Power & Market
There is a lot of confusion about the term "free market economics." It is not a matter of advocacy, but a description of what's studied. Just like labor economics is not a matter of standing up for working class interests, but a study of how labor markets work.
So free market economics is a study of how free markets (would) work. It is a positive theoretical study, not ideology. So, for instance, Austrian economics is free market economics in this very positive sense, and for good reason: in order to understand how an economy (specifically, markets) functions, one must first establish which processes are innate to markets and how they work. Only after this has been established can one introduce (theoretically) exogenous influences such as institutions (including but not exclusively interventionism).
Whoever starts with the present economy as-is finds himself in a problematic situation, because it is impossible to then separate what effects, outcomes, and orders are due to markets per se and which are due to other influences.
Markets (actually, economies) are inherently endogenous (causes are human action, which are influenced by the effects). This is also why a study of markets and economies cannot be studied inductively, because the result is just one big blob of interrelated data points.
Economists have understood this for centuries, which is why economics proper has always been primarily a study of theory.
To put it differently, there are no pure market economies in the world that one can study empirically to establish economic regularities to then apply on mixed and control economies.
In this sense, ALL economic theories must to some sense be free market economics: in order to study how economies work — what the effects of added or removed influences will be, etc. — one must first understand the pure mechanisms of what 19th century scholars called the "economic organism" (the economic aspect of society).
One can perhaps criticize economics on the ground that there are no pure economic mechanisms, that there is no economic aspect to human behavior. But experience (my own as well as economics' more than quarter-millennium-old) shows that such critiques are predominantly ideological and not theoretical.
The fact that economics proper is "free market" in the positive sense is no stranger than natural sciences using controlled experiments to separate true causes. It's just that economics is more difficult, because there is no way of constructing such experiments to capture the true workings of a complete economy, including the profit-and-loss system, real entrepreneurship, accumulation of capital etc.
To criticize economics proper, one must do better than to use one's own ideological biases to create misinterpretation of theory as ideology.
Formatted from Twitter @PerBylund
Donald Trump has not had an easy, straight-forward relation with the Federal Reserve. He has both claimed to be a low-interest rate person and accused the Fed of keeping interest rates too low for political reasons. He has also expressed regret at appointing Jerome Powell and the White House has even explored the possibility of firing or demoting the Fed chairman . Apparently, President Trump’s intention was that Powell was to keep interest rates low, and he is not at all happy with the Fed’s policy of allowing them to increase. But why, since the Fed is not immune to political pressure , has the central bank allowed rates to rise in the face of presidential opposition?
In fact, it is likely that the market rate of interest is rising — for whatever reason — and the Fed has to respond in ways that keep a lid on credit creation so as to avoid bubbles. That is, in response to rising market rates, the Fed must raise rates on reserves lest its member banks flood the economy with new loans — and with money.
This is now a possibility because it looks like there is now an increased demand for loans. After the long years of the Great Recession, private companies are finally beginning to expand business again and demand more loans from the banks. What has caused this change is not an easy question to answer. It might be that there is now less regime uncertainty. The financial crisis of 2008 ushered in an era of increased interventionism on all fronts, which is hardly conducive to a good investment climate. Now, the current administration is perceived – rightly or wrongly – to be more friendly to free markets. Investors therefore feel more confident in expanding business. Furthermore, the many government interventions following the financial crisis kept alive businesses and maintained malinvestments that should have been liquidated at the outset of the Great Recession. So, instead of a short, sharp depression it took several years before capital goods were rearranged and markets adjusted to more realistic expectations of consumer demand. One of the main causes of uncertainty was the Fed’s many interventions in the economy, and it’s decision to normalize policy in 2014 — in spite of the fact this policy is only be carried out at extremely slow speed — is one of the main reasons the market is waking up again.
But whatever the causes may be, there is now more optimism in the market and an increased demand for loans. And since the money supply is so far not expanding at a particularly fast rate (see here for the Rothbard-Salerno money supply measure), and there is no increase in the savings rate to offset the increased demand for loans, private businesses are bidding up the price of credit.
Money-supply growth is relatively low:
U.S. personal saving rate 2008-2019:
The Fed Follows Along
In this environment, the Fed simply has to follow the developments in the market and raise its own rates unless it wants to start a new credit expansion.
Hayek described this mechanism in 1929 (p. 167ff): with a greater demand for loans on the part of business, the banks, operating on the fractional reserve principle, would have a choice: raise the interest rate to equilibrate the investment demand with the supply of savings, or issue new fiduciary media at the old rates — or at any rate, at interest rates lower than they would have been had they only been set by the demand for and supply of savings. So far, the banks have refrained from issuing fiduciary media, in large part because it is still a good deal to keep reserves at the Fed (and they are in any case not yet in a position to create new fiduciary media – see below).
The following chart illustrates the point: for the longest time both the market interest rate, illustrated by the 3-month LIBOR, and policy rates were virtually flat. Then in late 2015, LIBOR started rising ahead of the federal funds rate.
Market rate of interest versus policy rates:
There is a complicating factor: the amount of excess reserves has been steadily declining for two years now. Does this not mean that the Fed has failed in its attempt to neutralize the effects of its unconventional policies and that we’re in the midst of a huge credit expansion? After all, the amount of bank reserves with the federal reserve system has fallen from a high of nearly $2.7 trillion in August 2014 to about $1.5 trillion in May 2019. However, all demand deposits are still fully backed by reserves, if only barely so, and the reduction in excess reserves has therefore not caused a credit expansion. Rather, it should be seen in the same way as a private individual who has hitherto kept a large proportion of his wealth in the form of cash but then decides to invest it. Such behavior is precisely what we should expect when the economic environment is improving and business is picking up: During financial crises and depressions, people and businesses will pile up money balances because they are increasingly uncertain about the future. And when conditions improve again, and people begin to feel more certain, they will draw down their accumulated cash balances, and either consume more or invest their funds in the economy. . (For more on this, see Hoppe’s article "The Yield from Money Held.")
The banks function in precisely the same way, with excess reserves being the analogue of increased cash balances. So long as the banks operate at or above 100% coverage of demand deposits, their lending out excess reserves can no more be seen as credit expansion than can the decision of an individual to invest his accumulated cash balance.
Reserve balances (blue) and demand deposits (red):
Prospects for the Future
This does not mean that all is well. For example, a lot of businesses (e.g., Netflix) have been financed and refinanced when the interest rate was extremely low. Will they be able to transition to an environment where debt isn’t that cheap? And just how many zombie companies have been kept alive by artificially low interest rates?
More importantly, the market rate of interest has reversed its upward trend and is now falling again, which indicates that the budding boom of the last few years is already over. While the Fed appears to be oblivious to the possibility of an economic downturn, others are not so sanguine. The American trucking industry is in dire straits as demand for trucking has evaporated, suggesting in turn that there is significantly less business activity now than one year ago. Significantly, the Fed may inadvertently strengthen the downward trend, as the spread between the market rate of interest and the Fed’s policy rates has narrowed, while the Fed has chosen to maintain current rates . This means that it is now a better investment for banks to increase their balances at federal reserve banks than to loan out money, and the data seem to indicate that they have done so, as reserve balances have increased by about $125 billion from May 1 to June 12.
Far from being upset with his central bank, then, President Trump should recognize that the Fed's lack of dovishness has allowed more market freedom in setting the interest rate in a long time. This does not mean that God’s in his heaven and all’s right with the world. If the market interest rate continues to fall without any action by the Fed, we can expect liquidity to drain fast from the market, as the Fed rewards the banks for just sitting on their cash.
To pursue a more sustainable policy, the practice of paying interest on excess reserves must be ended. To do this without causing credit expansion, it is necessary to neutralize the reserves. This can perhaps be done by open market operations, as possible Fed nominee Judy Shelton has suggested, but a different approach is preferable: now is an excellent time to enforce a 100% reserve requirement on the banks and thereby prevent future credit expansion. While this may cause some disruption to the banking sector, the negative impact can be lessened by, for instance, at the same time liberalizing the financial sector, thereby significantly reducing compliance costs and increasing the possibilities for productive investment, or by shelving all talk of trade wars and tariff increases. Once that is done, there will be no reason to keep the Federal Reserve around and it will be a comparatively easy task to eliminate the central bank and finally remove the state entirely from the business of producing money.
ZeroHedge recently reported an interesting trend occurring in the United States.
A U.S. Census Bureau map details some interesting patterns. Areas highlighted in purple, where the population is growing, are located in the West and the South. Those in orange, areas where the population is dropping are situated in the North and East. Although the Sun Belt does have considerable allure because of its weather, there are other institutional and economic factors at play.
For example, seven of the ten counties with the largest population increases were in Texas or Florida . Of note, Florida and Texas don’t feature the kind of income tax boondoggle we see at the federal level and even some anti-growth states like California.
According to the Freedom in the 50 States Index , Florida and Texas are ranked first and tenth in terms of overall economic freedom, respectively. Interestingly, North Dakota has two of the fastest growing counties in the country, McKenzie and Williams County . In the same freedom index, North Dakota is ranked sixth.
On the other hand, there is evidence that some of America’s largest urban centers are shrinking. From 2017 to 2018, New York City has seen a decline in its population. The Wall Street Journal reports that “New York’s population dropped 0.47 percent to 8.4 million by July 2018, compared with the previous year.” Although small, this could be the beginning of a negative trend as the city is starting to embark on a new path of anti-growth policies such as the Green New Deal and its insistence on keeping big spending intact .
The Chicago metro area’s population dropped for four straight years according to the Census Bureau:
“There were 22,000 fewer residents in the 14-county metro area than in 2017, a drop of 0.2 percent, and the first time since 2010 that the area’s population has slipped below 9.5 million people. Cook County, which accounts for 55 percent of the population in the metro area, lost 24,000 residents.”
This is an interesting case study of a larger macro-trend taking place in America. People are fleeing coastal areas and solidly blue states with burdensome governments for the more sleek, affordable, and business-friendly Sun Belt and Great Plains states.
That’s the beauty of competitive federalism, which allows jurisdictions to compete for the best talent and citizens. This is what helped make America and Europe prosperous over the last 500 years.
This type of competitive decentralization should be embraced and expanded upon in order to ensure prosperity for future generations.
Perhaps the most destructive premise of modern, mainstream economics is that a central bank-induced monetary/credit expansion can cause an economy to grow without adverse consequences. Let's be perfectly clear from the start: this policy has been tried by many central banks many times and all such attempts have led to economic disaster. The latest victims are the poor citizens of Venezuela, a once prosperous nation. Furthermore, we Austrian economists have sound economic science to explain why it must be so, despite the fervently held wishes of mainstream economists, politicians, and the public at large.
Born of Depression Era Keynesian economic theory which elevated "aggregate demand" as the driving force of an economy, central banks have constructed a fallacious model of how an economy works. Repeated failures of this model have served only to embolden them to double down and double down again and again, driving interest rates in some countries below zero in order to force the world to conform to their dogmatic theory. The simplest explanation of this theory is that counterfeiting money will cause people to spend and it is a dearth of spending that holds back prosperity. If people won't spend enough themselves, then it is incumbent upon government to do it for them by paying people the equivalence of digging holes in the ground and filling them back up. No, I am not making this up. Keynes himself said it! (See: book 3, chapter 10, section 6, page 129 of The General Theory).
The theory of lack of aggregate demand fails to recognize two essential facets of how an economy really works. The first is that production must precede consumption. In other words, we cannot consume what we have not first produced, and one's production constitutes one's demand either through direct or indirect exchange. This is the essence of Say's Law, which Keynes unsuccessfully attempted to refute in developing his theory of an economy driven not by production but by aggregate demand.
The second is that the structure of production is determined by time preference: the structure of production is merely all the intermediate steps that constitute production. There are fewer steps taking less overall time in an economy with a high time preference, meaning that people wish to spend most of their production-borne income in the short term. Likewise there are more steps taking more overall time in an economy with a low time preference, meaning that people wish to save more of their current income in order to have more in the future.
A simple example is that one must plant seeds in order to grow vegetables for current consumption. (Please keep in mind that what I describe is applicable for all types and levels of production.) The steps in this process are the saving of seeds from previous crops, the tilling of the soil, the planting of the seeds, the watering and perhaps fertilizing of the seeds, the spraying or covering of the young plants from the predations of birds, insects, and bacteria. You get the idea. The "structure" is the steps and the amount of production that is involved in each step. In a high-time-preference economy in which people wish to consume almost all of their crop production, saving more seeds is a waste of resources. Likewise, producing more fertilizer than is necessary for the size of the crop is also a waste of resources. Time preference is the underlying guide. However, if people are more future oriented, they will save more from current production in order to plant more crops; they will clear and till more land for the extra seeds; they will buy more fertilizer, etc. The increase in crop yields spurs a new level of production in the preservation of excess production for future consumption. The refraining from current consumption — i.e., savings — is what funds this increase in the new level of production. The preservation process takes more time, but in the end there is more to consume in the future, especially in cases of future crop failure. Think of the children's story of the ant and the grasshopper.
Substituting Money For Real Savings
Keynes thought that an economy could bypass the savings process and substitute an increase in the medium of exchange for real savings. The obvious flaw in this argument is that counterfeit money is not a substitute for saving real, fungible production. Counterfeit money is simply a watered down medium of exchange. Think of the old adage of watering down the soup when uninvited guests show up for dinner. The cook can serve more bowls of soup, but the nutritional value per bowl is less.
But monetary/credit expansion does more than just reduce the value of each monetary unit. Because the counterfeit money appears no different than existing money, entrepreneurs are fooled into believing that something real has been set aside and that people have chosen a lower time preference. With a lower interest rate level their plans for expansion appear to be achievable. Canning and/or freeze-drying facilities, for example, are constructed over a longer period of time in anticipation of an increase in sales of vegetables that may be consumed much later. Eventually the entrepreneurs realize that no such longer-term demand really exists. They have wasted time and capital, neither of which may be recovered. The workers who left jobs in businesses that served the higher time preference economy for higher paying jobs in the vegetable preservation plants must find new work. This takes time, and the ranks of the unemployed grow until the economy has once again achieved a structure of production more in tune with the people's higher time preference. Businesses lose money; the owners may even go bankrupt. Stock prices collapse. Banks may fail. Such a transition is called a recession. It is inevitable and unavoidable.
Yet it is highly likely — in fact it is almost a certainty — that central banks will fight the latest economic slowdown with the same old money printing and lowering of the interest rate. This was the conclusion drawn by Thorsten Polleit in his latest essay, published on Mises Wire: "The Fed Has No Choice But to Return to Ultra-Low Interest Rates." The Keynesians at the Fed are baffled that the world won't conform to their theory of aggregate demand. Their theory is a straightjacket from which they cannot escape intellectually. Unfortunately we all will pay the price.
In November a year will have passed since the renegotiation of NAFTA. Although this version has new guidelines, for the most part its main principle prevails: free trade is beneficial for both parties. This is true with or without free trade agreements or the existence of "fair" trade. However, as a Parametria survey published in 2016 shows, most Mexicans still don't understand the multiple benefits that these opening policies entail.
Those benefits include:
- A greater diversification of brands and categories of consumer goods (According to IMCO)
- An increase of 21.154 billion dollars on foreign direct investment and of 339.244 billion dollars on Mexico's annual exports of goods and services since 1994 (According to the World Bank)
- Indirectly strengthening libertarian principles such as globalization (the free movement of ideas, people, capital and consumer goods) and property rights. As the liberal economist Frédéic Bastiat explained in his essay titled "Communism and Protection":
Every citizen who has produced or acquired a product should have the option of applying it immediately to his own use or of transferring it to whoever on the face of the earth agrees to give him in exchange the object of his desires. To deprive him of this option when he has committed no act contrary to public order and good morals, and solely to satisfy the convenience of another citizen, is to legitimize an act of plunder and to violate the law of justice .
- A possible contribution to the reduction of extreme poverty (measured as an income interval and not as inequality — less than half of the average national income — or access to specific consumer goods and services)
In "The Role of Trade in Ending Poverty," the World Bank estimates that between 1990 and 2010 the global percentage of people living under extreme poverty fell by half. In this report they use as a reference Kraay and Dollar's article titled "Growth is good for the poor" (in which they concluded that growth benefits the poor as much as it does the typical household) in order to explain the correlation, and possible causal relationship, of multiple economic variables. Their interpretation of the data establishes that GDP growth increases both the demand for labor and real wages for low skilled jobs:
It is the strong growth of the global economy over the past 10 years that has enabled the majority of the world’s working-age population to find employment. Real wages for low-skilled jobs have increased with GDP growth worldwide
In "The macroeconomy after tariffs," after studying the economic behavior of 151 countries from 1963 to 1914, its authors concluded that each increase of 3.6% on effective tariff rate produces a productivity reduction of 0.9% in 5 years. In some cases, this increase in average productivity is not only the result of the exit of less efficient companies from the market. As Nina Pavcinik shows in "Trade Liberalization, Exit, and Productivity Improvements: Evidence from Chilean Plants," companies that survive this trade opening also experience an increase in productivity.
A little known fact is that the percentage of people in Mexico who lived below the international line of extreme poverty in 2016 (income less than $1.90 dollars per day) is lower than in 1994: 4.1% less. In absolute numbers a similar scenario also occurs: 2.9 million people less. If the poverty line is used as a measure below $3.2 per day, we observe a reduction of 4.6 million people and of 9.3 in percentage points.
Due to the particular circumstances of the Mexican case (e.g., the 1994 financial crisis, social programs such as Oportunidades, among others), it is not possible to accurately determine if this commercial treaty contributed to the reduction of extreme poverty by only using global aggregates. Nevertheless, because of or despite trade liberalization, Mexico's extreme poverty has decreased since NAFTA.
The environment of persistently low interest rates is not going to last forever. But a recent drive to change European fiscal rules assumes low rates forever, and may have dangerous and unintended consequences. So far, after years of continuous growth, many European countries have not yet tackled the issue of debt: will they be able to do better with looser and less punitive rules?
In the aftermath of the European elections, the race to describe which (different) path the European Union should undertake has started. Among those who contributed with reform proposals, we find the IMF's Olivier Blanchard, in his column "Europe Must Fix Its Fiscal Rules," explained how Europe could better take advantage of the current low interest rate framework.
According to French economist Blanchard, Europe must begin to fix its rules about public debt and public deficit to align them with the current low-interest framework, which is different to the one the rules were initially written for. Admittedly, the fiscal-arm of the European economic-policy is surely something that can be improved. Nevertheless, Dr. Blanchard’s proposals would work as a shield for fiscally irresponsible policies put in place by countries now most in need of reform. These countries —especially Italy — have been putting off these needed reforms for years, and that have largely taken advantage of the east-money policies of crisis periods to do so.
A Closer Economic and Monetary Union?
Some parts of Dr. Blanchard’s proposal do indeed raise questions. The idea of creating a larger common European budget, in fact, is the notorious third pillar of an economic and monetary union which has been missing in the eurozone framework from its very beginning. One aspect of this are ongoing demands that the eurozone change the Growth and Stability Pact to abandon the 3% deficit cap and the 60% debt/GDP cap. Regarding the debt parameter, Dr. Blanchard argues that under a low interest rate regime, the need to have such a low debt/GDP ratio is questionable. Hence, Europe must allow its member states to coordinate and carry out a fiscal expansion, either at an individual level or with a common budget financed through the issuing of the often invoked eurobonds.
The Keynesian, centrist reading of the European reality, however, does not take into account any of the concerns about the moral hazard which is intrinsic to any monetary union. Moreover, it does not take into account the recent history of the debate over the budget proposals between the European Commission and the member states. In fact, Dr. Blanchard is of the view that “The eurozone has gone so far in piling up constraints, on the assumption that governments will always misbehave or try to cheat, that the result is sometimes incomprehensible.”
On the contrary, we are of the opinion that what the eurozone history can tell us, is that if the increase in debt was contained during recent times, that was exactly thanks to those constraints and rules, since southern member states (i.e., Italy and Greece, et al) have always pushed for more debt and never for less.
Moreover, we do not understand the need for a Keynesian fiscal stimulus to push the eurozone back to its "potential level." For example, the European Commission calculated for Italy (one of the countries which would benefit the most from a loosening of the eurozone fiscal rules) a -0,1% negative output-gap for 2018 and a -0,3% negative output-gap for 2019, which they predict will close again in 2020. That considered, to increase the fiscal room of a country like Italy would mean to permanently enlarge the public sector, since to boost GDP beyond its potential level the stimulus must be perpetrated indefinitely.
The path that has brought interest rates down to the zero lower-bound has not been coincidental either, but it has been a direct consequence of the policy carried out in these years by the ECB. Thanks to those policies, which have had a Cantillon-effect backlash that have modified the relative prices of government bonds for the sake of countries with larger debts. Those very member states with troubling and urgent issues have been able to “kick the can” and ignore the risk-pricing assessments made by the market because of the protection and the extended time granted to them by the quantitative easing.
All this contradicts what Dr. Blanchard implicitly argued about moral hazard: the expansive monetary policy and consequent lowering of the interest rates — which was meant to grant time and breathing room to the troubled countries to fix their numbers while allowing them at the same time to use fiscal policy as a cyclical tool — was instead used to put off the need for decisions and reforms that was already compelling years ago, worsening those structural problems that hold to the present disappointing level their potential GDP.
To remove those rules would allow a serious situation not to become far worse. The current interest rate scenario is not going to last forever, but it will indeed change as soon as the quantitative easing of the ECB comes to an end. Removing what few restraints exist strikes us as an unnecessary hazard.
What, sir, is the use of a militia? It is to prevent the establishment of a standing army, the bane of liberty. …Whenever Governments mean to invade the rights and liberties of the people, they always attempt to destroy the militia, in order to raise an army upon their ruins. —Elbridge Gerry, Fifth Vice President of the United States
All too often, government-produced defense is discussed as an ideal — a force that protects people and their rights. Seldom does reality enter the picture. Standing armies, after all, often do not only practice defense.
Once established, a government’s military, its bureaucrats and leaders, as well as laymen all face a different set of incentives. Those with a job related to the military have an incentive to keep their job. In most cases, they probably also desire to see the scope of their power expanded and their pay increased. The support for war then, is the ideal policy for achieving those goals. These incentives may not transform a champion of peace into a war-loving bureaucrat, but they can have effects on the margins. It’s much easier to rationalize a war if your job depends on it.
Changes on the Ground
More interestingly, the average citizen’s incentives change. To see what I mean, let’s take a look at the introduction of the permanent standing army in 19th century America.
Prior to the rise of the U.S. standing army, relations between natives and white settlers were relatively peaceful. It’s not that white settlers always felt warm feelings toward native Americans (or vice versa). Many did not. The reality of fighting one’s own battles, however, entailed significant costs. In an essay entitled " Exchange, Sovereignty, and Indian-Anglo Relations," Jennifer Roback remarks: "Europeans generally acknowledged that the Indians retained possessory rights to their lands. More important, the English recognized the advantage of being on friendly terms with the Indians. Trade with the Indians, especially the fur trade, was profitable. War was costly" “More than is generally appreciated, the contact (between Indians and whites) was even friendly, or at least peaceful.”
After the US maintained a permanent army, however, things changed. Most of the disincentives for war disappeared. The monetary costs that maintained the army were spread out over the entire populace and those who demanded the army’s services paid no additional price. Nor did they now need to risk their own life. Frontiersmen could now call upon subsidized troops to do their fighting for them. This had the effect of lowering the threshold for when settlers could justify resorting to violence against their Indian neighbors.
"In Raid or Trade? An Economic Model of Indian-White Relations," the authors accounted for a number of possible contributing factors, such as population change and newly settled land, and concluded the establishment of a standing army during the Mexican War had an independent effect of an increase of almost 12 battles a year. They estimated the buildup of the standing army before and during the Civil War caused an increase of around 25 battles a year.
As the quote at the beginning of this piece indicates, the Founding Fathers feared a standing army, and for good reason. While its ideal purpose is to create peace, we do not live in a world of ideals. The actual effects are to lower the costs of war to those who would have it, and to create a special-interest group of bureaucrats and military personnel who have a vested interest in advancing the war machine. As long as the army stands, peace is unlikely to be achieved or long-lasting.
Of all the natural and social sciences, economics1 is the most crucial for the intelligent laity. This is because economic understanding among the public makes the difference between barbarism and a healthy society. While the other sciences are important, they only require a small minority of specialists with a deep understanding of those topics for the fruits of those disciplines to spread throughout society. But good public policy frequently depends on a sound understanding of economics, and thus depends on the public's understanding of it.
When passengers are sitting in coach, flying from the Bahamas to New York, it doesn’t matter whether any of them understand the laws of aerodynamics, or anything about the mechanical engineering of the plane they’re flying in. The successful operation of the plane goes on, so long as a small, specialized group of people understand. When millions of people take their medicine every night, it doesn’t matter whether they understand the chemistry underlying their pills and syrups, so long as a relatively small number of chemists who produced the medicine knew what they were doing. A cruise ship does not get lost at sea on the way to, say, Alaska, based upon the sailing expertise of those playing laser tag on its deck, if the captain and his crew know what they’re doing. A country, on the other hand, is a boat that only floats if those inside it understand how to operate it successfully.
Even a Non-Voting Majority Affects Policy
Accepting the key role of the economic system on a society’s wellbeing, it’s straightforward why representative republics or other forms of democratic government with populations that favor free markets have free markets, and those with populations that favor interventionism have interventionism. Politicians seek election, and if voters en masse really demand certain policies, politicians will pursue those policies. But why should non-democratic states care at all what their populations think? Doesn’t the dictatorship have all of the guns? Can’t they let the people pointlessly pass around their issues of The Austrian while the overlords continue about their business, undisturbed behind their battalions? As Mises stated in Human Action:
In the end the philosophy of the majority prevails. In the long run there cannot be any such thing as an unpopular system of government. The difference between democracy and despotism does not affect the final outcome. It refers only to the method by which the adjustment of the system of government to the ideology held by public opinion is brought about. Unpopular autocrats can only be dethroned by revolutionary upheavals, while unpopular democratic rulers are peacefully ousted in the next election.2
Emphasizing the strength of public opinion in the face of the state’s military might, Dr. Robert Murphy explains:
And if you think that’s naïve, well then if you were right, that means the most totalitarian states where the leader can just have somebody disappeared at night . . . then there they should have free and open internet access, they can let the schools teach whatever they want . . . if anyone gets out of line they just kill them. But no, it’s precisely in those totalitarian societies where they can just kill people at will where they want the most strict control over information.3
Indeed, in virtually every case, the most militarized and totalitarians states, those most willing to use force against their own people, are those most concerned with controlling the education, speech, and thought of their subjects. The reasoning behind such efforts is clear in light of two facts. First, the people are many and the state is few. Second, the constituent agents of the state itself, including members of the police and military, are not immune to infection by dissent, and can come to support regime change. Inverted pyramids of force are built upon the base of opinion. Even if, as Lenin said, one man with a gun can control one hundred without one, opinion can make that one man turn around onto his masters.
In some significant ways, dictatorships and monarchies face even stronger popular opinion constraints than democracies do. While elected officials are typically voted out of office in one piece, strongmen and their loved ones often face grotesque deaths when ousted. Additionally, the understanding among the public that democratic politicians can be voted out peacefully every few years can breed patience until the next election, whereas subjects of strongmen know change won’t come unless and until people take action. Thus, dictators have more personally at stake in the battle over popular opinion than do democratic politicians, and do not have the hope of periodic peaceful regime change to allay unrest among the masses.
Of all of the natural and social sciences, it’s most important that the intelligent layperson have a solid hold of economics, because their understanding of economics will shape the operation of the most powerful organization in every country in the world: the state. “The flowering of human society depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority.”4
On November 1, Mario Draghi’s tenure as governorof the European Central Bank (ECB) will expire, and the European Council will appoint a successor for the role. Moreover, it is now known that northern European countries are pushing for replacing Mr. Draghi — widely recognized as a “dove” — with a “hawk” — less accommodating toward the loose monetary policy being demanded by southern European states. Most especially, Italy.
On the other hand, there are plenty of economic considerations — besides the historical and political ones blaming the alleged excessive (but totally sensible and legitimate) German fear of hyperinflation — which support the northern European preference for a less accommodating governor, and a tighter monetary-policy stance. Let’s look at three of them, which are the most prominent amongst several others:
One: From March 2015 onwards, the Quantitative Easing program (QE, officially known al the Asset Purchasing Programme, APP) implemented by the ECB has been distorting the relative prices of European private and public bonds, delivering a perfect textbook-case of how Cantillon-effects distort the economy. Indeed, for instance, the current difference between the yield of American 10-year government bonds and Italian ones is much lower than the same difference between German 10-year government bonds and American ones, in spite of the total absence of macroeconomic fundamentals to account for this fact. Moreover, as figure 1 and 2 show, the Asset Purchasing Programme has been highly biased towards its public-sector branch (PSPP, Public Sector Purchasing Programme, painted in blue). This also distorts the relative prices of private and public securities, and brings about a crowding-out effect damaging private investments;
Two: From a historical and political perspective, Italy has been blatantly breaching the deals — i.e., the 1992 Maastricht treaty and the 1997 Amsterdam treaty — requiring limits of its public debt over a GDP ratio to the 60% level. In practice, this has reached a historical post-war peak of more than 132%. Hence, it is evident that Italy has been only reaping the benefits stemming from European integration. This includes lower public expenditure for debt-interests (from 12.2% in 1993 to 3.7% in 2018), monetary stability, low inflation, and commercial integration. Of course, northern states are no longer willing to let Italy have everything it wants, and are perfectly aware that Italy has been the country gaining the most in terms of lower interest on its public debt brought about by Mr. Draghi’s monetary policies;
Three: The central bank has been claiming these inflations are “justified” by the alleged empirical evidence entailed by the Phillips-curve. The central bankers have been lamenting excessively low inflation within the Eurozone, and Mr. Draghi has expanded the Eurozone’s monetary base up to a level equal to 28% (3.217-trillion euros) of its GDP. Meanwhile, the American monetary base has been reduced to a level lower than 17% of American GDP. This, combined with a stable — even though low — growth in the Eurozone, with a macroeconomic outlook close to its full potential (even Italy, the weakest of all European economies, is predicted to have an output gap equal to -0.3% of GDP in 2019 and -0.1% of GDP in 2020, thus practically reaching its full potential output) and the fear of an economic slow-down caused by trade-wars, has convinced north-European politicians that the current monetary-policy stance is no longer what Eurozone — as a whole — needs. (Even Italy, the weakest of all European economies, is predicted to have an output gap equal to -0.3% of GDP in 2019 and -0.1% of GDP in 2020, thus practically reaching its full potential output.)
Lastly — and subsuming the three aforementioned bullet-points — a “hawkish” ECB-governor would be also in the interest of Italy itself. After all, Mr. Draghi’s monetary-policy stance has allowed Italian governments to keep implementing unsustainable fiscal policies without sustaining the associated economical and political costs, such as higher public expenditures for debt-interests and lower bank-lending. The latter is being caused by the huge exposure of Italian commercial banks to Italian sovereign risk.
Ultimately, northern-European savers, the stability of the monetary union and — especially — Italy itself do not need a lovely, charitable and “dovish” mother at the central bank. We need, rather, a stark, strict and “hawkish” tutor.
The regular occurrence of traffic jams in major cities is not an immutable fact of urban life. Private roads show us the path out.
A shortage occurs when the price of a scarce good is set below the market-clearing price.1 If the state monopolized milk production, produced a fixed quantity of milk every year, set the price of milk at zero, and distributed it on a first-come first-serve basis, the result would be an anarchic rush to attain as much milk as possible, without consideration for the milk needs of others. A shortage would occur.
The state, for almost all of the highways and streets it controls, has set the price of this essential, scarce good at zero. Traffic jams are a manifestation of shortages in the road supply. Treating a good of which there exists a finite supply as though it existed in infinite abundance (had a price of zero) is incongruent with reality, and we should expect it to cause problems.
If prices were allowed to adjust to demand, the price of using a given highway would increase when more people want to use it and decrease when fewer people want to use it.2 The result would be that people would think twice before driving at a costly time. Those who needed most to use the highway at a time of high demand would be willing to pay the price,3 while those who were willing to wait would adjust their behavior on the margin. When demand and hence prices for roads are highest, more people would go to the close bowling alley instead of the far away movie theatre, the closer restaurant instead of the farther one, or do something at home instead of going for a drive. They would be more cautious to schedule their errands before or after peak hours, instead of during them. As a result, the number of cars driving during peak hours would be reduced, mitigating traffic jams.
Employers would also react to priced roads by altering their employees’ hours. Employers would seek to schedule their workers’ shifts such that their commutes are during cheaper, lower demand hours, lest the employer need to pay higher salaries to offset the inconvenience of more expensive, slower commutes to attract employees of the same quality. The result would be more staggered commute schedules, such that fewer people are driving to or from work at any given time, reducing traffic.
Some businesses like restaurants and movie theaters would not react much, because:
Most restaurants, for example, are busiest during breakfast, lunch, and dinner time, and perhaps, in some cases, after show closings, for late-night meals. In other words, restaurants suffer from congested traffic, a peak load problem, during these times. But, were a restaurant management seriously to propose that its customers stagger their meal times ‘in order to reduce and spread out the rush hour peaks,’ it would be laughed right out of business in a trice. Its competitors would have a field day.4
However, other businesses would be more capable of beginning their employees’ shifts a few hours earlier or later than the bulk of other employers:
. . . if a price reduction is offered for off-peak travel, all employers will be tempted to accede to the wishes of their employees for cheaper travel. The ones who actually give in and reschedule their work forces will tend to be the ones whose employees’ productivity is increased to the least degree by working the same hours as the general labor force.5
The result would be social coordination of road use. Those industries which least need their employees working at a particular time would most strongly react to road prices by scheduling shifts to provide the cheapest commutes. If omnipotent, caring Martians were to dictate to every industry when their employees’ shifts should begin to both maximize workplace productivity and minimize traffic, the result would be the same as under a system of private roads.
Not only would the currently existing roads be rationed according to prices instead of the current free-for-all, the ability to make money from providing roads would lead to the widening of existing roads and the creation of new roads altogether when demand points to new profits to capture, “Privately-owned roads and bridges would have tolls set by supply and demand, just like prices are set in any other market. Infrastructure in need of repair or expansion would get it, whereas wasteful boondoggles would be minimized with private money on the line.”6
Likewise, road owners hoping to lure potential customers to choose their routes instead of rival routes (intra-market competition) or to use their routes more often instead of staying at home and driving less altogether (inter-market competition) would wish to make their roads as safe, uncongested, and attractive as possible. This means wherever currently there is a stop-sign that should be a yield sign, a 45 MPH speed limit that should be a 65 MPH speed limit, a traditional intersection that should be a roundabout, or any other change in road design and rules, private road owners would be driven by self-interest to adjust in order to maximize safety and traffic flow.
Contrast this with the current system under which certain government run intersections are infamous for being dangerous and accident prone. Why do political actors allow these preventable series of tragedies to persist rather than adjusting the designs and/or rules of those intersections? The overseers of government run roads are chosen democratically, rather than by the market. Whereas the private owner of a road bears direct legal and financial responsibility for its safety, mayoral, gubernatorial, and presidential elections, occurring once every four years, seldom depend upon the candidates’ positions on individual intersections or roads:
The dollar vote occurs every day, the ballot box vote only every two or four years. The former may be applied narrowly, to a single product (e.g., the Edsel) while the latter is a ‘package deal,’ an all or none proposition for one candidate or the other. That is, there was no way to register approval of Bush’s policies in areas 1, 3, 5 and 7, and for Clinton in 2, 4, 6, and 8. People were limited to choosing one or the other in the last presidential election.7
Mayor Jones and Governor Smith may go through their entire election campaigns and reigns without giving a thought to death-trap intersections under their jurisdictions that could stop killing people if only some signs or speed-bumps were added. With privatization, each road would have a special caretaker, an owner, whose livelihood and freedom depended on the quality and safety of their product.
Road privatization launches a triple-attack on traffic. First, prices for road use allow coordination in when and how much travelers use particular roads. Second, the road supply is increased through construction of new roads and expansion of existing roads. Third, entrepreneurs seeking to improve their services would optimize the designs and rules of their roads. In severe traffic, how often have our thoughts turned to state-enforced population control, when we just needed to know that keeping the price of a scarce good at zero causes shortages?
- 1. The market-clearing price is the price at which there is a willing and able buyer for every unit of a good produced, and visa-versa.
- 2. Uber’s surge pricing works similarly.
- 3. If roads were privately provided, the state would no longer need to collect taxes to finance roads, and so society could use the money saved in taxes to pay for tolls, or anything else.
- 4. Walter Block, The Privatization of Roads and Highways, Ludwig von Mises Institute, 2009, p. 60.
- 5. Ibid., pp. 60-61.
- 6. Robert P. Murphy, “A Gas Tax Hike is the Wrong Way to Fund Highways,” Mises Wire, 2018.
- 7. Walter Block, The Privatization of Roads and Highways, Ludwig von Mises Institute, 2009, p. 196.