Too Big to Bail

No doubt I may well be the thousand and umpteenth person to blog this, though I thought I may as well do my bit to help spread this noteworthy video:

\”Fear the Boom and Bust\” a Hayek vs. Keynes Rap Anthem

Aside from the inaccurate portrayal of both men’s personalities (I think Hayek was much more of a lady’s man, while Keynes was a homosexual and not extraordinarily attractive to either men or women…), the video was excellent.

Keynes’s theory is portrayed fairly accurately as not much more than a scam based on the facile idea that keeping the money “moving around” lowering interest rates and boosting expenditure is somehow boosting the economy.

Hayek (or “Freddy H”) is then able to move in and flatly crush the theory, first pointing out that the policy consequences of credit expansion, thereby aritificially lowering interest rates then causes a false investment boom into certain projects that appear profitable, though this an illusion. The illusion is due to the fact the lowered interest rates result from central bank inflation of the money supply, and not increased saving and lowered consumption by the population at large. When this mismatch is finally communicated y the price system and the fact business owners can no longer find customers or returns to their long term investment projects a bust ensues. And we can thank “Lord Keynes” for that.

But hey, don’t take my word for it, here’s Freddy H!

The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.

It would have been nice to have a shout out to Mises and Rothbard too, but I guess you can’t have everything, perhaps a sequel is in store.  Kudos to John Papola and Russ Roberts in any case!

I would first of all like to apologise for the relative hiatus in my activity since November, with university course and project work time has been scarce, and even now seems to be getting scarcer. Nevertheless, the important things in life bear repeating, and since we are coming to the close of a year of horrible government interventions in the economy and moreover in violating property rights; it would be worth reflecting before Christmas on a simple truth taught by a great French man over 150 years ago.

This post is adapted from part of an essay I am currently in the process of writing.

Much of academic economics is filled with jargon, difficult to communicate and is itself rather conceptually muddled. Without entering into a discussion of its specific attributes and the reasons for its flaws, it should become fairly clear that the same cannot be said for Bastiat’s simple lesson of the broken window. Indeed try to think how many government interventions in the last year or so resemble the adoption of the simple fallacy in this tale.

Science is united in its use of logic and deductive reasoning. What may differentiate the sciences and characterise them, will of course be the facts and material that are the focus of their investigations, as well as the particular methods used to gain accurate statements across their subject matter. This would not of course mean, and never has meant that any science is necessarily restricted to utilising one form of procedure with which to build its theories.

The nature of logic is formal. Also, despite the intuitive nature of human inference, in the sense it can can correctly be considered a neurological and psychological process; the relation of implication it can grasp between propositions remains objective and formally governed by the principle that an argument based on true premises cannot yield a false conclusion.

It is perhaps an easy mistake to deny the cognitive value of reasoning from false premises. Yet there is scarcely anything more common than to regret and reflect on what could have been, but was not true. This is precisely what allows us to recognise the lesson of Bastiat’s parable of the broken window.

The hapless shopkeeper, who must repair the window broken by his son must enlist the services of a glazier paying him 6 francs. Many would falsely believe that this type of intervention is beneficial, since we are artificially spurring demand for goods and services, causing money to be spent, and flow around the economy. As Bastiat points out, this is rather facile and short sighted. If such an incident did not befall him, our shopkeeper could have spent the money buying shoes from the shoemaker while maintaining his window as part of his real capital. The former scenario on the other hand, ensuring the destruction of capital, is a negative sum game since the glazier gains at the expense of the shopkeeper losing his capital and the unseen shoemaker’s potential profit.

There is no need to artificially “spur” demand, the resources would have been utilised one way or another. All the intervention has achieved is to divert their use towards repairing damage of destroyed capital instead of furthering the consumption or capital investment(Bastiat notes the money could have been spent by the shopkeeper buying books for his library) that could have occurred instead.

Taken to its logical conclusion as an economic program, one could accurately portray the fallacy identified to advise widespread destruction, violent robbery and theft as a means of economic progress. Such is the wisdom of John Maynard Keynes. This is also the unfortunate reality of what is presently considered good economic policy, whether the fashionable buzzwords to mask it are fiscal stimulus, quantitative easing, cash for clunkers or “too big to bail” corporate welfare.

Indeed as the Keynesians seems to miss over and over again, the entire point of economising is not to boost aggregate expenditure or income but to ensure the correct resource utilisation and capital structure to meet consumer demand. With central banks buying government bonds with their counterfeited money, artificially increasing the money supply making money a “cheaper” commodity for bondholders, as well as lowering the interest rate at which banks borrow the counterfeited money from them; market interest rates were artificially lowered, also distorting their connection to consumer time preference and saving.

Their interventions with interest rates for the previous half decade helped distort this structure away, preventing the proper functioning of the price system two-fold.

The artificially lowered interest rates first of all distorted profit and loss, making longer term investment projects in higher order stages of production more attractive.

Subsequently, this artificially raised investment demand for scarce resources toward higher order stages of production, raising to an unsustainable level the prices of these scarce resources. This occurs precisely since increased investment does not coincide with increased savings and lower short term consumption demand from consumers for consumer goods ultimately derived from these scarce resources. As a result, this places inflationary pressures on all related goods, including consumer goods that are derived from these scarce resources, creating the much ignored impoverishment that occurs during the boom phase but is fashionably ignored by most financial commentators. During the housing boom, first time home buyers were more deeply disadvantaged, and many even went into debt further compounding the problem of capital consumption, in order to catch the trend.

With simply an economy of one person,  investing resources for a long term project at a rate that cannot be sustained since he has not reduced his rate of consumption; the error is easy to see, he is consuming his resources at an unsustainable rate. The only difference in our case is the way the mistake is realised. The losses made by businessmen at a later stage, indicate that the funds and capital diverted to long term projects were mal-invested precisely since they were not accompanied by the increased savings of consumers. Since consumer demand never shifted sufficiently away from present consumption, the savings necessary to enable them to purchase the products of these higher order processes were not gathered; losses were the inevitable result.

Yet these losses are the correction process, allowing the structure of prices and interest rates to correctly adjust to reflect the actual scarcity of capital. They are precisely the process that allows for the correct structure and distribution of capital to form; the one that correctly matches consumer demand as far as possible, and precisely for this reason allows for real, sustainable growth and progress.

Yet the same Keynesian economists, interventionist politicians and central bankers that created this problem are also the ones who appoint themselves the task of correcting it. Not only have they slashed interest rates so low they are practically negative, further preventing correction of this coordinating price mechanism, the coordinating function of which they had earlier broken; they also tell us to bail out the failed sectors using the money and capital that is diverted from the healthy parts of the economy, burdening the consumer who is the taxpayer and obligated user of their debased currency even further. They increase spending of course for their own political projects with no regard for what people actually want, since if they actually cared about that they would allow the market economy to function with the profits reflecting what people actually want.

They are nothing more than smiling murderers and robbers in expensive suits. To add insult to injury, those foolish enough to buy their scam think schemes like “Cash for clunkers” will help, when they are destroying capital and creating something worth less as dictated by its value on the market.

The apologist doctrines used to support these programs are of course complicated and convoluted. Yet once one understands the simple truth forwarded by Bastiat’s parable, one is able to pierce through much of this nonsense and see it for what it is. The truth, as is often the case in science has a real simplicity and beauty. Perhaps the reader shall enjoy reflecting on this lesson for a moment while enjoying their holidays.

Merry Christmas everyone.

I recently presented a paper on Economic Calculation at the Austrian Student Scholars Conference held by the Grove City College Economics department. I’ve placed some of the videos of the lectures I recorded, including my own. I hope you enjoy them:

Uncertainty and the Role of
Bureaucratic Management within the Firm by

David Gernhard (Grove City
College)

A Combinatorial and Praxeological
Exploration of the Economic Calculation Problem by

Abhinandan Mallick (University of
Birmingham)

Stateless Law in the Highlands of
Guatemala by

Michelle Carrera (Universidad Francisco
Marroquin)

I came across a set of interesting and really fun to read comics explaining basic economics from first principles recently. I hope readers enjoy them as much as I did!

Human Action Comics #1

Human Action Comics #2

Human Action Comics #3

Human Action Comics #4

I especially liked parts 2 and 3 on the theory of value, showing Marx and Ricardo’s theory of value being swiftly followed by their Mengerian refutation!

I found some interesting
articles a few days ago about the current situation in the Cayman
Islands.

http://www.guardian.co.uk/world/2009/sep/25/cayman-debt-crisis-budget-postponed

http://www.caymannewsservice.com/business/2009/09/25/travers-hits-out-damaging-uk-%E2%80%9Cdithering%E2%80%9D

The area is a British overseas territory located in the Caribbean, considered a “Mecca” for many of the most “notorious” financial institutions, like hedge funds, banks and other financial services firms.

Recently, the government of the area has been facing a large debt crisis partly brought about following expenditure on a large infrastructure program. It is now facing difficulties to continue financing its activities as the UK foreign office is currently not signing or permitting to grant its budget proposals involving large loans from banks.

Instead this territory is now being muscled to introduce direct taxation in the form of a payroll tax. In the guardian article, it has been mentioned how many of these firms have strongly indicated how these may have dramatic consequences, strongly hinting at reallocation. Understandably, the Cayman Islands government have been strongly resisting the pressure and protesting the current actions of the Foreign Office.

Indeed, this does provide a good microcosm I feel of the problem generally faced by small states, that also helps explain why many of them tend to be far more economically liberal. As noted by Hans Hermann Hoppe, states always
face the threat of exit, especially by often their most productive citizens. This threat is particularly fatal to states like the Cayman Islands, that will no doubt be hit hard should much of the financial services sector decide to relocate.

The broader picture also reveals the threat from larger territories and cartels, in this case the UK and the EU. Many commentators and politicians have naively regarded the existence of complicated financial instruments, and even
speculators who profit from judging the tendency of the market, and actually help enable its equilibration; as the chief culprits of the recession. A more careful reflection on what may be motivating these individuals reveals a far more sobering conclusion. Larger states have long been hateful of these “tax havens.” Indeed, the Cayman islands may well be high on the target list given it’s place on the OECD’s “black list”, and given the recent pledge by our wise overlords at the G20 conference to impose sanctions on these irksome holdouts of a long passed liberal age.

Economics is a little understood
branch of knowledge, and despite its ongoing relevance to our
everyday lives; is still relegated as a subject that must be left to
the specialists. This writer’s opinion is that modern man could
scarcely make a greater error. The present bust of our most recent
worldwide business cycle, provides us with a great exposition of the
dangers of leaving out analysis according to simple economic laws,
instead of highly abstracted models that idealise the rules they
follow and pretend to track cause and effect with complicated
statistical regressions.

Indeed the great delight one may
find, and this is a feeling I hope I am able to convey, is that
Economics should really tell you what you “already knew.” To give
an indication of what I mean by the statement, it is useful to dwell
on the fact that Phillip Wicksteed, a great economist in his own
right named his 1910 book: “The Common Sense of Political Economy.”

I feel it is worth mentioning
how I gained any of this knowledge in the first place. I am not a
student of Economics, indeed the discipline which I am studying at
the University of Birmingham is “Theoretical Physics”. I had an
interest in Economics at a younger age, mostly because I wondered why
my country of birth and early childhood, India; was still such an
underdeveloped country after so many decades of independence from
British rule. At the time, my search for explanations led me far and
wide, to come up with some, in retrospect; rather ridiculous
assertions. For one period of time, I even thought that our loss of
wealth had something to do with the Queen taking our jewels for her
crown!

It was not until I read “India
Unbound” by Gurcharan Das one week when I was about 17, that I
truly gained an appreciation of the impact free markets could have on
developing countries. The experience was life changing, and it
remains today one of only 3 books that I can say had a significant
impact on my philosophy and direction in life.

During the decades following
independence, many businessmen, small and big, made the dark joke
that once we were free from the British Raj; our country was captured
by the new “Licience Raj”, that strangulated investment,
development and private enterprise in India for many decades. When we
complain about corruption, we must realise that it is simply a result
of the perverse incentives created by draconian laws imposed on
entrepreneurs and already existing businesses. Indeed, it may sound
strange for the reader to hear this, but: as long as these laws
exist, we should actually be hoping for more dishonesty and
competition in corruption between public servants and officials, not
less! This competition between bureaucrats could lower the price of
bribes, improving the quality of service provided in navigating
restrictions, and would allow for smoother functioning of business,
in the midst of India’s strong regulatory atmosphere.

If the reader has ever read
India Unbound, one may quickly realise that my views today actually
differ to Mr Das’s, although I greatly respect him as a writer and
intellectual; his book was a stepping stone to my current position.
To cut a long story short, I was following the US presidential
campaign in late 2007, when I came across an obscure Republican
politician by the name of Ron Paul. Watching the Republican debates,
I was dumbfounded. It was the first time, and has remained one of the
only times I have heard a politician, of all people, make perfect
sense.

After viewing and searching for
several more clips of Dr Paul, I came across various sources on what
is known as the Austrian School of Economics. From this school I
found there were various significant historical figures like Ludwig
Von Mises, and his Nobel prize winning follower Friedrich August Von
Hayek. I also found some great sources, especially mises.org, the
website of the very institute I would have the honour to end up
studying this subject in the summer of 2009, with some of the world
leading scholars in the field. The experience I had with my week in
the “Mises University” program this year was by far the most
stimulating of my life.

So how did I myself join the
ranks of these “Austrian” economists (many of the current
followers of the school today are American) ? The path I took is not
a straight-forward one, and involved a long period of trying to
wrestle and reconcile the statements and theorems of a certain book.
That book was Human Action. This book greatly offended and
challenged my philosophical presuppositions, and it was a long time
before I finally came into agreement, now wholeheartedly, with its
author; Ludwig Von Mises.

Before reading Mises, I must
confess that I was pretty much a run of the mill positivist, though
at the time I did not appreciate the full meaning of the term, nor
recognise that I was one. From my state of knowledge I felt that
positivist statements about science were so obvious, only a fool
would rise up to challenge them. Thankfully, such a “fool” called
Mises did rise up to challenge the statements of these philosophers,
whose views have become so widespread in scientific discourse, that
many not familiar with philosophy take their doctrine as the only
valid criterion for science.

I will not enter into a full
refutation of positivism here, but instead highlight Mises’ positive
case for a method in the social sciences. Mises in Human Action
identifies a methodological dualism between the social and the
natural sciences. This dualism is simply how we use teleology and
causality to explain different kinds of events. These terms are best
explained by use of examples. We do not, for instance, reason that
when we throw a ball it is guided in a “teleological” way by some
mystical spirit or “prime mover.” Instead we use the laws of
mechanics and causality, to relate the position, velocity and forces
acting on the ball; to predict the future position and velocity of
the ball. Similarly, one does not reason that there is some sort of
direct causal relation between the fact that the pedestrian lights
turn green at traffic lights, and bodies begin to cross the road.
Such an assertion reveals an ignorance of the fact that these are
acting individuals with purpose crossing the road, who only when the
lights turn green, and possibly other unforeseen conditions are
satisfied; reason that it is safe to cross the road and proceed to do
so. The reckless individual who is late for work may rush across the
road regardless of what the traffic lights show.

It is this insight, that humans
act purposefully which Mises uses to build Economics deductively. To
act purposefully means to aim at achieving an end via a means. To
act, means to choose one mode of action out of all other possible
alternatives, it is a demonstration of preference. Of course one may
make errors in one’s judgement, whereby one realises that the state
of affairs produced acting one way actually satisfies one less than
the unrealised alternative would have.

This framework, with which to
explain and interpret is amazingly general, can be used to explain
all kinds of actions, even those normally considered outside the
realm “economic.” Indeed the monk who shuns material riches and
gives food to another man does so because he values feeding this man
more highly than he does feeding himself with the same food. It is
this type of subjective analysis that helps form the root of good
economic analysis.

A classic example of the
application of subjectivism, can be produced if we want to work out
the value of a factor of production, for example, land. Let’s say we
have a good produced like Champagne in Champagne, France. When asked
why Champagne is so expensive, the classical economists would have
said; the businessman has to pay so much for the land in this area of
France, that he must subsequently charge a high price for the product
he produces from it. Yet, if people begin to be worried about
Champagne, perhaps they feel it causes them ill health, they will
begin to value and demand it less with regard to other goods, hence
the market price will have to drop, as no one will exchange for the
previous price. Subsequently, the fall in the price of the product,
will “impute” backwards to the price of the land on which it was
produced. Hence we would see a drop in the price of land in
Champagne.

Hence we see that the consumer,
and his valuations lie at the root of all economic considerations. It
is because we, as consumers, value products for the subjectively
defined ends we feel they help us achieve; that they have any value
at all on the market at all. Although this may seem so obvious to the
reader, telling you what you “already know”, it relies on one
seeing more than what is immediate to the eye, or obvious in a sense.

In essence, perhaps the most
elusive entity in the entirety of Economics, is the market, the very
concept at the heart of its investigations. “How does Paris get
fed?” asked Bastiat. The assumption, first undertaken in how one
could get man to cooperate with man, was that authoritarian
interference would be required to have every specialist serve his
fellow citizen. The shock which economists experienced in their
investigations was how this mysterious, truly anarchic state of
society known as the free market nevertheless allowed for the
coordination of production among different individuals pursuing their
own self interest, truly got “Paris fed”, pursuing innovations
and supplying consumers better than the orders of a centralised
government ever could.

We
can see the effects of Government interference in the world around
us, if only we open our eyes. At each instance they dis-coordinate
the motion of the entrepreneur the steerer of “our ship” known as
the market economy with the orders and demands made by his captain,
the consumer.

The dis-coordination of consumer
time preference for consumer goods now as opposed to saving for
later, with the production ratio of consumer and investment goods,
brought about by central bank manipulation lowering interest rates,
otherwise determined by consumer time preference; produces the
recession we see now, after an investment boom whereby businesses
wasted resources and money on goods that ultimately, were not desired
by consumers. We see, that when a maximum price is placed on a good
that is below its market price, we see the destruction of a price
‘signal’ from the consumers to the producers, to pursue profit and
self interest in order to increase and improve production of the
desired commodity. Instead, we see supply shortages.

The lesson ultimately learned
albeit no-doubt depressing for those who would like to command and
control the lives of others, is that it is better to “stay out of
it” and not interfere with the functioning of the market economy,
and ultimately with the voluntary contractual relations of others
pursuing the best they can in peaceful cooperation. As Mises notes in
Human Action, the conclusion of the classical liberals; “Observe
the functioning of the market system, they said, and you will
discover in it the finger of God.”