25. Black Tuesday

The Concise Guide To Economics

by Jim Cox

25. Black Tuesday

October 29, 1929 is the day the stock market crashed and is commonly viewed as the day that the Great Depression started.  The usual explanation for this crash are theories such as overinvestment, an imbalance in the distribution of income and hence a lack of consumption spending, or just a crack-up of the free market.

The overinvestment theory is not fundamental enough to be meaningful--one must ask:  What caused the overinvestment itself? The imbalance of income and lack of consumption spending is not only an irrelevancy but also factually incorrect--consumption increased from 73% of GNP in 1925 to 75% in 1929.  Quoting Rothbard in America's Great Depression:

If underconsumption were a valid explanation of any crisis, there would be depression in the consumer goods industries, where surpluses pile up, and at least relative prosperity in the producers' goods industries. Yet, it is generally admitted that it is the producers' not the consumers' goods industries that suffer most during a depression.  Underconsumptionism cannot explain this phenomenon... Every crisis is marked by malinvestment and under-saving, not underconsumption. p. 58

The failure of the free market is wrong theoretically and historically.  The U.S. was not a free market economy; interventions in the economy abounded most importantly in the form of a centralized banking system.  In addition, subsidies, income taxes, regulations, tariffs and creation of money out of thin air by the governmentally established central banking system were exceptions to a genuinely free market economy.

The events that did cause the stock market crash are the deliberations relating to the Smoot-Hawley Tariff (which became law in June 1930) being considered by the interventionist Congress beginning in March 1929.  (On May 5th 1,028 economists signed a petition asking Hoover not to sign the tariff.)  If one tracks the day to day news regarding the tariff--as has been done by Jude Wanniski--the pattern is that the stock market dropped every time it appeared the tariff would be imposed and rallied every time it appeared that the tariff would be defeated.  And it became clear the tariff would indeed pass on Monday, October 28th, destroying vast value in stock market shares which then revealed itself when the exchanges opened the next day.

You may wonder how a law enacted in June could cause an event the previous October.  One of the determinants of demand for a good (including a stock share) is expectations.  The expectations of a severe tariff to be placed on imports reduced the demand for stock shares.  The reason an import tariff would reduce the value of an American firm's stock is that investors could understand that the likely result of American tariffs on imports would be a reduction in exports.  Quoting from the economists' petition:

Countries cannot permanently buy from us unless they are permitted to sell to us, and the more we restrict the importation of goods from them by means of even higher tariffs, the more we reduce the possibility of our exporting to them...

In other words, trade is a two way street and a barrier stops the traffic in both directions.  Additionally, retaliatory tariffs by other countries would further destroy American export sales which would reduce profits of those same American firms.  Also, high import tariffs would increase American firms' costs since many were buying foreign products as inputs in their manufacturing processes; again reducing the asset value of the firm.

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Peter Schiff On Bernanke - CSPAN2

Peter Schiff Criticizing Bernanke on CSPAN2

24. The Business Cycle

The Concise Guide To Economics

by Jim Cox

24. The Business Cycle

The business cycle is the recurring prosperity and depression seen over economic history.  Before the modern age of advanced industrialism the prosperity could be accounted for by events such as good weather yielding bountiful crops or the spoils of war from a military victory.  Likewise, depression could be accounted for by harsh weather resulting in poor crops or from a military defeat.  In each case the causes were fairly evident. 

The modern business cycle, however, needs a more sophisticated explanation as it is a more complex phenomenon.  Marxists believed that business cycles were the inevitable collapsing of capitalism, but this theory can be discarded since capitalism has not collapsed though socialism has.  Keynesians account for the business cycle by an appropriate level of spending (prosperity) or underspending (depression) but have been baffled by the simultaneous occurrence of both inflation and depression--a condition their theory treats as being as likely as a square circle.

The Friedmanite monetarists appropriately look to the money supply as the causal factor in the business cycle though they fail to realize the ill effects of their favored policy of a slow but steady increase in that money supply.  (Friedmanites also fail to consider the ethical aspects of such artificial increases in the money supply which create involuntary transfers of wealth.)

The correct Austrian theory of the business cycle also focuses on the money supply as the causal factor, but does recognize the intervention in the economy that an artificial increase in money and credit in fact is.  Basically, the Austrian theory recognizes that there is some voluntarily chosen ratio of consumption to saving by the total of individuals comprising the economy. 

When an artificial increase in the money supply through the banks occurs, this increases the available money in savings and depresses the interest rate, thereby encouraging an artificial increase in spending which is highly sensitive to the interest rate--capital spending.  This run-up in the capital goods industry is the boom, and the subsequent depression results when consumers reestablish their consumption to saving ratio--thus revealing that the capital goods boom was indeed artificial.  The only way to prevent the depression is to pump another dose of new money into the system to maintain the higher savings ratio, but eventually this must end or there will be a runaway inflation. 

The artificial increase in the money supply therefore is a government subsidy--through monetary policy--to the capital goods industry.  Naturally the subsidy stimulates production in the capital goods industry.  Once that subsidy is removed by consumers reestablishing their preferred saving ratio, there is a crash in the capital goods industry.

The Austrians, in contrast to all other schools of thought, do not regard the depression as bad news, for it is the necessary correction to put production back in line with consumers' preferences.  This view regards the preceding inflation as the ill setting the stage for the needed correction.  Two analogies follow to clarify this theory: 

Everyone understands that a drug addict will need higher and higher doses of his drug to get the same kick.  This is comparable to the growth in the money supply causing a capital goods industry boom.  The addict has the choice of increasing his doses of his drug until it kills him or of going cold turkey and suffering the withdrawal pains.  The withdrawal pains are similar to the economy's depression adjustment.

Second analogy:  If a person ingests poison into his system he will need to rid himself of that poison, say through vomiting. It's obvious that the unpleasant vomiting is the necessary cure for the evil of the poison ingestion.  In this analogy the poison is the inflation and the vomiting the depression. 

From the Austrian perspective the cure for the business cycle is a laissez-faire policy for the money supply, letting the money supply be determined by the free choice of individuals in the market.  The alternative to this Austrian policy is government involvement in money and banking which inevitably results in special interest pressure to increase the money supply to the benefit of those first receiving the new money--the banking system itself.

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23. The Federal Reserve System

The Concise Guide To Economics

by Jim Cox

23. The Federal Reserve System

The Federal Reserve is the third central banking system in the U. S.  The first two, called the First Bank of the United States and the Second Bank of the United States, were chartered for the periods of 1792 - 1812 and 1816 - 1836, respectively. 

The bank panic of 1907 motivated the major banking interests to assure that such difficulties would not plague them in the future.  In 1910 a group of such bankers, pretending to be on a duck hunting trip to Jekyll Island, Georgia, designed the future central bank.  After supporting the banking bill they had designed, it was defeated in Congress by suspicious rural and midwestern Congressmen.  So biding their time, they had the bill reintroduced--with a different title but now with their feigned opposition.  In 1913, while many members of Congress were on Christmas break, the remaining "in's" passed the Federal Reserve Act and rushed it over for Woodrow Wilson's signature on December 23rd.  Although the Fed was established by an act of Congress it is a privately owned--by banks in the twelve districts--organization which can be found in the white pages of your phone book.

The Federal Reserve System thus had its origin in underhanded dealings at the behest of the special interests of bankers.  The point of the Fed was to authorize a central bank which could generate an elastic money supply in time of bankers's needs.  In other words, it allows them to create money out of thin air without suffering the consequences of another panic or bank run. The Fed was thus created as a cartelizing agency for banks the same as the I.C.C. was for railroads, and the C.A.B. for airlines.  In addition, the Fed is an outlet for the sale of government bonds--government debt--and thus facilitates the deficit financing of the federal government.

The Fed coordinates the inflationary practices of banks, keeping each from the pressures of note redemption which would otherwise keep their artificial money creation in check.  Since the founding of the Fed in 1913 the value of the dollar has fallen by more than 90%!  So much for the conventional wisdom alleging that the Fed leads the fight against inflation.

Creation of the Fed should be understood as an important step in a number of steps in the undermining of an honest money based on gold.  Other steps in this process include the legal tender laws; the shift from Federal Reserve Notes redeemable in gold, to redeemability in gold or lawful money, to redeemability in lawful money only, to no redeemability at all; replacement of all bank notes with Federal Reserve Notes; abandonment of the gold standard domestically in 1933; and abandonment of the gold standard internationally in 1971.   Since the Federal Reserve Notes in your wallet are not redeemable in gold or anything else, it must be asked:  In what sense are they notes?  A note is a promise to pay.  The Fed promises to pay nothing more than another promise to pay!

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22. The Gold Standard

The Concise Guide To Economics

by Jim Cox

22. The Gold Standard

A number of different goods have been used as money across the globe and human history--sea shells, cows, cigarettes, beer, cabbage, tobacco, beads, etc.--but the most commonly used money has been the precious metals of gold and silver.  Such goods arose as a money not by democratic election or government fiat but by the free interaction of consumers in the market. 

Money serves as a medium of exchange facilitating trade, a measure of value and as a store of value.  The qualities that made gold and silver the first choice in money over the numerous others are inherent in the precious metals and is comparable to using cotton for shirts and ceramics for coffee cups.  Just as cotton has the qualities which make it a good material for shirts--light weight, breathability, washability, etc.--and ceramic has the qualities which make it a good material for coffee mugs--insulation, non-leaking, etc., gold is a good material for money. 

Gold has four qualities in the right combination to be money. These qualities are:  durability--a 100 year old coin is still recognizable and functional as a coin; widespread acceptance--people the world over value gold; high value per unit--1 ounce of gold is worth about $350 today; and divisibility--cutting an ounce of gold in half results in 2 fully gold 1/2 ounces.  Other goods which have been used as money do not have the same mix of qualities as fully appropriate as does gold.  Thus, gold as money is all quite rational, logical and reasonable in contrast to J. M. Keynes's famous edict that "gold is a barbarous relic."

Ironically, it is the current chairman of the Federal Reserve System, Alan Greenspan, who enunciated the correct view on the animosity toward gold in Capitalism the Unknown Ideal:

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense--perhaps more clearly and subtly than many consistent defenders of laissez-faire--that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. p. 96

One of the claims against a gold standard money--currency units denominated in a weight of gold with gold coins circulating and paper currency fully redeemable upon demand--is that it is silly to mine gold from the earth only to rebury much of it in bank vaults and incur significant costs in the process--unfortunately, Milton Friedman is in this camp.  These critics claim that it would be much less expensive to just establish a pure paper money standard.  While this claim is true as stated, it does not recognize the costs that are generated.  A gold standard puts a check on the creation of money since all paper and credit must be redeemable in actual gold bullion or coin.  The problem with a paper money standard is that there is no way to stop the creation of ever greater quantities of money once the authority to do so is granted. 

As an analogy, it could be claimed that it is silly to go to all of the trouble and expense of making locks out of hard metal when paper locks would be cheaper!  But of course the reason for metal locks is that thieves will not be deterred by the paper locks and refrain from theft.  Nor will those in authority of money creation refrain from the theft inherent in additional paper money creation.  Contrary to the notion that unlike a paper money supply, gold cannot be readily created in mass quantities and therefore is undesirable, this in fact is one of the major virtues of gold!

In a choice between the integrity of politicians and the stability of gold, George Bernard Shaw is reported to have advised:  "With all due respect to those gentlemen, I advise the voter to vote for gold."

Yet another ridiculous claim against gold is that the price of gold is too volatile--having run up from $70 in the early 1970's to $850 in 1980 and now selling in 1995 at $350.  But this line of analysis exactly reverses the true cause and effect.  Gold in terms of paper dollars soared in the late 1970's due to the growing distrust in the paper money when inflation hit double-digits.  With the disinflation of the 1980's fears subsided and the price of gold declined.  Gold is seen as the safe haven, the hedge against inflation.  The actual volatility was in the confidence of the paper dollar; the price of gold in terms of those dollars was an effect.

An additional commonly cited claim against gold as money is that our economy would be at the mercy of the world's major gold producers--Russia and South Africa.  What this argument conveniently overlooks is that the annual production of these two countries is tiny compared to the existing stock of gold. Additionally, it is costly to mine gold and will be done only if the price is high enough to warrant the costs.  But increasing production of gold reduces the price, thereby undermining the intended outcome of a country hell-bent on overproduction. However, for the sake of argument, let's assume both countries do engage in mass production to whatever degree possible and "flood" the world with gold.  Is this something to be upset about?  After all, gold is a valuable commodity in industry and for consumers--would this be such a tragedy?  I'll worry about this in the same way I lose sleep worrying that Russia may massively produce oil or wheat thereby reducing my cost of driving and eating!

One last claim against gold is that there just is not enough gold to reestablish the U.S. dollar's redeemability.  It is true that the number of paper and credit dollars created has been so vast that there is not enough gold to redeem dollars at the original rate of $20 to the ounce.  But, we can recognize reality and reestablish the dollar at an appropriate rate of approximately $2000 to the ounce.  Murray N. Rothbard has proposed just such a program in The Mystery of Banking:

1. That the dollar be defined as 1/1696 gold ounce.
2. That the Fed take the gold out of Fort Knox and the other Treasury depositories, and that the gold then be used (a) to redeem outright all Federal Reserve Notes, and (b) to be given to the commercial banks, liquidating in return all their deposit accounts at the Fed...I propose that the most convenient definition is one that will enable us, at one and the same time as returning to a gold standard, to denationalize gold and to abolish the Federal Reserve System.
   
   
   
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21. Inflation

The Concise Guide To Economics

by Jim Cox

21. Inflation

Inflation results from an increase in the money supply.  The traditional definition is "a rise in the general price level," but this is actually an effect, not the cause.  Most economists have given up trying to explain the difference in common discussion, partly because most people see the world through "Keynesian-colored glasses."  Keynesian theory says there can't be inflation caused by an increase in the money supply (or from any other cause other than supply shocks reducing total supply) at the same time that there is unemployment.  Any increase in the money supply, they say, will not cause inflation--it will just put people to work, not cause prices to go up.

The theory of inflation as an increase in the money supply, causing prices to go up, is consistent with basic supply and demand analysis.  When there is an increase in the supply of a good, the value of each unit has got to go down.  It is consistent with the law of diminishing marginal utility.  It is consistent with our history--inflation in the United States has occurred at the same time that the money supply has increased (likewise in other countries).

A point that has been grossly underemphasized in economic theory is that people steal through the money system, and inflation is a means of doing that--by creating more new money, the value of everyone's existing money is undermined to the benefit of those receiving the newly created money.  These would be the Federal Reserve first, then the banks, the government when it borrows the money from them, and so on down the line to the point where the dollar is worth much less when it gets to the average citizen. Inflation, then, is a result of special interest influence.

Stealing through the money supply is done today through the esoteric Federal Reserve System's open market purchases and fractional reserve banking.  (The third way of stealing through the money supply is appropriately illegal--counterfeiting--but is in principle no different.)  Thus Keynes's famous quote of Lenin is entirely correct:

Lenin was certainly right. There is no subtler, nor surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

The Federal Reserve's modern method of stealing through the money system is the parallel to the less sophisticated older means.  The two primary former means were coin clipping and debasement.  Coin clipping was the practice of filing the outer edge off a gold or silver coin and passing it on as if it still contained its full face value weight while keeping the filings as an ill-gotten gain.  Mill marks on coins (tread on the outer edge) were used as protection against such stealing.  Debasement is passing on a coin with all of the same look of a full weight of precious metal but with a cheaper base metal in place of the valuable precious metal.  As can readily be verified, current U.S. coinage (properly called "tokens" not coins) has been totally devalued--the silver in a pre-1965 quarter is worth more than 1/4 of a dollar, and the zinc and copper in a post-1964 quarter is worth less than 1/4 dollar.  These "coins" are made of cheap metals such as zinc and copper and the mill marks are there only out of nostalgia or attempted deceit!   

The effect of this increase in the money supply is an increase in prices in general, but this is not the most troublesome effect of inflation.  More problematic is the effect on morality as people realize hard work and saving are self-defeating, and the generation of the boom-bust of the business cycle due to the distortion of relative prices.

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20. Money

The Concise Guide To Economics

by Jim Cox

20. Money

As did language and customs, money evolved--evolved from the process of trade in barter (trading goods directly for goods).  It did not arise via vote or social contract or government decree. 

(This last statement may seem in conflict with the current experience wherein fiat money--money by government decree--is the norm.  Is this not an exception to money arising from a good in trade?  No.  The brilliant "regression theorem" of Ludwig von Mises demonstrates the original truth:  If one regresses through the history of our money it can be seen that the value of our fiat money is based upon the commodity value of gold.  The U.S. dollar was severed from gold in the international arena in 1971 and in the domestic arena in 1933.  Prior to these dates U.S. dollars were redeemable in gold at $35 and $20 to the ounce, respectively.  Without the experience of full gold redeemability a paper dollar could never have become a money.)

Barter however, had the problem of a double coincidence of wants--each party to the trade must have and be willing to trade for that which the other party has and is willing to trade.  As barter proceeded it was discovered by the traders themselves that certain goods were more readily accepted in trade than other goods, thus making those more readily accepted goods even more readily accepted in trade.  A snowball effect took place.  As this good became a standard in trade because of its widespread acceptance the problem of a double coincidence of wants was solved as money became half of all trades.  Having a money--a medium of exchange--facilitated trade and complex business arrangements. This effectively means money is important for human progress comparable to the wheel and fire. 

Money makes possible comparisons of value--a shirt can be bought for 1 gram of gold, and a camera for 5 grams of gold, for instance.  Having a common denominator measure of value engendered profit and loss assessment; without money one would have to list the entire period's exchanges under barter resulting in a huge array of exchanges with no common value.  Lastly, money serves as a store of value, carrying value comparisons over time, lengthening the time horizon available in carrying out productive work.  Notice that to the degree an economy suffers from inflation, money is a poorer gauge, distorting value comparisons, undermining it as a store of value and ultimately--during hyperinflation--failing as the medium of exchange as traders revert to a barter relationship.

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19. Free Trade vs. Protectionism

The Concise Guide To Economics

by Jim Cox

19. Free Trade vs. Protectionism

Economists of all schools recognize the value of free trade: greater overall production.  This greater production is due to the freedom of each producer to specialize in that line where he or she has a natural advantage.  The natural advantage of each trading partner results from the differences among people and locations.  A major reason the U.S. economy is as productive as it is, is that there is a large geographic area of free trade (the U.S. Constitution wisely prohibits protectionist tariffs and quotas among the various states).

Adam Smith enunciated the principle that it is foolish to produce at home that which can be obtained more cheaply abroad.  This is true not only literally of the home, but of the county, state, region and country as well.

This emphasizes that there is no distinction between trade and international trade in principle--one "exports" his labor to "import" goods consumed, as it is a cheaper means of obtaining goods than producing the consumed goods directly.

Despite the value of free trade there are continuous calls for disruption of an international division of labor by way of taxes on imports (tariffs) and numerical limitations on imports (quotas).  Such arguments are ultimately special interest pleadings advanced for the sake of a transfer of income to the special interest at the expense of the rest of the economy.

Henry George summarized the fallacy of protectionism this way: "What protection teaches us, is to do to ourselves in time of peace what enemies seek to do to us in time of war."

A review of the seven most common protectionist arguments and their rebuttals follows:

Military Self-Sufficiency

This argument claims that some vital military goods may be unavailable from other countries in time of war and therefore a viable domestic industry is necessary for defense.  A true concern with such a scenario, however, can be dealt with by means of stockpiling the needed goods.  Such a stockpiling program would leave the consumer still free to shop the world and not disrupt the international division of labor.  One must suspect many such arguments when those making the argument are the very firms supplying those goods.  Examples in recent U.S. experience include even wool socks and steel--goods with easy substitutes and existing viable U.S. production. 

Further, a program of reducing taxes and regulations would allow continued viable U.S. production.  As is so often the case, any concerns should recognize the violence done to the U.S. economy by current policies and the fact that it is economically more efficient and just to reduce, not compound government interference in the market.

Protection of Domestic Industry

The fallacy of such claims is that the protection of any U.S. industry is to that same extent a detriment to other U.S. industries. Protectionism against steel imports, for example, harms American firms which use steel as an input in their production process--auto, washing machine manufacturers, all firm's transportation expenses, etc.

Employment Protection

As Milton Friedman has stated, "we work to live, we do not live to work."  The concern should be with our production, not its means--employment.  Tariffs and quotas to protect American employment reduce our standard of living as we engage in lines of production that are not the most efficient in providing for ourselves.  The move to free trade which would reconfigure employment patterns in the U.S. would not be necessary except for the artificial pattern currently existing due to those tariffs and quotas.  In other words, the loss of employment in certain lines of work which would undeniably occur with a movement to free trade are due to the current absence of free trade.  These particular jobs would not have been created in the U.S. if policy had been one of free trade in the first place.

Diversification for Stability

Though this argument has little application to the U.S. economy, it is often used for say, Chile  which is heavily dependent on copper exports.  The fallacy is that Chile has a strong advantage in copper production and to forcibly diversify would be to pay dearly in opportunity costs.  Individual entrepreneurs should make these decisions according to their own assessments.  (On an individual basis this may be like cautioning a surgeon to find other means of  making a living.  While this would offer protection against the risks of being unable to perform as a surgeon the lost income in pursuing say, training as a lawyer would be vast.)

Infant Industry

Again this is not a currently fashionable argument for modern day America.  But the basic notion of protecting new industries competing with established foreign firms until they can "mature" and compete toe-to-toe is still false.  In effect, this suggests the substitution of government officials' judgment for that of private investors.  A truly viable firm can find investors who will be willing to absorb losses--as a form of investment--for the sake of the future profits to be earned.  This is in fact routine in the market as most new businesses or products earn losses in the early stages yet investors still see merit in such investments.  The fact that such firms are not currently successful in attracting investors voluntarily is strong evidence that there are no future profits to be earned.  Whose judgment would be superior:  private investors with their own money to lose or government officials with no personal financial stake in the outcome?  If in fact this was a truly valid argument for protectionism, it would logically be applicable not just to domestic firms competing with established foreign firms but to domestic firms competing with established domestic firms--a special tax on NBC programs for the sake of newcomer FOX, for example?

Dumping

There are two versions of dumping.  The first is selling products abroad at lower prices than at home.  But this is to be expected. Buyers are normally more loyal to domestically produced goods (all other things held constant of course) than to foreign made goods. The only way to successfully sell to foreigners is therefore with price concessions.  (Because of this loyalty factor, it would be strange if dumping was not the norm.) 

A second version of dumping is a subsidy to firms to sell abroad. Naturally, American firms complain about such practices by other nations.  (And this is not to say that American firms receive no such subsidies--as special interests using the power of government for their own financial gain, it is common.)  If other countries do subsidize their sales in the U.S. then they are making a gift to American consumers.  While this is not wise for the sake of the economy doing the subsidizing, it is not right to correct the situation by punishing the American consumer with tariffs and quotas.  A consitent application of a prohibition of gifts  would prohibit samples!  The analogy often cited in other countries resorting to this form of dumping is to consider each economy to be a man in a lifeboat.  The lifeboat is the overall standard of living in the world.  If one person in the lifeboat foolishly takes out a gun a fires a hole into the bottom of the boat, the last thing others should do is to retaliate likewise with additional blasts to the boat bottom!  Compounding mistakes is not a solution.

Cheap Foreign Labor

This argument claims that American workers should not have to compete unfairly with low paid foreigners.  (Everyone comes up with some reason to except themselves from free competition; low paid foreign workers claim it is unfair for them to have to compete with high skilled American workers!)   As do all protectionist arguments this one violates the principle of not producing at home that which can be obtained more cheaply abroad. Besides this self-interest argument against protectionism, it is anything but humane to call for sacrificing the living conditions of already poor foreigners to that of relatively very wealthy American workers.

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18. Market vs. Command Economy

The Concise Guide To Economics

by Jim Cox

18. Market vs. Command Economy

There are two polar opposite approaches to an economy's operation.  The command economy is the top-down, centrally-planned economy of socialism.  The market economy is the decentralized economy of the free market.  The most fundamental distinction between the two is the existence of private property in the free market and the absence of private property in the command economy.

The alleged virtue of the command economy is that it is planned in contrast to the unplanned market economy.  The error in this view is that the market economy is actually very rationally planned by means of consumer demand through the price system.  Additionally, for four reasons the command economy will be deficient.

First, an attempt to plan an entire economy by a central committee is bound to be inefficient just because the task is so large. There is no way that a committee of say, 300 planners can know the needs, conditions of resource availability, and localized knowledge spread throughout an economy.

Second, the command economy ultimately rests on coercion as its means of motivation.  Socialists will typically claim that the resort to coercion (the Berlin Wall, Russian gulags, etc.) is not part of their system, but only an unfortunate bad choice in political leaders and that socialism only attempts to control the economy, not people's individual liberties.  But, of course the main element in an economic system is in fact people; therefore controlling an economy is first and foremost control of people--the Berlin Wall was no peculiar misfortune.  Suffice it to say further that human motivation is diminished when coerced.

Third, the command economy is a collectivized system.  All work for the benefit of their quotal share of total production. Individual incentives are absent.  As an example, with 100 workers in an economy each will receive 1/100 of total production.  If one worker shirks, his loss is only 1/100 of the production he otherwise would have generated.  (Imagine the incentives when this system is broadened to a nation of 200 million!)  Each ends up attempting to live at the expense of others and total production plummets.

And fourth, the incentive of production is to please the political authorities who have life and death control over the workers.  In contrast to the market, where production is predicated on consumer demand, the consumer is the forgotten being in a command economy.

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17. Market vs. Government Provision of Goods

The Concise Guide To Economics

by Jim Cox

17. Market vs. Government Provision of Goods

Its often heard that government is not as efficient as business. This is not a knee-jerk ideological reaction.  It is grounded in the real differences of the incentives facing government and private enterprises.

In the market, a private enterprise is dependent on the flow of consumer dollars into the organization for its success.  Thus a tight link exists between consumer satisfaction and business success.  In contrast, a government enterprise has a second source of income available to it--tax revenues.  With an alternate source of income to support it, a government enterprise will necessarily have a lesser incentive in serving consumers.  Realize, this is not a matter of good people in management of private enterprises and bad people in management of government enterprises, but a different incentive structure in the two arenas.

Most people attempt to please their bosses on the job as a means of generating an income.  Winning the lottery often reveals the employee's true underlying attitude toward working at the behest of the boss.  Government enterprises have won the lottery, so to speak, and thus treat the consumer not as the end all and be all for the organization but as a nuisance interfering in the peace and tranquility of the day.  Additionally, many government enterprises hold a legal monopoly relieving them of the fear of loss of customers to rivals, unlike private enterprises in a free market.

An easy example to illustrate these points is the U. S. Postal monopoly.  With tax dollars available to make up for any shortfalls from consumer-derived revenues, the Post Office can afford to treat its customers as an unwanted interference.  The Post Office is notorious for its lack of innovations.  For instance, while private enterprises in the free market offer customers bags in which to secure their purchases (even in the case of minimally priced purchases) the Post Office does not bother to stock and offer bags to its customers regardless of the value of what they buy. 

Advertisements in your Sunday newspaper will typically offer return address labels with a more expensive peel off option as well as a cheaper lick and stick option.  Stamps until quite recently were lick and stick only.  Why should the Post Office go to such trouble when the taxpayers make up losses and it's illegal for others to deliver first class mail?

Federal Express began offering urgent overnight delivery years before the Post Office.  Why should the Post Office take chances on such innovations which may or may not pan out? 

Fast food restaurants, banks, dry cleaners, liquor stores and other businesses offer drive-in service.  But again, why should the Post Office take chances on such innovations which may or may not succeed?

But, the grand example which clearly illustrates these differences is late Fall with the approach of the Christmas buying season. While businesses take out ads virtually begging customers to shop with them--even late in the season--the Post Office is haranguing the hapless public to "mail early!"  In effect, what the Post Office is spending money to do is to tell their potential customers not to bring their damned Christmas cards in for delivery at an inconvenient time.  Customer satisfaction takes a back seat to the convenience of the Postal organization.

A further approach to these issues can be delineated as five significant differences between the two means of providing for consumers.  First, the market provision of goods is based on a voluntary relationship between firm and customer.  Government provision of goods is based on a coerced relationship between enterprise and customer.  This difference alone is all the difference in the world as far as consumer satisfaction is concerned.  It is the difference between employment and slavery, charity and robbery, seduction and rape. 

A summary statement concerning market provision of goods is the well-know phrase, "the customer is always right."  Notice there is no such similar phrase "the voter is always right", or "the taxpayer is always right" in describing the attitude of government enterprises.

Second, in the market there is proportional representation; that is, consumers get the goods they "vote" for in proportion to their "votes."  If ten percent demand green cars then ten percent will get green cars.  With government provision it's a winner takes all deal; either we all have the Social Security program or none of us have it, regardless of our preferences.

Third, in the market there are small individual choices.  Just because you buy a Sears refrigerator does not mean you then have to buy a Sears washer and dryer and tv, etc.  With government provision, there is a package deal arrangement.  Mixing and matching is unavailable with government provision of goods.  It's either Bill Clinton's policies on taxes, the environment, and foreign policy or it's Bob Dole's policies on these issues. 

Fourth, choice in the market is continual.  One can replace unsatisfactory goods at any time.  Tired of the car you thought would be so great?  Sell it and get a different model.  No longer happy with your detergent, buy a different brand.  Realize the first brand was good after all?  Re-replace it at your discretion.  Now compare this to government.  Want to drop out of the Social Security program--go to jail.  Tired of the president. Four more years.

And fifth, a private firm is held liable for damages to those it may harm.  Suing companies for compensation is the norm. Government enterprises often enjoy "sovereign immunity," placing them above reproach (an ill carried forward to America from the European theory that the king could do no wrong).  Government enterprises can and do wreak havoc with peoples' lives without suffering any financial consequences.  In a real sense it is dangerous to have government enterprises providing consumer goods since an absence of potential liability will result in a reduced emphasis on safety.  Private firms facing potential liabilities for their damages have a financial incentive to be safe.

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16. Owners vs. Managers

The Concise Guide To Economics

by Jim Cox

16. Owners vs. Managers

In the relentless attack on economic freedom waged by statists, the modern corporation has been targeted for scorn.  The perfectly valid theory that a profit-maximizing firm will generate efficient production for consumers has been turned into a "judo" argument against the free market.  This theory states that the old nineteenth century firm was an efficient producer since the owner (who wanted to maximize his profits) was one in the same with the manager (who made actual day-to-day decisions).  However, today the modern corporation is run by "hired gun" managers who are not the owners of the firm and its assets, and thus are less interested in profit maximization than in a comfortable existence, while the owners are often passive investors uninvolved in the decisions of running the business. 

Thus, according to these critics the firm will not be efficiently managed for consumer benefit but will result in management taking advantage of the owners for their (the managers') personal benefit.  From this viewpoint the statists argue for regulation and denunciation of the free market process--a process which often results in these large, corporate business enterprises.  (First, let me acknowledge the dichotomy of interests which does exist between the owners and the managers; a dichotomy which also exists even with a single owner and a single-employee sized firm.  The owner will be diligent in his behavior, whereas the employee does gain personal benefits from slacking.  Obviously, the benefits of having employees outweigh the negatives of having employees since we find a world of firms with employees instead of one-man enterprises.)

The free market has inherent remedies for such ill-behavior on the part of the "hired-gun" managers.  At least four offsetting influences will tend to mitigate the dichotomy of interests: First, any abused passive investor can always sell his share of stock in such a corporation.  While this will not save the investor from past personal losses he can at least extricate himself from the abuse.  But if this response is widespread, the effect of many small investors selling their stock will put downward pressure on the price of the stock.  A reduction in the price of the stock will surely get the attention of the major investors who do involve themselves in the decision making of the corporation--the board of directors, if no one else--who can take meaningful action!

Second, it is very, very common for managers to be paid in stock or stock options in a corporation.  Thus the managers are owners who will benefit from an increase in the stock value--as the passive investors prefer--and lose the opportunity for gain from a decrease in the stock value; a conjoining of interests!

Third, who would the board of directors--as owners interested in profit-maximization--choose to manage their corporate assets?  A "natural selection" process will occur in the market as those managers who have shown their determination and ability to create profits will be promoted to the pinnacles of corporate management, while those more interested in personal comfort at the expense of the stockholders will be passed over.

Admittedly, none of these three listed influences will totallyovercome the dichotomy of interests problem, but as usual, the free market inherently has appropriate motives for efficiency. The final solution to any remaining negatives can and is overcome by the effects of corporate raiders.  Corporate raiders--the mis-analyzed and under-appreciated cleansing acid of the corporate community--can be relied on to serve the interests of consumers and efficiency.

Any poorly managed firm will, to that degree, be ripe for a buyout by those specializing in profiting by the spread between the actual and the potential value of a firm's assets.  Corporate raiders will approach current owners of undervalued assets with the offer of a better price in order for the corporate raider to reap the profits available from a change in management of those assets.  A well-managed firm--one whose potential stock value and actual stock value are already in line--will be passed over as a target of a buyout.

The problem of owners versus managers is therefore most acute when there is no marketable stock share as in citizens' "ownership" of government enterprises.  Rather than agonizing over for-profit corporation management, the theorists of management abuse of owners should instead direct their attention to government enterprises.

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15. Heroic Insider Trading

The Concise Guide To Economics

by Jim Cox

15. Heroic Insider Trading

Insider trading--making profits in financial markets from knowledge not available to the general public--has been a universally scorned activity of late.  But what is the nature of this alleged crime?  Making financial gain on superior knowledge is exactly what the stock market is all about.

In fact, this is what all business activity is about.  Doesn't Delta make a success of its airline business because it knows better than others how to run an airline?  Doesn't Coca-Cola make a success of its soft drink business because it knows the ins and outs of production, distribution, marketing and consumer demand better than other establishments?  Certainly, Delta and Coca-Cola don't reveal to competitors their insider's knowledge of their businesses.

But beyond the universal nature of insider trading what are its effects on the stock market? 

Let's say Investor A has knowledge that Acme is about to be bought by Ajax and therefore buys Investor B's stock at the current price of $20.  The takeover occurs, and the price shoots up to $40. Investor B would have sold the stock anyway, whether Investor A had his knowledge or not.  But, somehow in inside-trader-hater logic, ignorant but lucky Investor C, the one who would have made the purchase from Investor B if Investor A had no superior knowledge to act on, could have legitimately been the one to make the quick $20 profit.

But we must ask:  Why is C's ignorance a legitimate means of earning  profits but A's knowledge an illegitimate one?  This boils down to scorning the knowledgeable for being knowledgeable and elevating the ignorant for being ignorant--hardly a desirable trait for social well-being.

Besides, the very act of making stock purchases on insider trading helps to reveal to the world, through the higher stock prices, that these stocks are currently undervalued.  Thus, economic information is actually spread through markets more quickly when insider trading occurs than when it is effectively outlawed.  And every economic theory I'm aware of says more information sooner is better than less information later.

There's a rule of thumb popular among investment advisors which says the amateur investor should not buy individual stocks because individual stock investing is a full-time job; likewise one should realize when undertaking stock investments that there are bound to be people with more knowledge than he has about the prospects of future stock values.

Insider trading is a victimless crime, and its prohibition should be viewed as nothing more than a welfare program for S.E.C. lawyers.  This becomes all the more obvious when it is realized that "insider trading" is not even defined in the laws.  It is in fact so vague that it could be used against virtually any investor. 

The one legitimately-wrong kind of inside trading is where someone uses "inside" knowledge in violation of a contract or explicit trust.  In such cases, civil law ought to apply, with damages to those wronged, rather than criminal law with fines to the U.S. Treasury. 

"OK," you may be thinking "there really isn't anything so evil about insider trading, and all of the recent legal activity is no better than a witch hunt, but why call them heroes?"

Well as stated (in regard to other alleged scoundrels) in Walter Block's, Defending the Undefendable:

...others are generally allowed to go about their business unmolested, and indeed earn respect and prestige, but not so these scapegoats; for not only are their economic services unrecognized, but they face the universal bile and wrath of virtually all, plus the additional restrictions and prohibitions of governments.  They are heroes indeed; made so by their unjust treatment at the hands of society." Foreword

Further, since they act on a legitimate, but unacknowledged right, they help secure the liberties of all, while more timid souls shrink from the battle.  Inside traders should be granted the respect they truly do deserve.

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14. Speculators

The Concise Guide To Economics

by Jim Cox

14. Speculators

Speculators--those attempting to gain by guessing future conditions (in particular prices)--are a subcategory of entrepreneurs; everything written previously about entrepreneurs applies as well to speculators.  However, while the public will often have sympathy and understanding for the role of entrepreneurs, there is a general disdain for speculators. 

In redeeming the reputation of speculators let me first point out that everyone speculates.  Consumers speculate when they decide to buy a house now rather than wait for lowering prices or mortgage rates, students speculate when they choose a major in college, etc.  But beyond noting the universal practice of speculating there are other redeeming qualities to speculators. 

If, for instance, someone is speculating in the future price of sugar then he will pay much more attention to the weather conditions, technology, and political influences on sugar than will the consumer.  For the consumer, sugar is a passing and minor part of his life; for the speculator it is his means of livelihood.  At a time when the price of sugar is $1 per pound a speculator will begin buying sugar if he has reason to anticipate a future lack of supply.  His speculative demand added to that of consumer demand will increase the price to say, $1.50 per pound. This is one source of the animosity typically directed by the public toward speculators. 

The higher price will have two effects:  First, the consumer will begin to economize on sugar, treating it as more valuable than before.  And second, suppliers will be encouraged to produce more sugar than before.  The speculator is, in effect, acting as an early warning signal notifying others of the impending future reduction in supply--much like a smoke detector alerts otherwise distracted residents about a spreading fire.  Then when the reduced supply becomes evident to all, the speculator will dump the sugar at the now even higher price of say, $2.00 reaping a $0.50 profit per pound.  This is another source of the animosity typically directed by the public toward speculators. 

But, what has the speculator actually done?  He has taken the plentiful sugar away from consumers when they were ignorant of its future higher value and returned it to them just when they needed additional supply the most--he has provided a marvelous service to others in the pursuit of his personal gain.  He should be cheered for his actions; he is a benefactor of consumers.

Another way in which speculators do good but receive condemnation is in futures contracts.  Take the example wherein a farmer has planted his peanut crop in January when the price of peanuts is $2 per pound.  The farmer will not reap his harvest until June, by which time the price of peanuts may have changed dramatically.  A speculator comes along and offers the farmer $2.20 for every pound he can deliver in June. 

If the farmer accepts the deal then he can concentrate on his farming without worrying about some uncertain future price for his peanuts.  He can sleep peacefully at night, certain of his price because the speculator has agreed to shoulder the burden of future price changes.  A division of labor has occurred with the farmer specializing in farming and the speculator in risk-bearing.  If the price of peanuts in June falls to $1.50 then the farmer will be overjoyed that the speculator has saved him from such a catastrophe and will think speculators are the best people on earth.

But if the price in June goes to $3.00 per pound the farmer will curse the name of the fast-talking slicky salesperson of a speculator who deprived him of the high profits.  The farmer will forget all about the peaceful sleep he enjoyed due to the speculator's guaranteed price, and he'll forget all about the fact that he freely chose to enter into the agreement in the first place.  This is yet another reason for the public's negative view of speculators. 

But, which speculator will be around to speculate again?  The one so popular with the farmer has lost a fortune and cannot or will not care to try his hand again.  The successful speculator, the one the farmer has such disdain for, has made a major profit and will be able and interested in pursuing another contract.  It at least makes some sense that speculators are unpopular, but in evaluating their role in the economic system they should properly be regarded with the same appreciation as all other productive parties.

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