Depressions and Their Solution

This is a simple outline of what depressions are and how they are solved. The problem and its solution are simple and should be understood by every voter. It may take a little effort, but the answers are available to us all.

(1) The market, if left free of government intervention and other forms of fraud and misappropriation, is immune to serious economic downturns (Say’s Law). There will always be individual business failures, but the misfortune of one person in the free market is another person’s opportunity. The same amount of material wealth in the economy remains the same; there is just a change of ownership. Because of this balancing of fortunes and the fact that the total wealth of the economy remains the same, there should never be epidemics of business failures.

(2) Business failures reach epidemic proportions because there is a change in the money supply. A reduction in the money supply, referred to as deflation, means that there are insufficient funds to maintain the demand for goods and services at existing prices. This change in demand reduces trading and creates employment. This is the essence of a depression. There is the same amount of wealth in terms of real goods and services but there is not enough money to purchase them.

(3) All that needs to be done to prevent depressions is provide a money supply that cannot be reduced. If the money supply were stable, there will still be goods on the market that are overpriced, causing business failures, but the money of the economy would be directed to cheaper alternatives. These cheaper alternatives would provide new business opportunities to offset the losses, preventing business failures from reaching the epidemic proportions that are characteristic of depressions.

(4) Durable commodities, such as gold, do not disappear and therefore can serve as a money supply that would prevent depressions from happening. In turn, government issued money can be made stable and can also serve an economy that is depression-free. Even if a government caused inflation through deficit spending, it would not necessarily lead to a depression, since the government’s money would still not disappear and thereby lead to the reduction of money that would cause a depression. This inflation would cause a misallocation of the economy’s resources and reduce its overall productivity but it would not lead to the unemployment that is caused by a reduction in the money supply.

(5) However, the US government, along with the other governments of the industrial world, cannot provide us with a money supply that is invulnerable to depression-causing deflation. Why? Because governments have no control over the creation of most of the money in their own economies – banks do. To see how this is done, please read the previous post to this blog “Our Money is Not Real” below. Through fractional-reserve banking, banks are allowed to multiply the government issued money up to six times through issuing credit on money that they do not really possess. This money exists on paper only and can disappear with the application of more paperwork. When our banks contract their credit (reduce the loans outstanding), the money supply of the nation is reduced and a depression results.

(6) The fractional-reserve banking is solely responsible for our recessions and depressions and it is nothing more than a form of fraud that our governments allow bankers to perform upon the rest of the economy. It is supported legally through transparent legal fictions that actually contradict each other and make no sense. The primary fiction is that bank deposits are not really deposits, but rather, are loans. But if this is the case, then the depositor commits fraud every time he writes a check on money that he has already loaned to his banker. An accessory to the depositor’s fraud is the banker who honors the check even though he has already borrowed the money and loaned it to another customer.

(7) Depressions can be brought to an end if the lawyers and judges of our country consistently apply the laws of fraud to the bankers who duplicate and triplicate our money during boom times and then reduce that money to vapor when they contract that credit.

Indeflation

Indeflation is the phenomenon that turns a curative recession into a disastrous depression. It is what happens when a government attempts to stimulate its country’s economy with inflationary spending but, paradoxically, causes that economy to further deflate and sink deeper into a state of high unemployment and falling prices. It happened in the Great Depression; it has happened again in Japan’s ongoing depression; and it is happening now in America under the misguided leaderships of George W. Bush and Barack Obama.

The term “indeflation” is not being coined for the first time here; it lives on the internet, where a working definition can be found at http://mileslater.wordpress.com/2008/05/05/indeflation/. According to that site, “INDEFLATION is the production of traditionally inflationary observations and reactions causing deflationary results.” The seeming paradox of inflationary reactions actually causing deflation, along with all of the unemployment that comes with deflation, can be explained very simply. It might seem like a paradox, but it is actually the natural consequence of a government attempting to prevent an economic correction that cannot be denied.

To understand how indeflation happens we must begin by recognizing that a recession is a curative process whereby market prices go down to correct their overpriced state during a preceding bubble. If left to run it s course, a recession results in a lower volume of money but approximately the same amount of goods. Because of the lower volume of money, the same goods sell for a smaller price. The inflation caused by the preceding bubble is corrected by the recession’s deflation.

However, governments tell us that they can prevent the corrective process of a recession and keep us in the bubble of poor investments that we have made for ourselves, and this is how the healthy process of a recession gets turned into the unhealthy state of a depression. The government, regardless of its leadership under either party, attempts to prevent a recession by “stimulating” the economy with deficit spending. Hoover did it, FDR did it, Bush did it, and Obama is now doing it – governments, unfortunately, do it. This stimulating deficit spending is intended to inflate the economy and undo the corrective work of the recession’s deflation, however, the needed correction cannot be denied and these attempts at inflating the economy will have the effect of actually further deflating the economy, causing more unemployment and increasing the misery of the adjustment process.

The government’s attempt to create inflation actually causes deflation because that government is only one of many producers of money. Banks, by issuing credit, actually produce money, just as they destroy money be withdrawing credit (to understand the simple mechanism of credit expansion and contraction, see the previous post on this blog). The one large inflater, the government, has the effect of activating thousands of small deflaters, the banks attempting to remain solvent. The cumulative effect of the many deflaters far exceeds that of the government – the deflationary credit contraction of banks exceeds Obama’s inflationary spending.

As a model of this indeflation phenomenon, let us take a hypothetical miniature economy where the government has issued and distributed $1,000. According to monetary theory, when the initial $1,000 gets deposited in a bank, the bank “multiplies” that money by loaning it to borrowers at the same time it makes it available to the depositors – deposited money gets duplicated and then duplicated again. Economists even have a formula that determines how much that initial money supply gets multiplied by the bankers. It is simply expressed as “1/R” where R represents the amount of reserve the bankers must keep of their deposit money. Since R is a fraction, usually around 1/6, the result of dividing it into one simply results in an inversion of the fraction: a 1/6 fractional-reserve requirement means that the banks can expand the money 6 times and a 1/8 fractional-reserve would mean that the banks can expand the initial money supply 8 times.

So, to elaborate on our simple model economy, let us say that the fractional-reserve is 1/5, meaning that the banks must keep 1/5 or 20% of its deposits on hand as a reserve, allowing themselves to loan out the other 80% of the deposited money. This means that the original $1,000 issued by the government will be expanded 5 times by the banks to produce a total money supply in the economy of $5,000.

Now, the government, in an attempt to stimulate the economy, decides to issue an additional $100, bringing its total issue into the economy to $1,100. The government plans to have its additional $100 expanded by the banks by a factor of 5, increasing the money supply by $500, for a total money supply of $5,500 – this is inflation.

However, the banks are wise to their government’s inflationary intentions and, just like the rest of us, begin to put their money into inflationary hedges, things that will not become less valuable if the government succeeds in making the dollar less valuable. Why have their money tied up in loans that are basically cash that cannot be touched for the term of the loan? By the time that the loan is repaid, the money is diluted by the government’s stimulation. The banks, as a way of not losing their shirts in the impending inflation, put their money into gold or otherwise act as we would all do to avoid being victims of inflation. The result of the banks’ adaptations to the government’s inflationary intentions is to reduce the volume of their credit. Although the law may only require them to reserve 1/5 of the money deposited in their safes, their financial strategies cause them to keep what Murray Rothbard referred to as “excess reserves.”

Returning to our model, let us say that the average bank in our little economy, in reaction to its government inflationary behavior, decides to keep 1/4 of its deposits in reserve, even though it is required to keep only 1/5. This would mean that the “multiplier” that determines the total money supply from the government issuances would be 4 rather than 5 (where R = 1/4, 1/R = 4). Since the government has issued a total of $1,100 into the economy, the total money supply after the banks have performed their credit expansion, would be only 4 times the original $1,100 or $4,400. In other words, an economy that had a money supply of $5,000 now has a money supply of $4,400 – it has been deflated by $600, resulting in further unemployment and a level of misery that would not have been necessary if the recession could have been allowed to run its natural course.

Recessions are the result of banks being able to expand and contract the money supply through fractional-reserve banking and the government cannot do anything to prevent this from happening. As long as we have fractional-reserve banking, there will be cycles of booms and busts and unfortunately, government intervention will only prolong and deepen the misery of the busts.

Our Money is Not Real

Economic depressions are all the result of one single phenomenon – government sponsored fraud. If we eliminate the monetary fraud that empowers our politicians, we will have a stable economy that provides growth and full employment without the need for manipulative political institutions like the Federal Reserve. How the government, through its enabling of monetary fraud, causes economic downturns can be explained simply in the following few short paragraphs.

The marketplace, when it is not disturbed by government intervention, is an adaptive system that is self-correcting, eliminating the possibility of long-term downturns. Supply always changes to meet demand as producers change their prices and offerings to meet consumer needs. Massive unemployment is avoided because workers, like other producers, must occasionally change their services and their rates to meet the true sovereign of the market – the consumer.

Large adjustments in consumer demands that are pervasive across the economy are the result of an unstable monetary policy that causes surpluses and shortages of money. These monetary surpluses (known as inflation) and their corresponding shortages (known as deflation) cannot occur if the economy’s money is real. If money is real, its existence remains relatively constant through time without inflation or deflation. On the other hand, if it grows with our “irrational exuberance” and shrinks as our consumer confidence shrinks, it is not real and its volatility is caused by its fraudulent foundation.

How has our government enabled a form of money that is essentially fraudulent, causing depressions and credit meltdowns? To answer this question, we need to first recognize the vaporous quality of our money. The vast majority of our money has no physical existence at all. It is not backed by gold, green paper, or anything else. We can claim to have a thousand dollars in the bank simply because the bank says we can. Our money, known among economists as “fiat” money, is just a recorded number that our bank is required to keep accurate track of. Fiat money exists for no other reason than the right authorities say it does and this nebulous nature of our money is, as we will see, the reason why it can mysteriously come and go from our economy.

To understand fiat money we have to understand that fiat money is produced by our banks; not by the treasury department, the mint, or some other government organization. It is produced as if it was counterfeit currency, by private companies that actually increase their profits by making more of it through a practice that is essentially fraudulent. Banks become profitable businesses by producing as much fiat money as they can. To see how this is done, let us take three simple examples of a bank issuing credit:

1. The owner of the bank loans out $1,000 of his own money. In this case, the borrower has $1,000 more to spend, but the banker has $1,000 less, so the total effect of the transaction does not inflate or deflate the economy. This was the original form of credit but it is now almost nonexistent.

2.The owner of the bank loans out $1,000 that he has borrowed from his customers. He has given the loaning customer a $1,000 CD and he has given the borrower $1,000 as a loan. The total effect on the economy is again innocent. The borrower has $1,000 more to spend for the period of the loan, let us say two years, but the CD holder, who cannot claim his money for the two year period of his CD, has $1,000 less to spend. Again, there is no inflation or deflation. This form of credit, however, is minor and not important for the subject of this post.

3. The owner of the bank accepts $1,000 from a depositor into a checking account. He promises, with the government’s help, to keep the money safe, however, in truth, he actually loans the $1,000 out to a borrower (the government actually requires him to keep a small token of the checking out in a "fractional reserve," but the amount is insignificant and is ignored here for simplicity sake). There are now two people who are walking around claiming to have the original $1,000, the depositor, with his check book, and the borrower. The original $1,000 has turned into $2,000 in the economy’s money supply. This is called inflation.

The vaporous quality of our money is caused by the loaning out of our deposited money. Loaning out money that the depositor has a right to immediately demand is the source of the fiat currency that represents most of the money in our economy. When there are lots of borrowers with “irrational exuberance,” our economy inflates and when there are foreclosures and fewer borrowers we have deflation and rising unemployment as employers run out of the cash needed to make payrolls. Our government’s endorsement of the duplicating of depositors’ money through “fractional reserve” banking is the source of all monetary instability.

But fractional reserve banking is not only the source of our vaporous and unstable money supply, it is essentially fraudulent. If the banker is promising to keep the depositor’s money in safekeeping while loaning it to borrowers, his promise is made under false pretenses. On the other hand, if the depositor is making the claim that he actually has the money in a safe place while it has gone to a borrower, he is, perhaps unwittingly, making a false claim – his claimed money is really unavailable to him.

Once the government begins to enable this fraudulent money juggling, it either has to have the courage and integrity to fix the problem or it has to hide the problem through a series of techniques that protect the local banks from getting caught appropriating their depositors’ money. This is precisely the reason why politicians created the Federal Reserve System in 1913. Through a central bank, any local bank that ran short of money could be protected by the central bank. This plan, of course, failed in the Great Depression when the number of local banks with shortfalls became too great. Now the government had to take another step to cover its mistake, creating the FDIC which insured depositors even in periods of massive shortfalls. The FDIC, of course, only works because now the bank failures are covered directly by the taxpayer (the ultimate but involuntary insurers). Once the government begins to correct its distortions of the marketplace it needs to cover its ineptitude with even greater market distortions.

The only regulation that is needed to protect bank deposits is the enforcement of the law against fraud. If a bank promises to keep your money in a safe place and then is caught using it for another purpose, the officers of the bank are guilty of fraud and should go to jail. Enforcing this simple regulation would eliminate the need for the Federal Reserve System and the FDIC and would allow our economy to be based upon money that is real.

Jefferson’s Economic Recovery

Thomas Jefferson solved the problem of economic downturns, and, if we had followed his lead, there would have been no Great Depression and we would not be mired in another one today. Jefferson was a good friend of J. B. Say, the French economist who solved the problem of rising unemployment. Jefferson tried to recruit Say to his beloved University of Virginia and he commissioned the English translation of Say’s A Treatise on Political Economy, which became America’s standard textbook on the subject for the next fifty years. Had we continued its use we would be without the Federal Reserve Bank, Keynesian monetary manipulation, and the costly recessions that they have caused.

At the center of Say’s economics is the insight that money, while serving as a medium of exchange that makes our markets work, also serves as a veil that obscures our vision of how those markets work. Piercing money’s veil of obfuscation, the market appears in its full reality as a magical place where men and women can magnify the value of their labor a hundred-fold by trading what they produce using their comparative advantage for the products of other people with their own specialized advantages.

Man, incapable of lifting himself out of a stone-age existence using his own self-reliance, can trade a few minutes of his own specialized labor for woven cloth, liquid fuel from rocks, and the written record of the greatest thoughts of his species. Trading, the activity of the marketplace, provides food, housing, and intellectual nurture to an individual barely capable of surviving on his own in the harshness that is nature.

But trading is both facilitated and obscured by money. As a commodity valued by men of different appetites, money allows a dairy farmer to trade his wares for the bread of a lactose intolerant baker. However, as it becomes a measure of the value of everything else in an economy, money disguises the fact that the dairy farmer and the baker are essentially both bartering what they produce for the product of another. Looking beyond the efficient medium of money, there is no distinction between consumers and producers, every transaction in the marketplace represents the culmination of an act of production and the initiation of an act of consumption.

Say knew, as did his friend Thomas Jefferson, that only governments can create unemployment and only traders in the marketplace can resolve their own unemployment. We are all traders and we must therefore be willing to trade our specialized services for the specialized services of others. We must offer the wealth that is our own comparative advantage for the magnifying wealth of the marketplace. We must trade for real wealth rather than the unstable veil given to us by a government that once deserved our trust.

Our Dangerous Banking System

Although I enjoyed using the Seinfeld sitcom as a literary device in the previous post to illustrate the internal workings of American banking system, I think a little history is needed to fully reveal how dangerous that banking system is to our general welfare.

According to Murray Rothbard, in The Mystery of Banking, 2nd Edition, banks originated as trusted places where people, for a small fee, kept there valuables in a safe place (this practice continues to this day in the form of safety deposit boxes). This practice of protecting people’s deposited valuables turned to fraud over one-thousand years ago in China when banking merchants first used their deposits to inflate the economy. Customers were given receipts for their deposits of gold and these receipts were treated as substitutes for the gold itself and could therefore be used in commercial exchange. The banks eventually were caught issuing more receipts than they actually held as gold. This attempt to inflate the economy with counterfeit receipts of gold was then considered to be a crime, although it is now hailed as our modern “fractional reserve” banking system.

Venice, the home of Marco Polo, adopted many things from its Chinese trading partners, among which were noodles, silk, and the bad practice of using bank deposits to inflate the economy. In Venice as well as China, however, the issuing of more gold receipts than gold was considered a form of fraud, rather that the heart of a banking system that made national heroes of its leading perpetrators. The wizards of our current Federal Reserve would have been ringleaders in those more innocent times.

The Middle Ages in Europe witnessed the growth of another form of banking which we are also today very familiar with – the loaning of money for interest. But, in the Middle Ages, the banking families that grew rich financing the wars of kings, loaned only their own money – not the money of other people who had intrusted their wealth to them. This type of issuing of credit has a far different effect on the general economy than the modern practice of loaning out other people deposits. When a Rothchild loans $1,000 of his own money to a customer, there is no inflationary effect on the economy. The customer has $1,000 more to take to the market to bid on fabrics and spices, but Rothchild has $1,000 less to make competing bids in that market. The result of loaning your own money out is that the money supply remains the same; there is no inflation, and the costs of the fabrics and spices remain essentially unchanged.

The practice of bankers loaning only their own money ended in England and America in the nineteenth century when courts held consistently that depositors’ deposits were not deposits at all, but rather, were loans from the depositor to the bank, to be used by the bank for its own purpose of making loans to customers. On the surface, this does not seem to be such a bad practice; the additional money that banks are able loan is available for expanding businesses. However, let us take a look at the inflationary effect of banks making loans from its depositors’ accounts.

When customer Richman deposits his $1,000 in the local bank, he receives a deposit slip that proves his checks are worth that sum. He is able to go to the market and write checks just as if he had the $1,000 in his pocket. However, the bank takes his deposit and loans $800 to Poorman (the $200 is held by the bank to satisfy the government’s requirement of a 20% “fractional reserve”). Now, Richman and Poorman each go to the market with what they believe is a pocketful of money, Richman with $1,000 and Poorman with $800. But doing a little addition, we can see that the market has a total money supply from our friends of $1,800 from what began as Richman’s original $1,000. The marketplace has suffered an inflation of an addition $800.

Poorman, however, does not carry around his $800 in cash. He took his loan and immediately deposited in the bank. Now it is safe and all he has to do is carry his checkbook and a deposit slip that proves that he has $800 deposited in the bank. It is as good as carrying around cash. However, now the bank has a total amount on deposit of $1,800, Richman’s $1,000 and Poorman’s $800. Since it can loan out 80% of its total deposits, it is able to loan out an additional $640 (80% of the Poorman’s $800 deposit) to Realpoorman. Realpoorman, in turn, deposits his $640 in the bank and the bank has even more deposits and the inflationary growth of the money supply continues.

This modern banking practice works if you don’t think of the damage done to Richman when he goes to the market and finds that the goods he once purchased for $10 are now costing him $20 because he must now bid for those goods against other people with money – the additional money that the bank has created by issuing credit on his original $1,000 deposit. Richman is a victim of an inflation that diluted the value of his $1,000.

But there is a greater danger to this “fractional reserve” banking system. Just as they can create inflation by issuing credit, banks can also create deflation by reducing the total amount of credit issued. Banks have the power of credit expansion that inflates the economy and they likewise have the power of credit contraction which deflates the economy. When an economy inflates, the good that once sold for $10 has the inflated price of $20; and when an economy deflates, the good that once sold for $20 has a sales price of $10. Merchants who don’t reduce their prices fast enough get caught holding unsold goods. Other merchants who do reduce their prices make sales that are less than their costs. Businesses lose money in what is called a recession.

And merchants aren’t the only victims of the banks’ credit contraction; employees who sell their labor must also reduce their prices (wages) to adapt to the deflating economy, and their failure to do such leads to their inevitable unemployment.

The real problem with “fractional reserve” banking is that the whole economy is dependent upon the psychology of the bankers. When bankers are optimistic, the economy booms, but when they lose confidence in their borrowers, they recall their loans and cause the economy to deflate through credit contraction, causing a spiral of deepening financial depression.

Seinfeld, Kramer, and the Federal Reserve

Every American taxpayer should know how his country’s banking system works. While how it operates may appear obscure and even intimidating, it is really so simple that all you have to do is watch one particular episode of the Seinfeld sitcom reruns to master its dark secrets.

In the episode entitled “The Wigmaster,” the mechanics of our Federal Reserve banking system are perfectly modeled through the mischief of an unscrupulous parking lot manager. Think of the parking lot as your local bank, watch the show carefully, and walk away with the equivalent of a graduate degree in money and banking.

Two Seinfeld buddies, George and Kramer, have decided to “deposit” their cars in Jiffy Park’s long-term parking lot (Kramer actually gets a free t-shirt for making his initial deposit). The manager of Jiffy Park, like your local bank president, agrees to take care of the deposited property, including providing the necessary storage and protection.

Our two heroes walk away satisfied that their properties are safe, apparently unaware of the deceptive use that will be made of their vehicles. The manager of Jiffy Park, like the president of our local bank, is not really in the business of storing and safekeeping people’s property – instead of depositing the deposits, he loans the deposits out to others for his own gain. In the case of Jiffy Park, the cars are borrowed by prostitutes to perform “tricks,” while in the case of our local bank, the deposits are borrowed by business people, homeowners, and other people performing transactions of a more legal nature.

That our bank deposits are loaned to borrowers is not really a secret to most of us, but the more sinister aspects of the banking system become apparent when we realize that, if our deposits have been loaned out to borrowers, they should not be available to be returned to us upon our demand. This, like the case of Jiffy Park, reveals the dark side of loaning out for profit what really belongs to other people.

Kramer chooses to withdraw his deposit (his car), when it is currently being used by a prostitute plying her trade. This is invariably what will happen when people make withdrawals from their bank accounts. In Kramer’s case, Jiffy Park tells him that his property is currently unavailable, but he can have a Mary Kay Cadillac instead. In the case of our bank withdrawals, our money might be on loan, but we can have someone else’s deposited money instead.

Like Kramer, we can go about our business using someone else’s deposits. In Kramer’s case, the excitement of a pink Cadillac is enough to make him forget that his own deposit is unsafe. In the case of our bank deposits, the money of another bank customer is just as good as our own. Everything is fine until Kramer and the owner of the Mary Kay Cadillac want there vehicles at the same time or until there are a large number of simultaneous withdrawals from our bank.

For Jiffy Park, there are other vehicles to tantalize the gullible customer but in the case of our local bank, fooling the customers requires the help of the Federal Reserve. As the “lender of last resort” the Federal Reserve is in the business of providing an endless supply of Mary Kay Cadillac’s to our local bank. If too many customers want there deposits back when they are on loan to others, the Federal Reserve will always produce more deposits that look just like our deposits, keeping the bank from the embarrassment of having to admit that your deposits are not really deposited – they are being used by the bank to make its own profit.

So, as long as the Federal Reserve keeps coming up with pink Cadillacs, what is the harm? The harm is called inflation by credit expansion. Jiffy Park has taken, for example, ten cars and made them look like twenty. Ten drivers deposited ten cars and think they are the sole possessors of the ten cars, but ten prostitutes also think they are the rightful possessors of ten cars. Twenty people think that they have exclusive use of a vehicle, but there really was only ten cars deposited in the lot. Jiffy Park has counterfeited ten additional cars.

In the case of our bank, the amount of money originally deposited is believed to be owned by the depositors, but the borrowers actually believe that they own the money also (there is a “fractional reserve” of the deposited money that the bank cannot loan out but that amount is small and disregarded here for simplicity’s sake). Due to the bank’s ability to loan out deposits, the economy has far more money in it while having the same number of goods to buy with the money – the bank is the source of inflation. In the same way that Jiffy Park inflated the number of cars possessed through its deceptive practices, the banks are allowed, legally, to inflate the economy by loaning out money that they are pretending to keep “on deposit.” Your local bank counterfeits “legal tender.” In boom periods, banks inflate the economy; in periods of pessimism, they reduce the loans and thereby deflate the already inflated economy, causing unemployment.

The Seinfeld episode ends with an innocent Kramer in a police lineup after he and a prostitute made simultaneous claims to a Mary Kay Cadillac. This is where the analogy to our bank ends; unlike Jiffy Park, there can never be a shortage of Mary Kay Cadillacs for our banks, the Federal Reserve can produce an endless number of them. The Ponzi scheme of banks counterfeiting money by undepositing deposits can continue until the American taxpayers learn about their banking system and find out that they are the ones buying all the Mary Kay Cadillacs.

Econ 101. The Auction

The following few short paragraphs provide the reader with one of the essential foundations of economic thought. It will be simple and easy to understand because it will be free from the complications and self-contradicting delusions of so-called experts who are blinded by their psychosexual need to be “stimulating.”

The economy can be accurately modeled as a simple auction, an activity that easily demonstrates the convergence of supply and demand but in terms that can be related more easily to our common experiences. In an auction, a seller offers to supply a good to the highest bidder. Prospective buyers bid against each other until there is only one buyer remaining, who, by making his final bid, sets the price of the good.

The bidding usually begins at a very low price and there are a number of persons bidding against each other for the good. The initial large number of bidders represents the large demand for the good at its initial low price. As the bids become increasing larger, the number of bidders drops, reflecting how the demand for the product goes down as the price of its supply goes up.

If there is more than one seller of the same type of good, the resulting prices will be correspondingly lower, reflecting how the increase supply of the good causes the demand to go down. In the same way that the buyers competed with each other to drive the price up, the sellers must compete with each other and drive the price down. Because the buyers have a large number of alternative sources, they can purchase the good at the price set when there was a large number of bidders in the original auction.

In the end, each seller will be forced to sell at nearly the same price, the so-called “market price” for the good. Economists graph this market price at the convergence of two lines on a “supply and demand” graph, one line representing the supply of the good and the other line, sloping in an opposite direction, representing its demand. Without the art work, it is really just an auction.

Every seller will be able to dispose of his good as long as he is willing to accept the highest bid. This is known as Say’s Law. Alternatively, the seller may exercise his option to not sell the product at the market price. The seller’s choice to not sell can be interpreted in two different ways:

1. Reasonably. The seller has just decided that, in his judgment, the good is more valuable than the money offered for it. Perhaps, it will bring a better price tomorrow.
2. Hysterically. The failure of the good to “clear the market” is a sign of economic stagnation, a recession, or even a depression.

The reasonable interpretation leaves the seller (perhaps a labor seeking employment) with the freedom to sell his product at the price and time of his choosing, eventually finding a better price or lowering his expectations and accepting the current bid.

The hysterical interpretation believes that the seller is a victim of bidders who need stimulation. Invoking the delusional teachings of John Maynard Keynes, a man who didn’t have a real understanding of auctions or other economies, the followers of the hysterical interpretation allow themselves to be the pawns of power-hungry politicians who promise to stimulate the bidders. According to these “Keynesians,” by giving everyone more money, the value of money will go down and the bidders will be willing to bid higher for the unsold good – they will be “stimulated.” Of course, this all depends upon the seller being too stupid to get as stimulated as the bidders and demand more of the devalued money for his good. The economy’s wealth remains the same; there is just more green paper.

Economics is the easiest social science to intellectually comprehend; however, it remains an obscurity because the government needs to make people believe that they can produce wealth by stimulating consumers and fooling producers.

The True Economic Recovery Plan

…the only means to shorten the period of bad business is to avoid any attempts to delay or to check the fall in prices and wage rates.

Ludwig von Mises, Human Action (1963, p. 570)

This post borrows liberally from the thoughts of famous economist, Ludwig von Mises. Mises had extensively studied the cycles of business booms and crashes and had an acute understanding of their causes and cures. His voice from the past can give us great comfort in our current time of financial crisis. It can also help us avoid the mistake of government “stimulation.” Mises foresaw the economic collapse of the Soviet Union seventy years before it occurred, having based his insight, not on political and military history, but on an acute understanding of the effects of government intervention in the economy. In relation to our current crisis, he begins by providing us with a very reassuring definition of what a depression is.

...depression is in fact the process of readjustment, of putting production activities anew in agreement with the given state of the market data:

Ludwig von Mises, Human Action (1963, p. 572)

In other words, a depression or recession, such as the one that we are in now, should be looked at as a useful time when, if government intervention can be avoided, the economy can cure itself of its ills and recover to be stronger and more efficient than ever. The free market is a dynamic system that is always repairing itself and moving towards full employment and maximum productivity. The monetary contraction that occurs during a recession is really just a means for wisdom and caution to correct the mistakes that were caused by the excesses of the economy’s preceding boom period. The overly optimistic outlook of an expanding economy led to overinvestment in capital (particularly housing in the current period) and this overinvestment led to bidding wars that brought prices too high. Now, those prices must be brought down to where they belong, even if the government attempts to prevent it.

The recovery and the return to “normalcy” can only begin when prices and wage rates are so low that a sufficient number of people assume that they will not drop still more.

Ludwig von Mises, Human Action (1963, p. 569)

Can we have excessive boom periods and, perhaps with the government’s help, avoid the succeeding recessions? Mises is correct in answering in the negative. Mankind will, in any type of economy, always work to his own advantage and this productive feature of the human character means that people will correct their mistakes of judgment and cure their own excesses. The economy must cool itself down as a way of improving itself, regardless of the government’s attempts to prevent this improvement.

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

Ludwig von Mises, Human Action (1963, p. 572)

Each stimulation package from the Bush and Obama administrations has brought us one step closer to what Mises calls a total catastrophe. Each month that the recession is prolonged will reduce the confidence that the people have in the economy and its monetary system and this lack of confidence will make the inevitable lowering of wages and prices more drastic and severe.

We can take the advice of Ludwig von Mises and allow the recession to run its course and cure itself quickly or we can do what we did in the 1930’s (and what Japan did in the 1990’s) and demand that the government try to prevent the inevitable and, in so doing, allow a short-term recession to turn into a decade-long depression.

There is no use in interfering by means of a new credit expansion with the process of readjustment. This would at best only interrupt, disturb, and prolong the curative process of depression.

Ludwig von Mises, Human Action (1963, p. 578)

Beware of Governments Bearing Gifts

The popularity of inflationism is in great part due to deep-rooted hatred of creditors.

Ludwig von Mises, Human Action (1963, p. 467)

In this pivotal moment in our economic history, battle lines are being drawn from the halls of academia to the chambers of our Congress. The intellectual geography upon which those ramparts of ideological combat are drawn is the issue of whether a government can create something from nothing. On one side of the battlefield are the faithful, those people who have defied all of the empirical evidence available to them and have blindly accepted that something comes from nothing. Opposing the followers of blind fiscal faith are those that rely on historical evidence and the common-sense knowledge that is the result of their own individual experiences.

The faithful belong to a religion known as the Keynesianism and the god upon whose alter they sacrifice our tax money is the modern deity known as the state. Keynesians believe that their god has the power to rain down manna upon its people, providing them with bread where before there existed not even the grain to mill into flower. Their logic is simple: if people are becoming poor, the state can just produce more money and give it to them. Paying no heed to the idea that real economic wealth is measured in commodities such as food, cloths, houses, and automobiles, the Keynesians claim that if commodities are purchased with money, all the state has to do is produce more money and the commodities will just appear out of nowhere.

The opponents of the faithful include the practical economists whom the Keynesians have labeled as being classical, neoclassical, Chicago school, Austrian school, or supply-siders, and libertarian and Republican politicians whom ABC’s Cokie Roberts has collectively condemned as “those who should be punished.” The single characteristic that has held these diverse opponents together is their tendency to look beyond blind faith and empty promises and try to find the source of the newfound wealth that the Keynesians have assured us comes from the simple application of green ink to paper.

It is the source of the state’s blessings that the Keynesians have always kept bound in layers of promises of other blessings, each one meant to distract the seeker in his probing to their empty core. For example, to inhibit the least forceful probers they have claimed that the cost of state largesse is “built into the system” or “just a write-off.” And with each additional level of probing there is the assurance that if the prober was only sufficiently sophisticated he would see that the state is so great that it does not need a source.

Pressed by those whom Cokie Roberts truly believes are in need of punishment, the Keynesians will admit that wealth must come from someplace but that someplace is in the future. Rest assured, you will not have to pay for the state’s gifts – it is your children and grandchildren who will gladly foot the bill. You should just accept your role as a devourer of your own young and depend on later generations to pay for today’s play. In the words of their founder, John Maynard Keynes, we should not worry about the long run because “in the long run, we shall all be dead.”

But the Keynesians are wrong – there is no long run that we can dump on our young. The future of the state’s devouring is not the future of your children and grandchildren; the future that pays for all exists in the present and is called “credit.” The extra money that the Keynesians produce does not create more wealth, only more paper. The additional paper reduces the value of existing paper, and more importantly, it reduces the value of money invested in American businesses as credit. The people who are really paying for the state’s gifts are the creditors, exactly those people who are needed most to help gives us jobs. The quote from Ludwig von Mises is an accurate one; government handouts are little more than thinly veiled attacks upon creditors, the very people who can turn the threats of the present into the promises of the future.

Beware of governments bearing gifts – what appears to be manna from the sky is really hail.