumptions. In other words, you are using numbers, which you yourself claim is a no-no].

    A reply to this is simply to say that Caplan misunderstood Mises.
    There was a school of economics which tried to find out the secret numbers that lurk in an economy. They were hoping that they could find a formula such as "Increasing the money supply by 10% will cause the price level to rise by 5%." They were hoping that there is a secret number waiting to be discovered, [it would be 1/2 if the above statement was right], that connects the money supply increase to the price increase. That's one example of what they were looking for. Their dream was to find many other such constants that they assumed connected economic entities to each other.

    What Mises meant, if you read him in context, is "Forget it. You have no chance of finding those magic numbers, because they don't exist. Just because the numbers were a certain way today doesn't mean they will always be that way. They change all the time. We should be studying why they change, not what they are at a given point in time, and not to ever assume we have nailed down a number, like the inflation constant, that will be fixed forever."

    Caplan misunderstood him to mean that every economics book can never have any numbers in it. Maybe Caplan reluctantly admits that Mises allowed page numbers in economics books, but that's it. No other numbers. Which is why he asks, "Hey there must be a cutoff population number at which an economy loses its ability to calculate. So you too, Mises have to use numbers."

    Which is, I hope the reader sees by now, a sign that Caplan missed the boat once again. Yes there must be such a number, but it will be different for each situation. It, too, is not an eternal constant.

    3. He continues:
    Ever since Mises, Austrians have overused the economic calculation argument. In the absence of detailed empirical evidence showing that this particular problem is the most important one, it is just another argument out of hundreds on the list of arguments against socialism. How do we know that the problem of work effort, or innovation, or the underground economy, or any number of other problems were not more important than the calculation problem?

    This is an easy one. And you should have known this on your own, Bryan. All the other problems can be solved by good will, in theory. Edifying speeches could, possibly, make people work hard, innovate, stay away from underground economies. But the calculation problem is a brick wall that cannot be solved ever. Thus its theoretical importance.

    The collapse of Communism has led Austrians to loudly proclaim that "Mises was right." Yes, he was right that socialism was a terrible economic system - and only the collapse of Communism has shown us how bad it really was. However, current events do nothing to show that economic calculation was the insuperable difficulty of socialist economies. There is no natural experiment of a socialist economy that suffered solely from its lack of economic calculation. Thus, economic history as well as pure economic theory fails to establish that the economic calculation problem was a severe challenge for socialism.

    I notice no footnote referencing the "overuse" or the "loud proclamations". In any case, think of a dead man with a thousand diseases caused by germs evident in his bloodstream, plus his head has been chopped off. The germs might have gotten to him first historically. But germs can be cured by antibiotics, missing heads cannot be cured at all.
    So too, Russian Communism was sick many ways. Theory has not shown why it had to have any of the many diseases it suffered from. Mises showed that it did have one fatal illness. The head was chopped off. It could not calculate.

    Lebron and psychology

    It's a real shame there can be only one winner in these NBA playoffs. So many deserving talented players, and only a small handful will be "winners". There must be a better way.

    In any case, I want LeBron to win, and also want him to lose. I feel bad for him already, seeing his hopes dashed pretty bad tonight by the solid Bulls team. He's playing two and a half guys against nine, to quote Bill Simmons.

    But if he pulls it off and beats them in the rest of the series, and goes on to win the championship, how will that feel? Like when the class egomaniac, who bragged all year that he will be teacher's pet, actually does become teacher's pet. Grrrr.

    How does this all fit in with psychology as explained by T. I Rubin? It has to do with humility. We all like Kevin Durant and Derrick Rose, because they are humble. The quiet self collected way they just do their jobs.

    Where does humility fit in with the evil Mr Hyde? Very simple. Evil Mr Hyde, the internal critic out to destroy us, tells us we are less than we really are. Often, out of desperation, we defend ourselves by lying and declaring to ourselves and the world that we are more than what we really are. We feel a need to be more than we are, to cover up and hopefully silence Hyde's constant chatter that we are nothings. Mr Hyde is of course very happy to see these feelings, and makes them part of his arsenal against us.

    And that's where humility comes in. It is both the cause and the result of Hyde's defeat. If we somehow see the light and realize that we don't have to be what we are not, that any demand or insistence that we be better than what we are [I am the greatest in this world! In the next world! In any world!] is Mr Hyde doing his thing, that realization weakens him. When we turn off that part of him, he is one step closer to death.

    And when we do finally turn him off, we can relax and live our lives in peace. We have no need to brag, to strut, we just feel that deep content of being pleased with our very selves, as is. That's humility, and it is very powerful and very attractive. It's why we like Durant and Rose. They are not out to one up anyone. They are relaxed, so we can relax with them.

    [Note to self: Remember that you haven't actually met any of these guys. You have no idea what they are really like. Self notes it]. 

    Partial Refutation of Brian Caplan on Socialism

    He wrote the famous Why I Am Not an Austrian Economist. This is about the section called "Economic Calculation and the "Impossibility" of Socialism".
    He begins by quoting Mises:

    Socialism is not a realizable system of society's economic organization because it lacks any method of economic calculation... Socialism cannot be realized because it is beyond human power to establish it as a social system.
    And Caplan asks:
    This conclusion is amazing, for Mises repeatedly insists that economic theory gives only qualitative, not quantitative laws? 

    OK, Bryan, hold it right there. That line contains your big mistake. Your thinking seems to be:
    1. Economic theory gives only qualitative, not quantitative laws.
    2. Socialism is an economic theory.
    3. Therefore Socialism need only give qualitative, not quantitative laws.
    4. Which is the same as saying it need not calculate when running a country.
    5. So what's Mises doing, saying Socialism will fail, cause it can't calculate? No economic theory can or need calculate, according to Mises.

    The error should be crystal clear by now. It's step 4, which fails to distinguish between the theory of socialism, and the practice of socialism. In step 1. Mises was talking about economic theory, meaning a statement of the laws of economics. Stuff like the law of supply and demand, diminishing returns, theoretical things. But when he says Socialism will fail, he was not talking about Socialism as a well of knowledge that leads to economic insight. He was talking about Socialism in practice, about will happen when a country is run the way socialist theory wants .

    He was saying that putting all the means of production into the hands of one man, as Socialism insists is the right way, will leave that man high and dry, unable to know what to do. All the insights of socialism and capitalism and everything else under the sun will not tell him whether to build his house from wood or brick. [To see why this is so, you have to read his one of his books. Or you could read my series of articles about it, starting here].  

    To make the distinction very clear, let's look at a Math book about the theory of arithmetic. A really advanced book might not have a single number in the whole thing. All X's and Y's, upside down A's and backwards E's.
     Because it is a book ABOUT arithmetic; it is not a book where an accountant records his calculations, say, which would be full of numbers.

    Similarly, a book of economic theory is ABOUT how people run an economy or a business. Such a book, Mises claims, need not contain a single number. But a person actually running a business had better have some books full of relevant numbers, or he will go bankrupt. What where our costs? Our profits? Etc etc. The practice of Socialism, meaning having no competitors in a bidding war for the means of production, will deprive the decision maker of these vital numbers, and he will bring to ruin whatever he is in charge of.  

    OK guys, I need feedback. If someone wants me to point out the other goofs in that section, let me know.

    Sunday, May 15, 2011

    More on the Blinder article

    1. To continue the discussion of Mr Blinder's article defending QE2 from it's critics, he goes on about how wonderful it is to have inflation, if it's within reason. About 2% is a really good amount of inflation to have every year, he thinks.

     This is the official line taken by all the govt mouthpieces. The bete noir is deflation, and inflation is a good thing, at least in small portions. The great Henry Hazlitt did a great job demolishing this nonsense in a free, short readable, informative book [can you tell I like it?], The Inflation Crisis, and How to Resolve It. So we'll move on.

    2. Mr Blinder's explains that is the perfect right of the Fed to do as it wishes, the rest of the world be damned:
    [His words in italics, my comments in normal font]:
    ...it is commonly assumed that expansionary monetary policy depreciates the currency. That's why some foreign governments, especially the more mercantilist ones, are apoplectic. What's down for us is up for them.
    Mercantilist? Germany is mercantilist, hey? At any rate this is just irrelevant name calling on his part. If they are right they are right, right?

    But calling QE2 "currency manipulation" is a grotesque abuse of language. After all, the U.S. dollar is a floating currency. Many factors, including but certainly not limited to monetary policy, influence the exchange rate, which changes every minute. But the Fed will not intervene to push the dollar down. If the dollar should rise instead of falling, c'est la vie.

    Let me get this straight. Since monetary policy is only one of many factors that influence the exchange rate, then it is a grotesque abuse of language to say manipulating monetary policy is manipulating the exchange rate.
    OK. So it is a grotesque abuse of language to say that stealing the signals from a baseball team is "cheating". After all, many thing influence the outcome of a baseball game. Or that taking steroids is "cheating" in any sport. After all, many things influence the outcome of a game.
    I guess the author is an economist, not an English professor. So he may be forgiven for his curious definition of "grotesque abuse of language".

    More important, the U.S. is a sovereign nation with a right to its own monetary policy. So I was stunned when a top aide to the Russian president suggested that the Fed should consult with other countries before making major policy decisions. Come again? An independent central bank doesn't even consult with its own government.

    Oh, I see. The US is a sovereign nation. And the Fed does not consult the elected officals of that sovereign nation, but does what it pleases. How sovereign are we, then, when a handful of unelected bankers make major policy decisions for us, whether we like it or not?

    Also, let's assume for the moment that the Fed has the "right" to do what it wants. But the USA does not live on a desert island. There is a whole wide world out there which we trade with, or more precisely, which we owe trillions of dollars to. And whose products fill our shelves. We need them. It is the mark of the wise man to listen to his friends before taking steps that will harm them, lest they stop being his friends.

    3. Mr Blinder's next argument is that we can't have inflation and unemployment together. So accusing the Fed of creating both at the same time is a mistake:

    Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work?

    Actually, the two usually go hand in hand. Zimbabwe has rampant inflation, and its economy did not get much of a boost. Same with Weimar Germany. And Argentina. And Nixon's USA.
    How does it work? Very simple. The govt always prints money to give to itself and its friends. They thus impoverish most of the private sector, and take away resouces and squander them on themselves, and cause prices to skyrocket. All of it explained nicely in Mr Hazlitt's book linked to above.

    If buying Treasurys [sic] is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary.
    Before the Fed can buy Treasuries, it needs money in its wallet to pay for the Treasuries. They fill their wallet by printing money [as Mr. Blinder admits explicitly in the article], then they use the money to buy Treasuries.

    The inflation comes from the money printing.  Giving the money to the govt [buying Treasuries] is a weak policy tool. Well, actually it is a powerful tool of destruction, sucking money out of the private sector ot be wasted by the govt, as explained in our first post on this subject .

    There is no magic link between growth of the central bank's balance sheet and inflation.
    No, it's not magic. It is the law of supply and demand. The greater the supply of paper money, the less it is worth [=inflation].

    4. Mr Blinder then exhorts us not to blame the Fed, because it does not operate in a vacuum. It's everybody else's fault, he tells us.

    People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.

    Oh. I get it. If you print the money, but stuff it under your mattress, it's OK. And that's exactly what's going to happen. The govt is going to get all the newly printed money from selling those T bills and will never, ever, ever spend it.  And if it does spend it, don't blame the Fed.
    It's like saying there is no magic link between a meth lab and drug use. People have to take actions--like injecting the drug, snorting the drug, and smoking the drug--to connect the two. If they don't we will get neither meth addicts nor criminals, just more idle piles of meth lying there useless.

    There you have it. Mr Blinder presented a defense of QE2. We have seen its intellectual honesty and perspicacity. And he's a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, and a former vice chairman of the Federal Reserve.

    Makes you wonder about our educational, financial, and govt institutions. 

    Gentle Sarcasm, or the websites I follow regularly

    1. http://schiffradio.com Wonderful source of gentle sarcasm and Austrian Economics. I don't listen to it live, for that would involve commercials. Instead I wait to about 5 PM when you can dowload [for the rest of the day] a commercial free podcast.

    2. http://www.fmylife.com/. Where losers go to whine and be laughed at. Hilarious.

    3. The forum at Mises.org  Great place to search for my posts, talk to the guys about AE and current events, solve the world's problems, debate leftists, and see my posts. Just search for Smiling Dave.

    4. http://dilbert.com  He knows what's what.

    Rebuttal to Our man Blinder, appropriately named.

    Quick one line intro. Austrian Economics is not about Austria. It's what Peter Schiff and others have called the only true economics, started by people who lived in Austria, thus the name.

    And now for the meat and potatoes:

    A Nov 15, 2010 Wall Street Journal article lays out why it thinks Ben Bernanke is so wonderful and why only the silly dare disagree with what he's doing. Smiling Dave's Gentle Sarcasm will rebut. I'll quote a bit from Mr. Blinder, former vice chairman of the Federal Reserve, in italics, and then refute in normal type.

    For months, we have witnessed the spectacle of people arguing that Keynes was wrong. Somehow, additional government spending actually reduces employment—even when the economy has huge amounts of spare capacity and unused labor desperate for work; even when the central bank will prevent interest rates from rising to "crowd out" private spending. Really?

    Let's explain how govt spending reduces employment, even under the conditions Blinder thinks it doesn't happen.
    First, lets make this point. When the govt spends, say pays people to build houses, then there is an increase of employment in the housing industry. The moment they stop buying, off toddle the jobs. So we are talking about an eternal injection of govt money into the housing industry. 

    This is in contrast to when private people decide they want more houses. After all, there must be a reason they want more houses suddenly. Maybe prices of houses went down, or a new use has been found for houses. But there is a reason. And as long as the reason is there, the jobs will be there. When the reason stops, the workers will get laid off, as they should be.

    And of course govt spending indeed reduces employment. Because for every dollar they take away from us and use to hire someone, we have a dollar less of our own to spend. So people who used to work for us will lose their jobs.
    Now one may say that it's a trade off, gain one job here, lose one job there. So that the worst we can say about the gov is that it does not help. But why do we say there will be less jobs, not the same amount as before?
    That's a deep question. The answer is that there is a huge difference between a govt job and a regular job. The govt job is always to make something nobody wants. After all, we are talking about the govt building houses because nobody is buying them. Which by definition means the govt is building houses nobody wants. A result of that is that resources like factory space, raw materials, and labor, have been wasted. They cannot be used to make things people really want, because they have been turned into houses.
    When a country has less resources available, it is poorer. People cannot afford to hire others like they used to. So of course there will be more unemployment.

     Our man Blinder may agree with all this in principle, but thinks we have failed to grasp the important special case we are living in. He asks us if we think govt spending cause unemployment...

    even when the economy has huge amounts of spare capacity and unused labor desperate for work?

    What does he mean by "spare capacity"? I assume he means that GM has this big factory for making SUVs and nobody is buying SUVs. So there is a spare capacity for SUV manufacture. And he proposes that the govt keep buying those SUVs to keep the factory open.
    By this thinking, when cars were invented and the buggy factories had spare capacity, the govt should have given them money to keep on making buggys. Or when electricity was invented, the govt should have given money to the whaling ships to keep on bringing in blubber.
    The point is, if a factory has "spare capacity", there is a reason for it. Always. And just like the whaling ships and the buggy factories, if no one is buying, they have to shut down.

    As for "unused labor desperate for work", I guess he is saying the govt should get these people hired, by buying blubber and buggies. Is there not a flaw in this picture? There sure is. In a sane economy the workers would stop working for GM and get jobs doing something else. No more blubber, no more buggies, but something else.
    The reason they cannot find other jobs in our insane economy is because of govt regulations and taxes that prevent people from hiring new workers.

    Mr. Blinder hints at another reason govt spending, in this particular case, will not create unemployment:

    even when the central bank will prevent interest rates from rising to "crowd out" private spending[?]

    So low interest rates ensure that private spending will keep on happening. Whatever the private sector was spending until now it will keep on spending, plus we have the new govt spending, so the whalers will keep their jobs.
    But if the private sector is spending the same amount, that means that of course it still HAS all its money to spend. Meaning no new taxes are being imposed. In that case, where is the govt getting the money to spend? I guess they are borrowing it from someone outside the USA, since the Americans will have all their money to spend. Which means one day we will have to pay it all back with interest. I wonder where the money will come for doing that?
    But we all know where the money will really come from. Hot off the printing press on the QE2. Which by the law of supply and demand applied to money, means inflation. Meaning the private sector will lose purchasing power. Which means the private sector will NOT keep on spending.

    Getting long, so we'll stop here. A lengthier rebuttal of Blinder's absurd article is right here on the Mises forum, Smiling Dave style.

    Don't forget guys, keep those favorable comments coming. 

    Quick intro to useful psychology

    Welcome to my new blog.
    Let's jump right in.
    I see the world through the specs of T. I. Rubin's psychology, which I call the modified Jeckyl and Hyde theory of life.
    The idea is that we are born with the good guy in us, Dr Jeckyl, but then internalize a bad guy, the evil Mr Hyde.
    He is NOT the Mr Hyde of Stevenson's classic, a guy whose evil is directed at everybody else. Rather the evil Mr Hyde we really have is someone whose evil is directed at Jeckyl, in other words, at our own true selves.
    Another name for this evil Mr Hyde is The Inner Critic.
    We'll be talking more about this as time rolls on. Hurry in with your comments, questions, advice for the lovelorn requests.
    Next post will be a bit of Austrian Economics, Smiling Dave style.