Download 09/10/07

12/27/07
The Commanding Heights
Purpose of viewing this material – discover threads of thought, their implementation, and their
consequences – to avoid the mistakes of the past, as ‘old’ and ‘failed’ ideas and nostrums as sold
to an unsuspecting new generation.
Nine hour PBS Special first aired in 2002. For full ‘Story Line, see: www.pbs.org/wgbn/
commandingheights/
-- Episode One: The Battle of Ideas
-- Episode Two: The Agony of Reform
-- Episode Three: The New Rules of the Game
Key points:
Free trade of the second half of the 19th Century [after abolition of the Corn Laws]
World War I -- the end of ‘free trade’
Russian Revolution
‘War communism’ – failure
Lenin – “Two steps forward, one step back” -- state control of the ‘Commanding
Heights’
New Economic Policies (NEP)
Economic Debate
Victory of Stalin and the First Five Year Plan (FYP)
Keynes and Hayek – Profiles and predictions
Hyperinflation in Germany – war reparations, the destruction of the German middle class, and
the rise of National Socialism and Hitler
Great Depression
Hayek’s warning
Central Banks’ role
Bretton Woods (Keynes)
Post War Britain/‘fair-shares’/defeat of Churchill/Labor nationalizes the ‘Commanding
Heights’
Milton Friedman
Democracy and free-markets
Germany
Ludwig Ehrhardt’s dilemma: price controls vs. inflation – Price controls & shortages
The first ‘oil shock’ and ‘government failure’ – James M. Buchanan @
www.dallasfed.org/research/ei
Stagflation – if we had only had an Ehrhardt – the failure of the ‘New Economics’ aka
Keynesianism; see: Henry Hazlitt, 2007/1957. The Failure of the ‘New Economics’: An
Analysis of the Keynesian Fallacies.
Thatcher and Hayek
Thatcher and Reagan
Deregulation of sandwiches
Shock Theory
The Battle of Ideas
A critical point of Episode One is the a description of major political/economic trends from the
‘free trade’ era of the end of the 19th Century focusing around the ideas of two economists:
John Maynard Keynes
Advocate of ‘central planning’
Fix ‘market failure’
and
Frederick von Mises
Advocate of prices & ‘free markets’
Avoid ‘government failure’
Preserve individual ‘freedom’
Markets are self-correcting
The first era of globalization (or ‘free trade’) came to an end with an act of terrorism in August
1914 – the assassination of Archduke Ferdinand of Austria by a Serbian. This act launched the
First World War. Hayek fought with the Austrian artillery in the Italian Alps, while Keynes
advised the British government on the allocation of resources to win the war (‘government
planning’). This war brought to an end the prosperity of the ‘first era of globalization’
associated with the British rule of the sea.
Free global markets →
Specialization of task &
specialization of area →
Lower prices for all
consumers.
The end of the war brought heavy ‘reparations’ [payments to the allies for war ‘damages’ by the
losing parties] imposed on the losers at the Treaty of Versailles: Germany/Austro-Hungary and
Turkey. Keynes left the peace conference and wrote: The Economic Consequences of the
Peace.
The war brought on a revolution in Russia, overthrowing Czar Nicholas II and the murder of the
royal family. It also led to the rise of Communism in the Soviet Union under V.I. Lenin, and then
J. Stalin, and a retreat to ‘regionalism’ (‘Communism in one country’).
Socialism was viewed as ‘more just’ than ‘free markets,’ this was a lure of socialism -communism for a better, more just world. Hayek’s view was: Markets work, government
doesn’t! Without a free-market, prices cannot be set by consumers’ choices – to buy at some
price or to refrain from making purchases – the consumer is no longer free to tell producers: (i)
what they want; (ii) in what color or style; (iii) in what quantities.
The Smithian (Adam Smith) admonition: “All production is for consumption” had been lost sight
of by a self-anointed elite – an elite that presumes to know what consumers want or, at least,
what they should want. Prices serve, as noted in the video, as ‘traffic signals’ and if they are
messed with, it leads to chaos, or a ‘traffic jam’. It is not the free-market that is chaotic (as
argued by Marx, Lenin and Stalin), but it is government intervention (the arbitrary setting of
prices where the elite believe they should be set, for whatever reason) into the free-market that is
the sources of the chaos. In the USSR, under the period known as ‘War Communism’ (1917-21),
wages and prices were fixed, which led to disaster – shortages – as can be seen plainly in Boris
Pasternak’s Dr. Zhivago. The shortages were especially severe in the towns and cities – since
farmers couldn’t by anything with the money they received from selling their agricultural
products – industrial production had collapses under ‘war communism.’ – and farmers refused to
sell their products.
In Germany and Austria/Hungary the devastated economies were kept afloat and the
‘reparations’ were financed by printing more and more money (by inflation). These actions
resulted in inflation and then more inflation and finally, hyperinflation. The hyperinflation
destroyed the ‘middle classes’ by wiping out their savings and it helped bring the ‘fascists’ and
‘Nazis’ to power in Germany. For the Austrian School of economics it is inflation that is the
greatest evil. This is just the opposite of Keynes’ position on inflation –
The expectation of a fall in the value of money stimulates investment and hence
employment generally, because it raises the schedule of the marginal efficiency
of capital, i.e., the investment demand-schedule; and the expectation of a rise in
the value of money is depressing, because it lowers the schedule of the marginal
efficiency of capital. (1936. The General Theory of Employment, Interest and
Money, 141-142)
To which, Henry Hazlitt has responded:
This is the equivalent of saying that inflation, and even more, the threat of further
inflation, is good because it stimulates investment and employment. (1959/2007.
The Failure of the ‘New Economics’: An Analysis of the Keynesian Fallacies, 160)
Disillusionment with the existing socio-economic systems (capitalism), bitterness over the
distribution of ‘wealth’, demand for a ‘more just’ society and the desire and belief in a better
world stimulated the ‘socialist’ movements in Europe – whether National Socialism (Nazi) or
Marxism/Leninism.
Hayek became a member of a discussion group led by Ludwig von Mises – a well known
economic Libertarian who believed that individuals should be free as should markets, free from
the intrusiveness of government. Both Mises and Hayek pointed out that ‘prices’ serve as ‘traffic
signals’, that without them, economic chaos (‘distortions’), the inability of consumers to convey
their NEEDS and WANTS to producers!! If the producers are government agencies, things
become orderly, but consumers remain unsatisfied, as the needs and wants of the government,
expressed in the Soviet Union by GOSPLAN (the Central Planning agency) are IMPOSED on
consumers. [The ‘central planners’ know what’s best!] Mises argued: “Free markets do it best,
why mess with anything less.”
Upon seizing power in Russia in 1917, Lenin abolished private property, ‘pooling’ productive
assets and consumer goods – abolishing the ‘chaos’ of the free market. In the USSR [Soviet
Union] in 1917-1921: Lenin encountered economic difficulty (‘War Communism’ – nationalized
the land, did away with individual property rights, confiscated all industries, implemented ‘wage
and price controls,’ and making ‘free market’ transactions ‘economic crimes’ punishable, even
by death); thereby destroying individual INCENTIVES to provide ‘factors of production’ and to
PRODUCE and MARKET goods and services. The economy was at the point of collapse and
Lenin was forced to relax these strict economic laws, called the New Economic Policy (NEP) –
he was attacked by the Left-wing of the Communist Party of the Soviet Union (CPSU) and he
defended the NEP by reporting that the “Commanding Heights” (heavy industry, mining,
electricity) would remain under the control and direction of the government. After Lenin’s
death, Joseph Stalin gained control, ‘purged’ [murdered] all political opponents and ‘enemies of
the state’. He collectivized agriculture, re-socialized ALL economic activities, and made it a
crime to work for any employer, BUT the STATE, and implemented Central Planning.
In the United States, un-ravished by the ‘direct’ effects of WW I enjoyed an economic boom, as
explained by L. von Mises:
It is customary to describe the boom as overinvestment. However, additional investment
is only possible to the extent that there is an additional supply of capital goods available….
The essence of the credit-expansion boom is not overinvestment, but investment in wrong
lines, i.e., malinvestment. …The unavoidable end of the credit expansion makes the
faults committed visible.
The erroneous belief that the essential feature of the boom is over investment and malinvestment is due to the habit of judging conditions merely according to what is perceptible
and tangible. (Human Action, 556; emphasis added)
Notice, ‘what is perceptible and tangible’, is reminiscent of Frederic Bastiat’s Things Seen and
Things Unseen in the ‘Broken Window Fallacy.’
Interestingly, Mises continues his dissection of economic booms and ‘malinivestment’:
The increase of the quantity of fiduciary media certainly always has the potential
effect of making prices rise. …Output per unit of input was increased and business
filled the markets with increasing quantities of cheap goods. If the synchronous
increase in the supply of money (in the broader sense) had been less plentiful than
it really was, a tendency toward a drop in the price of all commodities would have
taken effect.
The essential features of a credit expansion are not affected by such a particular
constellation of the market data. What induces an entrepreneur to embark upon
definite projects is neither high prices nor low prices as such, but a discrepancy
between the costs of production, inclusive of interest on the capital required, and
the anticipated price of the products. A lowering of the gross market rate of interest
as brought about by credit expansion always has the effect of making some projects
appear profitable which did not appear so before. (Mises, 558, emphasis added)
… What is needed for a sound expansion of production is additional capital goods, not
money or fiduciary media. The boom is built on the sands of banknotes and deposits.
It must collapse.
The breakdown appears as soon as the banks become frightened by the accelerated
pace of the boom and begin to abstain from further expansion of credit. The boom
could continue only as long as the banks were ready to grant freely all those credits
which business needed for the execution of its excessive projects, utterly disagreeing
with the real state of the supply of factors of production and the valuations of the
consumers. These illusory plans, suggested by the falsification of business calculation
as brought about by the cheap money policy, can be pushed forward only if new credits
can be obtained at gross market rates which are artificially lowered below the height
they would reach at an unhampered loan market. It is this margin that gives them the
deceptive appearance of profitability. The change in the banks’ conduct does not create
the crisis. It merely makes visible the havoc spread by the faults which business has
committed in the boom period. (Mises, 559, emphasis added)
An integral element of the boom in the 1920s in the U.S. was growth of ‘new industries’ based
on the technological changes (electrification, refrigerators, radio, automobiles), the ‘internet’
companies of that period. The boom was expressed through ‘a stock market bubble’ as seen in
the price of RCA’s stock which rose from $1.50 per share to $ 600 per share … much like ‘dot
coms’ of the late ‘90s). Additionally, it might be acknowledged that the Great Depression
corresponded with an extended drought in the mid-west, as chronicled in John Steinbeck’s
classic: The Grapes of Wrath. [Since reading Steinbeck is no longer in vogue, watch the film,
starring Jane Fonda’s humiliated father.]
The Great Depression was blamed on the ‘chaos’ of free markets, greedy businessmen and the
like, absolving government of all responsibility for creating the favorable ‘environment’ for the
boom! It’s important to question this conclusion and ask whether or not the Depression was the
result of the failure of capitalism (‘free-markets’), or of government intervention in the market?
The money supply was controlled by the Federal Reserve, which had been formed in 1913, and
the Congress had passed the Smoot-Hawley Act (tariff) helped bring the ‘first era of
globalization’ to an abrupt end. This is not an uncommon pattern. The government creates a
problem, blames someone else, and intervenes even more intrusively to fix the problem that they
have caused. A wonderful example may be found in Alan Greenspan’s brief paper, “Antitrust,’
(1962), reprinted in Ayn Rand. 1967. Capitalism: The Unknown Ideal, 63-71. Greenspan opens
his essay with:
The world of antitrust is reminiscent of Alice’s Wonderland: everything seemingly
is , yet apparently isn’t, simultaneously. It is a world in which competition is lauded
as the basic axiom and guiding principle, yet ‘too much’ competition is condemned
as ‘cutthroat.’ It is a world in which actions designed to limit competition are
branded as criminal when taken by businessmen, yet praised as ‘enlightened’
when initiated by the government. (63)
As an example of his thesis, he considers the expansion of the U.S. railroad system, comparing
its growth in the east (1830s-1860s), with its extension to the west coast (post-1965), first noting
railroad growth east of the Mississippi River:
The railroads developed in the East, prior to the Civil War, in stiff competition
with the older forms of transportation – barges, riverboats, and wagons. By the
1860s there arose a political clamor demanding that the railroads move west and
tie California to the nation: national prestige was held to be at stake. But the
traffic volume outside the populous East was insufficient to draw commercial
transportation westward. The potential profit did not warrant the heavy cost of
investment in transportation facilities. In the name of ‘public policy’ it was,
therefore, decided to subsidize the railroads in their move to the West. (64)
Notice the points that Greenspan makes: (i) competition in the East;
insufficient demand outside the Northeast; (iv) lack of demand in
profits, in a market context, could not cover the costs of railroad
‘political solution’ (government, i.e., taxpayer) was substituted for
guiding currents of profits. He continues:
(ii) political pressure; (iii)
the West meant expected
construction; (v) hence, a
the ‘free market’ and the
Between 1863 and 1867, close to one hundred million acres of public lands were
granted to the railroads…. with the aid of the federal government, a segment of
industry was able to ‘break free’ from the competitive bounds which had prevailed
in the East. … (64)
…The western railroads were true monopolies in the textbook sense of the word. They
could, and did, behave with an aura of arbitrary power. But that power was not derived
from a free market. It stemmed from governmental subsidies and governmental
restrictions. (65)
When, ultimately, western traffic increased to levels which could support other profitmaking transportation carriers, the railroads’ monopolistic power was soon undercut. In
spite of their initial privileges, they were unable to withstand the pressure of free
competition.
In the meantime, however, an ominous turning point had taken place in our economic
history: the Interstate Commerce Act of 1887.
The Act was not necessitated by the ‘evils’ of the free market. Like subsequent legislation
controlling business, the Act was an attempt to remedy the economic distortions which
prior government interventions had created, but which were blamed on the free market.
(65)
Clearly, it is necessary to keep Frédéric Bastiat’s comments on ‘things seen and things unseen’
in mind!
Back to The Battle of Ideas:
The global depression ensued and John Maynard Keynes formulated his General Theory, rewriting the rules of economics by splitting the discipline into two segments: (i) macroeconomics;
and (ii) macroeconomics. He sought to layout the means for human beings to MANAGE
economies – markets are incapable of operating smoothly without human guidance – markets are
subject to ‘failure’…i.e., excesses. [See: A. C. Pigou. Economics of Welfare] Some argue
(Keynesians), that Keynes’ policies would “save capitalism from itself.”
In the U.S, Franklin D. Roosevelt (FDR) fought the Depression by regulating the ‘recklessness
of the unfettered market.’ The bold (Nazisesque) sculpture, at the ICC (Interstate Commerce
Commis-sion), of a man bridling/reigning-in a horse is symbolic of the wild, ‘animal nature’ of
the market and the social, ‘pacifying-nature’ of the government! There is a need to protect ‘the
people’ from the excesses of ‘the market’ – regulate it to eliminate the boom/bust cycle [go back
and read Mises comments on the ULTIMATE source of malinvestment and the ‘boom/bust’
cycle. Here once again, the view is that government is the solution, not the problem. The
government has a responsibility to maintain ‘full-employment’, a la Keynes’ prescription of
‘contra-cyclical government, spending’ – in an economic downturn, practice deficit-spending to
stimulate the economy, and during an economic expansion build-up surpluses to slow the
economy. [Interestingly, the avowed Keynesians now disregard this prescription.] Note that John
Kenneth Galbraith of Harvard University believed himself to have been the bearer of
‘Keynesianism’ to the U.S. He served in the FDR administration (Office of Price
Administration – the usurpation of the basic functions of a free-market, based on the setting of
mutually agreed upon prices) and argued that we had to endure “… a little inflation to assure low
rates of unemployment.” Galbraith maintained that we “must put up with a little inflation in order
to maintain high rates of employment”. This implies that a ‘trade-off’ exists between ‘inflation’
and ‘unemployment’, known fondly as the ‘Phillips Curve,’ after A.W. Phillips, an economist
from New Zealand, who ‘postulated’ the trade-offs, based on historical data from Great Britain.
[A.W. Phillips. 1958. “The Relation between Unemployment and the Rate of Change of Money
Wage in the United Kingdom, 1862-1957,” Economica. His original argument:
…measured inflation by percentage change in wages, rather than by the percentage
change in prices. Because wages and prices usually move together, this difference is
not important to our discussion.” (Hubbard and O’Brien. 2006. Macroeconomics,
516, emphasis added).
On the following page, Hubbard and O’Brien report in a marginal note, “The Phillips Curve”:
A.W. Phillips was the first to show that there is usually an inverse relationship
between unemployment and inflation. (517, emphasis added)
Notice the scientific precision of their argument – usually! Such terminology is NOT an
attribute of a true science – the ‘law of gravity’ usually holds? ‘Ohm’s law of electricity’ usually
works? ‘Boyle’s laws of gases’ usually predicts well?
Even more revealing are the comments on the ‘Phillips Curve” found on Wikipedia (I know, this
is a suspect source, since it is ‘open-source’ and people can write or add whatever they like … it
is not the truth as revealed by peer review and editorial ‘correction’ … Yet as an open source,
Wikipedia is constantly updated and revised by its users):
… many economists in advanced industrial countries believed that Phillips’ results
showed that there was a permanently stable relationship between inflation and
unemployment. One implication of this for government policy was that government
could control unemployment and inflation within a Keynesian policy. They could
tolerate a reasonably high rate of inflation as this would lead to lower unemployment. (Emphasis added)
During the late 1960s and early 1970s in the quest to ‘manage’ the economy, governments used
‘fiscal’ [government’s use of coercive taxes and preferential spending (redistribution of income)
to achieve macroeconomic goals] and ‘monetary’ [use of money supply (printing press) and
interest rates set by the Federal Reserve to attain macroeconomic objectives] policies to ‘tweak’
the economy. Such machinations to reduce unemployment resulted in ‘stagflation’ during the
late 1970s – the simultaneous occurrence of slow economic growth, high rates of inflation and
high levels of unemployment! Wikipedia, paralleling the narration of “The Commanding
Heights,” report that:
Theories based on the Phillips Curve suggested that this [‘stagflation’] could not
happen.
Nonetheless, it had happened! In a critique of the Keynesian economic management model,
Milton Friedman argued that
… the demonstrable failure of the relationship [Phillips curve’s rates of and
rates of unemployment] demanded a return to non-interventionist, free market
policies. The idea that there was a simple, predictable, and persistent relationship was abandoned by most if not all macroeconomists.
During World War II the FDR administration assumed DIRECT control over markets by ‘Wage
and Price Controls’. [Ironically, the market distortions of THIS policy plague us today … to
attract SCARCE workers, firms COULD NOT offer higher wages, so they offered FRINGE
BENEFITS which were not controlled by John Kenneth Galbraith and his Price Administration.
One of these fringe benefits was health care benefits provided by PRIVATE INSURANCE
COMPANIES (a Third Party payer) … If an individual does not have to pay the ‘full’ market
price for a good or service there is a propensity for her/him to over-use those goods/services,
thereby stimulating higher prices… Look at a Supply and Demand curve relationship with an
equilibrium price (Pe) reflecting free market conditions, compare this with a price set below
equilibrium (Padmin), and compare the quantities supplied (Qs) and demanded (Qd). Note that the
quantity demanded (Qd) exceeds the quantity supplied (Qs).]
At the London School of Economics, Frederick Hayek wrote The Road to Serfdom (1944) …
Too much central planning →
Too much government
power in the market →
Too little individual
freedom.
It’s all about the acquisition and perpetuation of ‘political power’ by the ‘intellectual elite’ that
has experienced the revelation of divine (with a small ‘d’) will … that human direction of the
economy is far superior to the impersonal operation of the free market.
At the Bretton Woods Conference, which sought to design a framework to ‘organize the postwar economy’ [‘human direction’ as opposed to ‘the operation of free-markets’], the Keynesian
worldview (discrediting of Capitalism and the need for external control) was adopted with the
creation the World Bank and the International Monetary Fund (IMF).
In Great Britain, the desire to ‘build a new society’ based on ‘fairness’ or ‘equity’, in stark
contrast to ‘efficiency’ of the free market, was labeled ‘fair share’ in reaction to the Great
Depression. Churchill warned of the need for ‘economic police’ to assure that the full
implementation of a ‘planned economy’, while the socialists ridiculed ‘that foreign chap’ (von
Hayek)! The socialists won the election and turned-out Prime Minister Winston Churchill →
using William Blake’s quest for the ‘New Jerusalem’ → which “Broke into the sacredness of
private property.” It might be observed that the Austrian economist, William Block (1998) wrote of
the sanctity of private property and the individual’s property rights to the fruits of his/her labor:
Economic freedom also admits of a straight-forward definition. It is the idea
that people legitimately own themselves and the property they ‘capture’ from
nature …
In 1947, in the fresh air of the Swiss Alps, Hayek brought together a group of similar minded
economists and journalists, including Ludwig von Mises and Milton Friedman, to formulate the
spread of ‘free market’ ideas. The group generally agreed that freedom was in danger from
‘central planning’, the group believed that free markets were an essential pre-requisite for
individual liberty and political freedom!
While in Berlin, hyperinflation was running wild, with military imposed wage and price
controls designed to curb inflation. Cigarettes and cognac (‘coniac’) served as the medium of
exchange in the ‘illegal’ [notice: ‘illegality’ and Churchill’s warning of the need for ‘economic
police’] black market. Ludwig Erhard abolished the ‘wage and price’ controls, and within days
the economy began to recover, as prices stabilized and hoarding ceased. Hummm, now there is
a ‘real’ economic experiment! Germany’s free-market, welfare state economy overtook the
British socialist, welfare state.
In India, with political independence, Gandhi’s economic vision was for a village-based, smallscale production model, while Nehru sought to create a British-style parliamentary democracy
with a Stalinist planned economy of large, state-owned industries. This became the ‘preferred’
model adopted by many of the world’s developing nations.
The Chicago School of Economics – “The Commanding Heights’ erroneously places a great
deal of emphasis on the role of Milton Friedman – as important personages, if not more
important, were Frank Knight and George Stigler [For both Friedman and Knight, see:
www.dallasfed.org/research/ei]. The hallmark of the school is its emphasis on a minimal role for
government in the economy, i.e., free markets. There are forces at work in the free market
economy – much like the “winds and the tides” (natural forces), they can be ignored or
overridden (by humans) only at great risk. [Man over Nature…!].
By the 1970s, Hayek had been marginalized by ‘mainstream’ (i.e., Keynesian) economists, but
the rise of stagflation signaled (were symptomatic of) that something was wrong → both high
levels of ‘inflation’, slow growth, and high rates of ‘unemployment’… something that shouldn’t
be happening, according to the Keynesian formulation (‘Theory’). If a model or theory fails to
predict accurately, the Baconian Scientific Method requires that it be REJECTED, not just
‘tweaked’ to improve its level of predictive power! [See: Michael Crichton. “Aliens Cause
Global Warming” and “Testimony before the United States Senate,” @ www.crichtonofficial.com]. Nonetheless, many economists sought to ‘salvage’ this bulwark of Keynesianism,
adopting short-run and longer term models of ‘rational expectations’ and ‘natural rate of
unemployment’ approaches (‘tweak’, ‘tweak’). [See: “Phillips Curve,’ Wikipedia.com] Some
even changed ‘rates of inflation’ and ‘rates of unemployment’ found in the original formulation
to ‘rates of change of inflation’ and ‘rates of change of unemployment.’ (‘tweak’, ‘tweak’) In
some circles this might even be described as “Procrustian-bed economics” [i.e., make the data fit
the model, even if we have to cut-off the subjects feet and legs, or stretch the body on the rack to
fit the roll-away bed.]
President Richard Nixon, caught in the beginnings of ‘stagflation,’ declared himself a
Keynesian, sought to ‘spend his way out of the problem’…exacerbating the situation! [Keep in
mind Milton Friedman’s comment about the placement of blame] He was forced to resort to
‘wage and price controls,’ to appease the public – remember Ludwig Erhard and the ‘wage-price
controls’ imposed by General Clay?
In regards to employment/unemployment, Ludwig von Mises has observed:
If a job-seeker cannot obtain the position he prefers, he must look for another
kind of job. If he cannot find an employer ready to pay him as much as he
would like to earn, he must abate his pretensions. If he refuses, he will not get
any job. He remains unemployed.
What causes unemployment is the fact that … those eager to earn wages can
and do wait. A job-seeker who does not want to wait will always get a job in the
unhampered market economy in which there is always unused capacity of natural
resources and very often also unused capacity of produced factors of production.
It is necessary for him either to reduce the amount of pay he is asking for or to
alter his occupation or his place of work. (1998. Human Action: A Treatise on
Economics, 595; emphasis added)
…. Unemployment in the unhampered market is always voluntary….on the
unhampered market, there is always for each type of labor a rate at which all
those eager to work can get a job. The final wage rate is that rate at which all
job seekers get jobs and all employers as many workers as they want to hire.
(596-7, emphasis added)
Wage rate fluctuations are the device by means of which the sovereignty of
consumers manifests itself on the labor market. (597, emphasis added)
Mises goes on to demonstrate that in an ‘unhampered market’ their will be the greatest amount
of freedom for both worker and employer:
This amount of freedom is the maximum of freedom that an individual can enjoy
in the framework of the social division of labor, and this amount of coercion is
the minimum of coercion that is indispensable for the preservation of the system
of social cooperation. There is only one alternative left to the catallactic pressure
exercised by the wages system: the assignment of occupations and jobs to each
individual by the preemptory decrees of an authority, a central board planning all
production activity. This is tantamount to the suppression of all freedom. (597,
emphasis added)
Little wonder that Von Mises found it so difficult to find an academic (teaching) position in the
United States in 1940, in ‘intellectual tolerance’ of the Keynesian economic environment.
The virtues of the ‘free (unhampered) market’ begin with individual freedom and political
liberty. The Commanding Heights reports that the economic consequences of government
regulations are reduced production, leading to higher prices which fuel inflation, the
suppression of competition, and reduced liberty. The French economist, Frédéric Bastiat, had
written in the first half of the 19th Century, that: “C
Competition is merely the absence of
oppression.” The examplar of this process was the airlines industry. The program noted that the
airlines in existence during the Depression were the same air lines providing service in the late
1970s … government regulations served as a ‘barrier-to-entry’, keeping new and innovative
firms out of the market! Such governmental regulatory actions, the very opposite of ‘the
invisible hand’ of the free market (Adam Smith), became, for Milton Friedman, ‘the heavy foot’
of government.
In 1977 President Carter appointed Alfred E. Khan (Economics Professor at Cornell University)
to head the Civil Aeronautics Board. Kahn noted that the largest branch of the CAB when he
took office was the ‘Enforcement Branch’ [remember the comment made by Churchill about the
need for ‘economic police’ whenever there is a ‘government economic planning agency]. He
reported that 5% of the cases involved companies charging prices that exceeded the prices set by
the government (‘too high’) and 95% involved companies charging prices that were below the
prices set by the government (‘too low ’)! Now that’s ‘real’ consumer protection! Khan reported
that the CAB even decided on the size of sandwiches that could be served on airlines. Clearly,
air carriers enjoyed such government intervention on their behalf, at the expense of the consumer
– higher prices, assigned routes, lower levels of service (times and destinations)! Under Khan’s
leadership the Airlines Deregulation Act of 1978 was passed, abolishing the CAB and privatizing
the U.S. airline industry, his evaluation of the results includes:
(i)
(ii)
(iii)
(iv)
(v)
lower fares;
increased productivity;
improved safety;
improved services;
increased competition.
[See: Alfred E. Khan. “Airline Deregulation,” www.econlib.org/LIBRARY/Enc/AirlineDeregulation.html.]
In the discussion of the airline industry a woman is interviewed discussing the plight of her
father, a jet-mechanic at Braniff Airlines when it failed from increased competition. He was
hired back when Braniff emerged from bankruptcy, but at half his previous salary and “He
played by the rules.” The rules of the game include inflated salaries in a government-protected
industry, not subject to the disciplinary competition of a ‘free-market,’ all at the expense of
consumers. Just a reminder, von Mises had written: “All production is for consumption.” That
being the case, the United States has a current population of 305,593,462 and a total of
136,174,000 job-holders … 306 million consumers and 136 million workers! Hence,
government is willing to intervene on behalf of 136 million workers at the expense of the rest of
society!
In the United Kingdom, the Socialist, welfare-state, whose solution to stagflation was to ‘spend
their way out of the problem,’ was wracked by STRIKES. Margaret Thatcher was elected Prime
Minister and her solution was PRIVATIZATION of the state-owned industries. In the United
States in 1979 President Carter was officiating over an economy beset by high rates of
unemployment, high rates of inflation, slow economic growth – stagflation! Carter appointed
Paul Volker as the Chairman of the Federal Reserve. He viewed INFLATION as a drag on the
economy – his response was a tightening of the money supply (a monetary contraction) – with
a decline in money supply, interest rates (i) would rise, slow private sector household spending
(C), decrease production (GDP), cause an increase in unemployment and result in a decrease in
the inflation rate. According to the video, unemployment rose to 10% [annual rate 1982 – 9.7%
and 1983 – 9.6%] and interest rate to 20% [1981 -- average annual prime rate 18.8%].
Money supply data is available at the Federal Reserve website (www.federalreserve.gov). These
data reveal that money-supply [M1 and M2] grew at excessive rates from 1969/70 onward
through the late 1980s/early 1990s:
Year
Money Supply
CPI [M1 + M2]
Year-over-Year
Rate of Change
Change in
GDP
1968
1969
4.7
6.2
569.7
590.1
….
3.58
3.6
3.5
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
5.6
3.3
3.4
8.7
12.3
6.9
4.9
6.7
9.0
13.3
627.8
711.2
803.1
856.5
903.5
1,017.8
1,153.5
1,273.0
1,370.8
1,479.0
6.39
13.28
12.92
6.01
5.49
12.65
13.33
10.36
7.68
7.89
4.9
5.9
5.6
4.9
5.6
8.5
7.7
7.1
6.1
5.8
5.8
- 0.5
- 0.2
5.3
4.6
5.6
3.2
Prime Rate
(Ave. Mon.)
8.03
10.81
7.86
6.84
6.83
9.06
12.67
Unemploy.
Rate
1980
1981
1982
1983
1984
12.5
8.9
3.8
3.8
3.9
1,604.8
1,760.1
1,918.2
2,137.0
2,322.0
8.51
9.67
8.98
11.47
8.66
- 0.2
2.5
- 1.9
4.5
7.2
15.26
18.87
14.85
10.79
12.04
7.1
7.6
9.4
9.6
7.5
1989
1990
1991
1992
1993
4.6
6.1
3.1
2.9
2.7
3,171.5
3,292.0
3,393.4
3,449.3
3,504.3
…
3.80
3.08
1.65
1.60
3.5
1.9
- 0.2
3.3
2.7
10.89
10.01
8.46
6.25
6.00
5.3
5.6
6.8
7.5
6.9
1998
1999
1.6
2.7
4,406.3
4,675.1
…
6.10
4.2
4.5
8.35
8.00
4.5
4.2
2000
2001
2002
2003
2004
2005
3.4
1.6
2.4
1.9
3.3
3.4
4,962.7
5,486.0
5,832.3
6,112.0
6,456.7
6,713.4
6.15
10.55
6.31
4.80
5.64
3.98
3.7
0.8
1.6
2.7
4.2
3.5
9.23
6.91
4.67
4.12
4.34
6.19
4.0
4.7
5.8
6.0
5.5
5.0
Sources: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau
of Economic Analysis; and the Federal Reserve Bank.
Review the ‘Unemployment rate’ available on the U.S. Department of Labor, Bureau of Labor
Statistics website, from 1968 [3.6%] through 2006 [average is less than 5.0%] … Notice that the
peak rate of unemployment occurred during the 1982-83 period, [so much for the ‘worst rate
since the Great Depression’] resulting from the tightening of the money supply by Paul Volker
during the Carter/Reagan Administration … the lagged-recessionary-effect as the COST OF
BORROWING increased [the average annual prime interest rates rose from 6.84 percent (1977)
to nearly 19 percent (1981)], the economy (GDP) slowed over the 1976 through 1983 period.
Notice the comments Gwartney, Stroup, and Lee [2005. What Everyone Should Know about
Wealth and Prosperity] have made concerning ‘Inflation’ [Part II ‘Seven Major Sources of
Economic Progress’: “Monetary Stability: Inflationary Monetary Policies Distort Price Signals
and Undermine a Market Economy.”] Noting the three functions of money: (i) medium of
exchange; (ii) a store of value or purchasing power; and (iii) a unit of account, they go on to
demonstrate why monetary instability is so important – reduces exchange and retards
specialization of task and area – permitting societies to be WORSE-OFF than the would
otherwise have been! Notice their comment:
There is no mystery about the cause of monetary instability. Like other commodities,
the value of money is determined by supply and demand. When the supply [of] money
is constant or increases at a slow steady rate, the purchasing power of money will be
relatively stable. In contrast, when the supply of money expands rapidly and unpredictably relative to the supply of goods and services, prices are inflated and the purchasing
power of money declines. This often happens when governments print money (or
borrow from a central bank) in order to pay their bills.
Politicians often blame inflation on greedy businesses, powerful labor unions, big oil
companies, or foreigners, for example. But their efforts are a ruse – a diversionary
tactics. Both economic theory and historical experience indicate that persistent inflation
arises from a single source: rapid growth in the supply of money….
Inflation undermines economic prosperity. It makes the planning and undertaking of
capital investment projects extremely hazardous. …
When governments inflate, people will spend less time producing and more time trying
to protect their wealth. … Speculative practices are encouraged as persons try to outwit
each other with regard to the future direction of prices. Funds flow into speculative
investments like gold, silver, and art objects rather into productive investments like
buildings, machines, and technological research. As resources move from productive
to unproductive activities, economic progress is retarded.
But perhaps the most destructive impact of inflation is that it undermines the
creditability and confidence of citizens in their government.
So, there you have it! Notice, gold prices have risen steadily over the past three years! It’s too
late to buy gold NOW, despite all the advertisements! There is a historical chart of gold prices
available at: www.kitco.com/scripts/hist_charts -- in 2001 -- lows @ $ 270/oz.; May 2006 $
700/oz.; early October 2006 $ 590/oz.; and December 14, 2007 $ 793/oz.
Consider the material describing ‘fair-shares’ advocated by the Labor Party and the
nationalization of the ‘Commanding Heights’ [heavy-industry, including coal mining, rail, steel
smelting, utilities, communications, etc.]. Is this related to the condemnation of the income
distribution in the United States today? [“Voters most often blamed the gap on ‘excessive
salaries and bonuses’ and competition from companies overseas.”] “Highly paid CEOs!” No
mention of the ‘incomes’ paid to Democrat Senators [Heinz-Kerry and Kennedy] from
investments abroad (Caribbean and Pacific island nations), and untaxed or minimally taxed in the
U.S.!
The argument is that there is a ‘wealth-gap’ that exists in America; that there is a certain amount
of ‘unfairness’ in how wealth is distributed; that there are ‘two Americas’! In order to evaluate
such hyperbole, several concepts have to be understood, and understood precisely. First, there is
a distinction that must be drawn between ‘income’ and ‘wealth’: Income represents a return to a
factor over some specified time period, e.g., what an electrician earns weekly, monthly or
annually; while wealth is what an individual has acquired and owns at some point in time, e.g.,
assets that the electrician has acquired and possesses at the time she decides to retire. Income is a
flow, and wealth is a stock. It is important to keep the two separate, but to understand the
relationship between them: wealth of a household is functionally related to its levels of past
incomes.
Wealth = f (∑ of past levels of income).
Sadly, the terms in the popular press are frequently used interchangeably. Wealth, since it is a
function of time, is heavily influenced by the age of the head of the household. Young heads of
households have not had as long to earn income and to acquire wealth. So the issue of ‘fairness’
of the distribution of wealth at some moment in time, without paying attention to age of
householders is MEANINGLESS, but is frequently stated. For example, consider the data in the
following presentation compiled from the U.S. Bureau of the Census:
Income and Earnings Summary Measures by Selected Characteristics:
2004, 2005 and 2006.
2004
Median Income
[dollars]
2005
Median Income
[dollars]
2006
Median Income
[dollars]
All households
45,817
46,326
48,201
Family households
Married couple
Female householder,
no husband present
57,179
65,946
57,278
66,067
59,894
69,716
30,823
30,650
31,818
48,218
31,101
59,427
48,554
30,858
61,094
50,675
31,969
64,238
Race of householder
White
Black
Asian
Age of householder
< 65 years
52,562
52,287
54,726
15 to 24 years
28,497
28,770
30,937
25 to 34 years
46,985
47,379
49,164
35 to 44 years
58,578
58,084
60,405
45 to 54 years
63,068
62,424
64,874
55 to 64 years
52,077
52,260
54,592
> 65 years
25,336
26,036
27,798
_________________________________________________
Source: U.S. Census Bureau. Income, Poverty, and Health Insurance Coverage in the
United States: 2005 and 2006, 6.
Several significant points are apparent in this table … it substantiates the casual observation that
household income is a function of age (education and experience), peaking-out in the 45 to 54
years age group. Notice that female head of households have less than half the income of that of
a married couple (two- or three-workers); Black householders have 62.5 percent of the income of
white householders (does female householder play a role in this?); and white householders have
only 78.9% of the income of Asian householders!
Episode Two:
‘The Agony of Reform’
Privatization of the Russian economy and the example of Norilsk
The limits of Central Planning were exposed by India and the corruption (loss of incentives for
Investment and reduced rates of growth) … ‘Permit Raj’
The costs of protectionism become increasingly obvious
Dependency Theory became the guiding principle of economics in Latin America
It is unfortunate that an economy refuses to obey orders
Milton Friedman and the ‘Chicago Boys’ in Chile
Reform of the Chilean Social Security System = ‘privatization’
Gorbachev/Chubais/Gaidar – reform in Russia
Poland/Solidarity/Lech Walesa and Thatcher and Pope John Paul II
Bolivia/Jeffrey Sachs and ‘Shock Therapy’ (shades of post-war Germany)
Poland, the price of eggs and price controls
Soviet ‘free-fall’ failure of the privatization of agriculture
India escapes collapse
Lessons from the Soviet Union (USSR)
End of ‘Permit Raj’ (the Central Planners’ fall from grace)
Russia and ‘voucher capitalism’
Yetlsin and the Oligarchs
Episode Three:
The New Rules of the Game
Global ideas – Bill Clinton/comments by Robert Rubin/the capitalist elite and the Democrat
Party
NAFTA and the new rules of the game
Regional Economic Free Trade Areas
Clinton shifts his position/Gephardt on NAFTA
Crossing borders – ‘Free-trade’ vs. ‘Managed-trade’ (Mercantilism reborn)/Laura
Tyson
Winners and losers
Emergence of Global Markets
Invisible trade – markets are us!
Pensions go global (higher returns abroad)/CALPERS
The ‘emerging market hunters’
Capture of returns/Mark Mobius/Tyson/Rubin
Awaiting a melt-down
Capital gets nervous/George Soros and the run on currencies
The Global Vision
Communications explodes
Borderless world
Venture capitalism
China and the ‘Tiger economies’
Singapore’s miracle
The Japanese paradox
Global ‘contagion’/overheating of the Southeast Asian economies/’easy money’ and
gambling/low interest rates (1997) – the ‘classic’ Austrian bubble, see:
L. von Mises, Human Action, Chapter XX. “Interest, Credit Expansion,
and the Trade Cycle,” 535-583.
Central Bank of Thailand – the baht was too high (tied to the dollar)/international
investors (Soros) short the baht/devaluation of the baht/cost-of-living rises
Rubin and ‘open-markets’
Speculative ‘bubble’ and the IMF (International Monetary Fund) – bail-out loans
conditional on ‘cutting Government spending’ and increase in interest
rates (so much for ‘free-markets’) – Stanley Fischer
The bubble-burst/contagion engulfs the world/Tyson – US didn’t intervene/conditions
worsen/contagion spreads/money pulled-out of the region
Spreads to Malaysia (short the market)
Spreads to Indonesia
Investor/fund manager bail-out
Spreads to Korea (December 1997)/Rubin and Fischer/Central Bank/loan- rollover
Largest bail-out in history, up to that time
Rubin and the Clinton administration might have averted the melt-down had they
acted earlier in Thailand
Russia defaults (February 1998), contagion contained – ruble falls in value/panic
The ‘crisis’ reaches America – Long Term Capital/direct and indirect costs