New Jersey Survival

It is 79 years since the Great Depression. Some fear that this week’s chaos in the financial world means that the curtains are rising on Great Depression II. I don’t have a crystal ball, but I’m sure the immediate future is grim. At the very least we are in for a long and deep recession and our medicine will be very bitter indeed.

Clearly the style of capitalism which has dominated world markets for the last 20 years or so is flatlining. The question now is whether it is worth resuscitating. The answer must be Yes – but only if we jettison the “greed is good” ideology made famous by the slimy character Gordon Gekko in the 1987 film Wall Street. That was a movie. In real life it was the philosophy of Nobel Prize-winning economist Milton Friedman.

Friedman was probably the greatest economist of the 20th century. He influenced Ronald Reagan in the US, Margaret Thatcher in the UK, Brian Mulroney in Canada, and Paul Keating in Australia and his ideas led to critical economic reform in each of their countries. These economies were made stronger by following much of Friedman’s economic rationalism.

But at the heart of Friedman’s thought was the idea that greed is good, that greed works because it drives people to succeed. The reality, as we can now see, is that greed, in its truest sense, does not work.

A deadly sin

I have no doubt that greed is the cause of the current crisis. It was the greed of those who took easy money to buy houses beyond their means and the greed of bankers who lent to people borrowing beyond their means. The depth of this depravity can be seen in the Wall Street bankers who were collecting salaries over US$100 million per year even as their banks were collapsing.

Right now, even as the dominoes fall, disciples of Friedman are still contending that the culprit is not capitalist greed but excessive government regulation. However, while poor legislation and regulation may have contributed to the subprime mortgage market crisis that sparked the conflagration, it is absurd to suggest that the solution is merely a less regulated market.

Friedmanistas claim that the US subprime mortgage crisis didn’t happen in markets like Australia and the EU because their consumers are more sophisticated. Nothing could be further from the truth. Australians and Europeans are not smarter; they were protected by more stringent regulatory frameworks. If foreign banks have been dragged into the American crisis, it was mainly because they had joined the orgy on Wall Street.

Less regulation may be a good thing; but good regulation trumps it any day. How many ordinary Americans have to lose their jobs and homes before the ideology of laissez-faire capitalism is finally debunked?

Greed needs to be kept in check. Governments the world over should take the matter of bank regulation more seriously. The US’s subprime mortgage mess was created by politicians pandering to the not-unreasonable desire of Americans to own their own homes. But Congressmen who are currently skewering greedy Wall Street bankers should have protected ordinary consumers aspiring to home ownership. Their negligence points to a failure of leadership that reaches to the very top of the American political totem pole.

Tough choices

So, should governments be putting together rescue packages like the US Federal Reserve’s US$800 billion one to save the banks? Aren’t these rescue packages throwing good money after bad? After all, it was bad, even unethical, business decisions that have sunk the biggest financial institutions. If only that money were available now to help the people who are losing their homes, who face unemployment and who need to feed and educate their children.

But leaving the financial institutions that created the mess to stew in their folly is not a solution.

The viability of the world’s banking system needs to be ensured. If the banking crisis gets worse and more banks go under, it will be harder for businesses, big and small, to expand. Markets — which ultimately thrive on confidence — will shrink. That will mean more job losses and more pain. It could bring the world to Great Depression II, complete with soup kitchens and Hoovervilles. Right now, not bailing out the banks and other financial institutions is unthinkable.

Modern day capitalism may well be wanting. But – to paraphrase Winston Churchill’s description of democracy – it is the worst economic system except for all the others. The Great Depression played a part in the rise of communism, socialism, fascism and Nazism in the 1930s. That is, I am sure, not an outcome many would want from this crisis.

Saving the financial institutions that caused this crisis is the only way to keep the world from sliding into worse turmoil. But we have to learn from this calamity. Greed is not good. We need to inoculate our children against idolising Gordon Gekko. And we need to demand that governments regulate the markets more tightly . Capitalism works; but not when it is based on every man for himself. We need to find our way to a capitalism based on values and virtue.

Alistair Nicholas lives in Beijing where he runs a consultancy firm. He has been an economic researcher, political adviser, and Australian diplomat. In his consultancy he advises international corporations on business ethics and communications in China. He is the co-author of a study on the privatisation of welfare in Australia.

Caveat Emptor!     http://www.nakedcapitalism.com/

Jeffey Frankel
Politicians have always faced the temptation to give their constituents tax cuts. But in recent decades “conservative” presidents have enacted large tax cuts that have been anything but conservative fiscally, and have justified them by appealing to theory. In particular, they have appealed to two theories: the Laffer Proposition, which says that cuts in tax rates will pay for themselves via higher economic activity, and the Starve the Beast Hypothesis, which says that tax cuts will increase the budget deficit and put downward pressure on federal spending. It is insufficiently remarked that the two propositions are inconsistent with each other: reductions in tax rates can’t increase tax revenues and reduce tax revenues at the same time. But being mutually exclusive does not prevent them both from being wrong.

The Laffer Proposition, while theoretically possible under certain conditions, does not apply to US income tax rates: a cut in those rates reduces revenue, precisely as common sense would indicate. As detailed in a new paper of mine “Snake-Oil Tax Cuts,” for the Economic Policy Institute, this conclusion was the outcome of the two big experiments of recent decades: the Reagan tax cuts of 1981-83 and the Bush tax cuts of 2001-03. It is also the conclusion of more systematic scholarly studies based on more extensive data. Finally, it is the view of almost all professional economists, including the illustrious economic advisers to Presidents Reagan and Bush, even though it contradicted the views of their employers. So thorough is the discrediting of the Laffer Hypothesis, that many deny that these two presidents or their top officials could have ever believed such a thing. But abundant quotes show that they did.

The Starve the Beast Hypothesis claims that politicians can’t spend money that they don’t have. In theory, Congressmen are supposedly inhibited from increasing spending by constituents’ fears that the resulting deficits will mean higher taxes for their grandchildren. The theory fails on both conceptual grounds and empirical grounds. Conceptually, one should begin by asking: what it the alternative fiscal regime to which Starve the Beast is being compared? The natural alternative is the regime that was in place during the 1990s, which I call Shared Sacrifice. During that time, any congressman wishing to increase spending had to show how they would raise taxes to pay for it. Logically, a Congressman contemplating a new spending program to benefit some favored supporters will be more inhibited by fears of constituents complaining about an immediate tax increase (under the regime of Shared Sacrifice) than by fears of constituents complaining that budget deficits might mean higher taxes many years into the future (under Starve the Beast). Sure enough, the Shared Sacrifice approach of the 1990s succeeded. Compare this outcome to the sharp increases in spending that took place when President Reagan took office, when the first President Bush took office, and when the second President Bush took office. As with the Laffer Hypothesis, more systematic econometric analysis confirms the rejection of the hypothesis.

These matters are not solely of interest to historians or economists. The presidential campaign of Senator John McCain appears set to drive its wagon down the same road in which Reagan and Bush have already worn deep ruts. The candidate is apparently selling the same snake oil: he says he believes that tax cuts increase revenues. His principle policy director disavows the Laffer Principle, just as the economists who advised Presidents Reagan and Bush did. But the views of the economic advisers are not what determines what these presidents do.

“The Queen in Alice in Wonderland said that, with practice, she was able to believe as many as six impossible things before breakfast. Most of us are more limited in our capacity for credulity. If John McCain believes both the Laffer Proposition (tax cuts raise revenues) and Starve the Beast (higher revenues lead to higher spending, anathema to conservatives), then as a good conservative, his duty is clear. He ought to run on a truly novel platform of higher tax rates! Why? Higher tax rates would reduce revenues (this is what Laffer says would happen) and thereby reduce spending (this is what Starve the Beast says would happen).

Seriously folks. If McCain continues to propose extending the Bush tax cuts, he should at least be forced to choose between the Lafferite defense and the “Starve the Beast” defense. Only then can the rest of us know which of the two mutually inconsistent propositions to refute.

As the economic debacle facing Americans continues to materialize, those responsible are running for cover with ten Republican senators refusing to attend their own national convention. Four years ago we observed that the so-called “Republican philosophy” of small government, sound money, and balanced budgets was illusory in terms of the history and then-current policies of the Republican Party.[1] However, even we would never have guessed how awful the Republican Party economic policy would become. From mere mercantilism, the Republican Party is now flirting with comprehensive socialist economic policy and another Great Depression.

But the real problem is that their policies will lead to the nationalization of much of the mortgage-real-estate market. On July 30, 2008, President George Bush signed a bill into law that bails out Fannie Mae and Freddie Mac to the tune of an estimated $25 billion dollars in taxpayer losses, according to the Congressional Budget Office (CBO). The bailout is intended to stabilize the short-term economy, but this ill-conceived nod to socialism will have disastrous long-term effects. First, according to most economic estimates, the bill that taxpayers would have to eat is laughably small. Economist Don A. Rich has calculated the possible losses at as low as $1.3 to $1.6 trillion given likely housing price declines and as high as $2.5 trillion (if the housing price fall mimics that of the Great Depression).[2] The fallout from either of these scenarios would be catastrophic as the Federal Reserve accommodated (within the fiat money system) the taxpayer-backed debt. The real debt would be inflated away and America’s real income could be reduced by as much as twenty percent.

Further, every incentive by profit-seeking lenders and asset-poor buyers will be in place for a continuing or recurrent mortgage debacle. Financial institutions will not only have mercantile “protection” from the federal government in terms of regulations; they will become social arms of that government. While Democrats certainly facilitated these economic actions as fellow travelers, Republicans, most especially George W. Bush, acquiesced. (His only objection was a $4 billion grant to states and cities to “refurbish” foreclosed homes). The economic choice is clear: either maintain a fiat-money-creation system and reinstate the asset proscriptions of the Glass-Stegall Act or abandon or modify the existing system of money and banking altogether, possibly including elements of a gold standard. Without some basic alteration in rules, the entire economic system will continue to be at risk, as will America’s predominance in the world of finance.

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Notes

[1] Robert B. Ekelund and Mark Thornton, “Republican Redux,” Review: Milken Institute (Third Quarter, 2003): 5-7 and Robert B. Ekelund, “The Awful Truth about Republicans” (March 25, 2004).

[2] Don A. Rich, “The Real Cost of a Full Bailout” (August 22, 2008).

by Ludwig von Mises

The Characteristics of the Market Economy Capital Capitalism The Sovereignty of the Consumers Competition Freedom Inequality of Wealth and Income Notes

This article is excerpted from chapter 15 of Human Action. Robert Murphy has written a study guide for this chapter, available in HTML and PDF. This chapter follows “The Scope and Method of Catallactics.”

1. The Characteristics of the Market Economy

The market economy is the social system of the division of labor under private ownership of the means of production. Everybody acts on his own behalf; but everybody’s actions aim at the satisfaction of other people’s needs as well as at the satisfaction of his own. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens. Everybody is both a means and an end in himself; an ultimate end for himself and a means to other people in their endeavors to attain their own ends. This system is steered by the market. The market directs the individual’s activities into those channels in which he best serves the wants of his fellow men.

There is in the operation of the market no compulsion and coercion. The state, the social apparatus of coercion and compulsion, does not interfere with the market and with the citizens’ activities directed by the market. It employs its power to beat people into submission solely for the prevention of actions destructive to the preservation and the smooth operation of the market economy. It protects the individual’s life, health, and property against violent or fraudulent aggression on the part of domestic gangsters and external foes. Thus the state creates and preserves the environment in which the market economy can safely operate.

The Marxian slogan “anarchic production” pertinently characterizes this social structure as an economic system which is not directed by a dictator, a production tsar who assigns to each a task and compels him to obey this command. Each man is free; nobody is subject to a despot. Of his own accord the individual integrates himself into the cooperative system. The market directs him and reveals to him in what way he can best promote his own welfare as well as that of other people. The market is supreme. The market alone puts the whole social system in order and provides it with sense and meaning.

The market is not a place, a thing, or a collective entity. The market is a process, actuated by the interplay of the actions of the various individuals cooperating under the division of labor. The forces determining the — continually changing — state of the market are the value judgments of these individuals and their actions as directed by these value judgments. The state of the market at any instant is the price structure, i.e., the totality of the exchange ratios as established by the interaction of those eager to buy and those eager to sell. There is nothing inhuman or mystical with regard to the market. The market process is entirely a resultant of human actions. Every market phenomenon can be traced back to definite choices of the members of the market society.

The market process is the adjustment of the individual actions of the various members of the market society to the requirements of mutual cooperation. The market prices tell the producers what to produce, how to produce, and in what quantity. The market is the focal point to which the activities of the individuals converge. It is the center from which the activities of the individuals radiate.

The market economy must be strictly differentiated from the second thinkable — although not realizable — system of social cooperation under the division of labor: the system of social or governmental ownership of the means of production. This second system is commonly called socialism, communism, planned economy, or state capitalism. The market economy — or capitalism, as it is usually called — and the socialist economy preclude one another. There is no mixture of the two systems possible or thinkable; there is no such thing as a mixed economy, a system that would be in part capitalistic and in part socialist. Production is directed either by the market or by the decrees of a production tsar or a committee of production tsars.

If within a society based on private ownership of the means of production some of these means are publicly owned and operated — that is, owned and operated by the government or one of its agencies — this does not make for a mixed system which would combine socialism and capitalism. The fact that the state or municipalities own and operate some plants does not alter the characteristic features of the market economy. These publicly owned and operated enterprises are subject to the sovereignty of the market. They must fit themselves, as buyers of raw materials, equipment, and labor, and as sellers of goods and services, into the scheme of the market economy. They are subject to the laws of the market and thereby depend on the consumers who may or may not patronize them. They must strive for profits or, at least, to avoid losses. The government may cover losses of its plants or shops by drawing on public funds. But this neither eliminates nor mitigates the supremacy of the market; it merely shifts it to another sector. For the means for covering the losses must be raised by the imposition of taxes. But this taxation has its effects on the market and influences the economic structure according to the laws of the market. It is the operation of the market, and not the government collecting the taxes, that decides upon whom the incidence of the taxes falls and how they affect production and consumption. Thus the market, not a government bureau, determines the working of these publicly operated enterprises.

Nothing that is in any way connected with the operation of a market is in the praxeological or economic sense to be called socialism. The notion of socialism as conceived and defined by all socialists implies the absence of a market for factors of production and of prices of such factors. The “socialization” of individual plants, shops, and farms — that is, their transfer from private into public ownership — is a method of bringing about socialism by successive measures. It is a step on the way toward socialism, but not in itself socialism. (Marx and the orthodox Marxians flatly deny the possibility of such a gradual approach to socialism. According to their doctrine the evolution of capitalism will one day reach a point in which at one stroke capitalism is transformed into socialism.)

Government-operated enterprises and the Russian Soviet economy are, by the mere fact that they buy and sell on markets, connected with the capitalist system. They themselves bear witness to this connection by calculating in terms of money. They thus utilize the intellectual methods of the capitalist system that they fanatically condemn.

For monetary economic calculation is the intellectual basis of the market economy. The tasks set to acting within any system of the division of labor cannot be achieved without economic calculation. The market economy calculates in terms of money prices. That it is capable of such calculation w-as instrumental in its evolution and conditions its present-day operation. The market economy is real because it can calculate.

Continue at : http://mises.org/story/3029