simply Capitalism

posted by Beth @ 11:08 AM

Regional Cost Differences in Medical Care: A Case in Point

"We have long known that some places...offer high-quality care at costs below average."
--Barak Obama, 09-09-2010, Joint Session of Congress

“[O]ne of the biggest signals of inefficiency in American health care is the massive regional variation in cost and health outcomes…yet the higher cost areas and hospitals don’t generate better outcomes than the lower-cost ones. The result is an estimated $700 billion a year spent on health care that does nothing to improve patient health.”
-- Peter Orszag, OMB blog post, 05-28-2009

It ain't so much the things we don't know that get us into trouble. It's the things we know that just ain't so.
--Josh Billings, and several others

President Obama has promised he will not sign any health care reform bill that "adds one dime to our deficits" and that his "approach would bring down the deficit by as much as $1 trillion over the next two decades^." In addition to employing deceptive budget gimmicks, Obama's health care budget depends on a 30% reduction in Medicare expenditures. Mr. Obama and his budget director, Peter Orszag, believe this can be accomplished through elimination of rampant "waste and abuse" as evidenced by the wide regional variation in Medicare spending.

Orszag’s claims of $700 billion in potential savings originate from a specific single analysis, theDartmouth Atlas of Health Care, the conclusions of which are being challenged, most recently in last month's issues of the New England Journal of Medicine and Medical Care, and others. Thecritics raise reasonable concerns about the methodology used to conclude that regional differences in health care spending are due to waste and fraud, and that greater expenditures fail to achieve better outcomes. Drs. Jonathan Skinner and Elliot Fisher, principal authors of the original analysis, havepublicly responded in defense of their work. This debate is important, not just because it raises serious questions about the potential for savings in proposed reforms, but more importantly, it calls into question justifications for greater government control of health care.

Regardless of who is right and who is wrong on this specific issue, of far greater importance is the inappropriateness of employing scientific research to frame and justify political action. Politicians are increasingly adept at finding and quoting research results which appear to support a particular program or policy, while conveniently ignoring any contradictory evidence or analysis. Through subsequent loud and frequent repetition, a statistic or study result becomes accepted knowledge...even when it isn't so.

Obama and Orszag both refer to scientific studies in an attempt to provide legitimacy to their political agenda. The conclusions of the Dartmouth Health Atlas seem to support allegations that"high spending represents 'waste' and low spending represents 'efficiency'." Yet, even before this month's pair of articles, other investigators (also here and here) have questioned the validity of those conclusions, pointing out erroneous assumptions and faulty methodology. The recent articles strengthen those criticisms.

If Congress succeeds in passing legislation based on results that are false, savings will not materialize, and we will be stuck with an expensive, intrusive bureaucracy scientifically designed to correct a problem which does not exist. All errors will be fossilized in a legal morass. Even the initially correct portions (if any) would remain stuck in a moment of time, unable to shift with changing circumstances or expanded and improved understanding. Leaving the details to regulatory control is not a solution as that merely exchanges the problem of rigidity for the problem of arbitrary and unpredictable rule.

Legislation is rigid, and slow to adapt--a blunt tool which is able to provide restraint, capable of enforcing opinions, but not of uncovering truth. To maintain the Rule of Law and the protection of individual rights, this is precisely what law must be: stable, predictable, thoroughly deliberated, easily understood, and universal.

Science is fluid, and constantly changing. Results are typically complex and controversial, frequently unexpected, arcane and particular.

The political apparatus is not designed to move with the ebb and flow of scientific knowledge, nor should it even attempt to be. Laws of nature are revealed, not legislated. Laws of men, to be objective, are predicated on the unchanging fundamentals of human nature.

We do not need government to enforce scientific findings. Left alone, the truth will emerge. Besides, a superior system already exists which responds flexibly to expansions and refinements in knowledge. This system is fluid, decentralized, relatively quick to react, and consistent with individual rights. This system is the free market-- able to function not just for material goods but also in the realm of ideas. Contrary to the slow, deliberative and ideally universal functioning of government and law, the free market is poised to quickly recognize and apply new information in an almost infinite variety of ways to a multitude of unique situations. With a profusion of simultaneous, privately-funded experiments, entrepreneurs sift through a plethora of alternatives, and then, by competing for the reward of profits earned through voluntary exchange, the most effective, accurate and efficient processes emerge.

Science enhances the ability of free men to make informed decisions regarding how best to achieve their life's goals. Man's flourishing, and very life, depends on the freedom to direct his actions according to his own judgment. When governments employ the fruits of science to usurp private judgment, it turns science against man's lives through the destructive hubris of central planning.

Governments must stick their proper function: the protection of individual rights--and leave the work of science and production to those who do it best: free individuals in peaceful pursuit of their lives.

And any mistakes made, will be on our own dime.

Cross posted at WINTP

Labels: health care

posted by Doug Reich @ 5:50 PM

If I were to urge you to grasp one principle of economics, a principle that would help you throughout your life dissect and refute virtually every government scheme to take your money in the name of the "public good", it would be the Broken Window Fallacy. This parable was created by Frederic Bastiat in 1850 and popularized by Henry Hazlitt who used it to refute dozens of economic fallacies in his famous book Economics in One Lesson. Despite over 150 years of knowledge and experience, this fallacy permeates every facet of politics today and is committed routinely by politicians and Nobel Prize winning economists alike.

I gave detailed descriptions of this principle in two past posts here and here so I will not go into full detail. Briefly, the principle is that one must focus on both the direct consequences of an action AND consequences that would have occurred in the absence of the action. In certain contexts, it could be called the law of unintended consequences. Another way to put it: in order to understand the consequences of government action, do not just look at what it does directly, but also imagine what could have happened and what did not happen as a result of government action.

For example, in the parable, when a brick is thrown through a shopkeepers window, observers are led to believe that the broken window is "good" for the economy since it increases the revenue of the glass maker. Such a view might lead someone to think that destruction is good for the economy and even to conclude that wars are actually a benefit. As a result, someone might advise routinely burning the entire town to the ground to "help" the economy. Sound familiar? Isn't this the argument at the base of the claim that World War II helped end the Depression? What is not seen by these observers, is the action that would have taken place if the shopkeeper had not had to pay for the broken window. He would have had more money to spend elsewhere on the movies, new furniture, or perhaps to expand his own business. In this instance, although the glass maker benefited, the broken window is at best a zero sum game as far as the economy is concerned since the movie theater, furniture maker, or anywhere the shopkeeper would have spent the money has lost potential revenue. (In actuality, I would argue that the broken window is less than a zero sum game - it is highly destructive to the economy to the extent that it subdues capital investment which subdues innovation and productivity.)

Once one fully grasps this principle by applying it to numerous instances as Hazlitt does, it becomes clear how futile and destructive are government policies implemented on the basis of this fallacy.

One of the most obvious applications of this principle is to the idea of "make work" jobs which are jobs "created" by the government for the purpose of employing individuals. For example, say the government announces a plan to employ 10,000 individuals digging ditches. For the 10,000 people who get this job, it clearly is a benefit. After all, they are now working and making wages which they can use to support themselves. However, is such a plan "good" for the economy?

First, where did the government get the money to pay these workers? It obtained the money through taxation which means the wages paid to the 10,000 workers is money no longer available to those who paid the taxes. These taxpayers now have less money to spend on other things like food, computers, or automobiles. Again, it is at best a zero sum game and in actuality worse since the government generally spends the money on activities that no one wants or needs.

How could anyone think that robbing money from some people and giving it to others could result in a "better" economy? If that's true, why don't we legalize theft by, for example, the Mafia. Then, when the economy needs a jolt, the government can urge the Mafia to shake people down for their money in order to spend it. Won't that be good for the economy? How is the logic any different?

If such a notion seems absurd - it is, yet, this is the exact reasoning behind the "stimulus" package unveiled by Congress earlier this year. It is exactly the reasoning behind the argument being offered that the cap and trade energy bill, despite the fact that it will increase energy costs, is actually good for the economy since it will "create" so-called "green jobs".

In this case, the stimulus bill and the climate bill are supposed to actually create jobs since the government will spend money in various areas. In fact, in this Yahoo article, seven "lucrative" new jobs from the Obama stimulus plan are highlighted. What are they? Among others include "solar panel installer", "cost estimator" to estimate costs of spending the stimulus money, and "physical therapist" since so many people are unemployed and apparently will need physical therapy (I'm not making this stuff up...). This means that individuals rather than being motivated to enter productive professions like medical research or computer science will instead be encouraged to install solar panels and to monitor the expenditure of loot that is robbed from taxpayers.

Let's ask another important question: is the government literally magic? Can it simply spend other people's money and, voila, create prosperity? Apparently, the government is magic since Nobel Prize winning economists like Paul Krugman endorse the government's plan to spend other people's money and in fact call for even more spending. Obama claims that the climate bill will create "millions of new jobs" which, of course, relies on the Broken Window Fallacy.

What creates real wealth? Making more with less effort or productivity is what leads to real gains in prosperity. "Jobs" in the sense of "people doing things" is not necessarily good for the economy nor does it necessarily lead to increasing prosperity. In other words, "activity" should not be confused with "productivity". When people make more with less effort, it frees up time so that people can work and produce in other areas. Hundreds of years ago, virtually everyone spent their time simply producing food and subsisting from day to day. More efficient agriculture due to new technology allowed the same amount of food to be produced by less people and freed people up to work on things like inventing electricity, the locomotive, and medicine. Robbing some people and giving it to others to spend does not benefit the economy in terms of creating real wealth and prosperity. Such a plan only redistributes wealth to some for the unearned benefit of others.

In April 2009, Dr. George Reisman posted Green Jobs in which he facetiously discusses how Obama's stimulus plan is capable of creating an infinite number of "jobs":

Indeed, advancing the goals of environmentalism is capable of creating a virtually limitless number of jobs. Big-rig trucks and their “polluting” emissions might be done away with by replacing them with human porters who would carry freight on their backs. Ocean-going ships and their emissions might be done away with by replacing their “dirty engines” with the clean labor of banks of oarsmen. (Sails would be a substitute too, but they are no match for oarsmen when it comes to the number of workers needed.) Automobiles and their emissions might be replaced by sedan chairs and teams of litter bearers.

Later, he discusses a brilliant idea that could literally "employ" millions:

And finally, think of all of the jobs that a program of environmental “stewardship” might make available. Thus each patch of desert, each rock formation, each clump of grass, and each tree stump, might have assigned to it one or more “stewards” whose job would be to watch over it, protect it, and “preserve it for future generations.” To carry out this valuable work, there could be a whole corps of “stewards.” They could be dressed in special uniforms displaying various ranks and medals, all gained in “service to the environment” and the defense of nature and its resources against the humans.

Indeed, once we put our minds to it, nothing is easier than to think of things that would require the performance of virtually unlimited labor in order to accomplish virtually zero result. Such is the nature of all job-creation programs. Such is the nature of environmentalism. Such is thought to be the path to economic recovery by most of today’s intellectual establishment.

When you understand the Broken Window Fallacy, programs offered to "stimulate" the economy and "create" jobs seem laughable. It's too bad it's not funny anymore.

posted by Doug Reich @ 9:29 AM

Below is an updated version of a post from May 2008.

Amidst all the hysteria related to rising gas prices including Congressional "investigations" of the oil companies and threats of additional taxes on their profits consider the following:

If you drive 15,000 miles per year and get 18 miles to the gallon you will consume 833 gallons of gas per year. This means that if gas prices rise $1 per gallon it will cost an extra $833 per year and if they were to rise another $2 per gallon it would cost an extra $1666 per year. Of course, no one wants to pay more, but consider the value you obtain from driving an automobile. It is an almost indispensable part of most of our lives and adds tremendous value in terms of our ability to travel and work. Consider that oil companies are delivering fuel to the consumer at about $2.50 per gallon despite regulations preventing domestic drilling which forces them to rely on hostile foreign governments, regulations that have prevented any new domestic refineries in the last 30 years, and TAXES on the production and sale of gasoline.

Now, if you make $40,000 per year in income, which is about the average yearly income in the United States, consider this back of the envelope calculation of the taxes you must pay the government:

Sales Tax on a 2010 Toyota Prius Hybrid: 6%*$24,000 = $1,440
Income Tax, say 15% = $6,000
Social Security Tax, 7.5% = $3,000
Employer Match (which could be yours) , 7.5% = $3,000
Medicare, 1.45% = $580 State Income Tax,
average 5% = $2,000
Sales Taxes (say you spend $10,000 per year at 5%) = $500
Gas Tax (0.40c per gallon at 833 gallons per year) = $333
Property Tax (say you own a $150,000 house at 1.5%) = $2,250

TOTAL = $19,103 or 48% of yearly income, and were not done!

Consider the hidden taxes one pays, which I will not even attempt to quantify. For example, consider that taxes on businesses get passed on to consumers and make the price of goods and services higher than otherwise. Consider that government caused inflation and regulations drive up the cost of everything on the order of 3% to 6% per year as well as having the effect of destroying capital and reducing the productivity of labor which further reduces real wages. Consider the lost return on money you could be saving that instead went to Social Security. Consider the cost of simply filing a tax return which often requires the assistance of a trained accountant if you itemize deductions or own a business. Consider the lost productivity due to the fact that legions of highly intelligent people, viz. accountants and tax attorneys, which could be doing something valuable, are instead employed in the preparation and understanding of the 70,000 page tax code. Consider the cost of health care which is generally deducted from an employees salary as part of an employer sponsored program which reflects the high costs caused by government intervention into medicine and the insurance market. I could go on, but I think I have made my point.

Perhaps most importantly, consider that if you don't like the price of gas then you do not have to buy it! You could simply choose not to purchase it or drive less. The oil companies don't put a gun to your head and demand you buy their product. They offer a product that is of the utmost value and people are voluntarily willing to pay the price. On the other hand, if you don't pay the government you will end up in jail, i.e., the government takes your money under the threat of physical force. This represents the difference between "economic power" and "political power", i.e., the voluntary exchange of value for value versus the point of a gun.

To top it off, consider this recent article which states that

Taxpayers are on the hook for an extra $55,000 a household to cover rising federal commitments made just in the past year for retirement benefits, the national debt and other government promises, a USA TODAY analysis shows.

The 12% rise in red ink in 2008 stems from an explosion of federal borrowing during the recession, plus an aging population driving up the costs of Medicare and Social Security.

That's the biggest leap in the long-term burden on taxpayers since a Medicare prescription drug benefit was added in 2003.

The latest increase raises federal obligations to a record $546,668 per household in 2008, according to the USA TODAY analysis. That's quadruple what the average U.S. household owes for all mortgages, car loans, credit cards and
other debt combined.

In summary, consider that the government takes roughly 50% of what you earn in a given year through income and various taxes, impedes productivity and capital formation, and then saddles each household with an additional $546,668 in debt to be paid for out of future taxes including interest. If the government takes 50% of what you make, is it a surprise that both parents must now work to support a household despite massive increases in productivity over the past 100 years? Consider this crushing tax burden in relation to the fact that when gas went from $2 to $3 per gallon it cost the average person an extra $833 per year.

Why are we investigating the oil companies and not our own government?

posted by Kendall J @ 9:34 AM

The conventional wisdom today lays the blame for today's financial crisis on the free market. The mortgage market collapse is thought to be due to unscrupulous lenders who relaxed lending standards and then sold risky mortgages to unsuspecting investors. Both Presidents Bush and Obama used this narrative in justifying their policy actions. Closer examination reveals that government interference played a much more fundamental role. Specifically, the ballooning of the secondary mortgage market by government sponsored entities, followed by the "cheap money" policy of the FED created the basic structural distortions which would ultimately lead to the financial crisis.

Government sponsored entities [GSE] such as Freddie Mac and Fannie Mae are key players in home mortgage markets. They were created by and have a specific mandate from congress to help assure "affordable" housing. Although these entities operate as "private corporations" today, they receive favorable treatment by the government and their boards and hence their operating policies are primarily government controlled.

The secondary mortgage market was created primarily by these GSE's. Up through the 1990's, most mortgages were held by private corporations in what is known as the "originate to hold" model. However, GSE's increased the flow of capital into the mortgage market through what is known as the "originate to distribute" model. Through this model loans are bought, packaged into securities, and sold to investors on the secondary market. GSE's either perform this activity directly or they insure the securities created by private firms. Practices like these effectively mask risk from investors and give mortgage originators no reason to closely examine the quality of the loans they issue. GSE's fueled the mortgage practices that today are blamed on the free market.

GSE involvement had been relatively small up until the 1990's. The most striking growth in the secondary mortgage market occurred in the 1990's, before the housing boom, with that market reaching a size of $3.3 trillion by 2001. Eighty five percent of that market was based upon securities issued or insured by the GSE's. This growth was fueled by specific changes to GSE policy to stimulate home ownership.  Structurally, the stage had been set for a large housing boom, and all that was needed was a precipitating condition. 

That condition came in the form of the monetary policy of the Federal Reserve during 2001-2004. During that time the FED lowered and held interest rates at near record lows. Chairman Alan Greenspan noted that he was attempting to stimulate the economy, and specifically home ownership. He states in his autobiography, "I was aware that the loosening of mortgage credit terms for subprime borrowers increased financial risk, and that subsidised home ownership initiatives distort market outcomes. But I believed then, as now, that the benefits of broadened home ownership are worth the risk."

The FED is a government entity and itself acknowledges the role of low interest rates in fueling housing boom cycles. From a 2005 study on housing booms and monetary policy, FED analysts indicate that "house price booms are typically preceded by a period of easing monetary policy, but then diminishing slack and rising inflation lead monetary authorities to begin tightening policy."

Demand for housing, previously steady at 3% annual growth, ballooned to 9% as a result of FED policy. Construction boomed, home prices escalated significantly, and debt levels rose on this rising tide of newfound "home equity." The well-established secondary mortgage market served as a ready catalyst to funnel capital into the market to meet this ballooning demand, magnifying the size of the boom.

During an artificial boom, risk levels are masked. Because house prices are escalating dramatically, borrowers feel that they can take on more debt. Because foreclosure rates actually go down, lenders begin to feel that they can lend to borrowers who before might have been perceived as risky. And because mortgage securities continue to pay out well, investors continue to demand them. Some even begin to think that this boom will be sustained and increase their risk levels beyond what would normally have been considered prudent. These effects are not a result of an unexplained aberration in the free market. Rather they result from the fundamental distortions that created the boom in the first place.

The FED's fiscal tightening in 2005-6 precipitated the crash. Because of the extended boom however, a significant amount of capital had been placed into poor investments, and the magnitude of the crash had already been determined, left only to play itself out.

While the conventional wisdom may blame markets for the financial crisis, government interference in the mortgage market for the expressed purpose of stimulating home ownership was at the heart of the collapse.

[Editor’s Note: this article was written for a writing class I’m taking, as an example of an op-ed article.]

posted by Doug Reich @ 4:52 PM

One reason why spending at the state level can rarely get out of control is because states lack the power to print money. In other words, they must rely on taxation or municipal bond offerings to raise money to fund their budgets. Since taxation is unpopular, there is an obvious political limit to increased tax rates. Since private municipal bond investors can only buy so much debt before asking for higher interest rates, there is also a limit to the amount states can raise through borrowing. The federal government figured out how to get around this limit by creating the Federal Reserve System which is a pseudo private bank with the power to create money. The Fed can buy federal government debt from the public with fake money. Therefore, the federal government always has a buyer for its paper.

Now, the states want to get in on the action.

Of course, the states will not ask for the direct power to print money. They have a more clever way.

In a move with only one modern-day precedent, California Gov. Arnold
Schwarzenegger and Democratic lawmakers are pressing the Obama administration and members of Congress for federal loan guarantees to help the state out of a desperate, multibillion-dollar jam.

California is not asking for cash, like the tens of billions given to AIG, General Motors or Morgan Stanley. (MS) Instead, the state with the worst credit rating in the nation is asking that Washington act as a sort of co-signer on the state's borrowing, to be backed up with money from the Troubled Asset Relief Program.

California leaders say that would make it easier and cheaper for the state
to borrow money on the bond market, reducing the interest rate by as much as
half and saving taxpayers hundreds of millions of dollars.

So, here we go. The states are "not asking for cash" - only federal government "guarantees" to get them out of a "jam". Sound familiar? This is exactly the premise of government sponsored agencies (GSAs) like Freddie and Fannie that were to "guarantee" pools of mortgage backed securities. Such guarantees resulted in the massive issuance of mortgages since they could be pooled and sold to GSAs all in an effort to "help" first time home buyers by keeping mortgage rates down (and underwriting standards lower than otherwise). That worked pretty well, right...?

If the federal government offers similar guarantees to state municipal bond offerings, it will effectively remove any constraint to state level spending. States will no longer have to face the politically unpopular choice of raising taxes to generate revenue or, gasp, cut spending. They will be able to borrow ad infinitum since the federal government will stand behind the state debt with its printing presses in tow. Such a mechanism would effectively transfer the power of printing money to the state level with all of its attendant consequences: reckless spending and runaway indebtedness all backed by the United States taxpayer who will shoulder the burden directly through increased federal taxes or by paying more for everything in the form of inflation as the dollars created to pay for this mess work there way into circulation.

Because this idea is unjust - it effectively spreads state level obligations to other states - and because it is economically disastrous - it will encourage states to spend and borrow more thus crowding out private investment and spurring inflation - and because it mitigates the short run need for politicians to face the consequences of their actions - look for it to pass unopposed.

posted by Realist Theorist @ 3:33 PM

Falling off a roof, I'd rather have a soft landing than a hard one. Metaphorically, people speak positively of a "soft landing" for the economy. However, the economy is not a single organism that is falling. When an economy falls, individual units -- people or companies -- "fall": individual people become unemployed, individual homes are foreclosed upon, and individual businesses go bankrupt. I think the notion of a soft-landing for an economy is often a fallacy of composition.

Consider the experience of two countries. The unemployment rate is shown in this diagram:

posted by Beth @ 10:43 AM

The president has also proposed savings on a much larger scale. The president has proposed ending the bank middle man for college loans, saving $94 billion over a ten-year period of time.

--Robert Gibbs, Press Secretary for President Obama

In yesterday's (4-21-09) press conference, Mr. Gibbs used the above statement to defend the President's $100 million budget cuts. Set aside for the moment that $100 million is only 0.0028% of the $3.6 trillion budget, and stop to consider the full implications of this casual comment. This assertion flowed effortlessly from Gibbs as part of his explanation on how the government is going to save us money. In the very next sentence, he implies that private insurance companies needlessly duplicate coverage the government already supplies through Medicare. (video clip; transcript)

What does this reveal about the administration's beliefs on the relative roles of government and business in meeting the economic needs of this country?

Just who exactly is the "middle man" and what are the implications of cutting him out?

The "middle man" is private enterprise, and our leaders, in the highest executive office of our country, view private enterprise as less efficient than government.

What system views government as the preferred manager of business?
Socialism.
What system views private enterprise as the proper mechanism for economic transactions?
Capitalism.

It doesn't get much clearer than this.

posted by Realist Theorist @ 10:23 PM

A tale of three homes: Consider this tale of three modest suburban homes on Adams Street (1). The one in the middle is owned by Mr. and Mrs. Chips who have lived there for 28 years. The homes on either side of them were bought more recently.

Mr. and Mrs. Chips, retired in 2000. Purchased in 1980 at $100K, their house was valued around $200,000 in 2000 [a nominal appreciation of 3.5% a year (2)]. They paid off their 30-year mortgage in 25 years, using a few extra principal payments when they could afford them.

Between 2000 and 2006, the market price of the Chips' home started to rise by 6-7%, then 8-10% a year. Finally, in 2006, similar homes were being sold for about $320,000! These higher valuations were of little use to the Chips. If they sold, they would have to buy something else at equally high prices. Then, in 2007, home prices began to fall; by Jan 2009 their home was valued somewhere around $220,000!

In terms of direct impact, the housing boom and bust made no difference Mr. and Mrs. Chips. It was as if it did not happen. It was like a storm they slept through. If prices in general flatten out (deflation-like) while credit-money contracts, they would be happy, because their savings will go the extra mile.

The Ketchums moved in next door to the Chips, buying a similar house for almost $300,000. Their home value has plummeted too and they feel terrible, because it is far below what they paid. Of course, their 30-year mortgage is unchanged. They had originally budgeted for certain monthly payments and can continue to meet those even if the economy turns down for a while. This would eat into the "buffer" in their budget, and they would have to scrimp, but they would pull through as long as things weren't too bad for too long.

The Smiths: The house on the other side of the Chips was bought by the Smiths. They suspected they could not afford it; but, they stretched to buy it. They lied about their income and borrowed 90% of the purchase price. Even while taking on a long-term commitment, they did not think of checking what interest rates were (say) 10 years ago; they took an interest-only ARM with extremely low introductory payments, and hoped it would not reset at too high a rate. They hoped that in a few years their home would have risen in value and they would refinance and end up with a better "cushion" of equity. The Smiths' plan did not work out. Their home value fell, ruling out refinancing. Meanwhile, their interest rate went up from their introductory rate. They are hurting. If things do not get better soon, they might not be able to afford their mortgage.

posted by Beth @ 12:32 PM

While checking out blogs on Tax Day Tea Parties, I discovered a wonderful post written back in January on Haight Speech.

Who could have Foreseen?

Oftentimes people respond to a crisis by claiming that it could not have been foreseen. (Government officials said this in the wake of 9/11, as one example.) With regard to the housing crisis, I have an answer: Henry Hazlitt. From his 1946 book Economics In One Lesson:

The case against government-guaranteed loans and mortgages to private businesses and persons is almost as strong as, though less obvious than, the case against direct government loans and mortgages [for homes]. … Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to ‘buy’ houses that they cannot really afford. They tend to eventually to bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with the guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief, in the long run they do not increase overall national production but encourage malinvestment.

Over sixty years ago, and he nailed it. What a shame nobody was listening.

Hazlitt's book is a wonderful introduction economic analysis in which he takes a fundamental principle and applies it to a number of commonly held, but erroneous, economic assumptions. In the introduction, he summarizes the principle as follows:

The art of economics consists in looking not merely at the immediate but the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Using this approach, Hazlitt examines the ignored effects of policies such as rent control, minimum wage, protectionist tariffs, make-work schemes, subsidies and bailouts, and several others. He clearly and simply demonstrates that by looking beyond the immediate effects, what at first glance appears to be beneficial is in fact harmful. Written for the intelligent layman, this book can also be read by an interested high-schooler.

Hazlitt's formulation is a recipe to correct the error in thinking of known as "context dropping." Ayn Rand explains this error in her essay "The 'Conflicts' of Men's Interests."

[T]here are two major ways of context-dropping: the issues of range and of means.

A rational man sees his interests in terms of a life time and selects goals accordingly. This does not mean that he has to be omniscient, infallible, or clairvoyant. It means that he does not live his life short-range...It means that he does not regard any moment as cut off from the context of the rest of his life, and that he allows no conflicts or contradictions between his short-range and long range interests. he does not become his own destroyer by pursuing a desire today which wipes out all his values tomorrow.

A rational man does not indulge in wistful longings for ends divorced from means, He does not hold a desire without knowing (or learning) and considering the means by which it is to be achieved.*

Leonard Peikoff elaborates further:

Whenever you tear an idea from its context and treat it as though is were a self-sufficient, independent item, you invalidate the thought process involved. If you omit the context, or even a crucial aspect of it,then no matter what you say will not be valid...

A context-dropper forgets or evades any wider context. He stares at only one element, and he thinks, "I can change just this one point, and everything else will remain the same." In fact, everything is interconnected. That one element involves a whole context, and to assess a change in one element, you must see what it means in the whole context.*

Looking at the whole context is key to evaluating the effects of any action or policy. Attempting to raise the number of home owners through government-guaranteed home mortgages drops the context both in terms of range and of means.

In terms of range, subsidizing loans for people who in fact can not afford the homes the loans are intended to purchase, has created not home-owners but mortgage defaulters. The effects of artificially lowered interest rates spread through the economy, distorting risk and profit calculations, leading to outrageous levels of leverage, culminating in the recent collapse which has destroyed the businesses and savings of millions of people and trillions of dollars. All of these events are intricately interconnected.

In term of means, all government subsidies necessarily involve violating property rights in the name of the "redistribution of wealth," which is nothing more than today's euphemism for the Marxist principle, "From each according to his ability, to each according to his need." No policy which violates a fundamental right can be considered valid.

When evaluated in the entire context of range and means, government subsidies are neither moral nor practical. With the application of properly constructed principles to the full context, the destructiveness of such policies can easily be foreseen.


*Quotes for Ayn Rand and Leonard Peikoff were taken from The Ayn Rand Lexicon, edited by Harry Binswanger, New American Library, 1986, pg 105

posted by Kendall J @ 8:00 AM

I enjoyed this Blogging Heads video featuring Arnold Kling, and Russell Roberts discussing the roots of the economic crisis. Both came to the Austrian school from others, specifically Keynsianism, and Monetarism.

In this video they discuss a little bit of the history of these schools and their arrival at an Austrian perspective. I enjoyed their initial discussion of “perils of Econ 101” where they illustrate the danger in macroeconomics of rationalism (using the C + I + G formula). They do a nice job of illustrating how one must go back to reality to ground the theory (“curing cancer vs. filling holes”).

The discussion is technical rather then philosophical, but it is a well-reasoned discussion. They correctly identify government policy in the housing market as the root of the crisis, and they concretize how that happened. They question the use of stimulus and the model that Ben Bernanke is using to prescribe such actions.

Labels: stimulus

posted by Kendall J @ 8:44 AM

Peter Schwartz has a great op-ed this week, “Mob Rule Comes to Washington.” In it he asserts that arbitrary, unchecked use of government power is tantamount to mob rule and that this is what exists today. President Obama even made a concrete reference to the force of the mob when he reportedly told bankers behind closed doors that his administration “is the only thing between you and the pitchforks.” But is this hyperbole? I mean, there isn’t really a mob of people with pitchforks out there, right? What does Swartz mean by “mob rule” and how does it manifest itself in today’s crisis.

The answer is in the arbitrary use of government power, in other words, the imposition of force, or the reversal of previous actions based upon whim. One of the clearest examples of this type of action is the ex post facto taxation of AIG executive bonuses. Congress used it’s legislative powers to essentially rewrite the terms of previously granted TARP investments to AIG. The government issued TARP investments under certain terms, typically as warrants for stock or as preferred stock. The terms of these investments are typically passive as far as company operations are concerned. That is, the investments do not allow the entity providing funds to exert control over the bank’s operations. Yet, the government, after the fact, exerted just such control.

But why is such action so destructive? This action took the form of a law passed by a legislative body, yet it is a blow at the very idea of rule of law. It destroys the idea of a contractual agreement, since the original investment terms mean nothing. And that will destroy man’s ability to use his rational faculty to live, by destroying decisions he has previously made. Had AIG known before hand that such terms would be imposed they might have chosen not to accept TARP funds. Yet they did not know and could not have known that such actions would be taken. These actions are forms of tyranny.

What precipitated this government action? Public outrage over the fact that bonuses were given. It was popular opinion expressed as displeasure to our elected officials. But the concept of rule of law is intended to prevent such expressions from resulting in arbitrary force.

Other examples of arbitrary actions include strong-arming of several of the large banks to “accept” TARP investments in the first place, firing CEO’s as preconditions of investment funds, proposed legislation to regulate any and all salaries at companies, refusing to take back TARP funds, and demanding such things as programs for investment in green auto technology.

Yet, if these companies were in bankruptcy some of the same actions, such as removal of executives, might occur as conditions or restructuring. Is this not the same thing? Clearly not. When we first defended CEO bonuses here, we had a commenter who suggested otherwise.

and i know government played its (small) part in the crisis, but we live in democracy. and as long as this plan is going forward, put into place by our elected officials, i think there should be ACCOUNTABILITY. since i have become a shareholder, so to speak, i say: don't take the money if you can't pay the price.

While I can certainly understand those who rightly fume at the government handing out TARP funds, and feel as though their money should be managed properly, the principled course to take is one that preserves the rule of law, does not unleash the mob, and accomplishes the same thing. This process exists already. It is bankruptcy.

What about the idea that such actions are just because these bank executives (or auto executives ) are deserving of the punishment they receive? Justice is not the arbitrary use of force. The sense of satisfaction that one feels when they see an executive being punished cannot be called justice if obtained in any manner whatsoever. There is a difference between justice in a courtroom and “justice” on the guillotine. The latter is not justice at all, but tyranny, and it is what we see the signs of today.

Schwartz is right. The mob is loose, and arbitrary government action is it’s harbinger.

Labels: bankruptcy, bonuses, Obama, TARP, Wall Street

posted by Doug Reich @ 4:58 PM

Here is an interesting piece on the "impenetrably misguided policy response to this financial crisis, which seeks to address the downturn by encouraging more of what got us into this mess in the first place" by John Hussman. He discusses the U.S. Treasury's "toxic asset" plan and various other measures which do nothing to address the actual causes of the financial crisis and that will likely only exacerbate the problem.

This piece can be read alongside my below post on recent Fed policy and provides further evidence of the utter destruction being wrought by government interference in the economy. It also provides further evidence of the effects of bad philosophy on our lives. Economists and government officials, unable and/or unwilling to integrate facts with valid economic or moral principles or who simply wish to usurp ever more power, continue to propose and execute plans which entail massive abrogrations of individual rights and destroy the economy. Meanwhile, the bewildered American populace, intellectually disarmed by over 100 years of progressive education and modern philosophy, sits idly by hoping things will somehow get better.

posted by Doug Reich @ 9:50 AM

In a previous post, The Fed’s Wish, I attempted to analyze the recent changes in the Fed’s balance sheet and the explosion of the monetary base as a means to understand the mechanism by which the government creates money and understand better the potential effects of such actions on the economy. As well, my purpose was to provide a more philosophical interpretation of the act of money creation in so far as government counterfeiting represents an attempt to evade the law of identity or reality and therefore constitutes a “wish” that reality is not what it is. In analyzing the technical details of the Fed's actions, I followed the analysis done by econbrowser and attempted to distill it into terms that might be more understandable to the non-economist. Econbrowser has two recent posts linked here and here that are very good at explaining what is going on and serve as a good follow up to my post. I will attempt to explain the recent activity in very brief big picture terms and refer you to his post if you want more detail and supporting charts and data.

The Fed’s goal has been to lend money to financial institutions (including foreign financial institutions) that are in trouble as a result of holding asset-backed securities (mostly bonds collateralized by real estate). But where does the Fed get the money to loan to these institutions? Up until about September of 2008, it sold some of its own assets (treasury securities) and used the cash it obtained from the sale. This meant that the Fed was primarily just changing the composition of its own balance sheet (going from holding mostly treasury securities to holding a combination of treasury securities and asset-backed bonds). It then realized that the problem was much bigger than it thought and if it wanted to continue lending money it didn’t have enough treasury securities to sell to raise the money needed. So where could it get the money?

As I explained in more detail in my last post, it has created the money out of thin air. But, if the Fed is creating money out of thin air and giving it to banks, won’t this inflation of the money supply lead to massive increases in prices?

The Fed has found a few "tools" that it has used to keep the money it has created from entering the economic system. Mostly, it began paying banks interest to hold excess reserves at the Federal Reserve. In the past, the Fed would not pay interest on excess reserves so banks would find something else to do with it – like lend or invest it. Since the Fed is paying interest (and because they are scared of lending it), the banks decided mostly to just keep this extra cash at the Fed. In other words, the Fed has created money to lend to troubled financial institutions, and then essentially found a way to keep the money at the Fed so that it doesn't immediately affect the general price level.

To summarize, the Fed has created a pile of money and lent it to banks. The banks leave it at the Fed and this big pool of money is sitting in an account available to be withdrawn at any time and turned into cash. What happens if banks start to pull this money out of excess reserves and begin to lend it? Such an outcome could lead to massive inflation or potentially even hyperinflation.

To prevent these reserves from going into currency in circulation, the Fed could simply sell some of the asset backed securities or fail to renew the loans. This would reduce their assets and correspondingly reduce the excess reserves in the system. However, the post offers this quote from the President of the Federal Reserve Bank of Philadelphia:

It is true that a number of the Fed's new programs will unwind naturally and fairly quickly as they are terminated because they involve primarily short-term assets. Yet we must anticipate that special interests and political pressures may make it harder to terminate these programs in a timely manner, thus making it difficult to shrink our balance sheet when the time comes...

In other words, there will be political pressure on the Fed not to unwind these loans. So then what?

...the following clause in the joint Fed-Treasury statement suggests that perhaps the Fed intends this, like most of the previous balance sheet changes, to not be allowed to impact total currency in circulation:

"the Treasury and the Federal Reserve are seeking legislative action to provide additional tools the Federal Reserve can use to sterilize the effects of its lending or securities purchases on the supply of bank reserves."

John Jansen (hat tip: Tim Duy) construes that clause to mean that the Fed is going to request the ability to borrow directly as well as for exemption of any borrowing done by the Treasury on behalf of the Fed from the congressional debt ceiling.

This means that the Fed wants to issue its own debt or borrow endlessly from the Treasury in order to remove the money that it has created! This would have multiple potential effects. First, it would put an unelected body, the Federal Reserve Board, in charge of determining fiscal priorities on a massive scale, i.e., this board would effectively be risking taxpayer money on programs that it deems worthwhile. Not only would it put the taxpayers on the hook for its investments, such borrowing would represent a massive drain on private capital which could otherwise be used to fund productive investments. Although the Fed is doing this to some extent now, the contemplated legislation would provide a formal sanction of these activities which are far beyond the parameters specified by the Federal Reserve Act. Such a sanction would represent a massive transference of power to the Federal Reserve and may actually represent an all out coup d'etat.

Such are the consequences of evading reality. The government caused the economic crisis with a combination of easy money and policies designed to facilitate and encourage reckless lending and borrowing. The government, instead of limiting its errors by allowing bankruptcies, is now compounding its evasion by attempting to bail out banks without having to tax Americans. So it counterfeits money which will lead to a hidden tax in the form of more inflation or it will borrow the money which will crowd out private capital, increase the debt burden on taxpayers of the future, and severely dampen economic growth. In the meantime, ever more power is being conferred to the Federal Reserve and the federal government which will in turn demand control over the enterprises which it chooses to shower with its largess. Such controls and attempts at central planning will lead to more destruction and more failures and more calls for regulation and/or an easy money fix. Investors, faced with massive uncertainty and the threat of arbitrary and/or confiscatory government policies will lessen or stop investing in productive assets altogether and seek the safety of unproductive government bonds or hoard precious metals.

Such an economic spiral accompanied by profound losses of freedom or outright fascism in the form of the loss of private property rights, confiscatory taxation, debasement of the currency, price controls, arbitrary regulations or imprisonment of businessmen, and potentially even the loss of freedom of speech as the state moves to silence its critics (see this post) can only be fundamentally stopped in one way. The ultimate solution is the complete abolition of the Federal Reserve system accompanied by the recognition of a fully private banking system based on sound money, i.e., precious metals. Such a system would be fully compatible with the principle of individual rights including private property and would entail a necessary delimitation of the federal government's role to its proper function as the protector of rights. Although constitutional limitations on the government's abridgment of the freedom of production and trade would be ideal, practically speaking, a system of private banking based on precious metals would necessarily limit the government's ability to intervene in the economy as it would no longer have the ability to fund its deficits surreptitiously through the creation of money.

The Federal Reserve's activities must be monitored closely. This rogue pseudo-government agency has mostly caused the boom bust cycle including the Great Depression as well as the latest fiasco, and is now threatening even greater usurpations of our liberty in the name of promoting financial "stability" (see this post). The first step on the path to abolishing the Federal Reserve is to expose their activities. HT to econbrowser for helping us towards this goal.

posted by Doug Reich @ 9:00 AM

Given the torrent of frightening news related to the abrogation of freedom in America, it is hard for me to be even taken aback anymore. Then I read this article in the Washington Post.

The Obama administration is considering asking Congress to give the Treasury secretary unprecedented powers to initiate the seizure of non-bank financial companies, such as large insurers, investment firms and hedge funds, whose collapse would damage the broader economy, according to an administration document.

The government at present has the authority to seize only banks.

Giving the Treasury secretary authority over a broader range of companies would mark a significant shift from the existing model of financial regulation, which relies on independent agencies that are shielded from the political process. The Treasury secretary, a member of the president's Cabinet, would exercise the new powers in consultation with the White House, the Federal Reserve and other regulators, according to the document.

But not to worry:

The Treasury secretary could act only after consulting with the president and getting a recommendation from two-thirds of the Federal Reserve Board, according to the plan.

So the Treasury secretary would merely have to deem a firm a potential threat to the "broader economy" in order to seize the firm. And who decides this vague and arbitrary standard? He would have to "consult" with the President and get approval from the Federal Reserve Board, an unelected board whose chairman is nominated by....the President.

Once again, we see the devastation wrought by the rejection of reason and principled thinking in favor of pragmatism. Note the line stating that at present the government only has the powers to seize banks. Is it shocking that if the government was given the power to seize banks that it would only be a matter of time before it sought to seize any financial institution? How long will it be before the word "financial" is removed and the government applies this argument to other industries?

This is the pattern of virtually all abridgements of our rights. At first, the government only seeks a limited intrusion to be applied to a small sub-set of individuals or firms and only under special circumstances. Individuals and businessmen especially, unable or unwilling to think in principle, do not see the broader implication of the new policy, and since it appears to not directly affect them right-now-this-minute, they either do not object or are willing to compromise. Of course, granting the government any power sets a precedent, i.e., establishes a justification to be used in the future. Therefore, when the government seeks a broader application of this power, the pragmatist is helpless to resist.

To resist such government policies would require the ability to think in principle. It would require the ability to understand the fundamental justification of a policy and the power to abstract the broader implications. It would require at least a cursory understanding of the nature of individual rights and the proper role of government. It might even require a knowledge of history to be used as a guide by which one can isolate similar events in the past and observe the consequences. In short, it would require the ability to reason.

And where would anyone obtain such an education today? The universities teach that reason is invalid, that objective knowledge is impossible, and that there are no black and whites. Therefore, economics today consists of the study of empirical relationships of quantitative data divorced from any general understanding or principles. History, they teach, is always biased by the historian and can only be seen through the prism of race, gender, and ethnicity. The history of the nation which brought about the greatest prosperity and happiness in world history is reduced to the study of the native American "genocide", slavery, and misogyny. Business schools use the "case study" method to reinforce the idea that the world is a stream of random concretes with no connection to one another. Psychologists tell us we are a product of our genes or environment. Moralists argue that ethics consists of self-sacrifice to God or in modern times, the "environment", and that man by his nature is a cancer to the planet. In short, the modern student is taught that principles are useless, everything is relative except that man (well, Western man) is evil and is destroying the planet, and his duty is to sacrifice.

Given the state of modern philosophy and its ripple effects throughout university curriculum's, is it any wonder that this country is in decline?

Jefferson was supposed to be the source of the quote: "The price of freedom is eternal vigilance" which is absolutely true. Vigilance means paying close and continuous attention and implies an ability to understand the broader implications of any action by the state. If man is stripped of his essential faculty, the reasoning mind, and told that it is useless to seek knowledge and abstract principles - if man is told that life is meaningless - if man is told that he has no control over his life and is a product of his genes or environment - if man is told that he is evil by nature and that his sole purpose is sacrifice and/or to minimize his "carbon footprint" - how can he be "vigilant" in this sense?

It is not the Obama's and Geithner's of the world that are responsible for our loss of freedom. The cause is a lack of "vigilance" brought about by the systematic attack on the efficacy of the human mind and therefore on individual rights. Nothing short of a philosophical revolution will allow and inspire vigilance once again.

posted by Galileo Blogs @ 12:11 AM

What is bankruptcy?

Bankruptcy is the financial state that occurs when a person or business can no longer repay its debts. In the legal sense, bankruptcy begins when a court recognizes that the financial state of bankruptcy exists. The bankruptcy court takes charge of the bankrupt entity and disposes of its assets or reorganizes it to pay off as much of the debts as possible.

A bankruptcy proceeding recovers money for the creditor, but both parties benefit.

The purpose of a bankruptcy proceeding is to facilitate the maximum recovery of the money owed to the creditor. But it also benefits the debtor. After the debtor pays off what he can, his remaining debt is extinguished. This is not a “get of jail free” card; the debtor, whether a person or business, must face the damage to its reputation and a greater difficulty in obtaining credit for a long time into the future. Rather, it is an acknowledgement that the debtor simply cannot repay his debt. For both parties, bankruptcy offers timely resolution to an otherwise unsolvable dilemma. The creditor regains a portion of the money owed, and the debtor, relieved from the burden of a debt he cannot pay, can move on with his life.

Bankruptcy is economically valuable.

In economic terms, a speedy and fair process of bankruptcy allows both assets and people to resume being productive as quickly as possible. The creditor regains cash that it can redeploy as it sees fit. If it is a bank, it has regained funds that it can loan out again to more productive businesses or creditworthy individuals. The creditor can also redeploy the assets of the bankrupt entity into the hands of a more capable manager.

Take the financial malaise of General Motors as an example. Although effectively bankrupt, there has been no legal recognition of this fact (as of this writing in March 2009). As a result, its factories and workers continue to be tied up inefficiently making mediocre cars. General Motors is a drag on the American economy.

Bankruptcy would free General Motors’ factories and employees to be more productive. Once a court legally acknowledges General Motors’ bankruptcy, it could allow General Motors’ new owners, its creditors, to appoint a more competent manager. Or the creditors could sell the plants to a superior car manufacturer, such as Toyota. Either way, after reorganization under bankruptcy, the plants would be used to make cheaper, more attractive cars that customers want to buy.

The creditors may also choose to shut down some or all of the plants and sell them for scrap. But recycling the old plants into new steel that becomes the girders of modern, efficient factories is a better use for those plants if they are obsolete. No party is in a better position to make these judgments than General Motors’ creditors, who have their financial self-interest at stake.

While General Motors is just a single, albeit enormous, example, speedy and fair bankruptcies end the bleeding of money-losing operations across the economy, and re-direct inefficiently utilized assets and capital to more productive activities. In sum, bankruptcy facilitates economic recovery. A failure to permit bankruptcy prolongs stagnation.

Some fallacies about bankruptcy

Bankruptcy always means shutting down a business. This is not true. Creditors, in consultation with the bankruptcy court, decide whether to shut down and liquidate, or to operate under new management. Creditors have every incentive to make the decision that maximizes their pay-out over time, not just the amount of cash that can be had right now.

Bankruptcy is bad for employees. Considered in full context, bankruptcy is good for employees. An economy with speedy and fair bankruptcy procedures is one where healthy, growing companies predominate. Healthy companies can pay employees more because their labor is worth more to them. Therefore, employees benefit from bankruptcy, even if someone occasionally faces dislocation or the uncertainty of working for new management. But, even if employees dislike such occasional dislocation, there is no alternative to bankruptcy if their employer is not financially viable.

Bankruptcy allows deadbeats to avoid meeting honest obligations. When bankruptcy laws are properly drafted and applied, this is the exception rather than the rule. Bankruptcy laws are designed to protect the rights of all parties, not to unfairly favor debtor or creditor. Bankruptcy acknowledges a fact, that the debtor cannot repay all his debts, and it facilitates the repayment of all debts that can be repaid.

Government should stop bankruptcies. During financial panics, governments sometimes try to prevent bankruptcies by putting moratoriums on them, subsidizing bankrupt entities, or changing the laws governing bankruptcy to favor debtors. Such interventions are both unjust and impractical. They are unjust because they deny the legitimate right of the creditors to collect what they are owed. The money they are owed is their property, and they have the right to collect it, to the extent it is reasonably possible. Such interventions are unjust and impractical because they attempt to deny reality. “Stiffing” the creditors or forcing innocent third parties to bail out the bankrupt entity through subsidies does not change the fact that the bankrupt entity cannot repay its debts.

Bankruptcy is moral.

Bankruptcy is just, if resolved through a fair and speedy judicial process. A bankruptcy proceeding acknowledges the actual state of affairs that exists, that the bankrupt entity cannot repay its debts. It resolves this dilemma for the maximum benefit of the creditor, but in so doing allows both parties – debtors and creditors – to resolve this matter with finality, and move on with their lives. Bankruptcy only involves the parties to the debt obligation. It does not require that innocent, third parties be forced to subsidize or bail out creditors or debtors. In doing so, it respects the rights of all concerned.

A just process of bankruptcy is also economically practical. Bankruptcy removes assets from those who have mismanaged them, and puts them into the hands of those who are most capable of putting them to productive and financially responsible use. The institution of bankruptcy is an essential part of a prosperous and just capitalist society.

Labels: bankruptcy, General Motors

posted by Beth @ 6:00 AM

[O]ne of the high points of the semester, if you’re a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off.
--Paul Krugman, "When Consumers Capitulate" 10-31-08

Savings a public vice? Krugman tells us we have a savings glut, and explains how we are suffering from too much savings. How can we have too much savings and too much debt at the same time? Ah, yes. Foolish non-Nobel Prize winners. You fail to understand the mysteries of the "Paradox of Thrift," "Liquidity Traps," and "Damnification." It's obvious that what we need is "a surge in public spending," and to quit worrying about the deficit.

If you think Krugman's recommendations defy common sense, you would be right. They also fly in face of good economics. What Krugman, and his influential predecessor John Maynard Keynes, fail to understand is the difference between real savings and the artificial "savings" of credit and money created out of thin air. Their convoluted arguments in defense of increased deficit spending crumple into nonsense once you grasp the real meaning and role of savings.

Savings consists of production which is not immediately consumed. Savings is the excess wealth we have already created, which can then provide for our immediate needs while we expend time and resources to produce an even greater amount of wealth in the future. Without savings to sustain us, no investment in the future is possible. We can not sustain ourselves on paper, so printing money only creates the illusion of wealth. Reality eventually catches up, and all the plans that were constructed on that illusion come crashing down. Sound familiar?

I recently stumbled across an example of real savings in an unexpected source: Up from Slavery, the autobiography of Booker T. Washington. Washington, an American statesman and former slave, tells the remarkable story of his struggle to better the lives of blacks in America following the Civil War. To provide them with the knowledge and skills needed for self-improvement, he built from almost nothing the Tuskegee Normal and Industrial Institute. As an essential part of the educational program, students and faculty at the school built and operated all of the facilities themselves. School farms provided a substantial part of their food. Even so, the impoverished condition of his students required constant fund raising in order to purchase materials they could not supply themselves. Occasionally, Washington was able to secure a sizable donation of $1000, but the bulk of contributions were small--$10 or $25, or even less. The following encounter is one of many similar vignettes which poignantly illustrates the real meaning of savings.

I recall one old coloured woman, who was about seventy years of age, who came to see me when we were raising money to pay for the farm. She hobbled into the room where I was, leaning on a cane. She was clad in rags; but they were clean. She said: “Mr.Washin’ton, God knows I spent de bes’ days of my life in slavery. God knows I’s ignorant an’ poor; but,” she added, “I knows what you an’ Miss Davidson is tryin’ to do. I know you is tryin’ to make better men an’ better women for de coloured race. I ain’t got no money, but I wants you to take dese six eggs, what I’s been savin’ up, an’ I wants you to put dese six eggs into de eddication of dese boys an’gals.”

Six eggs. Six eggs were the sum total of her excess production, not immediately consumed, and thus available for "investment." Those six eggs were eggs that Washington and his students would not have to produce themselves, thus freeing their time for activities aimed at the future, a future of increased prosperity through the improved productivity their education would make possible.

We have moved beyond a barter economy but the fundamental nature of savings has not changed. Before we can invest in the future, we must first produce the wealth to meet our immediate needs. Production beyond immediate consumption is what we call savings. Only with this excess can we afford the luxury of production aimed at future goods. Only with our immediate needs provided for do we dare take risks on new, and hopefully improved, methods and products. With this excess, our savings, we can accumulate the capital required to increase productivity.

We now trade in money rather than eggs, but to serve its proper function, money must remain directly and irrevocably linked to real, existing wealth. To inject into the economy paper money not backed by real goods disrupts our ability to calculate how much we can afford to invest in the future. Because of its historical connection to real wealth, paper money is treated as equivalent to real wealth (but it is not.) Personal and business plans are made on the assumption that those paper dollars will provide for our immediate needs while we spend our efforts and resources on projects which will not come to fruition until a future date. But, if Washington's benefactor had given him six pieces of paper, and he made plans as though it were six eggs, when dinnertime came around, he would go hungry.

Now it is our dinnertime and we are realizing we are out of eggs. Common sense tells us we need to restock our egg supply rather than exchange them for less immediate needs, or before taking risks on a future supply of eggs. Krugman, and his followers in Congress, want us to continue to pretend our larder is full. Paper money and credit creation help with that deception. By ignoring the true meaning of savings, it is possible to construct a host of sophisticated arguments which make it appear as though the answer is more spending, and more debt. But it all falls apart if you start with the fact that real money means real goods, and anything else is a paper fantasy that won't feed you come dinnertime.

posted by Doug Reich @ 1:44 PM

Post on the absurdity of the idea that the "boom-bust" cycle is inevitable.

Frequently, you hear Obama and his ilk make the claim that economic conditions are "likely to get worse before they get better." Now in the practical sense that his administration's policies are designed to destroy the economy, I agree with them. However, those making this claim are the ones who are in control of the policies and therefore they are unlikely to believe their polices are the cause. In other words, they appear to be making this claim on the premise that it is a metaphysical absolute that things must get worse before they get better. It's almost as if they believe there is a mystical force shadowing the nations' economy which necessitates recession and malaise and which can not be understood or resisted.

Is this true? Must things get worse? Also, many in the financial industry and elsewhere are absolutely bewildered by Obama's plans which fly in the face of logic and history. Why would he propose such policies?

posted by Beth @ 6:00 AM

I've been reading lately that President Obama is over-worked and tired because of trying to deal with the financial crisis. This fatigue has even been offered as an excuse for his shabby reception of British Prime Minister Gordon Brown. (From the article: "Sources close to the White House say Mr Obama and his staff have been "overwhelmed" by the economic meltdown and have voiced concerns that the new president is not getting enough rest.")

Maybe that's because he is literally trying to do the work of millions.

A market economy is the result of an uncountable number of individual decisions and actions, coordinated through price signals which provide crucial information on the availability of every imaginable resource. Profit and loss calculations provide essential feedback on the relative efficiency with which a multitude of producers use those recourse to meet the needs and desires of an even larger number individual consumers.

Central planning consistently fails because it is impossible for a small number of individuals, let alone one man, to obtain the requisite information, create the necessary plans and subsequently attempt to implement them.

Mr. Obama, meet the Fatal Conceit.

Labels: Obama