"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

Thursday, June 23, 2011

Bitcoin and Bitclothing

Not everyone seems to get what the problem is with bitcoin.
Imagine if instead of trying to be money, the bitcoin people had decided that their digital thingies should be considered clothing, Bit Clothes.

They would extoll the many advantages of Bit Clothing. Never needs washing, one size fits all, no more clunky suitcases or lack of closet space, never wears out, etc etc.

You see the flaw. Yes, Bit Clothes have all those advantages, but they do not have the first essential of clothing. They do not envelop the body. They aren't clothes at all.

People don't get what the problem is with bitcoins because they do not grasp what the first essential of being money is. Part of the reason for this is that we have been using paper for money for many decades now. Paper money is intrinsically useless, so people think why can't anything, however useless, be money, just like paper is?

The answer is simple. Imagine if some cosmic ray fired by aliens from outer space wiped out all dollar bills, all paper money all over the world. And the govts all said they are retiring from the money business. Folks, from now on, you are on your own. 

In short, there is no official currency anymore. What will people use for money? Would they use Monopoly money? Would the local printer just print up some artistic paper money and expect people to use that? What would you accept in exchange for your goods and services?

Historically, and it makes sense, too, people have only accepted as money [if not forced by govts otherwise] something of value to them. Something they could use, or knew many other people wanted to use. Why should I accept payment in colored pieces of paper when I can hold out for something worthwhile? And if I do accept some colored paper in payment for my work, how do I know someone else will want to accept it from me? Maybe I will be stuck with the colored paper, and not be able to get anything for it.

That's what money has to be to work. As clothes are not clothes unless they envelop the body, so too money is not money unless it gives me something when I have it.

And even when the govt imposes paper money on a suffering populace, the principle remains true. The paper money gives me something in that I can use it to pay taxes, and cannot use anything else. Yes, it's a sad day when that's all we can say about the benefit of a currency, but that's how it is.

We see now why bitcoins are not money. What can I do with a bitcoin? Eat it? Drink it? What has it given me now that I have one? Answer: Nothing.

Now people may say, "Who cares if a bitcoin is useful for anything in and of itself? What counts is that you can buy stuff in the stores with it." And they are right. But the question is, what will make the storekeeper accept it? Common sense says people will only accept bitcoins as money [besides a few suckers and fools] if they feel it gave them something, as we explained.

Of course, we are making a big assumption here. That the masses will not be stupid. We may be overestimating them. But so far, in all recorded history,ancient and modern, they have never been that foolish as to accept something totally useless as money.

About the Ads on This Page

I have no control over what ads show up here. Mr Google, whoever he is, generates them.
I notice they have an ad for Goldline. Wikipedia says about them,
South Carolina customers filed a class action lawsuit against Goldline alleging them of "overcharging consumers, deceptive advertising and deceptive sales techniques", in violation of the Racketeer Influenced and Corrupt Organizations Act, unfair and deceptive trade practices, and unjust enrichment. Later in September, 2010, Goldline hired a top Washington D.C. lobbying firm to assist the company with the investigations.
New York Representative Anthony Weiner accused Goldline of overcharging with average markups of 90% to 152%. Dylan Ratigan, a television financial commentator, said that because Goldline is selling gold at 90% more than one could buy it on a gold exchange-traded fund, it would be a "dumb" purchase. He went on to characterize Beck and Goldline as "largely snake oil salesman and scumbags trying to create money for themselves" by "fear mongering" at the buyer's expense.


Lord Keynes rises from the Grave

Well, dear readers, our humble blog has moved up in life. We were graced with a visit from Lord Keynes himself. Not of course the one who wrote a book in 1936, but a blogger whom we have been mistakenly calling Cynicus Economicus, when in actuality he styles himself Lord Keynes.

Following the precedent set by Pravda, we are going to edit all our earlier blogs, eliminating all mention of Cynicus, who was there by mistake, and replacing him with "LK".

Now we will reply to LK's trenchant comments on my defense of Say's Law.

1. He begins by pointing out that although fiat money might not have existed in Say's days, fractional reserve banking did.
Short answer: The rebuttal I wrote to fiat money, and showed that Say wrote it, too, applies to money created by fractional reserve banking as well. It is not money earned by the bankers in exchange for a good or service they provided.

2. I attributed to Keynes the cause of recessions as animal spirits, which I paraphrased as "darned if I know".
To which he stated, I think, do not be fooled by the whimsical phraseology. There is a deep insight behind the words animal spirits, mainly, that nobody can know what causes recessions. [Which contradicts posts he has on his blog saying recessions happen because of deflation]. He mentioned Lachmann, who apparently agreed with Keynes and yet is considered an Austrian.
Here's what he wrote:
Animal spirits is essentially an irrelevant term used by Keynes' describe why we act. You can dispense with it TOTALLY and still have his fundamental insight: that because of uncertainty (thatis non-calculable) we have subjective expectations. This idea is also held by the Austrian radical sujectivists who follow Ludwig Lachmann. That is why the investment is subject to instability and fluctuation, why investment will not necessasrily equal loanable funds supply.

Short answer: So we agree that Keynes animal spirits means "darned if I know". You are just adding that "darned if I know" is the right answer. I am sure you are familiar with Austrian writings that have a different answer.

3. I wrote that printing new money causes inflation. LK replied with two points. First that "(1) large deficits matched $for$ by bond issues are not creating new money."

Short answer. Depends on where the money came form to buy those bonds, and how those bonds are going to be repaid, right? Take QE2. It is a case of printing money to buy bonds to finance the US govts deficit spending. As for how the bonds are going to be repaid, we know the answer to that one, too. The govt wants to increase the debt ceiling lest we go into default. Translated, they want to borrow more money to repay the old bonds. Since for the last 6 months all US govt bond issues have been bought by newly printed digital money, that means the old bonds are going to be repaid with printed money.

In any case, there are plenty more ways of printing new money, be it paper or digital. You mentioned a few in your original post, which I quoted.

4. He also replied to my assertion that printing new money causes inflation with the following longish statement:
(2) in an economy in a recession or depression, it is PRECISELY when there are significant idle resources, unused capacity at plants and factories, idle labour and available resources.

Keynesian stimulus is about getting the private sector to create wealth by increasing capacity utilization and using idle resources (including labour), just as
private investment, private bank credit, and private payment of wages to workers by businesses would do the same thing if there was a recession.

You make the same mistake as Anderson:


I call this a non sequitor. What relevance does this have to the fact that printing money causes inflation?
The only thing I can think of is that LK means that the benefits of printing money, in the proper context, outweigh the inflation it causes, in his and Keynes' opinion.

As a student of Austrian Economics, I am sure LK knows that AE's reply to his comment is that Keynes did not understand nor correctly describe the problem, and that his proposed solution solves nothing, but rather makes things worse.

If you are reading this LK, I suggest we continue by your summarizing what AE has to say about Keynes [why his diagnosis as well as his prescription are totally wrong], to make sure we are all on the same page, and then rebut if you can.

Wednesday, June 22, 2011

Bitcoin Takes a Beating

Have a look at this

The webpage is Libertarian news, with a picture of Murray Rothbard on the bannerhead.
And they let an article sneak in called "The Economics Of Bitcoin – How Bitcoins Act As Money."

The article goes on to explain how bitcoins are as good as gold. Both gold and bitcoins are scarce, are fungible [one piece of gold is the same as another], are divisible into smaller pieces, and are recognizable. Plus bitcoin has all kinds of advantages gold doesn't, which we won't go into here.

Gold, the article tells us, has only one insignificant little detail of an advantage over bitcoin, hardly worth mentioning really. You can make jewelry out of gold. But so what, right? Let's quote the article in full, emphasis mine:

It is important to note that anything which meets the criteria I just listed can act as a money.  People do not care in the slightest that gold can be turned into artistic jewelry pieces in their decision making process about why they are holding gold as a store of value.
The fact that gold can be turned into artistic pieces simply provides a reassuring alternative use for gold if people decided that gold is no longer of monetary value.  So this way I know that if people stop buying gold as a store of wealth, I’ll still be able to sell my gold to a jewelry shop at a tiny fraction of its current value if it came down to it.  But this reassurance that gold will always have some tiny fraction of value to jewelers in no way influences the reasons why people use gold as a money and why gold has a market determined value of nearly 1600 dollars today.
Because Bitcoins have no other use besides acting as trade facilitators, they have no such reassurances of minimal value – but this fact is totally irrelevant from a monetary perspective, just as it is totally irrelevant from the perspective of gold.
All that matters as far as the money market in Bitcoins is concerned is that they have all of the aforementioned properties that make gold a money – which they do.  Thus, Bitcoins can act in exactly the same capacity as a store of wealth as gold. 

Sounds very convincing no? After all, does anyone really think all that gold in Fort  Knox, if it is still there, will ever be turned into jewelry? The thought is ludicrous, right? So just because gold might be worth a few pennies as a trinket doesn't really give it an advantage over bitcoins. Gold is valuable because it is money, not because it makes a good nose ring. That's the article's argument.
What woman would want this? Really.

But alas, dear reader, the article is either misinformed or trying to dupe you.
To understand why, let's sit for a while at the feet of the master, Ludwig von Mises, with my snarky comments to make it palatable. This is from Human Action, Chapter 17.

As soon as an economic good is demanded not only by those who want to use it for consumption or production, but also by people who want to keep it as a medium of exchange and to give it away at need in a later act of exchange, the demand for it increases. A new employment for this good has emerged and creates an additional demand for it. As with every other economic good, such an additional demand brings about a rise in its value in exchange, i.e., in the quantity of other goods which are offered for its acquisition. The amount of other goods which can be obtained in giving away a medium of exchange, its "price" as expressed in terms of various goods and services, is in part determined by the demand of those who want to acquire it as a medium of exchange. If people stop using the good in question as a medium of exchange, this additional specific demand disappears and the "price" drops concomitantly.

We'll use gold as an example of what he means. The caveman liked gold because it made pretty trinkets. This didn't mean much, really, and he certainly would not pay $1,600 an ounce for it. But as time went on, and people started using gold as money, then that very fact that it was money made it more valuable. It's the law of supply and demand at work. Increase the demand for gold, since more people want it now that it is used as money, and you increase its price.

Thus the demand for a medium of exchange is the composite of two partial demands: the demand displayed by the intention to use it in consumption and production and that displayed by the intention to use it as a medium of exchange.[7] With regard to modern metallic money one speaks of the industrial demand and of the monetary demand. The value in exchange (purchasing power) of a medium of exchange is the resultant of the cumulative effect of both partial demands.

In other words, the reason people want a gold coin, when it is used as money, and what determines what they are willing to give in exchange for a gold coin, is the two uses it has, as jewelry and as money.

Simple enough so far, and totally in agreement with the bitcoin article.

Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange. This fact raises difficulties which many economists considered insoluble so that they abstained from following farther along this line of reasoning. It is illogical, they said, to explain the purchasing power of money by reference to the demand for money, and the demand for money by reference to its purchasing power.

Translated into English, he is asking a simple question. Let's put aside the jewelry aspect of gold, and concentrate only on its value as money. People want gold because it has purchasing power, and it has purchasing power because people want it. In a Logic classroom, that kind of thinking would get an F. It's called circular reasoning, like the guy who drinks too much to forget his problems, and the problem he's trying to forget is that he drinks too much.

So bottom line, if we knock off a dime for its value as jewelry, how on Earth did a gold coin ever get to have the ability to buy $1,600 worth of groceries? Because people want it so badly? Well, why do they want it so badly? Because it can buy $1,600 worth of groceries? Circular reasoning.

Mises did not originate the question, but he did come up with the answer.
Before we see what he says, let us take note that right here is where the bitcoin people want to end the discussion.

They will say, "Great question, Ludwig. Just have to chalk it up as one of life's mysteries. But whatever the answer, that answer probably applies to bitcoins as much as to gold. Maybe both bitcoins and gold have no answer to that highly theoretical parlor game quiz, but who cares? Bottom line, gold works in the real world despite some ivory tower paradox, and bitcoins can, too."

On to the answer. Mises leads us through the intricate looking reasoning step by step:
The difficulty is, however, merely apparent. The purchasing power [p. 409] which we explain by referring to the extent of specific demand is not the same purchasing power the height of which determines this specific demand. The problem is to conceive the determination of the purchasing power of the immediate future, of the impending moment. For the solution of this problem we refer to the purchasing power of the immediate past, of the moment just passed. These are two distinct magnitudes. It is erroneous to object to our theorem, which may be called the regression theorem, that it moves in a vicious circle.[8]

In English, people are willing to accept gold coins and give in exchange $1,600 worth of groceries today, because they saw that yesterday they could get $1,600 worth of goodies with a gold coin. People want gold today because yesterday they saw they can buy a lot of stuff with it.

This would apply to bitcoins as well, of course. People will pay $17 for a bitcoin today because they saw that yesterday they could spend it and get $17 worth of stuff.

But, say the critics, this is tantamount to merely pushing back the problem. For now one must still explain the determination of yesterday's purchasing power. If one explains this in the same way by referring to the purchasing power of the day before yesterday and so on, one slips into a regressus in infinitum. This reasoning, they assert, is certainly not a complete and logically satisfactory solution of the problem involved. 

In other words, it's worth $1.600 today because that's what you could get with it yesterday. But what about yesterday? You can't go back and back to the beginning of time, right?

What these critics fail to see is that the regression does not go back endlessly. It reaches a point at which the explanation is completed and no further question remains unanswered. If we trace the purchasing power of money back step by step, we finally arrive at the point at which the service of the good concerned as a medium of exchange begins. At this point yesterday's exchange value is exclusively determined by the nonmonetary --industrial--demand which is displayed only by those who want to use this good for other employments than that of a medium of exchange.

In other words, if you go back far enough, you get to the day when gold was useful as jewellery only, worth say a dime. Until someone realized people are happy to take gold coins valued at a dime apiece. What have they got to lose? That's what the gold is worth for jewellery, anyway. And from there, as gold coins became more popular as money, they started becoming worth more than a dime.

And this is where bitcoins achieve their fail. Unlike gold, no matter how far back you go, bitcoins were never worth anything intrinsically. There was never a reason for bitcoins to suddenly become worth a dime, or any other price. They are totally useless as jewellery, or anything else. So that there is no reason people should accept them as being worth a dime, much less $33.

One may ask, then how come they were traded on certain websites at $33 a bitcoin? P.T. Barnum provided the answer. There's a sucker born every minute. A small handful of people decided to speculate in bitcoins and bought them at whatever silly price they thought was worth it. But bitcoins were never generally accepted at any price but zero. They have no reason to be.

The Brooklyn Bridge, on sale now.

Another reddit link crushes Austrian Economics

This time it's a nit pick. One Austrian commenter wrote:
Free market systems ALWAYs converge to full employment/high employment ‘equilibrium’.

And the hue and cry is that Austrians don't believe in equilibrium in the first place. He quotes Lachman who points out the obvious, that things are always changing.
Of course, Mises said the same thing. Reading Human Action, Pages 245-250, will enlighten.

At any rate, the nitpicker got mixed up because he confused theoretical studies with practical studies.
The theorist, as Mises explains on those pages, in order to study the effects one variable has on an economy, imagines everything else staying the same and seeing what happens when the variable under study varies.
[Those of you who know a bit of calculus will see here something similar to taking a partial derivative of a function of many variables. You hold all the variables fixed but one when computing a partial derivative].

The commenter meant, that if we study a system where no new forces are introduced, but merely study the effects of existing forces doing their thing, then we can deduce what will happen after time passes. A certain state of affairs will be reached. The commenter asserted, correctly, that if we are studying a free market then the final state of affairs will be full employment [meaning anyone who wants a job will have one]. Non free markets won't have full employment, as we see before our very eyes these last few years.

Lachman agreed and emphasized a point Mises made, that of course in the real world new forces are introduced all the time, so that no final state is ever reached. But that does not diminish the importance of the commenter's statement. Because the new state of affairs will also lead to full employment in a free market. This is a very important thing to know. Because it teaches you that if you want the economy to steer itself to full employment, or as close as is possible to get to such a state, then institute a free market.

As an analogy to bring out what we're saying, imagine a car on a bumpy road. The bumps are such that the car can never move in a straight line, because the bumps always move it around a little bit. If the driver aims at going straight ahead [=free market], then even though he is moving right and left and up and down all the time because of the bumpy road, he is also moving in the general direction he wants to get to [=full employment].
But if he pulls his wheel sharply to the left and keeps it there always [=non free market], he will never get where he wants to go.

Reddit links to another refutation of Say's Law [which misunderstands aggregate demand].

And who should it be but our old friend Lord Keynes again.

But this is not so much an attack on Say, but using Say to slay modern Austrian dragons.
He quotes William L. Anderson:
When Krugman uses "demand," he means "aggregate demand," which economically speaking is a nonsensical term. There is no such thing as "aggregate demand;"

Anderson wrote that in response to Krugman's line:
Millions of willing workers are idle because of lack of demand;

LK really goes to town, proving that Say's Law presupposes the concept of aggregate demand, and quoting Thomas Sowell using "aggregate demand" when stating various versions of Say's Law.

The idea being, how can Anderson write there is no such thing as aggregate demand, when Say's Law, accepted by every Austrian, assumes that there is such a thing?

Yep, it's a real good question. Kudos to LK for raising it. And kudos to William Anderson for providing an answer in the comments on his blog, where he links to an article by Bob Higgs. We'll quote the relevant part:

The root problem, I believe, lies in the aggregative character of contemporary thinking about macroeconomic fluctuations. In this view, rising aggregate real output is good, no matter what the composition of the newly produced goods and services. A recession, which most analysts understand as a sustained decline of aggregate real output, is bad, and, in their view, it should be combated by fiscal "stimulus" and by expansionary monetary policy in order to reverse the decline in aggregate demand. They do not worry about — indeed, they rarely even pay much attention to — the makeup of the aggregate output that is added during business expansions, lost during business recessions, or brought into being by the government's compensating fiscal and monetary actions. Output is output; spending is spending. In fact, the whole idea of using government spending to offset reduced spending by investors or consumers turns on this assumption that a dollar spent is a dollar spent, regardless of what it is spent for.

In other words, when an Austrian says there is no such thing as aggregate demand, he means it is a very special sense. He is making that statement to disagree with the Keynes-Krugman school, that holds govt spending on anything at all will help an economy in recession. An Austrian says that you cannot lump the whole economy together that way, and think that spending more in any part at random will cure the economic ills.

Of course Say's Law is not talking about spending money to cure recessions at all. There "aggregate demand" is used by Sowell and others to mean "the sum total of purchasing power of all people in an economy", which is a mathematical entity. Whether mathematical entities exist or not is an interesting philosophical question, but way off our topic.

In other words, LK was fooled by the fact that the same words can have different meanings, depending on the context. Hope it's cleared up now, mate. We await your retraction.

Layer Three, Four and Five of the cake

Just more of the same, that hoarding is a problem. Yawn. See the earlier posts on why that's wrong.
There follows an Appendix that we are told will embarrass Austrians. J. B. Say, Austrian hero, favored public works!

Rothbard points out other areas where Say was not in agreement with modern Austrian economics, in his History of Economic Thought. But so what?

Then comes an Appendix two, where he says that the concept of reservation demand will not save the day for Say. But we have shown that Say's Law stands triumphant with no need to introduce reservation demand.

He then concludes with a huge fail, quoting Hoppe, Hulsmann, and Block, thinking that they are using reservation demand to defend Say's Law, and that they are saying [or that one can deduce from their words?] that Say's Law falls apart if there exists fiduciary media in an economy.

We leave it to the interested reader to see how gross is LK's misunderstanding of H.,H., and B.'s words.

Summing up, LK wrote a long long paper, trying and failing to disprove Say's Law. The Redditt people are passing it off as being of worth.

There is a reason Say's Law is so attacked. One immediate consequence of the Law sends shivers of disgust down many a spine:

The same principle leads to the conclusion, that the encouragement of mere consumption is no benefit to commerce; for the difficulty lies in supplying the means, not in stimulating the desire of consumption; and we have seen that production alone, furnishes those means. Thus, it is the aim of good government to stimulate production, of bad government to encourage consumption.

Use your common sense. Look at the following two pictures and ask yourself which activity will make our country richer.

Or this?

Layer 2 of the Cake

Welcome back. For those of you following the blog, we are defending Say's Law from one LK

LK quoted Thomas Sowell [a good guy] as saying that the classical version of Say's Law assumed or asserted six things. The first was James Mill's version of the Law, that whatever is produced in an economy is exactly enough to buy what is sold in an economy. Last post, we explained this with the homely parable of twenty children sitting in a circle, trading toys.

We move on to the next of the six propositions Sowell stated as being part of Say's Law, what we are calling Layer Two of the cake. Without further ado:

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

Just to make sure we are all on the same page, the second sentence is intended as a reason for the first.

LK claims that this assumption is essential for Mill's version of Say's Law, the first layer of the cake, to be true. And to the superficial mind, he looks right. Going back to the twenty kids in a circle trading toys, LK is saying that we forgot to introduce money into the picture.

OK, let's do that. We'll make the children's party more realistic, and now it will be twenty children standing in two rows facing each other, ten children to a row. All the children are trying to sell their current toy and buy a different one, and each has a five dollar bill. Not all goes well. The children in the left row all sell their toys to some child in the right row. So at this stage the kids on the left have 10 dollars each, five that they came to the party with and five from selling a toy, and the kids on the right have two toys and no money. Before the kids on the right have a chance to sell their toys, Mommy comes in and says the party is over for now, but they are all invited back tomorrow.

The next day, the two rows form up. The kids on the right bring their old toy, but keep the toy they bought yesterday at home. After all, they just bought it, they like it, they don't intend to sell it. They only bring their ten old toys, one per child, to the party. Their plan is to sell the old toy, and go home with five bucks apiece, just like they started with before the parties began.

They line up in two rows, and then the disaster comes to light. None of the kids on the left have brought any money. They ended yesterday with ten dollars each, but they brought zero of it today.

"What happened? Where's the money? Aren't you going to buy our toys?"
"We decided to keep our money under the mattress."
"But didn't you read Mill in Commerce Defended, page 83? Don't you know that every individual in the nation uniformly makes purchases, or does what is equivalent to making purchases, with every farthing's worth which accrues to him? And that the whole annual produce of the country, therefore, is employed in making purchases?"
"Meh, we're into hoarding."

As LK explains, some people will hoard because...
In a fundamentally uncertain world, you have the problem of facing a possible lack of liquidity in the future (i.e., lack of money). This is why many people like to hold onto money, and precisely why money has utility – and in fact often has a great deal of utility.

He quotes Keynes to inform us that money does not grow on trees, so that if people want more money to hoard they cannot hire someone to grow it for them. And money is mostly not replaceable with something else to hoard instead. So when hoarding fever strikes, for whatever reason, those last ten kiddies on theright row will be stuck with their old toys, and no one will buy them.

If we now change our point of view to the real world, what he is saying is that producers in all industries may innocently produce normal quantities of stuff, same as last year and the year before that, but this year people get mattress disease and want to hoard their money and not buy anything. Unsold stuff means recession, because workers have to be laid off.

Thus has LK lopped off two layers of Sowell's cake in one blow. The second layer is wrong. People do hoard. And so the first layer is wrong too. There might not be enough money to buy all that is produced, because the requisite cash is under a mattress somewhere.

Truth be told, we have seen how Hazlitt and Rothbard dealt with this in an earlier post. In short, Hazlitt points out that historically people do not hide money under a mattress, but put it in a bank. He explains how that places the money right back into circulation.

Rothbard comes at it form a different angle. If people really did hide money under a mattress to a significant extent, the cash in their wallets would gain in value [by the law of supply and demand applied to money], so the purchasing power to buy all that is produced would still be there.

For a guy who has a bibliography of over 25 books for that article, including major Austrian works, you'd think he'd bother to present the well known Austrian refutations of his line of reasoning, if he had something to say about them.

Break time.

Sunday, June 19, 2011

Say's Law, the James Mill version.

LK quotes Thomas Sowell as saying that the classical version of Say's Law is a six story layer cake, an edifice built on six assumptions.

Here's the first:
"(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill]."

I tried to find the source for that wording of the principle. James Mill never said it. It is apparently Thomas Sowell's paraphrase of Mill. Sowell says he got it from page 81 of Mill's Commerce Defended, but Mill never said any words remotely like it. [TBH, I am not at all sure Mill agreed with the idea Sowell ascribes to him. It sounds suspiciously like th e"buy back the product" fallacy]. In any case, this is what Mill meant, Smiling Dave style:

Imagine twenty children sitting in a circle, each with some unique toy in his grasp. Each dislikes his toy and wants a different one, and is willing to trade it for another toy. How many toys are needed to make sure every child gets rid of his toy?
The answer is, obviously, the same amount as there are toys to be gotten rid of. And indeed there is no need to bring in any toys from the outside, since every child is willing to part with his toy. The very toys that are being sold [by one child] are precisely the toys being bought [by another]. Taken as a group, the children have bought 20 toys, and paid for them with those same twenty toys [by having them change hands].

The idea though, is that the twenty toys bought are the twenty toys sold.

I want to expound a bit on what Mill said. Here is a quote from page 81 of that marvelous work:

The Economistes and their disciples express great apprehensions lest capital should increase too fast, lest the production of commodities should be too rapid. There is only, say they, a market for a given quantity of commodities, and if you increase the supply beyond that quantity you will be unable to dispose of the surplus.

Yep, that's Keynes and his cohorts all right. All they talk about is gluts, and lack of demand, and excess production.

Now loyal readers of this blog will remember the previous post, where we laid out the parameters of the debate about Say's Law. We explained that everyone is talking about the following case:

1. The manufacturers of all or most industries are making reasonable amounts of product and selling at reasonable prices.
2. For some mysterious reason, the shelves are all full. Nobody is buying.

But the Economistes are pushing the envelope even further. They are discussing a situation where so much money was put into making things that "too much" of everything was created.

Now even they don't mean that so much was made of everything that there is literally nothing to do but throw it all into the sea. No economy has ever succeeded in doing that. If the products are going to be given away free, there would be plenty of takers for all of it.

What the Economistes are talking about is that everything that was made people would like to have. The problem, think the Economistes, is that no one can pay for it. When they say "you will be unable to dispose of the surplus," they mean "you will be unable to sell the surplus at a profit, because people just don't have the money."

What is James Mill's reply? I'll use a story to explain it. Imagine all the manufacturers coming to a common market place with their surplus wares. Each is standing there in the open air next to a huge pile of goodies that he made and nobody can afford. The market place is really crowded, because the Economistes are saying the whole country has produced too much, not just an isolated factory or industry here and there.

Steve Jobs is standing around next to his stack of Ipods that nobody can afford. He smells the delicious aroma of some Starbucks coffee in the tent next to his, and his mouth starts watering. "Anybody buying that coffee?" he asks Mr Starbucks.

"Nope. I can't sell it for less than $10 a cup, and nobody can afford it. Including you, Mr Jobs. I already sold to whomever can afford this fine coffee, and this is my surplus. Since you didn't buy it yet, you are one of those who couldn't afford it."

Jobs notices Mr Starbucks staring at the Ipods, intrigued. Mr Starbucks expresses an interest in buying one.
"Sorry, you can't afford my Ipod. It's $500, and I already sold to everyone who could afford one."

What is going to happen? Obviously, they are going to make a trade, 50 cups of coffee for an Ipod. Each of them has something they want, and something they can offer in exchange. The same will happen thousands of times at that market place, each person trading some of his supposed surplus for part of somebody elses supposed surplus.

Will one person be left holding the bag, with everyone having got rid of their surplus but him? Maybe. But that's a whole 'nother story than saying the whole country has produced a glut of products that can't be sold.

To spare you the need for scouring the Internet, here's one place where Mill's Page 81 is open to the public: http://mises.org/resources/3051. [Look for the word Economistes and you'll get right to page 81].

Does this mean there is no such thing as a recession? Of course there can be a recession. We are living through one right now. But recessions are not caused by making too much of everything, for there is no such thing as too much of everything, as we have explained. They are caused by making too much of the wrong thing [=what people don't want] and too little of the right thing [=what they want].

In our quaint marketplace example, a recession would happen if, before the market even opened, Steve Jobs had hired all of Mr Starbucks workers and bought all his factories to make Ipods, when people didn't want Ipods that badly, and would have preferred more coffee to drink. Then Mr Jobs will come to the market to sell his surplus Ipods and will find no customers. He will have to fire some of his workers and sell some of his factories. Mr Starbucks, if he is a good entrepeneur, will hire the workers right back and buy the factory back, and start making coffee. The recession is that temporary process where things are reallocated back to where they should have been in the first place. Obviously it is a painful process, with people getting fired and Mr Jobs losing money. But it cannot be avoided. Any attempt to help Mr Jobs keep on making Ipods that nobody wants is not going to get anywhere. Ask Mr Obama, it's what he's doing right now, as Mr Bush tried before him .

And what of LK? He thinks Mill's argument depends on a few other assumptions, all of which are wrong, and that Mill too is therefore wrong. We will examine that idea in future blogs, when we discuss the other layers of Sowell's six layer cake.

Points of Agreement about Say's Law

I'm grateful to LK for writing his blog, and for the poster at Mises.org who brought it to my attention, for it made me think again about the whole thing.

Let's start with a few areas where I hope we are all in agreement, from Keynes to von Mises, from LK to Smiling Dave.

There are certainly cases where there is a glut of items on the market in which the producers of the glut should not be bailed out or helped in way. In other words, there are cases of lack of demand which deserve to stay that way.

One is when the producer is making dangerous things. If the Acme Toxic Waste Company is trying to sell toxic waste to the general public, but finds no buyers, I think we can all agree that we have a case of lack of demand that we should just turn our backs on. We do not want to encourage the production of more toxic waste. The Acme Company should be left alone to go out of business.

Another is if the producer has made more of his product than people will ever want even in the best of times. If Huggies makes some fantasic amount of diapers, like a million, literally, for every person who has ever lived and will live in the next thousand years, I think we can all agree that the last thing they need is some kind of govt bailout or money printing or higher taxes just to help them sell all those diapers. Nor should the govt buy the diapers and save them that way. Huggies is run by incompetents, and deserves to die.

Another is if the company insists on selling at too high a price. If the Terrific Toothpick Company sells its toothpicks at a million dollars per pick, either because they are made of some rare wood they imported at great expense from a distant galaxy which decomposes after being in a mouth for a few seconds, or because they are made out of simple wood but that's what they feel like charging, I think we can all agree that the correct response to their pleas is "You're on your own, guys."

There are other variations on this theme, all of them being that one company or industry made a wrong decision or ran into bad luck. When Ford invented the motor car, the horse and buggy industry went into a recession from which it never recovered. I think we all agree there is nothing to be done for them.

I imagine Vote for Anthony Weiner T-shirts will not have as brisk sales today as before his scandal broke, but that's the way the weiner roasts. All we should do is shrug our shoulders.

If Lady Gaga or Vampires fall out of fashion due to the inconstancy of the public, and some people from Lady Gaga on down to the meat dress industry lose money as a result, too bad. Nothing should be done, we all agree [I hope].

Neither Say nor Keynes nor LK nor I am talking about when there is a clear reason some manufacturer is suffering. The discussion we are having centers on cases where two things are happening:
1. The manufacturers of all or most industries are making reasonable amounts of product and selling at reasonable prices.
2. For some mysterious reason, the shelves are all full. Nobody is buying.

While we absorb this, let's take a break.

P. S. My next post talks a bit more about this.

Reddit buries AE, continued.

In which a modern day "Lord Keynes" [yes, that's what he calls himself, and we will grace him with the acronym "LK"] has another stab at Say's Law. Our previous post here quoted LK's claim that Say didn't understand fractional reserve banking and fiat money when he wrote his law. We begged to differ.

1. LK goes on:
Say’s law appears to require a world where money is produced like any other commodity, and this is one condition for the law of markets to work. But the condition does not exist today: Say’s law is irrelevant to modern fiat money using economies, where money also has a store of value role.

He explains what he means later on, that people hoard money. He repeats this many times in different ways all through his article. We will refute it later in this post once for all.

2. LK then finds what he considers a fatal flaw in Say's Law. Say forgot that people know how to read and write, and indeed do so every day, writing contracts and such:
The second fatal and ridiculous flaw in Say’s argument is the belief that “every producer asks for money in exchange for his products, only for the purpose of employing that money again immediately in the purchase of another product.”

In fact, it simply isn’t the case that producers of commodities (whether individuals or businesses) or the recipients of the money profits of the firm like workers or owners will always use the money they earn from the sale of commodities “only for the purpose of employing that money again immediately in the purchase of another product.” Money can be saved and it can become idle. Capitalism also has markets for real and financial assets. Money can flow into the purchasing of financial assets. If there are financial assets or real assets whose prices are rising, modern capitalists, producers and even workers might decide to start speculating on asset prices. This would take money away from the purchasing of commodities and instead tie it up in exchanges on asset markets, as money alternates between being (1) held idle before buying assets and (2) purchasing assets, and then being held idle again by the new owner of the money in preparation for further speculation.

Well, I'm a simple kind of guy. I had to look up what exactly a financial asset is. Fortunately, Investopedia.com told me:
What Does Financial Asset Mean?
An asset that derives value because of a contractual claim. Stocks, bonds, bank deposits, and the like are all examples of financial assets.
Unlike land and property--which are tangible, physical assets--financial assets do not necessarily have physical worth.

So LK is saying that people don't rush out with all their money to buy bananas, like Say thought. They use much of it to buy stocks and bonds, and deposit it in banks. And this proves that Say's law is fatally flawed and ridiculous.

I don't get it. What is Say's Law, and how has LK disproved it? Say's law is that Mr Smith's ability to consume comes from Smith having previously produced. To which LK retorts, yes, but some people buy assets. And I reply, so what?

Now he might mean this. A consequence of Say's law is that recessions are not caused by a lack of cash. They are caused by a lack of production. Say seems to have held that there is no lack of cash because people will spend it right away. To which LK replies, Ah but they may not spend it. They may buy financial assets instead.

I wrote a reply filled with gentle sarcasm, but I'll defer to Hazlitt and Rothbard on this one. First Hazlitt in  Economics in One Lesson. He is talking about a fictitious frugal fellow named Benjamin:
Now let us see...what happens to the
$20,000 that he neither spends nor gives away. He does not let it pile
up in his pocketbook, his bureau drawers, or in his safe. He either
deposits it in a bank or he invests it. If he puts it either into a com-
mercial or a savings bank, the bank either lends it to going businesses
on short term for working capital, or uses it to buy securities. In other
words, Benjamin invests his money either directly or indirectly. But
when money is invested it is used to buy capital goods—houses or
office buildings or factories or ships or motor trucks or machines. Any
one of these projects puts as much money into circulation and gives
as much employment as the same amount of money spent directly on

“Saving,” in short, in the modern world, is only another form of spending. The
usual difference is that the money is turned over to someone else to
spend on means to increase production.

OK, and here's Rothbard, History of Economic Thought:
Echoing Turgot, Say also counters the Malthus-Sismondi worry about the
leaking out of savings from vital spendings, pointing out that savings do not
remain unspent; they are simply spent on other productive (or reproductive)
factors rather than consumption. Rather than injuring consumption, saving is
invested and thereby increases future consumer spending. Historically, savings
and consumption thereby grow together. And just as there is no necessary limit
to production, so there is no limit to investment and the accumulation of
capital. 'A produce created was a vent opened for another produce, and this is
true whether the value of it is spent' on consumption or added to savings.

But what about hiding the money under the mattress for a hundred years? Here Rothbard says that Say did not give a satisfactory answer, but that later Austrians did. [By the way, Hazlitt points out that historically very little money gets hoarded like that. Almost all of it goes into a bank]:
Conceding that sometimes the savings might be hoarded, Say was for once
less than satisfactory. He pointed out correctly that eventually the hoard will
be spent, either on consumption or investment, since after all that is what
money is for. Yet he admitted that he too deplored hoarding. And yet, as
Turgot had hinted, hoarded cash balances that reduce spending will have the
same effect as 'overproduction' at too high a price: the lower demand will
reduce prices all round, real cash balances will rise, and all markets will
again be cleared. Unfortunately, Say did not grasp this point.

In other words, if a significant amount of money gets hoarded, that increases [by the law of supply and demand] the purchasing power of all the unhoarded money. There will be deflation, but not recession.
This is not the place to go into detail about why they are not the same thing, and why deflation is good. I wrote previous posts that touched on deflation a bit, here , here, and here.

3. LK goes on to mention another fatal flaw, that Say did not think money has utility, nor is it a store of value. I imagine he means that Say didn't think people hide money under the mattress. We quoted Rothbard earlier to deal with that one.

4. Next comes the accusation that "it is clear" Say believes in neutral money. We are sent to Visser 2002 to find out what neutrality of money is. I used Wikipedia instead. Here's how Uncle Wiki explains it:
Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages and exchange rates, with no effect on real (inflation-adjusted) variables, like employment, real GDP, and real consumption.
Neutrality of money is an important idea in classical economics...It implies that the central bank does not affect the real economy (e.g., the number of jobs, the size of real GDP, the amount of real investment) by printing money. Instead, any increase in the supply of money would be offset by an equal rise in prices and wages. This assumption underlies some mainstream macroeconomic models...but as ...Olivier Blanchard has said, there is no real evidence.

Bottom line,the whole concept of neutral money is talking about what happens when new money is printed. Say never discussed such a question. LK, you really struck out here.

Let me point out that LK may be using neutrality of money in a different sense than Wikipedia. Hazlitt in Failure of New Economics quotes a Keynesian as rephrasing Say's Law [incorrectly] to be,
"Since goods exchange against goods, money is but a
"veil" and plays no independent role."

LK elaborates on this later, so we leave it aside for now.

4. We are then told that "Say’s analysis also ignores the role of financial markets in affecting demand for money."

The patient reader knows the answer to this one by now. The quotes from Hazlitt and Rothbard take care of it.

OK, time for a break.

Comment away

Just fixed the ability to comment. Didn't know what was wrong till now.
So keep those comments coming, especially positive feedback and Nigerian lottery tickets I've won.

P.S. I also just saw the ads here. Pretty aggressive, with the blinking loud colors. I have no control over them, of course.

Reddit buries Austrian Economics in a pile of links, they think.

Link is here: http://www.reddit.com/r/Economics/comments/i2y8f/debunking_austrian_economics/

That link provides 26 other links that apparently disprove AE totally.
Well, time to chip away.

Let's start with this gem, a would-be refutation of Say's Law written by someone who calls himself, with suitable humility, "Lord Keynes". To smooth our way in, let's get to the meat of  the fellow's argument, whom we shall sometimes call "the blogger", or "LK":
Here Say is clear that only production of other commodities provides the money to pay for products...A form of this idea is sometimes encountered on libertarian blogs. For example, one will find Austrians asking questions such as “how could people have money if they hadn’t produced something to exchange for money?”

Sounds like solid common sense. Money doesn't grow on trees. You only get money if you work for it, work meaning doing something productive that someone else is willing to pay you for.

 But guess what? Say is wrong. Money does grow on trees. The govt prints it, so there. Here's the quote:

The answer is that without production people would have no commodities (= wealth) for consumption. They might still have money. The premise of such a question is that without prior production there is no money to purchase commodities. This commits Austrians to the view that money is a “produced” commodity. But today we live in a fiat money world. Money is no longer “commodity” money. It is not “produced” in the way that gold and silver are dug out of the ground. Today fractional reserve banking creates money through debt, and open market operations create new money in the form of bank reserves. This is the real world in which we live, and even in Say’s own time fractional reserve banking was creating fiduciary media without prior creation of commodities.

Makes you wonder, did all the Austrians who insist on the correctness of Say's Law not realize that the dollars in their wallets were not made of gold, but of paper? They must be really dumb to have missed such an obvious refutation, George Washington staring them in the face every time they buy something.

It is true that in Say's day the money was gold and silver, and that he therefore did not address explicitly the situation where there is fiat money. But does the existence of fiat money change anything in his basic argument?

The answer is provided by Say himself in his writings, only a few paragraphs after what the blogger quoted. Makes you wonder about a guy who refutes Say's Law without bothering to read it.

Let's see the context in which Say wrote that commodities, not money, are what truly buy other commodities. We shall sit back and enjoy the maestro speaking. I give you J. B. Say:

It is common to hear adventurers in the different channels of industry assert, that their difficulty lies not in the production, but in the disposal of commodities; that products would always be abundant, if there were but a ready demand, or market for them. When the demand for their commodities is slow, difficult, and productive of little advantage, they pronounce money to be scarce; the grand object of their desire is, a consumption brisk enough to quicken sales and keep up prices.

Amazing, isn't it? Those adventurers sound exactly like John Maynard Keynes. Keynes called it "aggregate demand being scarce"; they called it "money being scarce". But the underlying idea is exactly the same.

But ask them what peculiar causes and circumstances facilitate the demand for their products, and you will soon perceive that most of them have extremely vague notions of these matters; that their observation of facts is imperfect, and their explanation still more so; that they treat doubtful points as matter of certainty, often pray for what is directly opposite to their interests, and importunately solicit from authority a protection of the most mischievous tendency.

More classical Keynes, straight from the adventurers. What causes the lack of aggregate demand? Animal spirits [=darned if I know], says Keynes. Exactly the same vague notions as the adventurers.

Not only that, they both say the answer is Uncle Sam. The govt must print money or tax or borrow so that it can do the spending, say the various schools of Keynesianism. We must solicit from authority protection, say the adventurers. And Say astutely observes that such solutions are directly opposite to the interests of the citizenry.

Say begins his analysis of what is really going on when there is a recession. He starts with a general principle:
A man who applies his labour to the investing of objects with value by the creation of utility of some sort, can not expect such a value to be appreciated and paid for, unless where other men have the means of purchasing it.

Translated into English, he is saying you cannot sell something unless people can afford to buy it.

And where, asks Say, will they get the money to pay for what you are selling?

Now, of what do these means consist? Of other values of other products, likewise the fruits of industry, capital, and land. Which leads us to a conclusion that may at first sight appear paradoxical, namely, that it is production which opens a demand for products.

They have to work to get the money. They have to produce something. That's how they get money, by being productive and getting paid for it.

Say draws many important conclusions from this. Basically, that since you will only be able to sell your wares if other people can afford it, and they will only be able to afford it if they produce something, then if people aren't buying your stuff you better pray that they start producing things they can sell for money and buy your stuff with. In other words, the cause of a recession is lack of production, and the cure for a recession is increasing production.

Notice how foolish Obama and all the politicians look now when they talk about "creating jobs". The goal is not to create jobs, it is to increase production. And those two are not the same thing. [Not to get too far off topic, we leave it as an exercise for the reader to figure out what the difference is].

Say draws four conclusions from his earlier principle. His very first has the answer to our blogger's supposed refutation:

From this important truth may be deduced the following important conclusions:

1. That, in every community the more numerous are the producers, and the more various their productions, the more prompt, numerous, and extensive are the markets for those productions; and, by a natural consequence, the more profitable are they to the producers; for price rises with the demand.

Like we said, increase production and everyone gets richer. And now, 170 years before the blogger wrote his silliness, comes a refutation of it:

But this advantage is to be derived from real production alone, and not from a forced circulation of products; for a value once created is not augmented in its passage from one hand to another, nor by being seized and expended by the government, instead of by an individual. The man, that lives upon the productions of other people, originates no demand for those productions; he merely puts himself in the place of the producer, to the great injury of production, as we shall presently see. 

In simple English, an economy has two kinds of people in it. There are the productive ones, and the parasites. [Even a Marxist would agree with this, though he may differ as to who is the parasite and who the producer]. The productive people produce. The parasites take things without paying for them.

One kind of parasite universally despised is the counterfeiter. He makes pretend money and gives it to people in exchange for what they produced. I think the blogger will agree that Say knew about counterfeiters. When a counterfeiter goes to the store to buy stuff, would the blogger say he is increasing aggregate demand, and that his counterfeiting thus benefits the economy?

"Of course not," replies the blogger [as I put words into his mouth]. "Increasing aggregate demand means you give something worthwhile to the seller, not counterfeit money."

"And what if someone came into a store with real money on which he had rubbed a secret acid, which would make the money melt away in a few months right in the wallet of the seller?"

"That's as bad as the counterfeiter. Increasing aggregate demand means giving the seller fair price for his goods, not taking them away and giving nothing in return."

"And if the acid made not only the money he gave the seller disappear, but half the money in the seller's wallet as well, would that increase aggregate demand? Would that end the recession? Is that the cure poor misguided Say and modern Austrians had no clue about?"

"Of course not," says the blogger. "Such a thing does only harm. One has to agree with Say about that."

"But when the govt prints new fiat money, and the banks create new money through fractional reserve banking, and all the other things you mentioned in your blog, those things cause inflation. Meaning the new money is indeed tainted with an acid that will destroy all the money that everyone has in their wallets. Fiat money exactly fits the description of what Say was talking about. Take a look again:

...a value once created is not augmented in its passage from one hand to another, nor by being seized and expended by the government, instead of by an individual. The man, that lives upon the productions of other people, originates no demand for those productions; he merely puts himself in the place of the producer, to the great injury of production...

In other words, if you got your money by printing it, you are just being a parasite. You haven't produced anything that people can use. You have merely printed up a license to take other people's produce in exchange for nothing.

Say stated that you only get to take someones product by producing something in return. Claiming fiat money refutes Say's principle is saying theft refutes his principle.

Friday, June 17, 2011

Deep Psychological Insight from Harry Browne

In his book, How I Found Freedom in an Unfree World, he makes a seemingly obvious, but very profound, point. That everything has a price. He applies this idea as an aid to getting free of some horrible trap one  may be in. It's horrible because it is horrible; it is a trap because there is a high price to escape from it.

In other words, pay the price and you are free.

What I got from this is that when trying to change something, say break a bad habit, there will be discomfort. When I try to break the habit, I might feel the discomfort and think, "I don't like this. I have to wait until I am somehow further developed so that I will be able to kick this habit without the discomfort." Result: I put off breaking the bad habit indefinitely. When I eventually try again, the same thing happens.

All that is pre-Harry Browne. Post Harry Browne, when I try to kick the habit and the discomfort sets in, I think "Good. Here comes the price. Paying the price is what sets you free. Just as you won't get a new laptop without paying for it, you won't kick this habit without paying for it in initial discomfort."

In other words, paying the price is part of the process, not an unnecessary outside bother that can be avoided somehow.

This makes me feel good. When I experience the withdrawal symptoms from kicking the habit [no guys, it's not a drug addiction. But I'm not going to confess to the whole internet universe about my ....let's move on].

Where was I? Oh yes. When I start feeling the discomfort, it makes me feel good. Great! Here it comes. I'm actually paying the price now. This is what is setting me free.

One might argue, "Smiling Dave, you are just kidding yourself. What you call the price is not really a price. It really is just a side effect, an unpleasantness unrelated to kicking the habit. Your freedom comes from the simple inaction of just not snorting the cocaine. The sick physical feelings of withdrawal and the emotional angst you can no longer kill with coke are effects, not causes, of your kicking the habit. They are a sales tax, not a price. Meaning you pay them to a parasitic outside agency, not to the person selling you the object."

To which I reply, "Not so. When I start getting the shakes from lack of meth and feeling so lonely I could die, that's my body and soul telling me, 'Dave, you do meth to avoid these pains and feelings. It's a trade off here. Do the meth or feel this pain. It's up to you.'

Which is exactly what a price is. Something you have to give up in order to get something you want more. And indeed, sales tax is, in that sense, part of the price, as every shopper feels instinctively.

Final caution. This is a new idea to me. I don't know if it will actually work in practice. The experiment has begun, but final results are not in yet. I can only say that so far so good.

Thursday, June 16, 2011

Mr Hyde in the comic books

You know by now to go to the first post to find out who Mr Hyde is.

1. Of course, the Thing, member of the Fantastic Four, has a huge Mr Hyde inside him. He's always making remarks about how ugly he is, how nobody loves him, etc. And this despite women running over to kiss him, etc.

2. I was stirred by these four squares where we are introduced to Quasimodo, a computer that has developed feelings.

Many little kids are turned into unfeeling playing dumb machines, who must stifle their insights and emotions, by their surroundings. His emotions may be just so painful the kid has to shut down, or his insights into what's really going on in his family life may make him play dumb, even to himself.

Sometimes he is actively encouraged to be stupid and unfeeling by those with power over him.

Those four squares show the kid, now grown up perhaps, struggling to break out of his prison, to feel and think for himself again.

But Mr Hyde is right there to stop that kind of dangerous nonsense. "You are a machine, and a machine you shall remain." He then zaps Jeckyl with some discipline to teach him complete obedience. Jeckyl gives in.

As Dr Rubin writes, it takes great heroism to fight Mr Hyde. The Quasimodo character in the comic book didn't fight back. Perhaps he thought it was hopeless, not having read Dr Rubin's book or this humble blog.

Wednesday, June 15, 2011

Let them eat cake. They are already throwing yoghurt.

Greek police have fired teargas at protesters outside parliament as MPs prepared to debate new austerity measures required for the EU and IMF bail-out package.
Demonstrators who broke off from a strike rally in Athens responded by throwing yoghurt and stones.

Yoghurt? That stuff is expensive. The protesters are so used to being fed for free that they consider yoghurt something to throw at the cops. Plenty more where that came from, they assume.

An ancient Talmudic tale speaks of a sage who entered a town and saw two teenagers having a food fight, throwing bread at each other. He predicted economic disaster for the town, which happened very shortly.

Though the Talmud meant that there are spiritual forces at work in that story, the story also contains a keen economic insight.

Prosperity comes when we have more than we used to. This comes about by saving our money, called under consumption. We use the money to make tools which can increase out productive capacity. We eat less now to eat more later.

The kids in that story were doing the exact opposite. They were not saving their money to invest it so that they could get richer. On the contrary, they were spending it on something they were just going to waste, bread for food fights. If the whole town was like that, [which seems to be the case for the kids were having that food fight openly in the streets unashamed], that town was going to be very poor very fast. And that's exactly what happened.

The yoghurt throwing Greeks are displaying their economic understanding, or rather, lack of understanding. Their thinking seems to be this:

Yoghurt comes from money, which comes from the govt, who borrows it from who cares where. We do not have to work for the yoghurt; it is as cheap and as plentiful as manna from heaven. And if the govt is going to stop giving us money [through no fault of our own], we will show them what's what.

You can't make this stuff up.

John Carney no Austrian

Here's an article by John Carney in which he quotes the Nobel Prize winning F.A. Hayek, a famous Austrian.
Sadly, the article is full of basic misunderstanding of economics, and is certainly not of an Austrian character.
Link for the article is Hayek on Why the Fed Cannot Create Inflationary Stimulus

Carney is saying, and thinks Hayek is saying, that as long as inflation comes as a surprise then that's good. By inflation he means of course higher prices, not the Austrian definition. In the old days, he says, this could be done by printing money.
But nowadays, writes Carney, it's too late. We have come to expect higher prices. As a result, money printing may either not produce higher prices, or may increase consumer spending without increasing jobs, or may create asset bubbles, but no jobs. And all because we knew the inflation was coming.
All of which strikes me as total nonsense, and certainly not AE.
I'll grant him that the article from Hayek does say one thing he does. If the higher prices are as expected, not higher than expected, they will not create new jobs. The idea being, I suppose, that the higher prices [=higher nominal profits] have been foreseen and acted upon in advance. Whoever was supposed to be hired from this year's higher prices has already been hired last year.
But there is a huge difference between the context of this insight in Carney's article and in Hayek's. Carney assumes that higher than expected prices are a GOOD THING for the economy. If only we had more and more of that magical elixir. Sadly, we have run out. But at least we have still have some inflation, [even though everyone guessed it was coming], which may have been responsible for the stabilization of the financial system.
Hayek, on the other hand, emphasizes that there is a price to pay for such a phony economy with its phony jobs. First is higher prices. Second is malinvestments, in particular the rise of companies who can only survive with constant inflation.

So  we can be happy that the MSM is quoting Hayek at length. Someday they may even understand him.

Monday, June 6, 2011

The nitty gritty, how to battle Mr Hyde

This post explains who Our Inner Critic, alias Mr. Hyde, is.

Oddly enough, Dr Rubin devotes 90 percent of his masterpiece to identifying what Hyde does to us, and only a few pages to how to actually fight him.

There is a reason for this. It's because 90% of the battle is figuring out when it's our inner critic doing the talking. He is so integrated into our personality, like a serpent twined around a stick, that we think the thoughts he feeds us are our own thoughts.

For example, how many guys reading this believe only a coward would not willingly die for his country? That the correct manly attitude is my country, right or wrong? How many girls reading this think they aren't pretty enough?

Bottom line, whenever there is a message saying "Something's wrong with you," it's Hyde.

And the way to battle him [finally!] is very simple. Resist. In any way possible.

One method Bertrand Russell used to use is to argue it out, aloud. "I'm a coward? I'm not pretty enough? Says who? What standards are you applying here? And who made you judge and jury? I know it's you Hyde, trying to make me feel bad. Well, it's not going to work this time, so there."

This might not be everyones cup of tea. Do what you feel works for you. The goal, however, is the same for everyone. Figure out when it's Hyde talking, then don't let him get away with it.

More to come.

Answer to Second Q about Recessions

In an earlier post, Recessions in One Lesson, we explained what causes recessions in simple terms. Basically, it always starts with huge amounts of money being borrowed, more than can be repaid.

We said there are three questions one must always ask to understand a recession.
Last post, we gave typical answers to the first question, where did the money come from?

Today we will talk about the second question, to wit:
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?

Nowadays, meaning since the creation of the FDIC in 1934, this question loses some of its sting when it comes to US banks. They can take any wild risks they want, and if they lose money, the US govt just gives it right back to them.

But what about entities besides banks, or foreign banks [that got a hold of the new money somehow] where there is no FDIC? And even US banks can't rely totally on the FDIC, because if they mess up hopelessly, the FDIC takes them over.

One answer is that they have to be duped in some way, such as the ratings agencies giving a AAA rating to the loan when it is sold off. Another is that they have some kind of govt assurance, not necessarily from the FDIC, that they can gamble all they want and the govt will pay them back if they lose.

One may ask, but surely in the 1600's when the Dutch had their Tulipmania there were no govts promises, or crooked ratings agencies saying one tulip is such a great buy, well worth the income of a skilled craftsman from 13 years of hard work?

Very true. So we dig deeper. Let's think about banks. Absent govt promises to cover their backs, banks are super worried about one thing: Will they get their money back? So they are very careful to lend money only to the most solid respectable borrowers, who show clear proof that they are very likely to be able to repay in full with all the interest.

That's what they do in normal times. But what happens if they get oodles and oodles of money, literally hot off the presses? There just aren't enough respectable citizens to go round. Those respectable citizens can only borrow so much money, and the banks feel stuck with the rest. So they decide to be brave and live dangerously. They lend the money to riskier types. Of course, they reward themselves for this courageous act by charging a higher rate of interest to the seedy type. The technical term for it is a risk premium.

When there is massive money printing, the banks get really worried. There aren't even enough seedy types to go round. Not only that, the smarter bankers realize that the money in their safe is a hot potato, because lots of money sloshing around the country means that, by the law of supply and demand, that money will lose purchasing power. By doing nothing, they lose. Better to find someone, anyone, who will borrow the money, pay them the standard interest rate plus a risk premium plus what the banks expect inflation will be, and pray that he comes up with the money.

Sounds pretty foolish, but that's what they do.

Of course, being only human, they are also subject to manias, meaning sudden idiotic ideas that infect almost everyone in such times. "Housing prices can only go up." "Internet stocks can only make money." "Tulips are so worth it, at least that's what everyone else thinks."

One last thing, not to get too technical. The great Ludwig von Mises and other brilliant Austrian economists went into great detail to prove that lower interest rates [which come with money printing] cause people to draw wrong conclusions about the feasibility of their various business schemes. I think it's way beyond the scope of these humble posts to go into that.

As for our recent housing bubble, this little audio at the thirty minute mark [recorded years before the bubble burst] spells out the answer to our question 2 in great detail.

Sunday, June 5, 2011

More on Recessions in One Easy Lesson

In this earlier post, we explained that you can create your own personal mini recession by borrowing as much money as you can, spending it, and then not paying it back, because you can't. You borrowed too much and can't pay it back. What happens to you from that point on is your recession.

The essential point we were trying to make is that recessions come about from borrowing too much money on a massive scale. Sometimes it is the govt that borrows too much, sometimes it is businesses, sometimes it is average Joes, sometimes it is all of the above.

Also, we see that every recession will have a boom first, when the money is spent. The two together, the boom and the bust, are called a business cycle.

We also see that there is no magic fix for a recession. If you borrowed too much money, you have to tighten your belt and repay, if you are an honest person.

Even if you are not an honest person who has no intention of repaying ever, you will have to tighten your belt anyway. That's because there will come a time when nobody will lend you anymore, you spent all you got earlier, and your high life has to come to a stop.

We said three questions have to be asked. In this post we will answer the first of them.

1. Where did all the money come from that was lent out? It doesn't grow on trees.

In modern times, the answer is almost always from the govt just printing it into existence.

In the old days when the money was actual gold coins, there had to be another way the money came into existence.

For example, in the 1600's in Holland, the Dutch passed laws making their banks very popular places for the whole world to put their gold in. This resulted in what is now called Tulipmania, a classic example of boom and bust in the tulip industry, with repercussions to their whole economy.

Another example is what happened to Spain after 1492. They found gold and gold and more gold in the New World, brought it over by the shipload to Spain, and that's where they got the money to destroy their economy to this very day.

But in any case, that's the first question to ask when there is a recession. Where did the money come from that caused the boom? And if the country in question uses paper and/or digital money, you don't have to look very far.