Economics

Basics of Economics

Understanding economics can enable you to see a clearer vision of history, the present, and the future. With it you will improve your comprehension of activities and their results among the societies, governments, businesses – and most specifically, humans – that make up the world. The following is a walkthrough of a few key fundamental concepts of economics, which reveals the reasoning behind today’s broken economic system.

Contents:

  1. Humans Deal with Limited Resources
  2. Everyone’s Values are Different and Subjective
  3. Voluntary Trade Embraces Everyone’s Differences
  4. Money Makes Trade Easier
  5. Prices are at the Core of Economics
  6. Entrepreneurs and Profit Play Important Roles
  7. Economic Activity is Largely Subjective
  8. An Economy Cannot be Centrally Controlled
  9. A Failed Economic Theory Guides the U.S. and World Economy
  10. The Federal Reserve “Controls” Our Economy (and your money)
  11. Government Regulation of Industry Contributes to Economic Distortion
  12. Your Dollars Are Backed by Nothing
  13. Economic Fallacies We All Should Know
  14. Economic Theories
  15. The Science of Free Markets

Humans Deal with Limited Resources

–          There is a finite amount of accessible and usable resources (material and human) on the earth (air, sun energy, and water are ubiquitous, but not infinitely permanent resources) at a given time – This translates into a finite amount of products produced and services offered at a given time.

–          It is in everyone’s interest to efficiently allocate these resources while preserving order and freedom for each individual.

Everyone’s Values are Different and Subjective

Every action an individual takes involves an exchange to maximize value—a giving up of a state of affairs for what the actor expects will be a more satisfactory state. Here are a few simple, non-economic examples:

–          You chose to get out of bed this morning because you valued the action more that not getting out of bed

–          You chose to skip breakfast because you valued doing something else with that time more than the value you would have received from eating

–          You chose to get a job as a waiter because you valued the salary and activity more than doing something unproductive and more than being a bartender

In all cases of value decisions, the reason why only matters to you.

Relating value to economic decisions, when you buy a product:

  1. You value the product more than the money you paid for it.
  2. The business values the money you paid more than the product it sold to you.

–          Since each individual values things differently based on their own opinions and needs, value is subjective

–          Since value is subjective and therefore cannot be measured, value is determined based on an order of preference for a product or service valued over another (i.e. a value scale).

–          Voluntary exchange – or trade – of products and services enables the most efficient allocation of these products and services while preserving each individual’s freedom.

For additional information on the role of value in economics:

An Action as An Exchange – Man, Economy, and State – Murray N. Rothbard

Determination of Price: Equilibrium Price – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute lecture – Scarcity, Choice, & Value (video & audio)

Voluntary Trade Embraces Everyone’s Differences

Each individual possesses unique abilities physically and intellectually. For example, one person specializes in making shoes, while another can engineer and build televisions. However, just because the person that makes shoes can’t make a television doesn’t mean that they wouldn’t find value in having a television.

The existence of varying abilities, needs, and desires among individuals naturally leads to the division of labor, and ultimately to trade. Initially, trade was performed through barter (absent of money).

Example using modern products:

–          John knows how to create TVs from scratch – He created 2 TVs.

–          Mike knows how to create running shoes from scratch – He created 10 pairs of shoes.

–          John wants 3 pairs of running shoes, but doesn’t know how to make them, and he only wants 1 TV.

–          Mike wants 1 TV, but doesn’t know how to make it, and he has more than enough shoes for himself.

–          This situation provides a great opportunity for exchange.

–          Since John values the 3 pairs of shoes more than 1 of his 2 TVs, he is willing to trade a TV for the 3 pairs.

–          Since Mike wants a TV and has plenty of shoes, he gives John 3 pairs to take the TV.

–          Both individuals feel better off now that the exchange has been made.

Money Makes Trade Easier

Money has emerged and makes exchange easier because:

  1. Items desired in a direct trade are not always owned by both parties attempting to trade
  2. Many items are indivisible – When you divide the item (if it can be divided) for separate transactions each piece does not hold the same level of value as it did when it was part of the whole – An example is a TV cut in half – Each piece is worthless, when the 2 pieces together made a functioning television worth much more than its two separate halves.

Continuing the John and Mike example:

–          If Mike only has 1 pair of shoes left and is willing to trade it for a TV, the trade would not take place through barter because John wouldn’t be willing to trade the TV if he only gets 1 pair of shoes. Also, he can’t give Mike 1/3 of the TV as the TV would not function and would lose its value.

–          But, if in the past, Mike sold 2 pairs of his shoes for $100, he can now give John the 1 pair he has left plus $100 for the TV.

–          John can then use the $100 to buy 2 more pairs of shoes somewhere else to end up with the 3 pairs he needed.

–          In this case the trade could not have been made without money, or a symbol of value for exchange.

Money is simply a symbol of the value of your production which makes the trade of that production easier.

Some Implications of the Emergence of Money – Man, Economy, and State – Murray N. Rothbard

The Emergence of Indirect Exchange – Man, Economy, and State – Murray N. Rothbard

Prices are at the Core of Economics

Prices Connote Value and Address Resource Scarcity

–          In the first part of the John and Mike example, John charges 3 pairs of shoes for a TV, Mike charges 1 TV for 3 pairs of shoes.

–          The price was 1 TV for 3 pairs of shoes and vice versa.

–          If John had only made 1 TV instead of 2, TVs are more scarce than they otherwise would have been had he made 2. In this case, John may have required more than 3 pairs of shoes (or something in addition to the 3 pairs) to trade his only TV.

Supply and Demand Sets Prices

–          On a population level, supply of and demand for products and services impacts their prices.

–          If the supply of a product increases and customer demand stays the same, the price will be lowered by the sellers until the amount demanded by the customer equals the amount supplied. The sellers lower the price because they need to sell all of the products they have produced.

–          If the customer demand of a product becomes greater than the amount supplied, the price of the product will rise to reduce demand to the level of the amount supplied (i.e. if supply is not changing, the finite number of products would go to the people that are willing to pay the most)

–          When the price rises, the offering of the product becomes more profitable to the entrepreneur (the producer and seller), therefore, more entrepreneurs will flock to the industry (additional competition) to produce and sell more of the product. This increased supply will cause prices to fall again.

–          As you can see, the subjective value of the customer and entrepreneur heavily influences prices.

For additional information on supply and demand, and determination of prices, the following links may be

helpful:

Prices and Consumption – Man, Economy, and State – Murray N. Rothbard

Prices and Consumption Study Guide – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute lecture – The Determination of Prices (video & audio)

Interest Rates are the Prices of Money

Money abides by the same laws of supply and demand and consumer products.

–          If you immediately need money that you do not currently possess, you are willing to pay a given interest rate on a loan. That is the price you are willing to pay for having that money now (based on your time preference for money).

–          At a certain interest rate price level, the bank that provides the loan doesn’t need the money as immediately as you do.

–          Just as with consumer products, as the supply of money rises, the interest rate (or price) falls, and vice versa.

–          Absent an interest rate-manipulating central bank, interest rates are naturally set by the market as are prices of consumer products.

–          Just as with consumer product prices, subjective value heavily influences interest rates.

For additional information on the determination of interest rates, the following links may be helpful:

Production: The Rate of Interest and Its Determination – Man, Economy, and State – Murray N. Rothbard

Production: The Rate of Interest and Its Determination Study Guide – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute Lecture – Capital, Interest, and the Structure of Production (video & audio)

Wages are the Prices of Labor

–          Labor abides by the same laws of supply and demand as consumer products.

–          If the supply of labor is higher than what is demanded (more people are without jobs and in the job market) wages fall.

–          If there are few people looking for jobs, yet business is demanding more employees, wages rise.

–          Subjective value heavily influences the price of labor, or wages (as shown in the diagram below)

For additional information on the determination of wage rates, the following links may be helpful:

Production: Particular Factor Prices and Productive Incomes – Man, Economy, and State – Murray N. Rothbard

Production: Particular Factor Prices and Productive Incomes Study Guide – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute Lecture – Pricing of the Factors of Production and the Labor Market (video & audio)

All Prices are Based on Subjectivity

Interest, wages, and prices of products/services all stem from consumer subjectivity in the production and exchange of goods and services

The diagram below shows how the price a customer is willing to pay for a product drives the determination of all other factors of production, including employee wages, materials, machinery, etc. This concept applies to service industries as well.

Diagram: Subjectivity Determines Prices

Production: General Pricing of the Factors – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute Lectures:

The Determination of Prices (audio)

Money and Prices (audio)

Entrepreneurs and Profit Play Important Roles

Entrepreneurs create just about everything you own – look around and you will realize that nearly everything you see that was artificially created (or where its creation was enabled by various tools or machines) comes from a business which originated from an entrepreneur. Many of the items/services you purchase are for luxury, many were needed, some may be useless (but you wanted them), and many improve your standard of living.

Imagine your life without:

–          Air conditioning

–          Refrigerators

–          Clothes

–          Cars

–          Phones

–          Construction materials for houses

–          Computers

–          Televisions

–          And the list goes on…

Yes, you can live without these products as humans have in the past, but your standard of living has improved because of them.

The entrepreneur calculates that a product or service is desired by at least one other person (and usually many more), creates that product or service, and makes it available for purchase by the population.

Below is a nice short story that depicts the organization and complexity that go into the making of a simple product that many may take for granted.

I, Pencil: My Family Tree as told to Leonard E. Read – By Leonard E. Read

Entrepreneurs Take Extreme Risk

An entrepreneur takes significant risk. There are high-level errors that can be made which can drive their business to failure. They can:

–          Make the wrong product or offer the wrong service

–          Gauge or calculate the demand of the market inaccurately to offer too much of the product or service (wasted investment)

–          Gauge or calculate the demand of the market inaccurately to set the wrong price (e.g. people don’t buy even if the product is good because the price is too high)

Market calculations are fragile and must be made on an ongoing basis to make appropriate and timely adjustments as consumer demand is constantly changing for endless reasons.

There are also many risks and errors which can accumulate to drive the business to failure. A few are:

–          Running operations inefficiently (bad bookkeeping, setting the wrong wage levels, poor facilities management, etc)

–          Poor marketing of the product or service

–          Hiring bad employees

–          Lawsuits

–          Changes in government regulations

–          Crime

–          Disaster

If their business fails, they no longer receive income from their work activity, they may shoulder significant debt, and could be liable to lawsuits. Their lives can experience significant setbacks.

Profit is the Reward for Risk and Creation

The entrepreneur needs the potential upside of an attractive incentive to drive them to take the abnormal and extreme risk associated with entrepreneurial creation. Profit is the entrepreneur’s key incentive.

Take a look at some of the functions of profit:

–          Profit is often reinvested into the business, which translates into additional supply and innovation of products, which translates to better products, more job creation, and lower prices for consumers

–          Profit is often a safety net for the many risks entrepreneurs face (described above)

–          Profit enables employees’ salaries to increase over time

–          Profit taken home by the entrepreneur is often put toward good economic use through investment in other businesses outside of their own. A successful entrepreneur is likely to be a successful investor as they likely understand what it takes for a business to be successful.

–          Profit taken home by the entrepreneur that is used on luxury products and activities has a positive impact on the respective industry and thus the  economy as a whole

All of these functions of profit contribute positively to the economy by enabling more entrepreneurial creation, which translates into providing you with a higher standard of living.

For additional information on the function of the entrepreneur and profit, the following links may be helpful:

Production: Entrepreneurship and Change – Man, Economy, and State – Murray N. Rothbard

Production: Entrepreneurship and Change Study Guide – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute Lecture – Profit, Loss, & the Entrepreneur (video & audio)

Economic Activity is Largely Subjective

It should now be clear that supply and demand are based on subjectivity because:

–          You cannot force someone to buy a product – they must be willing to pay the price – a value judgment

–          You cannot force someone to create a business and sell a product:

  1. They must decide to do it on their own – a value judgment
  2. They have the freedom do decide how much of the product to sell
  3. Their decision and ability to sell the right amount at the right price will mean success or failure for their business

Because of the subjectivity of supply and demand it is extremely difficult to determine what a market is going to do (you cannot read peoples’ minds). Economic calculation, or the creation of certain products and services in appropriate quantities at appropriate prices, is a difficult task because no one can possibly know all of the variables involved. The best people for that job are the people directly interacting with that market – the entrepreneurs. They are most likely to minimize errors because the consequences for being wrong are great while they are driven by direct incentive for success.

A few of the concepts described above have used small scale examples for simpler communication. However, the concepts apply to the large scale economy, and not just among consumers and businesses, but between businesses as well.

An Economy Cannot be Centrally Controlled

Because of the subjectivity of economies outlined above, an economy cannot be controlled. A central controller or controlling body cannot possibly know the ever-changing demands of the millions or billions of individuals that make up an economy, nor can they know the infinite factors that drive those changes in demand.

Although America touts itself as a free market economy, it really is not. America consists of a planned economy controlled through:

  1. Keynesian economic principals
  2. The Federal Reserve (the U.S. central bank)
  3. Industry regulation

The following three sections outline the above economic planning concepts.

A Failed Economic Theory Guides the U.S. and World Economy

The main economic theory guiding the U.S. and world economies currently, and for most of the past seven decades, is Keynesian economics. The use of Neoclassical and New Keynesian economics attempts to control an economy through:

–          Monetary policy: attempting to regulate the speed of economic activity through interest rate/money supply adjustments (e.g. printing money/tax rebates)

–          Fiscal policy: attempts to influence economic activity through tax rates, interest rates, and government spending  (e.g. public works projects)

These actions are meant to affect aggregate demand and impact productive output, which is deemed by Keynesian economists as good for the economy. However, in the case that the actions do provide a boost, it is usually short-lived, causes price distortions, hampers economic calculation for entrepreneurs, and the underlying problems still exist. Understanding Say’s Law can help to explain why influencing demand is not the most ideal route to take for stimulating the economy.

Say’s Law in Context – The Mises Institute (2003)

Lord Keynes and Says Law – The Mises Institute (2005)

Say’s Law: Were (Are) the Critics Right? – William L. Anderson

Keynesian economics is driving the U.S. Federal Reserve and international central banks.

The key goals of this economic philosophy are to achieve:

  1. Full employment of resources – no involuntary unemployment, no idle resources
  2. Price stability – defending against deflation and inflation

Government Activity Exacerbates Unemployment:
Society will be as close as it can possibly be to full employment once government influenced wage restrictions (through unionism, minimum wage, etc) are eliminated. A business is not going to hire employees for more than they are willing to pay, which is defined by the level of capital the business brings in from what it produces. It will hurt the business to do otherwise. The business will find another way to accommodate the void that position is supposed to fill.

Involuntary unemployment can be dramatically reduced by allowing the market to define wage levels. For example, without a minimum wage, a person of low skill level and ability will be able to find some type of work because the job they are looking to fulfill is worth to the business a lower dollar value than what the minimum wage permits.

Also, it is damaging to attempt to add employment or allot resources through public works, such as building infrastructure or adding “green jobs”. This diverts money and resources from market-driven parts of the economy to government-driven parts of the economy (i.e. “crowding out”) through projects that are not only less economically fruitful, but will vanish once the project is over. Additionally, it does not allow for the proper natural economic correction of wages to transpire.

Wages, Unemployment, and Inflation – Ludwig von Mises (1958)

Full Employment and Monetary Policy – Economic Freedom and Intervention – Ludwig Von Mises

The Misesian Case Against Keynes – Hans-Hermann Hoppe (2009)

“Full Employment” and Freedom in America – Garet Garrett (1945)

Government Activity Exacerbates Price Instability:

Prices are inherently unstable. You cannot control prices because of the unknowns of supply and demand. When you add monetary policy (the Fed’s purposeful printing and retraction of money) you cause further price instability because you add the exacerbated variable of the supply and demand of money on top of the supply and demand of goods and services, which is already difficult to calculate.

One of the key ways the government attempts to prop up prices is through manipulation of the money supply. For example, in today’s environment, the government prints money to provide “economic stimulus“. The problem is that since an increased supply of money causes an increase in prices, the first receivers of printed money benefit the most. The later recipients of the added supply of money are harmed because at the later point, prices have risen, so their money does not buy them as much as the first receivers.

The increased instability makes economic calculation more difficult for business and consumers, which results in economic distortions.

The Myth of Price Stability – The Mises Institute (2003)

The Fateful Wish for Price Stability – The Mises Institute (2007)

The Free Market – The Myth of Price Stability – The Mises Institute (2004)

Keynesian Economics Assaults Savings

Keynesian economics says that saving is bad in an economic downturn. It states that the money saved could have gone toward consumption (the population using the money for purchases to boost economic activity) when the economy needs it most.  This is false reasoning because:

  1. Saving your money means putting it in the bank or investing it. The bank loans out your saved money, which is indirect investment. Any investment of your savings that you do directly also fulfills economic purpose.
  2. Saving allows the groups in which you are invested to prosper and you to gain additional money from interest making you better off than had you spent the money when you received it.
  3. Saving allows you to gain more capital for more significant economic purchases down the road (college tuition, buying a car, buying a house, creating a business, etc).
  4. Additionally, when prices drop in the downturn, your saved money will likely have more buying power when you are ready to purchase.

Here are a few articles and resources exploring the problems of Keynesian economics:

Failure of the “New Economics”: An Analysis of the Keynesian Fallacies – Henry Hazlitt (1959)

Or purchase the book: The Failure of the “New Economics”: An Analysis of the Keynesian Fallacies

Spotlight on Keynesian Economics – Murray N. Rothbard (1947)

The Misesian Case Against Keynes – The Mises Institute (2007)

The Critics of Keynesian Economics – Henry Hazlitt (1960)

Henry Hazlitt and the Failure of Keynesian Economics – The Freeman (2004)

Oh Keynesian, Where Art Thou? – The Mises Institute (2008)

Do We Need More of Keynes Now? – The Mises Institute (2008)

Heyek Tells Bill Buckley Even Keynes was Afraid of the Keynesians – The Mises Institute (2008)

Economic Freedom and Interventionism: Professor Hutt on Keynesianism – The Freeman (1964)

Government Spending Is No Free Lunch – The Wall Street Journal (2009)

Friedrich Von Hayek contended that Keynesian economics leads to socialism in his book The Road to Serfdom

Illustrated version of The Road to Serfdom

Or purchase the book: The Road to Serfdom

One of the major movements within economics stemming out of Keynesian concepts is a science called econometrics. Econometrics attempts to use quantitative or statistical modeling to analyze and test economic activity. Econometrics assumes the understanding of all variables involved, which because of human subjectivity (as shown above), is impossible.Take a look at a few articles about the problems of econometrics:

What is Wrong with Econometrics? – The Mises Institute (2002)

Econometrics: A Strange Process – The Mises Institute (2002)

Economic and Climate Models – The Mises Institute (2008)

Fools Put Faith in Data Alone – The Mises Institute (2006)

If Keynesian Economics is Harmful, Why is it Prevalent?

–         The great depression was misconstrued as being the fault of unfettered capitalism – In actuality, it was not – money policy was an active factor.

–          As the depression lingered, classical economists offered no quick fix to the economy

–          People looked to the government – and the government felt it had to try something. While doing nothing was the better option, it could not be considered as an option as people might look to blame government

–          Keynes swooped in with a book called The General Theory of Employment, Interest, and Money and the government used it to justify the New Deal

–          The government added several programs through the New Deal which prolonged and deepened the depression

–          Friedrich Von Hayek battled Keynes’ philosophy by communicating that the quickest and most robust recovery would come through non-intervention from the government

Keynesian economics (and modifications of it) won out and is perpetuated over true free market principals because it:

–          Makes the government think it can control what it cannot

–          Gives the government additional power

–          Allows the government to pose as a hero when the economy does well or rebounds

–          Most university economics departments preach Keynesian economics – they are often supported by the very government that desires the perpetuation of the theory

Notable articles on the subject:

Why Keynes Lives – The Mises Institute (1999)

Why the State Loves Keynesian Economics – Ron Morley’s Freedom Blog (2008)

The Federal Reserve “Controls” Our Economy (and your money)

With an arsenal of Keynesian economic principals, the Federal Reserve (Fed) attempts to control the U.S. economy, but instead worsens our economic stability over the long-term. Understanding the Fed brings light to the majority of U.S. and world economic problems as most of the world’s richer economies are controlled by central banks with similar mandates.

Brief History of the Fed

–          The Fed is the government controlled central bank of the U.S.

–          The Fed is the 3rd central bank since 1791 and it is the longest running of U.S. central banks.

–          There were significant periods of free banking before and between the periods of the 3 central banks.

–          Leading to 1913, bank runs were rising due to money policy [LINK] of National Banks from 1863 to 1913.

–          Men of JP Morgan and Rockefeller colluded to pass the Federal Reserve Act of 1913, benefiting their own business interests.

Makeup of the Fed

–          The Federal Reserve is made up of 12 regional banks.

–          It is run by the government – 7 member board appointed by president.

–          It is not transparent. The meeting minutes are not public.

–          They do not need approval to take significant economic action

–          No direct control over fed by president or congress (general Congressional authority and oversight)

The Fed attempts to control prices through the manipulation of the money supply. The Fed’s key tools are:

  1. Buying Government Securities – Indirect Taxes for You – Buys government securities from handpicked firms to increase the supply of money and credit (with newly created money). To tighten money and credit, the Fed sells securities.
  2. Setting the Discount Rate – Indirect Taxes for You – This is the rate charged to member banks who borrow short term from the Fed’s discount window. If the Fed lowers the discount rate for loans, commercial banks will borrow more because this increases the amount of funds to lend so that credit becomes cheaper. This translates into lower interest rates and cheap credit cards, while increasing the supply of money in the economy.
  3. Fractional Reserve Banking – Indirect Taxes for You and Very Dangerous
  • The Fed sets reserve requirements for banks. This is the percentage of customer deposits that are required to be held (not loaned out to borrowers) by the bank to meet depositors demands.
  • For example, if the reserve requirement is 10%, the Fed’s $100 that are asset backed (e.g. by gold) enables the printing of $1,000 for commercial bank reserves, which enables the commercial bank to then output $10,000 (holding the $1,000 as their 10%) through fractional reserve loans. In essence, that’s $10,000 backed by $100 of actual value. What’s more is that in today’s Fed, the original $100 is also backed by nothing.
  • This is the concept that makes bank runs very dangerous. Since banks hold a fraction of what their customers deposit, if too many depositors desire to withdraw their funds, the bank goes under and many depositors are left empty-handed.
  • This activity also increases the U.S. money supply beyond productivity-warranted levels and decreases the value of the dollar.
  •  If 1 to 1 money were the norm, there would not be problems with bank runs, the money supply would be stable, and prices would be as stable as they possibly could be.

Hidden Tax

The Fed has a monopoly on creating money. Creating new money is an alternative to raising taxes. The population doesn’t see the effects until months later. The resulting inflation makes your earned and saved money worth less, taxing you in an indirect way.

New money infused into the economy ultimately drives prices up. People that get the money first have an advantage because prices are initially still at low levels. As the new money infiltrates through the economy, prices rise and last people to get the new money have to pay higher prices for their purchases.

The Fed Creates the Boom & Bust Economic Cycle

While the Fed preaches that its work helps to contain the boom and bust cycles (over-production and subsequent correction or recession) so common to our economy, they actually are at the core of its cause.

–          The Fed undertakes inflationary policy – lowering interest rates to expand credit to consumers and businesses.

–          This easy money sends the wrong signals to businesses, which causes malinvestment, or businesses investing in more production because of perceived gains in demand (which is really artificial). This is the “boom”.

–          Once the businesses realize that the demand isn’t really there, they are forced to cut back and may even go out of business. This is the “bust”.

–          The cycle starts over again because the Fed comes back with more inflationary policy to attempt to stimulate the economy back to its prior levels of demand.

–          Take a look at the relevance of the boom-bust cycle in our current economic crisis.

Money, Banking, and the Federal Reserve

Below is an extremely informative video about the history and activities of the U.S. Federal Reserve.

Other resources about the Fed:

The Case Against the Fed – Murray Rothbard (1994)

Bring Back the Bank Run! – The Mises Institute (2009)

Purchase the book: The Case Against the Fed

The Federal Reserve as a Cartelization Device – Money in Crisis: The Federal Reserve, the Economy, and Monetary Reform (1984)

The Federal Reserve and Political Corruption – The Mises Institute (2000)

Going for the Heart – The Mises Institute (2008)

Will The Federal Reserve Create the New Socialist Man? – The Mises Institute (2006)

The Fed, Then and Now – The Mises Institute (2003)

Cheap Money, Gold, and Federal Reserve Bank Policy (published in 1924)

Free Lectures About the Federal Reserve (audio)

Government Regulation of Industry Contributes to Economic Distortion

The government attempts to regulate industries through:

  1. Federal agencies and commissions (e.g. SEC, FDA, FCC, FTC, etc)
  2. Legislation providing enforced advantage to unions, which attempt to control industries
  3. Special interest regulation (subsidies, monopoly break-up, price controls, etc)

The ineffective regulation that these organizations and activities produce causes negative economic impact through direct and indirect costs (time and money) to businesses:

  1. Often for over-compliance or needless compliance to useless or unfair regulation
  2. Because of the often whimsical changes that regulation may undergo over time
  3. Through hampering economic calculation because of the difficulty of predicting new regulation and regulatory changes
  4. Because of regulation loopholes that may be found by some businesses and not by others, which not only hurts the businesses that didn’t find the loophole, but diverted economic resources toward the finding of those loopholes while forgoing production and innovation

Because of the delicate nature and risk inherent in entrepreneurship, the costs stemming from these organizations and actions can cause entrepreneurs to:

  1. Fail
  2. Retreat from the industry because of a higher probability of failure
  3. Not enter the industry because of a higher probability of failure
  4. Collude with government causing further industry unfairness and economic distortion

All of this translates into a negative impact on the industry and economy. This does not mean that their should be no regulation of industry. However, it does mean that the government is ineffective at doing it and non-government alternatives are possible and may be worth exploring.

Alternatives to Government Regulation of Industry

To understand the possibilities of non-government regulation alternatives, take a look at how the process of regulation through free markets can occur:

  1. As a new industry emerges, consumers (including businesses that consume from other businesses) are responsible for judging the safety (physical or financial) of the associated products or services.
  2. During the industry’s evolution, if a business fails at providing the safety required, consumers will not purchase from that business and the business will then change its ways or go out of business because of the lack of profit from consumer purchases.
  3. If this regulatory task becomes too complicated or time-consuming for each consumer to perform on their own, then consumer demand for services of safety oversight and analysis will develop.
  4. This consumer demand will drive groups of people that see a market opportunity to join forces as entrepreneurs to offer the demanded research, analysis, and regulatory services to consumers.
  5. Because of the market opportunity, multiple businesses will form to offer regulatory services. This fosters competition among regulatory organizations which enables continued growth toward the best regulatory solutions, while failed solutions are quickly weeded out because of lack of consumer demand for their poor services.

Regulation through free markets provides an economic environment of:

  • Constantly improving regulation – Regulation becomes more accurate and well performed over time
  • Growing innovation in regulation – Competition drives competing businesses to take different approaches to regulation. Many can fail, but those that succeed offer leaps of regulatory accuracy and performance
  • Quick replacement of failed regulation – There is a mechanism in place to efficiently get rid of and replace failed regulatory organizations and formats

It is important to realize that failure is inherent in any kind of industry regulation. There will always be some level of corruption and mistakes made. As you can see throughout history and today, government regulation of industry has always had a large share of problems and failure. However, there has never been a mechanism to efficiently drive significant improvements in regulation because of a lack of regulatory competition, incentive, and accountability. These attributes of competition, incentive, and accountability are inherent in a free market industry regulation system.

To depict the inherent differences in nature between government regulation of industry and regulation through free markets, the Securities and Exchange Commission (SEC) offers a situation-relevant example. Take a look at the table below to view the comparison.

Table 1: SEC Regulation v.s. Regulation Through the Free Market

  Securities and Exchange Commission (SEC) Regulation Through the Free Market
Organization Structure The SEC is one organization by mandate of government; competition is not allowed. The organization’s nature is consistent with that of all government organizations. Multiple businesses can freely enter the market to compete to offer the best regulatory oversight solutions (e.g. various ratings companies, various companies organizing regulatory formats such as accounting rules, transparency standards, etc )
Consumer Responsibility Because of the public perception of government, the population becomes reliant on their ability to provide accurate and efficient regulatory services. False assumptions of security lead consumers to be less scrutinous in their investments and purchases. Consumers voluntarily paying for regulatory services have a vested interest to be wise about the direction of their financial support. Additionally, consumers voluntarily decide to invest in a given business regulated by competing organizations or regulatory formats. This offers added oversight to the industries being regulated.
Oversight of the Regulator There is no regulator directly regulating the SEC. Consumers voluntarily paying for regulatory services can decide that the regulatory businesses are doing a poor job and discontinue their financial support of those businesses leading them to either change their ways or go out of business
Incentive and Accountability Absence of incentive, accountability, and competing organizations makes the SEC complacent. Profit, the potential of going out of business, and competition make regulatory businesses constantly strive to offer the best solutions of oversight
Regulatory Focus They don’t know where to go – Do we tighten up regulation on ratings agencies and how? Do we regulate executive compensation and how? Their decisions are based on who barks the loudest and changes are made slowly and with uncertainty. Economic value drives the direction and level of market changes. For example, if executive compensation structure is a significant value problem, investors won’t invest in businesses with failed compensation structures. Organizations will change their compensation structures to again spur investment and other organizations could emerge to provide standards and oversight in the realm of compensation if the problem persists. Changes are made as efficiently as they could be made.
Regulation Failure When an SEC regulation or the organization itself fails, regulation adjustments take a long time to move through the system and the organization itself suffers no direct negative consequences. There are constantly competing regulatory formats and organizations at the ready to emerge as the best new solution.
Results Abundant loopholes and inaccuracies with a lack of regulatory improvement and innovation that allows new problems to come as a surprise as they always had in the past. Minimized loopholes and inaccuracies that are constantly being adjusted to maximize regulatory success. Regulatory innovation is enabled to allow for better anticipation of future problems.

Why can’t the SEC and other government regulatory organizations (like the FDA, EPA, FCC, FAA, FTC, etc) be replaced by private organizations? There is no reason other than the broad public perception that the government is the only institution capable of offering their services and fulfilling the consumer demand. Getting from point A (i.e. government regulatory organizations) to point B (i.e. regulation through private organizations/free markets) will certainly be a challenge, but just because it’s a challenge doesn’t mean we should settle for what is not working.

Your Dollars are Backed by Nothing

The nature of money described above is not the nature of today’s world currencies, including the U.S. dollar. The dollar is widely considered the world’s strongest currency. However, like all world currencies, it is a fiat currency, which means it is backed by nothing and can be created out of thin air. This gives the government the ability to print as much of the dollar as it wishes to fund whatever activity (past debt, wars, economic stimulus, new programs, etc) it wishes to fund and cannot afford.

If a given regular U.S. citizen undertook projects they couldn’t afford, racked up a bunch of debt, and then printed or made copies of money to pay it all off, would this be fair for others involved in the economy? It would not. This would increase the money supply and dilute the value of all dollars for everyone, while giving the criminal an unfair advantage over other citizens because they have the money to use before prices are affected. This is what is done on a mass basis when the government prints money for whatever occasion it wishes.

When a currency is backed by an asset, the government must be more responsible in its use of funds, which translates into better government actions and a currency that holds its value. This leads to a more stable economy.

The world’s current fiat money system and fractional reserve banking put the dollar and all other currencies at extreme risk.

The Dollar Crisis (Lew Rockwell) – The Mises Institute (2007)

The Dollar Crisis (Robert Blumen) – The Mises Institute (2003)

Why the Dollar is Falling – Why the Dollar is Falling (2005)

How to Save the Dollar – The Mises Institute (2004)

The Free Market – Death of the Dollar – The Mises Institute (2005)

Protectionist Rhetoric Will Accelerate the Dollar’s Slide – The Mises Institute (2007)

What Government Is Doing to Our Money – LewRockwell.com (2006)

Book: Understanding the Dollar Crisis – Percy L. Greaves, Jr. (2008)

Economic Fallacies We All Should Know

Henry Hazlitt’s Lesson

The following quote by Henry Hazlitt from his book “Economics in One Lesson” sums up an extremely important concept that is overlooked by mainstream communication:

“Economics is haunted by more fallacies than any other study known to man. This is no accident. The inherent difficulties of the subject would be great enough in any case, but they are multiplied a thousandfold by a factor that is insignificant in, say, physics, mathematics or medicine – the special pleading of selfish interests. While every group has certain economic interests identical with those of all groups, every group has also, as we shall see, interests antagonistic to those of all other groups. While certain public policies would in the long run benefit everybody, other policies would benefit one group only at the expense of all other groups. The group that would benefit by such policies, having such a direct interest in them, will argue for them plausibly and persistently. It will hire the best buyable minds to devote their whole time to presenting its case. And it will finally either convince the general public that its case is sound, or so befuddle it that clear thinking on the subject becomes next to impossible.

In addition to these endless pleadings of self-interest, there is a second main factor that spawns new economic fallacies every day. This is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences.”

Common Economic Fallacies

Government officials, the media, activist groups, unions, lobbyists, etc over time have all perpetuated many fallacies of economics to achieve their desired ends. Many of them are mentioned more frequently during times of economic crisis. Here are a few of the most popular (there are certainly more), along with a path of information to expose their flaws under the laws of economics:

Economic Stimulus

Public fallacy: Economic stimulus by government jump-starts the economy and gets it back on track when it otherwise would stagnate in recession.

Truth: Economic stimulus may (not always) provide a short-term boost, but the long-term damaging affects become greater.

Economic Recovery Requires Capital Accumulation, Not Government “Stimulus Packages” – The Mises Institute (2009)

Stimulus, Savings, and Stocks – The Mises Institute (2009)

Can Fiscal Stimulus Revive the US Economy? – The Mises Institute (2009)

“Stimulus” — the Urban Dictionary Definition – The Mises Institute (2008)

Government Spending Is No Free Lunch – The Wall Street Journal (2009)

Why the State Loves Keynesian Economics – Ron Morley’s Freedom Blog (2008)

Does “Depression Economics” Change the Rules? – The Mises Institute (2009)

Public Works

Public fallacy: Public works projects provide needed jobs and help fuel the economy back to good health in a downturn.

Truth: Public works projects do not allow for proper resource (labor, material, and money) reallocation or wage adjustments and slow down the economic correction process.

Does “Depression Economics” Change the Rules? – The Mises Institute (2009)

Ready for the Shovels – LewRockwell.com (2009)

Public Works Mean Taxes – Economics in One Lesson

Public Works Mean Taxes – Economics in One Lesson Discussion

Too Big to Fail

Public Fallacy: A business can be too big to allow its collapse because of its potential systemic economic risk (risk of causing cascading economic problems and failure).

Truth: The business will fail in the long term anyway and cause economic distortion and failure deeper and longer than if it had been allowed to collapse. Additionally, the moral hazard perpetuated through this activity will have negative implications far beyond the direct systemic effects of a collapse.

Are Fannie and Freddie Too Big To Fail? – The Mises Institute (2008)

Too Big to Fail? – Ron Paul – LewRockwell.com (2008)

Too Big to Bail – Ayn Rand Center (2008)

Too Big To Fail – Reason Foundation (2008)

Too Big to Fail, or to Survive – CATO Institute (2008)

Market Failure

Public fallacy: Market failure is a problem of free market capitalism not solving a given problem or failing to provide or allocate goods or services. It then follows that government intervention is required for success.

Truth: In a free market, there is no such thing as market failure. Businesses and industries can fail, but more evolved businesses and industries will simultaneously emerge to continue progress toward solving the problem. The market gets blocked from solving problems when government intervenes or creates a self-enforced government monopoly to attempt to solve the problem.

The Market Failure Myth – The Mises Institute (2002)

What Are You Calling Failure? – The Mises Institute (2005)

Market Failure Again? – The Mises Institute (2000)

Why Externalities Are Not a Case of Market Failure – National University (2003)

The Myth of Market Failure – Christopher Westley – The Mises Institute (2002)

Instead of listening to rhetoric about capitalist market failures, take a good look at the abundance of government failures.

Deflation

Public fallacy: Deflation is a downward spiral of prices that can cause severe economic depression.

Truth: Most deflation is harmless and is a natural economic process of falling prices often welcomed or needed. The dangerous type of deflation takes place when government intervenes on personal freedoms (e.g. controlling or halting the withdrawl of personal bank deposits).

Falling Prices are the Antidote to Deflation – The Mises Institute (2009)

Deflation and Liberty – The Mises Institute (2008)

The Imaginary Evils of Deflation – The Mises Institute (2002)

The Blessings of Deflation – The Mises Institute (2003)

The Anatomy of Deflation – The Mises Institute (2003)

An Austrian Taxonomy of Deflation – Joseph T Salerno – Pace University (2002)

Should We Worry About Deflation? – The Mises Institute (2008)

Inflation

Public fallacy: Inflation of the money supply is an economic tool that can successfully defend against deflation.

Truth: Inflation destroys the value of money, leads to economic distortion, can lead to economic disaster, and is a hidden tax that enhances government’s power.

Inflation and Compensatory Fiscal Policy – Man, Economy, and State – Murray N. Rothbard

What You Should Know About Inflation – Henry Hazlitt (1964)

Inflation and You – Economic Freedom and Interventionism – Ludwig von Mises

Inflation – Economic Freedom and Interventionism – Ludwig von Mises

Inflation: An Unworkable Fiscal Policy – Economic Freedom and Interventionism – Ludwig von Mises

Socialism, Inflation, and the Thrifty Householder – Economic Freedom and Interventionism – Ludwig von Mises

Inflation Must End in a Slump – Economic Freedom and Interventionism – Ludwig von Mises

Socialism

Public fallacy: Socialist programs and intervention in the economy can be successful under certain circumstances.

Truth: Socialism is a deeply flawed economic and political model on small and large scales. It does not allow accurate economic calculation because of the lack of a price mechanism. Its social approach to property rights destroys freedom and reduces prosperity for its population. Programs and societies that take on its philosophy and structure inevitably collapse.

Socialism: An Economic and Sociological Analysis – Ludwig von Mises (1951)

Beating Back Obamanomics – The Mises Institute (2009)

The Back Door to Socialism – The Mises Institute (2008)

Why Intellectuals Still Support Socialism – The Mises Institute (2006)

Middle of the Road Policy Leads to Socialism – Ludwig von Mises (1950)

Why Nazism Was Socialism and Why Socialism Is Totalitarianism – The Mises Institute (1998)

National Socialism – The Mises Institute (1998)

The Intellectuals and Socialism – F. A. Hayek – The University of Chicago Law Review

TIME For Socialism – The Mises Institute (2008)

A Theory of Socialism and Capitalism – Hans-Hermann Hoppe – The Mises Institute (1989)

Socialism vs. Market Exchange – The Mises Institute (2002)

Federal Reserve Credit Expansion

Public fallacy: Credit expansion makes it easier for businesses to get loans and therefore contributes positively to the economy.

Truth: Credit expansion creates an environment of malinvestment (investing to much where demand does not exists) and leads to eventual economic contraction.

The Trade Cycle and Credit Expansion: The Economic Consequences of Cheap Money – Ludwig von Mises (1943)

The Stock Market, Profits, and Credit Expansion – The Mises Institute (2002)

Credit Expansion, Economic Inequality, and Stagnant Wages – The Mises Institute (2008)

Interest, Credit Expansion, and the Trade Cycle – Ludwig von Mises – Human Action

Price Controls

Public fallacy: Prices controls keep prices at reasonable levels that people can afford.

Truth: Price controls cause supply distortions, hurt economic calculation, cause entrepreneurs to go out of business, and thus defeat their own purpose.

Price Controls Create Manmade Disasters – The Mises Institute (2008)

Four Thousand Years of Price Controls – The Mises Institute (2005)

Price Control – Man, Ecnomy, and State – Murray N. Rothbard

Backdoor Price Controls – The Mises Institute (2005)

Did Price Controls Work? – The Mises Institute (2002)

The Price-Control Calamity – The Mises Institute (2005)

Economists for Price Controls? – The Mises Institute (2001)

Price Controls, Again – The Mises Institute (2001)

Free Mises Institute Audio & Video Lectures on Price Controls

Wage Controls

Public fallacy: Wage controls give people the opportunity to earn fair wages for their work.

Truth: Wage controls cause unemployment and economic distortion that goes beyond the benefits of the improvement in wages.

America’s First Wage and Price Controls – The Mises Institute (2000)

Price Controls on Labor – The Mises Institute (2006)

Minimum Wage Laws and Compulsory Unionism – Man, Economy, and State – Murray N. Rothbard

Interventionism: Rent Control, Wage Laws, Trade, Unions – The Mises Institute (2004)

Free Mises Institute Audio & Video Lectures on Wage Controls

http://mises.org/multimedia/mp3/audiobooks/rothbard/CIL/I/1_3_31.mp3

Unionism

Public fallacy: Unions enable fair wages among workforces that wouldn’t otherwise be offered.

Truth: Because unions have a government-support advantage, their practices contribute to unemployment and slow economic growth.

Labor Unions – Man, Economy, and State – Murray N. Rothbard

The Union Hunt for More Victims – The Mises Institute (2005)

Where Would General Motors Be Without the United Automobile Workers Union? – The Mises Institute (2006)

The Union Myth – The Mises Institute (2004)

Less than Supreme Protection Against Union Abuses – The Mises Institute (2007)

Union Tales: My Father’s Experiences With Unions – The Mises Institute (2005)

Labor Unionism,Two Views – The Mises Institute

Inequality of Wealth

Public fallacy: The unequal distribution of wealth is caused by capitalism and is unfair for those at the low end of the range.

Truth: Inequality serves a natural purpose beneficial to society, capitalism minimizes the wealth inequality gap, and government intervention causes the problems associated with wealth inequality.

On Equality and Inequality – Ludwig von Mises (2006)

Has State Action Reduced Inequality in the US – The Mises Institute (2003)

Inequality of Wealth and Incomes – Economic Freedom and Intervention – Ludwig von Mises

What is Wealth Inequality? – The Mises Institute (2003)

The Income Inequality Hoax – The Mises Institute (2000)

Inequality of Wealth and Income – Human Action – Ludwig von Mises

The Inequality of Wealth and Income – Liberalism in the Classical Tradition – Ludwig von Mises

Is Inequality Necessarily Bad? – The Mises Institute (2003)

Inequality Serves a Social and Economic Purpose – The Mises Institute (2002)

Monopolies

Public fallacy: Monopolies are bad for the economy and consumer, and need to be broken up by the government.

Truth: Monopoly is communicated as a vague definition. The communication of the concept usually does not properly consider time nor the influence of government as a major cause of the monopoly.

Fear of Monopoly – The Mises Institute (2001)

The Myth of Natural Monopoly – Thomas J. DiLorenzo – The Review of Austrian Economics

Monopoly and Competition – Man, Economy, and State – Murray N. Rothbard

Free Mises Institute Audio & Video Lectures on Monopoly

Price Gouging

Public fallacy: Price gouging is unfair to consumers and needs to be regulated by the government.

Truth: Actual cases of price gouging are rare and are naturally corrected. Most cases labeled as price gouging are actually economically appropriate.

Price Gouging Saves Lives – The Mises Institute (2004)

“Price Gouging” Is Essential and Humane – The Mises Institute (2007)

The Non-Crime of Price Gouging – The Mises Institute (2003)

Fill-in-the-Blank Article About Price Gouging Laws – The Mises Institute (2008)

Price Gouging: Economics and Ethics – The Mises Institute (2006)

Price Gouging: Setting the Record Straight – The Mises Institute (2006)

Economic Theories

If you would like to learn more about economics, a nice exercise is to take a look at and compare the basic concepts of the most significant economic schools of thought and political philosophies:

  • Classical economics – the first modern school of economic thought
  • Socialism – widely attempted in different forms since the 1800s
  • Neoclassical economics – together with Keynesian economics forms today’s mainstream economics
  • Keynesian economics – together with neoclassical economics forms today’s mainstream economics
  • Chicago school – accepts neoclassical theory, and incorporates many principals of Laissez-faire capitalism (i.e. free markets)
  • Austrian school – embraces Laissez-faire capitalism based on the facts of individual differences and the inability to know all current and future variables that impact economies

The Science of Free Markets

Austrian Economics

As you may have deduced, Arbitrary Vote uses the Austrian economic perspective to provide a view of the world that is not normally communicated by the government and mainstream media. However, unlike the cacophony of confusion and conflict found in mainstream assessments of historical and current topics, the Austrian economic perspective provides a framework of fundamentally sound reasoning that instills clarity and confidence in analysis and action.

One important point to notice is that there are many Austrian economic concepts in which neoclassical and Keynesian economics derive value, while the reverse is not true. A valuable exercise is to further investigate how Austrian economics refutes the claims of today’s mainstream economic approach, some of which is outlined within the Basics of Economics and the Economy sections of Arbitrary Vote. Socialism is also directly refuted by Austrian economics and is discussed within Arbitrary Vote given its reemergence as an assumed viable philosophy in the solutions the U.S. government is implementing as it attempts to solve the current crisis.

While most mainstream economists may differ in nuances of their economic philosophies, they largely assume to know all variables of randomness and human action. However, take note that they are rarely correct in their predictions, and when they are, there was no solid framework of principals that led them to their predictions – in those rare cases of accuracy they were most likely lucky.

On the contrary, with a little digging you will discover that through modern history, and with our current crisis, most Austrian economists have been amazingly accurate in their predictions. Their steadfast application of logical economic principals enables them to easily see through the harmful approaches that are so often undertaken by mainstream economists and policymakers.

Additionally, many mainstream economists justify their own existence and jobs with the economic theories they preach and policies that they create.  Austrian economists preach a theory that actually makes themselves obsolete in the sense of their impact on driving economic policy if the Austrian economic model were to come to fruition.

Economic Corrections are Mild and Quick in Free Markets

Times of economic correction are always required in a given economy. The reason is because businesses are run by humans, and their customers are humans. Humans make mistakes in general, and more specifically, in predicting the unknowable variable of what another humans’ purchasing actions will be. This means that errors will be made in investing in certain business activities in anticipation of demand from customers that may not ultimately purchase the created product.

The government’s artificial manipulation of interest rates causes more errors of economic calculation of supply and demand. This creates the exacerbated booms (unwarranted economic growth) and busts (recession and correction of this overdone growth). The government then takes inappropriate steps to fend off recession, which inhibit the natural correction process from taking place while pushing off and exacerbating the core problems.

What should instead take place in any type of correction is a natural reorganization of resources – money, material and labor – toward more productive and profitable areas of the economy. This ensures the most expeditious and successful recovery possible.

It is estimated that 90% of businesses fail within their first year. This failure is good and should be allowed and embraced because it enables the most efficient emergence of the best possible products, services, and solutions for problems. Trial and error is what has brought civilization its greatest advances and standard of living. Free market capitalism most fully embraces trial and error.

Ideas and Creation Lead the Way

Today’s myth that capitalism has failed as a model for society makes it clear that the sources of mainstream communication do not understand the difference between pure capitalist economies and hybrid capitalist/government controlled economies – the latter being the current U.S. economic model. This flawed perspective results in the perpetuation of misinformation and false conclusions which leads to failed economic policy and solutions.

Free market capitalism involves no intervention from government whatsoever except for the enforcement of property rights between individuals and organizations. Even this role of government in an economy is debated as there are possible opportunities for free markets to fulfill this need as well.

Austrian economics includes a description of the science of pure capitalism and reveals the seldom heard or understood ability for markets to solve just about all of mankind’s problems as optimally as they can be solved. The same ends cannot be clearly described through other economic models. Austrian economics logically empowers ideas and creation through freedom; ideas and creation are what give humanity its best chance for progress and survival.