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.

The End of Unemployment

It is not the abundance of money but the abundance of other products in general that facilitates sales... Money performs no more than the role of a conduit in this double exchange. When the exchanges have been completed, it will be found that one has paid for products with products.
James Mill

The preceding quote by James Mill is a faithful summary of an economic principle known as Say’s Law. According to Say's Law, any real product on the market will sell if the price is right. This has a powerful implication towards the current economic crisis – in fact, Say’s Law tells us why this “crisis” is not really a crisis at all, but merely a time when, without government interference, the economy is only honing its skills and becoming more efficient.

To see how this is so, let us apply Say’s Law to a particular product on the market that is near and dear to most of our lives – our own labor. By offering to do work, we deliver a product to the market and, according to Say, by simply offering that product we are facilitating its sale – we are creating our own employment.

According to Say’s Law, there is no such thing as a real surplus of employment. Every man who wants to sell his labors should, without government intervention, find a buyer (that is, an employer). In short, what Say is saying is that:

IN A FREE MARKET, THERE IS NO REAL UNEMPLOYMENT.

Then, one must ask, what are the unemployment statistics that are now dominating our front pages? The unemployed represent the amount of the employment product that is stocked on the shelves at the market but, as yet, remain unsold. And, why do products sit too long on the shelves?

THE SELLER IS ASKING TOO MUCH.

Employees, like retail sellers, must realize that if a product is not moving it needs to be put on sale. The sale will invariably help the product “clear the market.” The unemployed person is either asking too much for his services or he is only offering his services in a limited field of application (a third possibility is that he is prohibited by the government to seek his market value by the so-called minimum wage laws).

The bigger question for 7.6% of America’s workers who are now unemployed is: “Is it right that I should have to take a smaller salary than what I am used to, or have to take a job outside my specialty? “ This question is actually what Keynes based his economic fallacies upon. Keynes saw that employee’s offer a product that is “sticky” in that it cannot be adjusted to work in a true marketplace. While the market forces every other commodity to go up and down, employees only want to go up. Employees accept a bull market for their services but will not accept it when it becomes bearish.

Keynesian ideas do not refute Say, however, they merely point out how employees need a little business training – they need to be trained in how to better provide a product for sale in a marketplace.

During period of optimism, credit expands and products such as employment are offered and sold at a price that is the result of the carelessness that comes from over confidence. In times of pessimism, credit contracts and makes corrections to the earlier carelessness. Employees must realize that they were perhaps making too much during the period of expansion and that the recession is “putting their feet back on the ground.” When the contraction is over, money will be less plentiful and they may well realize that the smaller salary that they accepted in a recession offers just as much buying power as the greater one that they held during periods of inflation.

Say’s Law is true and has never been refuted by the snake-oil salesmen that are still trying to sell government intervention under the fallacies of John Maynard Keyes. Unemployment is not being unable to find work; it is simply the unwillingness to satisfy other peoples’ needs at a fair price.

Economic Stimulus as Folly

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

Ludwig von Mises, Human Action (1949, p. 570)

The trillion dollar economic stimulus package will fail to resolve the current economic crisis and here is why.

Growth in employment, and the economic good times that it brings, occurs during periods of credit expansion. When credit is expanding, banks are creating money by making loans to people who hire other people to serve them. This happens regardless of whether the credit is issued to employers or consumers. Credit expansion occurs when creditors are optimistic about getting their loan money repaid.

Growth of unemployment, on the other hand, occurs during periods of credit contraction. When credit is contracting, banks are reducing the money supply by recalling loans to people who employ other people. Credit contraction occurs when creditors fear that loans will fail and should therefore not be issued.

In terms of credit contraction, it is important to note that creditors not only want a return of the loaned money, but they also want the loaned money to have the same value when repaid as it had when it was loaned out.

The government’s distribution of new money for no other consideration than to “stimulate” the economy tends to dilute the existing money in the economy, including the money that creditors have on loan to their clients.

Most creditors are smart enough to know that if they loan out $100 that will only be worth $90 when it is repaid, they will actually lose real economic value by making the loan. Therefore, the already pessimistic creditor becomes more pessimistic and tends to contract his credit even more.

The more the government threatens to dilute the value of the loaned dollar, the more creditors will keep their money in their pocket and let other people lose their jobs.

So, what is the solution to an economic crisis such as the current one? As von Mises points out in the above quote, the only real solution is to let the economy heal itself. This involves letting some bad investors take their losses while allowing wiser investors to buy back at a new “ground floor” and use their wisdom to create new jobs in an economy where resources are allocated more efficiently.

Left to itself, the economy would actually come out of the recession stronger than ever, but because of government intervention, credit contraction will be prolonged, unemployment levels will remain high, and an economy trying to correct itself will never fully heal.

Roosevelt, Reagan, and Inflation

“When you take a loan, money is created. When you pay it back, money is destroyed.”

Advocates of Liberty, http://www.iowaliberty.org/node/61

According to the now discredited theories of Keynesian economics, the government is suppose to be able stimulate a sluggish economy by deficit spending. Although the economics of John Maynard Keynes has been time and again proven fallacious, it remains a tempting morsel for socialist politicians who are looking for a justification for their big-government policies. In fact, at the current time, Washington is now proposing a “stimulus” package that promises economic recovery by throwing good money after bad.

Keynesian politicians tell us that the government can inflate the economy, and thereby stimulate it, by simply spending more money in that economy than it takes out in taxes. The corollary of this idea is that the government can also “cool down” an overheated economy by simply reducing its expenditures below its intake from taxes. Two seminal moments in American economic history fail to bear this out:

1. Roosevelt’s New Deal. In a desperate attempt to end the great depression, Roosevelt used deficit spending to try to inflate a dangerously deflated economy. Tremendous expenditures on public works and make-work projects were implemented in what was referred to as Roosevelt’s New Deal. Beginning in 1933 and continuing throughout the rest of the decade, the New Deal failed to inflate the economy and stimulate us out of the great depression. Eventually, American private enterprise began receiving large private contracts from the war-torn nations of Europe and the consequent rehiring of workers turned the economy around. Deficit government spending did not inflate the economy.
2. Ronald Reagan’s Cold War Victory. In the 1980’s Ronald Reagan won the Cold War by overwhelming the state-run Soviet economy with the challenge of an expensive new arms race. Reagan’s plan required massive military expenditures that could only be paid for with a deficit budget. Not only did his expenditures go up but he successfully pushed congress to pass large tax cuts which, by Keynesian theory, would have had the same inflationary effect as the deficit military spending. However, rather than inflating as Keynes had promised, the economy under Reagan stopped inflating for the first time in forty years. Again, deficit government spending did not inflate the economy.

Why did government expenditures during these two climactic moments in American history not have the effect on the economy that Keynes would have predicted? Because money, in essence, is really just credit, and the people that create most of the credit in our economy are primarily responsible for determining the supply of money that helps people get jobs while being able to reasonably budget their households. As explained in the previous post to this blog site, banks inflate the economy when they issue credit and they deflate the economy when they reduce their credit. When bankers are confident, they issue as much credit as they can and thereby inflate the economy; when they are afraid and timid in issuing loans, they will invariably deflate the economy’s money supply and reduce the number of jobs available.

Roosevelt failed to inflate the economy because, instead of giving bankers courage, he made them timid and afraid of his wrath. His patrician background had made him distrustful and envious of the nouveau riche money-changers who made our economy work.

Reagan, on the other hand, gave creditors courage to inflate the economy, but that inflation was limited by the governments limit on fractional reserves. The fractional reserve can curb inflation by putting a ceiling on the bank’s creation of money; however, this ceiling does not have a corresponding “floor” that would limit the amount of deflation. Reagan’s government could limit the inflation that threatened his economy, but he would not have been able to limit the amount of deflation that is threatening ours.

Money was the same thing under both Roosevelt and Reagan -- money was just “full faith and credit” and the bankers provided credit once they had full faith.