This is a very long reply of mine to a Rothbardian on youtube:
Government spending is not limited by borrowing. All the money that goes to paying taxes, all the money that goes to buying government debt - it all comes from government spending. Government spending finances government taxation. Vice-versa is not only illogical, it is operationally impossible.
1. Austrian belief that Gold standard was awesome. It's a myth, it wasn't awesome.
First of all, a Gold standard is a GOVERNMENT PRICE SETTING. It's not a "creature born out of the free market".
The reasons nations have gone off the gold standard isn’t because it was working so well and their economies were doing well. The reason they go off, like the US did in 1934, was because it was a disaster.
Historically nations suspend their gold standards in times of war, when they need their economies to function to the max. If a gold standard was so good for an economy, why suspend it when you need max economic performance? Obviously because it is not conducive of maximum real output.
The ideological issue is whether the primary function of the currency is to be an investment/savings vehicle, or a tool for provisioning government and optimizing real economic performance. In a market economy you can’t fix the price of two things without a relative value shift causing you to be buying one of them and running out of the other. Likewise, you can’t sustain full employment and a stable gold price if there is a shift in relative value between the two.
A gold standard is a fixed exchange rate policy, where the govt continuously offers to buy or sell gold at a fixed price.
This means the holder of a dollar, for example, has the option of ‘cashing it in’ for a fixed amount of gold from the govt, and a holder of gold has the option of selling it at a fixed price to the govt.
Therefore a new gold discovery which causes gold to be sold to the govt is inflationary and tends to increase output and employment, and a gold ship sinking in transit or a sudden desire to hoard gold is deflationary and tends to decrease output and employment. And there’s nothing that can be done about these relative value shifts, except to ride them out. The only public purpose served (by definition) is the stable nominal price of gold set by Congress.
With a gold standard, like any fixed fx regime, interest rates are necessarily set by market forces. With the govt’s spending being convertible currency, it is limited to spending only to the extent it has sufficient gold reserves backing the currency it spends. With gold reserves generally pretty much constant and not expandable in the short run, this means govt spending is limited to what it can tax and/or borrow. So when the govt wants to deficit spend, doing so by ‘printing’ new convertible dollars risks those dollars being ‘cashed in’ for gold. Govt borrowing, therefore, functions to remove that risk by delaying conversion privileges until the borrowings mature. This means the govt is competing with the right to convert when the govt borrows. In other words, the holder of the gold certificates has the option of either converting to gold or buying the treasury securities. The interest rate the treasury must pay therefore represents the indifference rate of holders of the convertible currency between cashing in the currency for gold now or earning the interest rate and not being able to convert until maturity. Note that it’s in fixed exchange rate environments that govt borrowing costs have soared to triple digits as govts have competed with their conversion features, and that govts generally lose those fights as the curve goes vertical expressing the fact that at that point there is no interest rate that can keep holders of the currency from wanting to convert.
Note that this also means the nations gold reserves are the net financial equity that supports the entire dollar credit structure, a source of continuous financial fragility and instability.
Being on the gold standard doesn’t prevent a financial crisis, but it makes the consequences far more severe.
We were on a gold standard when the roaring 20′s private sector debt boom lead to the crash of 1929 and the depression that followed. 4,000 banks closed before we went off gold in 1934, and it was only getting worse which is why we went off of it.
Gold would not have prevented the pre 2008 sub-prime boom, but it would have made the consequences far more severe. Including no Fed liquidity provision to offset a system wide shortage due to hoarding and banks bidding ever higher for funds that didn’t exist, most all firms losing inventory financing and being forced to liquidate inventories as rates spiked competing for funds that didn’t exist, and no deficit spending for unemployment comp as federal revenues fell from the collapse. In other words, the automatic fiscal stabilizers we rely on can’t be there. Instead it’s a deflationary disaster that only ends when prices fall sufficiently to reflect changes in relative value between gold and everything else.
Note that the recent decade of gold going from under $600 to over $1,600 is viewed as a sign ‘inflationary’ and a 250% ‘dollar devaluation’ as it takes 2.5x as many dollars to buy the same amount of gold. But if we were on a gold standard, and all else equal, and gold had been fixed at $600 back then, the same relative value shift would be manifested as the general price level falling that much in an unthinkable deflationary nightmare.
1.1 The austrian belief that fraction reserve banking is fraud. (false)
Example of voluntary FRB:
(1) We set up our fractional reserve bank;
(2) our clients hand over money to us and explicitly agree that the ownership of their money passes to the bank;
(3) the bank gives the client a bank account, which is a credit/debt instrument or an IOU redeemable on demand to return to them money up to the amount in his or her account from (a) the bank’s reserves, (b) from sale of financial assets, or (3) loans.
(4) it is understood by all parties that most of the original money has been loaned out (except for that portion held as reserves), and only a tantundem from the bank’s reserves, money from sale of financial assets, or loans is provided;
(5) the bank’s private notes are negotiable, so that they can be used by anyone who accepts them as a means of payment/medium of exchange. It is in our contact that our clients must explain to anyone who accepts our private notes the terms as stipulated to them. The private notes are widely accepted in the community. People are happy to accept them as a means of payment, and redeem them when they wish to.
(6) if the bank becomes insolvent, the clients holding accounts or unredeemed bank notes can sue to regain their debt from the liquidation of the bank’s assets. Everyone understands this and accepts the risk.
Where is the fraud here? Risk is part of any venture.
2. The concept of debt monetisation is a non sequitur. Once the overnight rate target is set, the central bank should only trade government securities if liquidity changes are required to support this target. Given the central bank cannot control the reserves then debt monetisation is strictly impossible. Imagine that the central bank traded government securities with the treasury, which then increased government spending. The excess reserves would force the central bank to sell the same amount of government securities to the private market or allow the overnight rate to fall to the support level. This is not monetisation but rather the central bank simply acting as broker in the context of the logic of the interest rate setting monetary policy.
Ultimately, private agents may refuse to hold any further stocks of cash or bonds. With no debt issuance, the interest rates will fall to the central bank support limit (which may be zero). It is then also clear that the private sector at the micro level can only dispense with unwanted cash balances in the absence of government paper by increasing their consumption levels. Given the current tax structure, this reduced desire to net save would generate a private expansion and reduce the deficit, eventually restoring the portfolio balance at higher private employment levels and lower the required budget deficit as long as savings desires remain low. Clearly, there would be no desire for the government to expand the economy beyond its real limit. Whether this generates inflation depends on the ability of the economy to expand real output to meet rising nominal demand. That is not compromised by the size of the budget deficit.
3. More austian myths: hyperinflation due to uncritical adoption of more money
A careful study of historical cases of hyperinflation shows the following causes: the collapse of production, brazen corruption, political instability, war or defeat, finally collapsing fixed exchange rate with a strong currency (Argentina). The over-production of money is always the result and never the cause of a crisis of hyperinflation.
“The quantity theory of money is based on two propositions. First, in the long run, there is proportionality between money growth and inflation, i.e., when money growth increases by x% inflation also rises by x% .... We subjected these statements to empirical tests using a sample which covers most countries in the world during the last 30 years. Our findings can be summarised as follows. First, when analysing the full sample of countries, we find a strong positive relation between the long-run growth rate of money and inflation. However, this relation is not proportional. Our second finding is that this strong link between inflation and money growth is almost wholly due to the presence of high-inflation or hyperinflation countries in the sample. The relation between inflation and money growth for low-inflation countries (on average less than 10% per year over 30 years) is weak, if not absent” (De Grauwe and Polan 2005: 256).
First, for countries with inflation rates less than 10% (which is most of the developed world), the empirical evidence for the quantity theory of money is either very weak or just non-existent. This is a serious blow to the quantity theory.
Secondly, although countries with high-inflation or hyperinflation show a correlation between the growth rate of money supply and inflation, contrary to the quantity theory, that relation is not proportional. A further blow to the quantity theory is that, in very high inflation countries, inflation rates exceed the growth rates of the money supply, because the velocity of circulation of money increases with high inflation rates (De Grauwe and Polan 2005: 257). This instability in the velocity of circulation is contrary to the quantity theory, which posits a stable velocity of circulation, as we will see below. Finally, De Grauwe and Polan reach the conclusion:
“Our results have some implications for the question regarding the use of the money stock as an intermediate target in monetary policy …. The ECB bases this strategy on the view that ‘‘inflation is always and everywhere a monetary phenomenon.’’ This may be true for high-inflation countries. Our results, however, indicate that there is no evidence for this statement in relatively low-inflation environments … In these environments, money growth is not a useful signal of inflationary conditions, because it is dominated by ‘‘noise’’ originating from velocity shocks. It also follows that the use of the money stock as a guide for steering policies towards price stability is not likely to be useful for countries with a history of low inflation” (De Grauwe and Polan 2005: 258).
4. A classical libertarian myth: Hyperinflation brought Hitler to power
The hyperinflation of the early 1920s hit brutally German society. Not yet brought Hitler into government. As Germany rode the waves of hyperinflation, the percentage of Nazis ranged below 4% (see the 1928 elections). In 1930 hyperinflation was tamed now. When the new Finance Minister Kurt von Brouningk imposed harsh austerity in the early 1930s, increasing unemployment vertically, gave the Nazis their first success (18.3% in September 1930). Two years later, under the ever harsher austerity Brouningk, unemployment and poverty drove Hitler to 37.2% in the 1932 elections.
5. Another myth, austrians understand endogenous money:
Show me an article from an austrian economist pre 2007-2008 that mentions the line "loans create deposits."
6. Another myth, Austrian economists understand that QE is not money printing/helicopter drop.
http://mises.org/daily/4029 Murphy still doesn't get it.
7. The "innocence" of Mises and Hayek vis-a-vis totalitarism and fascism.
Fascism is NEVER an alternative to Stalinism, nor was it ever. The fact that Mises took a job within a government that was authoritarian and corporatist shows just how much integrity the man DIDN'T have. To agree to apply socialist policies for the corporates but not for labor is clear as light that the man was a huge ass hypocrite. You don't stop the revolutionaries by giving more power to the reactionaries.
Also, Hayek and Mises are not some organic free-thinkers. Their work was backed by big money interests and this is fact!
Friedrich Hayek’s ‘the road to Serfdom’ was published the same year. With its defense of ‘laissez-faire’ capitalism and claim that any attempt at regulation would inevitably lead to totalitarianism, it was exactly what the Volker Fund had been looking for. It was only then that the Volker fund started to have a real impact. It arranged for a reprint of Hayek’s book with the University of Chicago and made sure the book ended up in every library in the United States.
The Volker Fund would finance all the leading Austrian Economists and would have a substantial impact on the ‘Chicago School of Economics’, including Milton Friedman.
Von Mises, who throughout his career never held a paid job at any University, was maintained first by David Rockefeller and then for decades received money from the Volker fund and related business men, like Lawrence Fertig.
Von Mises’ biographer, Richard M. Ebeling:
“Many readers may be surprised to learn the extent to which the Graduate Institute and then Mises himself in the years immediately after he came to United States were kept afloat financially through generous grants from the Rockefeller Foundation. In fact, for the first years of Mises’s life in the United States, before his appointment as a visiting professor in the Graduate School of Business Administration at New York University (NYU) in 1945, he was almost totally dependent on annual research grants from the Rockefeller Foundation.”
David Rockefeller himself was quoted as saying: “Finally, in his most surprising statement, he revealed he considers himself a follower of the Austrian school of economics. Friedrich Hayek had been his tutor at the London School of Economics in the 1930s.“
Rothbard too was financed by the Volker Fund:
“Rothbard began his consulting work for the Volker Fund in 1951. This relationship lasted until 1962, when the VF was dissolved. A major part of Rothbard’s work for the VF consisted of reading and evaluating books, journal articles, and other materials. On the basis of written reports by Rothbard and another reader – Rose Wilder Lane – the VF’s directors would decide whether to undertake massive distribution of particular works to public libraries.
Rothbard later called his work with the Volker Fund, “the best job I’ve ever had in my life.”
The Volker Fund also explored a tactic that was to find wider application later: it spawned an enormous number of organizations, loosely organized to suggest mutual independence and a ‘Libertarian Movement’. Among these was the Foundation for Economic Education, which in turn would create the Mont Pelerin Society.
The Mont Pelerin Society
The Mont Pelerin Society was named after the Swiss Alp where the first conference was held. It was founded by Hayek with the financial support of the Volker fund, which paidfor the expenses of all American participants. Key co-founders were von Mises, Milton Friedman and Karl Popper.
No less than eight Noble prizes for Economics were to be won by Mont Pelerin members in the decades ahead. Not bad, for a ‘fringe movement, ignored by the Mainstream’.
The Mont Pelerin, in turn, oversaw the creation of many influential institutions. One of them was the Institute of Economic Affairs in London, 1955. This organization reinvented the Conservative Party, of which Margeret Thatcher was to say: “You created the atmosphere which made our victory possible… May I say how thankful we are to those who joined your great endeavor. They were the few, but they were right, and they saved Britain.“
The Heritage Foundation was also a result of the Mont Pelerin Society, as were the Manhattan Institute for Policy Research and the Atlas Economic Research Foundation, which in turn birthed a plethora of think tanks, including the Fraser Institute.
The amount of money that was invested in all this was tremendous:
“John Blundell, the head of the IEA, in a speech to the Heritage Foundation, and Atlas in 1990, would identify a rare failure in the Society’s efforts. Shaking his head at the abortive attempt to subsidize academic “Chairs of Free Enterprise” in dozens of countries throughout the world, Blundell complained about wasting, “hundreds of millions, perhaps one billion dollars”. This was just one initiative among many.”
The Koch Family.
The Volker fund was disbanded in 1962. It still had $7 million in assets, which it donated to the Hoover society.
But in the mean time another very wealthy Jewish family, the Koch family had taken over the organization of Libertarianism and Austrian Economics.
Fred Koch founded the John Birch Society in 1958. Ed Griffin was educated there. He later wrote a famous book, “the Creature of Jekyll Island”. This was a rehash of Eustace Mullins’ brilliant ‘Secrets of the Federal Reserve’, with one exception: it left out all Mullins’ analysis of the Gold Standard as a Banker operation and how Britain’s demand for taxes paid in Gold were the cause of the war of Independence. Instead it called for the reinstatement of a Gold Standard. This is a key part of the story how Austrian Economics managed to take over the ‘Truth Movement’.
Koch’s son Charles Koch founded the CATO Institute, together with Murray Rothbard. The CATO Institute remains to this day a leading Libertarian outlet.
8. The love between Hayek and Pinochet
Hayek, interview to a Chilean newspaper:
“[A]s long-term institutions, I am totally against dictatorships. But a dictatorship may be a necessary system for a transitional period. At times it is necessary for a country to have, for a time, some form or other of dictatorial power. As you will understand, it is possible for a dictator to govern in a liberal way. And it is also possible for a democracy to govern with a total lack of liberalism. Personally, I prefer a liberal dictator to democratic government lacking in liberalism. My personal impression. . . is that in Chile . . . we will witness a transition from a dictatorial government to a liberal government . . . during this transition it may be necessary to maintain certain dictatorial powers, not as something permanent, but as a temporary arrangement.”
So there we have it: when the chips are down, Hayek presumably preferred dictatorship to a state with the rule of law and a social democratic or democratic socialist economics.
One wonders whether, if in his day when pressed, he would have expressed preference for Pinochet’s Chile (where people where regularly “disappeared”) to social democratic Sweden?
By contrast, a fair point that Hayek makes is that a dictator can pursue “liberal” or laissez faire policies. This is perfectly true: Mussolini originally pursued standard free market, neoclassical policies:
“From 1922 to 1925, Mussolini’s regime pursued a laissez-faire economic policy under the liberal finance minister Alberto De Stefani. De Stefani reduced taxes, regulations, and trade restrictions and allowed businesses to compete with one another. But his opposition to protectionism and business subsidies alienated some industrial leaders, and De Stefani was eventually forced to resign.”
Sheldon Richman, “Fascism,” Concise Encyclopedia of Economics
http://www.econlib.org/library/Enc1/Fascism.html
It is perhaps with this in mind that we must view the remark by Mises on Mussolini’s fascism:
“It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history. But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error.”
Mises, 1978 [1927]. Liberalism: A Socio-Economic Exposition (2nd edn; trans. R. Raico), Sheed Andrews and McMeel, Mission, Kansas. p. 51.
All in all, you don’t see the Austrians commenting much on these disgraceful remarks by either Hayek and Mises.
9. Hayek the Ethnic Bigot and the Perils of the Ad Hominem Fallacy
Hayek (1899–1992) was once asked what kind of people he disliked, and his response is not a pretty sight:
CHITESTER: …. Going back to the question I asked you about people you dislike or can’t deal with, can you make any additional comments in that regard, in terms of the characteristics of people that trouble you?
HAYEK: I don’t have many strong dislikes. I admit that as a teacher—I have no racial prejudices in general—but there were certain types, and conspicuous among them the Near Eastern populations, which I still dislike because they are fundamentally dishonest. And I must say dishonesty is a thing I intensely dislike. It was a type which, in my childhood in Austria, was described as Levantine, typical of the people of the eastern Mediterranean. But I encountered it later, and I have a profound dislike for the typical Indian students at the London School of Economics, which I admit are all one type—Bengali moneylender sons. They are to me a detestable type, I admit, but not with any racial feeling. I have found a little of the same amongst the Egyptians —basically a lack of honesty in them. (Nobel Prize-Winning Economist: Friedrich A. von Hayek, Regents of the University of California, 1983. p. 490).
So here we have Hayek asserting:
(1) Although he protested that he had no racial prejudices, Hayek admitted a dislike for a certain type of persons conspicuous among “Near Eastern populations” whom he found fundamentally dishonest, and who in the Austria of his youth could be described as “Levantine, typical of the people of the eastern Mediterranean.”
There is something shocking in these statements. Who on earth was Hayek talking about here? Some have charged that Hayek was showing latent anti-Semitism (Reder 2002: 263), and I find it difficult not to agree. Any person ranting about fundamentally “dishonest” Levantine people sounds like a cowardly anti-Semite to me. If not, who was the target? I don’t think there were many Syrians or Lebanese in the Austria of Hayek’s childhood and youth (which is the period from 1899–1918). Nor will the charge of ethnic slander and bigotry be dismissed if one chooses to deny that Hayek had in mind here human beings who happen to be of Jewish ethnicity: for now Hayek is open to the charge of even greater bigotry against Levantine people in general. Who seriously thinks that whole nations of people are all fundamentally “dishonest”? Anyone who thinks this is a bigot and an idiot.
(2) Hayek held a profound dislike for “the typical Indian students at the London School of Economics” supposedly of a particular detestable type, “Bengali moneylender sons.” Hayek showed himself guilty of a contemptible ethnic slur here, one which Anand Chandavarkar has described as Hayek’s “bizarre notion of Bengali students as sons of moneylenders, the one profession which the versatile Bengali has always scorned. The few postgraduate Indian pupils of Hayek – S. R. Sen, Said Ahmad Meenai and B. R. Shenoy – were all ‘honest’ high achievers who certainly did not answer to his image of Indian students” (Chandavarkar 2002: 224). I might add that I find it ridiculous and paradoxical that an inveterate apologist for Classical liberal, laissez faire capitalism like Hayek would have a prejudice against money-lenders’ sons. Isn’t money lending or banking a fundamentally important profession in modern capitalism?
(3) If this wasn’t enough, Hayek found time to use a similar ethnic slur of dishonesty (if not quite as pronounced) against Egyptians as well.
Now, to be fair to Hayek, I don’t see evidence of the kind of vile and shameful 19th-century racism in these opinions that holds that certain groups of human beings are inferior in terms of intelligence, morality or honesty owing to genetic or hereditary causes. But Hayek’s contemptible, irrational and disgraceful ethnic slurs and bigotry cannot be denied either.
If any apologist for Hayek contends that Hayek was kind and generous to his students and friends who happened to be Jewish or Indian, then the very same defence can be made of Keynes: just like Hayek, Keynes had Jewish friends and displayed great kindness toward them.
The lesson here is that Hayek, like Keynes, was also guilty of despicable ethnic slanders and prejudices (see Chandavarkar 2000 for Keynes’s anti-Semitism). Moreover, do these bigoted remarks provide us with any reason to reject the economic theories of Hayek?
Of course not. To do so would be to invoke the ad hominem fallacy. The shameful anti-Semitism of Keynes is irrelevant to the question of the truth of the economic theories in the General Theory and Keynes’s later work. The shameful (and arguably) latent anti-Semitism of Hayek is strictly irrelevant to the truth of Hayek’s economic theories.
Any modern Keynesian can condemn the bigotry of Keynes as an utterly disgraceful and immoral part of Keynes’s personality and character, while asserting the fundamental truth of many of the economic theories in the General Theory. The modern Austrian can condemn the bigotry of Hayek as an utterly disgraceful and immoral part of Hayek’s personality and character, while asserting the truth of the ideas in Hayek’s economics. The ad hominem fallacy and name calling abuse have no part in the debates on economic theory.
10. Hayek didn't accept Mises' Apriorism
It is now well known that Hayek disagreed with Mises on the role of empirical evidence. In a letter that Hayek wrote to Terence W. Hutchison dated 15 May, 1983, Hayek stated:
“I had never accepted Mises’ a priorism .... Certainly 1936 was the time when I first saw my distinctive approach in full clarity – but at the time I felt it that I was merely at last able to say clearly what I had always believed – and to explain gently to Mises why I could not ACCEPT HIS A PRIORISM” (quoted in Caldwell 2009: 323–324).
In fact, in 1937 Hayek had published an article called “Economics and Knowledge” where he criticised Mises’ apriorism, and appears to have moved closer to Popperian ideas on methodology in later years:
“I became one of the early readers [sc. of Karl Popper’s Logik der Forschung, 1934]. It had just come out a few weeks before …. And to me it was so satisfactory because it confirmed this certain view I had already formed due to an experience very similar to Karl Popper’s. Karl Popper is four or five years my junior; so we did not belong to the same academic generation. But our environment in which we formed our ideas was very much the same. It was very largely dominated by discussion, on the one hand, with Marxists and, on the other hand, with Freudians. Both these groups had one very irritating attribute: they insisted that their theories were, in principle, irrefutable. Their system was so built up that there was no possibility – I remember particularly one occasion when I suddenly began to see how ridiculous it all was when I was arguing with Freudians, and they explained, “Oh, well, this is due to the death instinct.” And I said, “But this can’t be due to the [death instinct].” “Oh, then this is due to the life instinct.” … Well, if you have these two alternatives, of course there’s no way of checking whether the theory is true or not. And that led me, already, to the understanding of what became Popper’s main systematic point: that the test of empirical science was that it could be refuted, and that any system which claimed that it was irrefutable was by definition not scientific. I was not a trained philosopher; I didn’t elaborate this. It was sufficient for me to have recognized this, but when I found this thing explicitly argued and justified in Popper, I just accepted the Popperian philosophy for spelling out what I had always felt. Ever since, I have been moving with Popper” (Nobel Prize-Winning Economist: Friedrich A. von Hayek, pp. 18–19).
One wonders what Hayek would have thought about the hordes of ignorant and “pop” Austrians on the internet today, claiming that the inferences of praxeology are irrefutable and praxeology has no need for empirical evidence (which is a distortion of what even Mises believed). If Hayek were alive today and gave an honest answer to this, he would have to class such vulgar Misesians as talking nonsense on a par with Marxism and Freudian psychology.
11. Your precious Rothbard defends monopoly and cartel prices:
Rothbard has a curious attitude to monopoly and cartel prices. Rothbard admits the possibility of monopolies and cartels arising on the completely free market, and defends their existence in these circumstances:
“So far we have established that there is nothing ‘wrong’ with monopoly price, either when instituted by one firm or by cartel; that, in fact, whatever price the free market (unhampered by violence or the threat of violence) establishes will be the ‘best’ price.”
(Rothbard 2009: 661).
Yet, since a monopoly or cartel will be a price setter, it is nonsense to talk about the monopoly price being the price the “free market establishes.” The charge that Rothbard exhibits a double standard on monopoly was also made by L. E. Hill (1963).
Rothbard’s views must be set within the framework of broader Austrian ideas on monopoly:
“Since Rothbard’s economic theories are generally within the Austrian economic tradition, it might be useful to compare his position on monopoly with those of Ludwig von Mises and Israel M. Kirzner. Mises held that monopoly could exist in a free market whenever the entire supply of a commodity was controlled by one seller or a group of sellers acting in concert. Such a situation was not necessarily harmful unless the demand curve for the commodity was inelastic. Then, according to Mises, the monopolist would have a perverse incentive to restrict production and create a monopoly price, and that price would be ‘an infringement of the supremacy of the consumers and the democracy of market.’ Kirzner has suggested that the monopoly ownership of some resource could have ‘harmful effects’ since it would create an incentive on the part of the resource owner to not employ the resource to ‘the fullest extent compatible with the pattern of consumer tastes’ in the market.” (Armentano 1988: 7).
Rothbard rejects the definition of monopoly as the control of the supply of a commodity, and thinks that there is no distinction between competitive and monopoly prices on a completely free market.
On pp. 662ff. of Man, Economy, and State, Rothbard engages in a tortuous and utterly unconvincing attempt to deny any difference between a small producer in a competitive market and a larger corporation with a large share of production. Rothbard’s eventual definition of monopoly only as a right of exclusive production granted by the state to some entity is a piece of legerdemain that allows him to argue that “monopoly can never arise on a free market” (Rothbard 2009: 670).
Moreover, Rothbard’s view is inconsistent, since elsewhere his view is that free markets are superior precisely because consumers set prices:
“On the free market, consumers can dictate the pricing and thereby assure the best allocation of productive resources to supply their wants. In a government enterprise, this cannot be done.”
(Rothbard 2009: 1261).
But, if on the unhampered market, cartels, oligopolies and monopolies could develop in product markets, and the prices of commodities were then set by price setters/price administrators, and not by the dynamics of supply and demand curves, then it is obvious that consumers are not dictating pricing. According to Rothbard’s argument here, unhampered free markets would not assure the best allocation of productive resources, with cartel and monopoly prices being present.
Of course, anyone who has read the specialist literature from modern marketing departments, which studies the empirical reality of how prices are set, knows that business prefers stable prices to the instability of fluctuating ones and disastrous price wars. In the real world, modern corporations are often prices setters, not price takers. Price setting has benefits overlooked by libertarian and free market ideologues.
There is another criticism that can be made. Rothbard thought free markets have a tendency to equilibrium, if not to reach an equilibrium state:
“Rothbard presumed that in individual markets, the law of one price dominated, and that market clearing happened rapidly and smoothly (124). Just as in conventional neoclassical economics, general equilibrium, the evenly rotating economy (ERE), was the direction in which the economy was headed. The pervasiveness of change made it unlikely that an economy would ever achieve the ERE, but nevertheless, like a dog chasing a mechanical rabbit, it at least could explain the direction of change (274). Although Rothbard warned against taking equilibrium too seriously given the world of constant change in which we live (277), it was nevertheless his underlying assumption that markets adjust quickly to new equilibrium positions. Indeed, his justification for the basic efficiency of markets was that ‘entrepreneurs will be very quick to leave the losing industry’ (466) when mistakes are made.” (Vaughn 1994: 97).
One of the elements that supposedly cause the basic efficiency of markets is the flexibility of prices. But with Rothbard’s recognition that cartels and monopolies could arise on a free market and set prices, there is actually less likelihood of price flexibility and market clearing.
Rothbard does not explain how an anarcho-capitalist society would deal with coercive monopolies arising on free markets.
A perfect example of how a competitive market in an anarcho-capitalist system could collapse into a coercive monopoly is protection and policing. Private protection firms would in fact have an incentive to victimise potential customers to increase market share. Violence of the type that already happens between private mafia groups might occur. A natural monopoly would probably develop as the most powerful firm drove its competitors out of business (or a cartel might become dominant), and one would be left with a de facto state, the very thing anarcho-capitalism sought to abolish.
12. No. Rothbard's writing is DEFINITELY not the one size fits all for anyone with a "decent level of intelligence" to learn all there is to know about economics. Neither is Keynes, neither is Marx, neither is any contemporary or dead economist. In order to understand political economy, one has to get familiar with anthropology, with universal human history, and with everything else in between. Audi Alteram Partem.
13. More austrians myths, inflation and the fall of Rome:
The myth that the Roman empire fell because of economic problems caused by inflation dies hard, and you can find it used by Austrians and free market libertarians:
Peden, Joseph R. 2009. “Inflation and the Fall of the Roman Empire,” Mises Daily, September 7.
Bartlett, B. 1994. “How Excessive Government Killed Ancient Rome,” Cato Journal 14.2 (Fall): 287–303.
There are a number of points to make in response to these attempts to blame government intervention and inflation for Rome’s fall:
(1) What do we mean by the “fall of the Roman empire”? In fact, the Roman empire split into two by the fourth century AD, with one emperor in the West and one in the East. The expression the “fall of the Roman empire” actually refers to the collapse of the western Roman empire: the Eastern Roman empire (or the “Byzantine” empire) continued, with its fortunes waxing and waning, until 1453 AD. The “fall of the Roman empire” describes the loss of territory the Western empire experienced from about 400 AD onwards.
(2) While the Roman empire was hit by severe monetary inflation from the late third century to the early fourth century AD, the economic crisis largely abated by the mid-fourth century (Whittaker 1980). The Eastern Roman empire had been hit by the same inflationary crisis, but it never fell. Moreover, while the inflation had bad social effects, the full effects are not clear to us. The majority of the population of the Roman empire were peasants, but they were largely self-sufficient:
“modern scholars seem agreed that inflation only hurt a small section of the population; maybe ‘craftmen’, or possibly only ‘the small creditor class and urban professional (a teacher for instance)’, but neither the peasant nor the magnate suffered. Whatever stratum of society suffered, it did not do so across the whole empire. The Roman empire was never a unified economy; each province followed its own trajectory” (Sidebottom 1998: 2800–2801).
Since the vast majority of the population was rural and engaged in farming (the most important productive activity in the empire), the inflationary crisis of the late empire probably had no great effect on them.
(3) The Western empire persisted for nearly 50 years after the end of the inflation before it began to gradually lose its territory, and as late as 357 the Roman Caesar Julian the Apostate (emperor from 355 to 363) was able to inflict a crushing defeat on the Germans (the Alamanni and Franks) at the Battle of Argentoratum, when they were attempting to invade the empire. The devastating defeat the Romans later experienced at the battle of Adrianople (378 AD) when the eastern Roman Emperor Valens fought a Gothic army was clearly caused by strategic and tactical errors, and not because of the empire’s fiscal problems or inability to field an army.
(4) The West lost most of its empire owing to barbarian invasions from 400–450, and there is an obvious explanation for this: military and strategic errors by generals and emperors. The Western empire ended in 476 AD because of a simple internal rebellion when the last Roman emperor (Romulus Augustulus) was deposed by Odoacer, the barbarian leader of mercenaries in Italy who had been proclaimed king of Italy.
(5) The economic problems that the Roman empire faced after the third century AD were of course real, but not the result of the simple morality tale about inflation spun by apologists for free market economics:
“According to the monetarist view, what buried Rome was inflation stemming from government spending and adulteration of the coinage, coupled with what Mikhail Rostovtzoff deemed to be over-taxation of the middle class. But what actually led to fiscal and monetary breakdown in the every major society from Babylonia through the Roman and Byzantine empires to more modern times was the ability of large property owners to break free of taxes. The Roman treasury was bankrupted by wealthy landowners using their control of the senate to shift the fiscal burden onto classes below them. Lacking the means to pay, these classes were driven below the break-even point. As debt deflation drained the economy of money, barter arrangements ensued. Trade collapsed and the economy shrunk into local self-sufficient manor units” (Hudson 2003: 53).
In other words, it was the super rich and propertied classes who evaded taxation and forced a highly regressive tax system on the middle classes and poor. The economic problems can be related to the structure and unfair burden of taxation, not taxation per se.
(6) The effects of deflation and debt deflation are ignored by Austrian economists and others. The Roman Republic (which existed before the empire) in fact faced excessive debt and deflationary periods in the first century BC, especially in the 90s and 80s BC, which caused serious social and economic problems (for deflation in the Republic, see Barlow 1980; Nicolet 1971; cf. Verboven 1997). Thus it was not just inflation that had undesirable effects, but also deflation.
14. More austrian myths, free banking and gold standard was a good combo:
The issue I want to raise here is this: what is the empirical evidence about systems that approximate the free banking ideal? I use the word “approximate” because obviously there is no real world example of a system that is a perfect example of the free bankers’ utopia. There are some approximations, and Australia in the late 19th century is one of them.
Although Australian banking supervision was originally done by the British Treasury, from 1846 all the Australian colonies (except Western Australia) received banking autonomy, and then from 1862 the British Treasury no longer exercised this responsibility, which passed to each colonial government. These colonial governments (or state governments as they are called in Australia) did very little to regulate banks. Under the Colonial Bank Regulations of 1840, Australian banks already had limited liability. But, unless one wants to argue that limited liability is anti-market, this was no anti-market measure.
And even the basic earlier regulations were not even followed to any great degree: the restriction on banks with regard to advances on real estate was circumvented by the 1850s by legal tricks, and in Victoria the regulation was abolished in 1888 (Hickson and Turner 2002: 154).
By the 1860s, the Australian banking system had these characteristics:
(1) a gold standard (usually dated from 1852 [Bordo 1999: 327] with a branch of the British mint established in Sydney in 1855);
(2) no central bank;
(3) no capital controls;
(4) few legal barriers to entry;
(5) no branching restrictions;
(6) no credible restrictions on assets, liabilities or bank capital;
(7) no legally established price controls;
(8) no government-provided deposit guarantees.
What happened?
One obvious factor that a free banking system will never control is the speculative inflows and outflows of capital that any country experiences: by this factor alone there will always be the possibility of rapid inflation of the commodity money base, which will allow a surge in credit. This happened in Australia’s case: there was a surge of capital inflows in 1881–1885 and a flood in 1886–1890 (Hickson and Turner 2002: 149).
There is a real paradox here: the free bankers, much like the Austrians, make a fetish of free markets. For them only unrestricted capital movements are consistent with economic freedom, but it is this very trait that means that any free banking system will be subject to exogenous factors that cause its capital inflows and outflows to fluctuate. This is the Achilles’s heel, so to speak.
There is no reason in theory why a free banking system overflowing with foreign capital could not experience a credit boom.
Secondly, with no prudential regulation there is nothing to stop banks from
(1) lowering lending standards (leaving the bank with loans that default), and
(2) buying the latest trendy, poor quality assets which will be held on their books, only to collapse in value later.
And why would a free banking system not get caught up in the speculative frenzies when people and banks think they can make money quickly on rising asset prices?
This is precisely what happened in the case of Australia: banks started directing credit to property speculators and to those purchasing what were called “pastoral securities” (Hickson and Turner 2002: 159). A new class of companies appeared that specialised in property and stock market speculation, as well as building societies and land development companies, and they obtained credit from the banks for this purpose (Hickson and Turner 2002: 159).
The speculative boom in the prices of real estate and stocks of land, land finance and mining companies reached its apogee in 1888, but terminated in October of that year (Hickson and Turner 2002: 148).
From 1891 to March 1892, 41 deposit-taking building or land finance companies failed in Melbourne and Sydney (Hickson and Turner 2002: 148). The full force of the banking crisis did not hit until after 30 January 1893 when the Federal Bank failed. From April, when the Commercial Bank of Australia was hit by the crisis, there was a major panic, and by 17 May some 11 commercial banks had been suspended, with runs on many others (Hickson and Turner 2002: 149).
There existed an organisation of private banks called “The Associated Banks of Victoria” that supposedly existed partly to co-ordinate the activities of banks. Free bankers think such associations will engage in self-regulation and provide a lender of last resort function in times of panic.
This is not what happened in the Australian case: in January 1893 the Federal Bank failed and it was a member of the Associated Banks association, and then the Commercial Bank of Australia failed without any help forthcoming.
What is ridiculous here are the excuses offered by free market apologists: they contend that the Victorian Treasurer’s attempts to force the Associated Banks to provide assistance to smaller bankers and the bank holiday introduced by the Victorian government in early 1893 exacerbated the crisis. Yet the full scale panic had already begun in April 1893, before these actions. None of these actions had anything to do with the creation of the asset bubbles in the first place, which had occurred in the previous decade of the 1880s. There had already been a credit boom in the decade before 1893.
From April 1893, there were a number of limited interventions some colonial governments undertook: some banks that suspended were allowed to engage in reconstruction (conversion of deposits into preference shares, changing short-term deposits into long-term fixed deposits and the issuing of new shares to obtain capital).
In Victoria, the state government declared a 5 day bank holiday on Monday, 1 May 1893, which is adduced by some as a move that made matters worse. However, what is not said is that history ran an experiment for us in 1893: the Victorian government did very little to stop the crisis in the way of interventions to save the financial system in addition to its bank holiday. In contrast, the New South Wales government took quite different action.
In New South Wales, the government made the bank notes of the major banks – the Bank of Australasia, Bank of New South Wales, City Bank of Sydney and Union Bank – legal tender, and announced that it was willing to act as a lender of last resort (on 21 April 1893). This restored confidence to the financial sector in New South Wales to such an extent that the crisis ended in a couple of days here (Hickson and Turner 2002: 165).
The government of Victoria failed to intervene in the way the New South Wales government did, and the result was clear: in Victoria there was a deep crisis and in New South Wales the crisis was largely avoided.
Victoria was a large part of the Australian economy, so it was only natural that the financial crisis exacerbated a recession in these years. In fact, the familiar pattern of debt deflationary disaster had already hit the Australian economy in 1890, after the asset bubble collapse and deleveraging of the over-indebted private sector:
“In Australia, GDP fell for four years running, from 1890 through 1893 ... Unemployment rose sharply. Immigration slowed and tentatively reversed direction. Social disorder spread, led by protesting sheep shearers, dock workers, and miners. Post-1893 recovery, if it may be called that, was slow and uneven” (Adalet and Eichengreen 2007: 233).
As always, when we are dealing with 19th century GDP, we can only ever have estimates.
One estimate is that real GDP fell by around 10% in 1892 (Kent 2011), and by 7% in 1893, and deflation occurred from 1891 to 1897. Angus Maddison has made the following estimates:
Year | GDP
1888 | $14,685
1889 | $15,953 | 8.64%
1890 | $15,402 | -3.45%
1891 | $16,586 | 7.69%
1892 | $14,547 | -12.29%
1893 | $13,748 | -5.49%
(Maddison 2006: 452).
On these figures, a moderate recession began in 1890, a recovery occurred in 1891, but this did not last and a real, technical depression (that is, a period of real GNP/GDP contraction of 10% or more) hit Australia in 1892, which continued into 1893.
After 1893, there was uneven growth, with actual recessions in 1895 and 1897, and the economy was mired in what we can call a chronic underemployment disequilibrium, just as many countries were in the 1930s.
15. A logical and empirical truth that libertarians/austrians refuse to admit: Coercion is the Basis of all Market Societies
This is a simple point, but important. All capitalist systems or systems based on markets – or indeed human society of any sort – require law and order and ultimately force and coercion to back up the law and the enforcement of the law. That is why a “pure” laissez faire society or economy in the strict sense is impossible, because it would reduce to a system without law, rules or the enforcement of law. It would be a literal anarchy with no rules. At a minimum, there needs to be respect for the law, property rights and the enforcement of non-fraudulent contracts when one party violates the contract or breaches a contract.
Even Rothbardianism, the most extreme laissez faire system dreamed up by libertarians, has as its foundation a private law code and private justice system, which would still ultimately require coercion and force to enforce and maintain that order. The only difference between a state-based system and a Rothbardian system is that in the latter the coercion and force is done by competing private protection agencies and a private justice system.
Obviously to decide what institutions (such as government) and practices are necessary, defensible and moral in any society in a prescriptive sense requires an ethical theory. At that point, debates about the ultimate basis of how a society enforces its laws and how and what laws it passes collapse into debates about philosophy of ethics.
16. I will quote here the words of Lachmann on the Austrian School:
“For Austrian economists the third quarter of the … [sc. 20th century] was a bad time. To those who lived through them these were years in the wilderness. It is often thought that this eclipse of Austrian fortunes was brought about by the ‘Keynesian revolution’, but in fact this was only one of the misfortunes that befell Austrian economics in the 1930s, a decade of calamity. The promise of an Austrian theory of the trade cycle, which might also serve to explain the severity of the Great Depression, a feature of the early 1930s that provided the background for Hayek’s successful appearance on the London scene, soon proved deceptive. Three giants – Keynes, Knight and Sraffa – turned against the hapless Austrians who, in the middle of that black decade, thus had to do battle on three fronts. Naturally it proved a task beyond their strength.”The Market as an Economic Process (Oxford, 1986), p. ix of his preface.
Lachmann held that the promise of the Austrian business cycle theory was “deceptive.” Also, that Austrians in the 1930s failed to meet the challenge of Keynes, Sraffa and Frank Knight.
Also, Lachmann’s view that there is no tendency to general equilibrium in market systems, he appears to be endorsing the Post Keynesian theory of markup pricing (or what he calls “fixprice” [Lachmann 1986: 132]) in certain markets:
“... in our world the flexprice type prevails in financial asset markets and those for raw materials, industrial and agricultural, while in modern industry, except in secondhand markets, the fixprice type predominates.” (Lachmann 1986: 132).
Lachmann is even willing to say that the concept of “market clearing prices” does not really apply to many markets where fixprices are set for other reasons (p. 134), and finds Austrian economics wanting for its failure to study markup prices or fixprices (Lachmann 1986: 130-131).
17. As an end to my long post, I would like to return to the roots of Austrian economics, to its founder who had to say this about government in his Lectures to Crown Prince Rudolf of Austria, p. 121.
“Government thus has to intervene in economic life for the benefit of all not only to redress grievances, but also to establish enterprises that promote economic efforts but, because of their size, are beyond the means of individuals and even private corporations. These are not paternalistic measures to restrain the citizens’ activities; on the contrary, they furnish the means for promoting such activities; furthermore, they are of some importance for those great ends of the whole state that make it appear civilized and cultured.
Important roads, railways and canals that improve the general well-being by improving traffic and communication are special examples of this kind of enterprise and lasting evidence of the concern of the state for the well-being of its parts and thereby its own power; at the same time, they are/constitute major prerequisites for the prosperity of a modern state.
The building of schools, too, is a suitable field for government to prove its concern with the success of its citizens’ economic efforts.” ~Carl Menger, founder of austrian economics.