The Socialist's Scapegoat

It was 1991. I was only an infant, the first George Bush was in the White House, and in December of this year, the Soviet Union collapsed. They were caught up in the arms race and the space race with the U.S. They lost both of them. They were outspent by the U.S., and this led to the collapse of the Soviet Union. At least, that is what is commonly taught. It's never flat out said that the Soviet Union was attempting to organize society under the flawed system of socialism. If it is, it's not what I was taught in public school.

No, contrary to what seems to be popular belief, no matter how much the U.S. chose to spend, it's not what caused the collapse of the Soviet Union. It sounds a little silly when you think about it. Today, if another country decided it was going to spend massive amounts of money, would that cause the U.S. to collapse? Not unless they attacked us. Otherwise, who cares what another country spends. The truth is, the Soviet Union collapsed from within, from its failing economic and social structure. But it seems that history/media tends to cover up the negative consequences that have stemmed from socialism. As you will see, this isn't the only example.

If you ask someone what caused the latest recession in the U.S., they would most likely blame banks that gave out bad loans based on greed... To make a profit as the little guy's expense. If we believe this, the obvious response to such a problem would be to more strictly regulate the banks. It just so happens, that seems to be exactly what the public is calling for. The conclusion that has been reached is that unrestricted capitalism isn't practical. Regrettably, I once believed this. We tend to believe things, if everyone is saying it. 

Let's look at the real causes of the recession. Yes, it goes back to the banks, but it goes beyond that. The accusation is that banks gave out bad loans based on greed. Well, in a free market system, there is no profit in giving out bad loans. Banks make a profit when loans are payed back, so they should have no reason to give out bad loans. So why were these loans given? It goes back to the Community Reinvestment Act, through which the government gave banks incentives to give out loans to lower income levels. This was done in the name of helping the poor (it didn't) - A socialistic policy. 

This policy led directly to the artificial housing boom. Those loans should have never been made, as there was no real credit available to many of the people who got loans. They would have never been made in a purely capitalistic system. But they were. Then reality struck back, when people couldn't pay off these loans based off of false credit. Seems like, if nothing else, this would be a great economic lesson for us. But, no, somehow they still managed to blame the recession on capitalism and greed, and we believed it. 

When when will the people stand up to the propagandists? My hope is that people won't believe what they are told, but will look into issues thoroughly, then make their own conclusions. If not, the problems we are facing may continue to be attributed to the wrong cause. I expect the lies to continue. I have already seen capitalism blamed for the recent riots in England. Why, you ask? It's because someone whose livelihood depends on defending a flawed system must find a scapegoat. Socialists found capitalism.  

A Free Market Approach to the Great Depression

Some of the most important lessons can be learned by studying history - that's why I have always enjoyed it. This is especially true for economics. If we want to understand how to deal with our current economic problems, let us look to the past and learn from the mistakes of those before us. The Great Depression is naturally a time that most economists like to point to, as a lesson. Being the most severe and long lasting recession in U.S. history, there is definitely a lot we can learn from it. While most of us studied The Depression in school, it seems that the general public does not have a firm understanding of it. Much of what we do understand is based off of myths and fallacies. I want to approach this subject from an Austrian economics view, a more free-market perspective, in order to dispute some of the misconceptions of the Depression Era.

Consider the common teachings on the Great Depression. We have all been told that it was started by the stock market crash of 1929. Stocks were being bid up higher and higher, until it was realized that the stocks were over-valued. People began to sell. Stock prices dropped. The people who hadn't sold realized their stocks were worthless, causing a rush on the banks. But the banks were broke too, and suddenly the entire country was poor.

Then we were told of how we escaped the Depression. The FDIC was created, the government began guaranteeing people's bank savings. This was part of the Glass-Stegal Act, which also prevented the banks from investing people's savings. All of this was meant to gain back the saver's faith in the banking system, and stabilize the economy. Then we look to monetary policy. The Federal Reserve began buying up treasury securities (although they temporarily sold them, running a contractionary policy, and worsening the Depression), increasing the money supply, and expanding the supply of credit, in hopes of increasing economic activity. Finally, we are taught that the long Depression ended with World War II. As unemployment dropped to nearly nothing, and GDP grew exponentially, it was clear that the Depression was over - or so they say.

Now, let's look at this from a different, and in my opinion more logical, point of view. We know that the Great Depression started with the crash of '29. But what caused the crash? Markets have natural positive and negative shocks, but they don't just crash spontaneously.  It's given that stocks were tremendously overvalued, and eventually the bubble burst. But a free-market economist would tell you that a market should not naturally be that far out of equilibrium. The only way for stocks to be so overvalued, is if the market was tampered with.

We know about the bust, what about the boom? Today, it is known as the Roaring Twenties. It was a time when GDP and prosperity rose exponentially. How did this all come about, we wonder. First, we should look to the creation of the Federal Reserve in 1913. As a young entity, the Fed would prove to make several mistakes. The first of which came in the early 1920s, when the Bank of England, wanting to keep its artificially high-valued currency, asked the U.S. to devalue the dollar. We agreed, mainly in order to help farmers increase their exports. The Fed expanded the credit supply through an increase in the money supply by about 60%. Prior to this, the country had also seen excessive spending to finance World War I.

This expansion in credit was created out of thin air. There was no real wealth being added to society, so there was no real increase in the supply of credit. It was a mythical credit expansion based off of the Fed's expansionary policies and the government's printing of money. The excess spending added no real wealth. In fact, the spending for WWI only destroyed, not created, wealth. But as the credit market was manipulated, people believed the expansion to be real and increased their spending during the Roaring Twenties. Since this false wealth could not continue forever, it had to leave the economy in some form - either through inflation or devalued capital. Think of the stock crash as the devaluing of capital. The stocks that had risen in price, had not risen in value. As people realized this, it created a run on the stock, then a run on the banks. Benjamin Strong, Governor of the Federal Reserve Bank of New York from 1914 to 1928, put it like this - "Very few people indeed realized that we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis." 

Critics of Austrian economics often argue that it offers no solutions. I would disagree. While it may not offer the same crowd pleasing, slogan solutions that Keynesian economics does, it offers more practical and logical solutions. Instead of looking at the busts, we should look at preventing artificial economic booms. It is  important to understand that credit cannot be truly expanded at the snap of the Fed's fingers. The government cannot add wealth to the country with the push of a button. Solution: stop manipulating the markets.

The commonly understood solutions to the Depression seem fallacious. The Glass-Stegal Act, while probably necessary only because of the prior harmful government interference, may have done more harm than good. As stated, it prevented banks from investing people's savings. This may sound good, however, it can be viewed as a prevention of real credit expansion. Banks are able to create money, by putting people's savings to economic use until the people need those savings. They lend the money to a corporation, through stocks, the corporation then uses that money for further investment. The bank gets the return on the investment, and is then able to loan out more money. This differs from the false credit expansion created by the Federal Reserve, because the corporation was able to add real value to the economy through the extra money available for investment. Unfortunately, this aspect of the Glass-Stegal Act remained in effect until 1999, so we will never know the economic growth that was potentially lost.

One aspect of Glass-Stegal that remains in place is the FDIC. The FDIC has helped people keep their faith in the banks, but is this such a great thing? The fact is, when you put your money in a bank, there is some risk involved, however slight it may be. Banks make money by loaning out and investing our savings. There is a chance, when you put money in a bank, that you will never see it again. Once again, it's not high risk, but there is a risk that should be accounted for. The FDIC manipulates with the market by taking away that risk. Falsely taking it away, that is. The FDIC can only protect your savings as long as the government can afford it. If the banks went broke, and everyone demanded payment from the FDIC, I doubt they would be able to pay off the entire country. Banks are not meant to be 100% safe, nor should they be considered so.

Possibly the most irritating myth of the Great Depression is that we escaped it through WWII. While it is true that unemployment went down and GDP rose during WWII, this says nothing about the quality of life. Of course unemployment was down, the men were overseas fighting a war. Back home, many basic necessities were rationed. That doesn't sound like prosperity to me. This is a perfect example of why unemployment rates are not always a good economic indicator. If you go by unemployment rates, might as well have locked everyone in jail, and considered the Depression over.

Truly, the Depression did not end until after WWII. At this time, government spending was finally cut. Thanks to Keynesian economics, we were able to end the Great Depression, only a couple of decades after it began.

Being one of the worst crises in American history, the Great Depression should be an important point of study. Unfortunately, most of us only understand generalities of the time period. "The stock market crash of 1929 led to the Great Depression." This tells us very little, and isn't helping us learn from the mistakes of our past. The free market approach is almost an untold story, in education. It is my hope that this perspective will be given a chance. After all, as evidenced by the latest recession, we haven't learned that much from Keynes.

The Job Creators

What will you do to create jobs? - This is a common question we hear asked of political candidates. It sounds like a fair question, especially in a country that has seen persistently high unemployment rates for a few years. People want to know what will be done to raise employment, and many believe this will be a deciding factor in the 2012 presidential election. 

However, while I agree that economic concerns need to be taken highly into account during the next election, I take issue with this question. When did the people of the United States, traditionally the most entrepreneurial country in the world, begin to expect the government to create the jobs? No, contrary to what seems to be popular belief, the government shouldn't create our jobs, nor should politicians. People are the job creators. 

Sure, the Obama stimulus created jobs, but temporarily. And in most cases, they seemed to be jobs given just for the sake of jobs. The result of these jobs, that I have witnessed, is pointless, useless new roads were built all over the country. At whose expense were the jobs? The taxpayer's. Yet the people who paid for these jobs, didn't get to tell their employees what jobs they wanted done. No, the jobs were determined through central planning, with the idea that it doesn't matter what the job is, as long as people are working. The 780 billion dollar stimulus was the largest in our history. If government spending truly creates more jobs, we should have seen a fast recovery from the recession. To the contrary, we have seen an abnormally slow recovery. 

So I propose a different sort of economic question for the candidates. What will they do to allow job growth and prosperity? No, I don't want the government to create a job for me at the taxpayer's expense. All I ask, and what I believe my fellow Americans should ask, is - What will the government do to stay out of the way, and allow jobs to thrive?

This doesn't mean "do nothing." There is a lot that can be done, but we should look at what the government needs to cut, rather than what it needs to add. It's not difficult to see what is causing harm to businesses. I spoke to a local air conditioning repair business owner yesterday. He had only three complaints. The first of which was the record setting heat wave, here in Little Rock. Then, he told me of how the sharply rising freon costs (stemming from EPA regulations) have hurt his business. The other complaint was about the government's mandates on thermostats, in an attempt to limit mercury (although the new thermostats still use mercury). Apparently, the government has created a monopoly on thermostats. As the A/C repairman put it, "It's not OK for anyone else to sell something with mercury in it, but it's OK for the government." 

The traditional way of approaching macroeconomic problems is to look at the aggregate numbers, and try to manipulate them into improvement. In my opinion, looking at the motivations of individuals, like my A/C repairman and other business owners, would be a better way of addressing economic problems. If you take this approach, it's blatantly obvious what is holding the recovery back. Here's a hint: it's not the lack of regulation in the market.

Let's stop asking our elected officials what they can do for us. Ask them what they can stop doing.

Life, Liberty, and the Pursuit of Great YouTube Videos

Here are some great videos on personal and economic freedoms:

One thing that stands out in this video is- the poorest people in the most free countries have a higher share of wealth than poor people in the least free countries. This means poor people in capitalist countries have a higher share of the wealth than they would in a communist country! Amazing, isn't it? How can this be? When you give so much power to a central government, you can't expect to be treated equally. Who do you suppose benefits from a communist system? Mostly, government officials and employees. They are able to build wealth while they force everyone else to be "equal."

If you went to a public school (like me), you've probably seen the graphs showing the inequality of wealth in the U.S. It's used as an argument for the redistribution of wealth, but if you consider the facts brought up in the above video, it really doesn't make sense. That's okay. Propaganda doesn't have to make sense.

This is one of my favorite videos, but I won't say much about it because it articulates the point way better than I could. But if you agree with this video, you must question even the basic idea of a progressive income tax system.

This video brings up a great point that many seem to forget. When we ask for government security, we are also asking for limitations on liberty. So, I ask you, how far do we allow the government to go in securing us? Our welfare, our health, our property? When you allow the government security over these things, you give also give up your own right to choose how you manage those things. Take public health care for example - If the government secures your health, they now have a right to tell you want you can and cannot eat or drink. Personally, I would rather be held responsible for my own health, and choose what I consume.

A Tragic Hypocrisy

The manufacturing industry of the United States is widely regarded as the most important industry for jobs. We hear it from the politicians. We hear it from the media. We even start to hear it from ourselves. It's used as a reason for bailing out large automotive companies and as an argument for tariffs and quotas against countries such as China, that compete with our manufacturing industry. They're too big to fail, of course. What would happen to the workers and their families if General Motors closed down?

I don't know of many people who aspire to be factory workers, but in the U.S., we have a peculiar obsession with those types of jobs. Has anyone questioned the importance of the manufacturing industry? If someone in the media has, it has went unnoticed. Certainly no politicians have. With the Democratic Party being funded by labor unions, and the Republicans funded by corporate fat cats, they wouldn't dare.

I guess it will have to be me.

Let me first say that I will not refute that manufacturing does currently provide many jobs for our economy. What I do argue is that those jobs are not any more important than any other type of job, and they are very much replaceable with other industries. Consider another industry that was once considered the backbone of America - farming.

Until the mid 1900's, 70-80% of jobs in the United States were farming related. Today, that number is down to about 2%. Yes, those farming jobs were "lost." But how many people would like to go back to those days, for the sake of keeping so-called important jobs? We produce significantly more food, with less effort now. So what happened to the people who lost their farming job? They moved on to something else that there was demand for, namely manufacturing jobs.

Sounds like the transition went smoothly, right? Wrong. Just as there are people today arguing that the manufacturing industry should be kept afloat at the expense of the public, there were people making the same arguments for farming jobs then. Franklin Roosevelt went as far as to pay farmers to destroy their crops! The intention was to keep the farmers well off (remember, this was the "important" industry of the time) and raise the price of food, for the farmers benefits. Well, anyone with common sense would tell you that destroying a country's food supply during a depression could have some negative effects on consumers, and it did. Many went hungry. Our government propped up an industry that was trying to shrink. Who knows how much the country was held back due to policies preventing the economy from progressing. But it was all for the sake of the precious farming jobs.

This was a long time ago, in a very different era. So you may be wondering what FDR's food destruction policies have to do with current industrial protectionists. We would never be so foolish as to destroy resources for the sake of a certain industry, would we? It turns out, we're just as foolish now as we ever were. Consider what a tariff or quota truly does. It limits the availability and raises the prices of goods, in the name of job protection. Sounds familiar, doesn't it? I wonder which industry we are preventing from development now.

My Republican friends are the first to bash FDR, especially for his food destruction plan. He's considered one of the worst presidents ever, by some (and I would agree with that). Yet many of those same people clamor for quotas and tariffs against those job-killing Chinese. That, my friends, is a tragic hypocrisy.

A Follow Up- Who Really Pays the Price?

In my previous post, the question was posed- When a business incurs and unexpected cost, is it passed down to the consumer? I came to the conclusion that it was not, but promised I would take the question into further consideration. Well, after months of deliberation, I have a definitive answer. I know all 3 of you eager readers out there have been waiting for a follow up. I will not disappoint.

While trying to answer the, by now, age-old question, there was a flaw in my thought process. I was attempting to find a general answer for a question that needs to be addressed on a case-by-case basis.

Let's look at the question from perspective of a large corporation, McDonald's. When Mickey D's experiences an unexpected cost (maybe they lost a lawsuit over hot coffee), does the price of a Big Mac rise? In this scenario, my logic works well. McDonald's would have already been charging the profit maximizing price. An increase or decrease in the price of a Big Mac in response to the unexpected outside cost, would only decrease McDonald's profits.

Now, we'll attack this question from another view point. A poor college student decides to start producing and selling bowls. One day, while deliver bowls, the entrepreneur is ticketed for speeding. Would this mean an increase in the price of bowls? Most likely, yes.

What's the difference? A large corporation will likely have large amounts of excess/rainy day funds. When they receive an unexpected cost, they can use these excess funds to maintain the same level of production of services or products (in this case, Big Macs). So for McDonald's, the supply curve doesn't shift leaving them at the same profit maximization price.

On the other hand, the poor college student likely has very limited excess funds. That means that they will be able to afford less resources, after the unexpected cost. In turn, they are not able to produce as many bowls. This would be a negative supply shock for the poor college student, increasing the profit maximization price.

Obviously, most businesses are somewhere in between, but in each case, the answer to the question depends on whether or not the business has enough in reserve to make up for the cost. If they do, it would be in their best interest to maintain the current level of profit. Meaning, there would not be a change in prices. If they do not, you could realistically see the customers pay the price. To summarize, it is possible that consumers would pay for an unexpected cost to a particular firm. Does that mean it's likely? Since most businesses seem to have some sort of excess or rainy day funds (especially the ones that would be subjected to the most extreme unexpected costs), I would think not.

So there you have it. I will now consider this case closed, as I have spent way too much time on it.

Who Really Pays the Price?

When a company experiences an unexpected cost, what happens? Is the cost passed down to "us" (the consumer) or does the company just lose money?

Intriguing question. I have mulled this over for several months. The question first entered my mind during a Legal Enviroment of Business class at my university. This class was extrordinarliy dull, but on this particular day, a debate had sprung among a few of my fellow students. I distinctly remember two students bringing up some interesting points. I do not remember the names of the students involved, but for the purposes of this writing, I shall give them names. Fighting out of the blue corner, was a non-traditional student. He was a polite, middle-aged man, say, 42 years old, who often contributed to class discussion. From this point on, I will call him Steve. In the red corner, we had your typical college student. He was about my age, red-headed, and passionate about random subjects for unknown reasons. He will be known as Brian.

Now, as I said, the class was extremely boring, so I do not exactly remember the subject of that day's class, but somewhere along the line, the class started discussing the frivolous lawsuits that you see so often against companies, in this day and age. Some in the class seemed happy that the consumer (the little guy, the underdog, cinderella) is being protected heavily from exploitation by the companies (the fatcats, bourgeoise bastards, the guy with the cigar from monopoly). Obviously, your typical Democrat vs. Republican battle would ensue. But a certain exchange of words stuck out to me. Paraphrasing (heavily paraphrasing)-- "It's important to have laws in place to protect people like you and I from being taken advantage of by companies that can afford the best lawyers and such," said Brian. Steve responded without hesitation, "Yes, but it's also important to create a business friendly enviroment. The welfare of the major companies is very much connected to the welfare of the average person. After all, when a company experiences a cost, from something such as a lawsuit, who do you think pays for it? You and I do. I own a small business, and when I receive an unexpected cost, I raise prices and pass it down to the consumer."

At this point, alarms are going off in my brain. As a student of economics, I assume that all for-profit organizations are always attempting to operate at a profit maximizing level. That was econ-speak for - you want to make as much money as you can. Assuming a firm is operating at a maximum profit price-level, why would a company adjust it's prices after an unexpected expense? If they were truly operating at full-profit, then changing prices, either an increase or decrease, would only decrease profits for the firm.

I considered calling Steve's bluff right then and there, but I decided not to. Besides, I liked Steve. Not enough to remember his given name, but I liked him. I could have spoken with him after class, but I did not have time to fully shape my thoughts. Had there been enough time for my humble thoughts to evolve, I would have asked him why, if he thought he could increase profits by adjusting his prices, why had you he not done so before he incurred the unexpected expenses? Was Steve just that nice of a guy? I don't think so.

As for Brian, he lost the debate, even though Steve's argument may have been flawed, but Brian will live to fight again.

Now, to answer my question -

When a company experiences an unexpected cost, is it passed down to the consumer?
As I see it, no. I just do not see it. Of course, I could be wrong, and I will continue searching for a more definitive answer. But, for now, the answer is NO.

Thomas Sowell makes a similar argument to Steve's in Economics Facts and Fallacies. Sowell claims that rent caps for one apartment causes rent to rise in another. Apartment owners raise their prices in certain apartments to make up for revenue lost due to rent caps in another apartment. See the flaw in Sowell's logic? I do. Sowell, however, is a well known Conservative, so I wonder, does he truly believe what he is saying or does he organize facts to fit his agenda? Could be both. Given the title of the book, I would have liked for Sowell to look deeper into the issue and take a more logical approach. Oh well.

It is an interesting topic for me. Many people do not see it as I do. Either I am wrong or the general public, Steve, and Thomas Sowell are wrong. Without a doubt, someone is wrong (or lying).