What makes robust political economy different?

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I encountered what would later become important elements of Mark Pennington’s book Robust Political Economy in two articles that he wrote on the limits of deliberative democracy, and the relative merits of market processes, for social and ethical discovery, as well as a short book Mark wrote with John Meadowcroft, Rescuing Social Capital from Social Democracy. This research program inspired me to start my doctorate and pursue an academic career.  Why did I find robust political economy so compelling? I think it is because it chimed with my experience of encountering the limits of neo-classical formal models that I recount in my chapter, ‘Why be robust?’, of a new book, Interdisciplinary Studies of the Market Order.

While doing my master’s degree in 2009, I took a methodology course in rational choice theory at Nuffield College’s Center for Experimental Social Science. As part of our first class we were taken to a brand new, gleaming behavioural economics laboratory to play a repeated prisoners’ dilemma game. The system randomly paired anonymous members of the class to play against each other. We were told the objective of the game was to maximise our individual scores.

Thinking that there were clear gains to make from co-operation and plenty of opportunities to punish a defector over the course of repeated interactions, I attempted to co-operate on the first round. My partner defected. I defected a couple of times subsequently to show I was not a sucker. Then I tried co-operating once more. My partner defected every single time in the repeated series.

At the end of the game, we were de-anonymised and it turned out, unsurprisingly, that I had the lowest score in the class. My partner had the second lowest. I asked her why she engaged in an evidently sub-optimal strategy. She explained: ‘I didn’t think we were playing to get the most points. I was just trying to beat you!’

The lesson I took away from this was not that formal models were wrong. Game theoretic models, like the prisoners’ dilemma, are compelling and productive analytical tools in social science, clarifying the core of many challenges to collective action. The prisoners’ dilemma illustrates how given certain situations, or rules of the game, self-interested agents will be stymied from reaching optimal or mutually beneficial outcomes. But this experience suggested something more complex and embedded was going on even in relatively simple social interactions.

The laboratory situation replicated the formal prisoners’ dilemma model as closely as possible with explicit rules, quantified ‘objective’ (though admittedly, in this case, low-value) payoffs, and a situation designed to isolate players as if they were prisoners in different cells. Yet even in these carefully controlled circumstances, it turns out that the situation is subject to multiple interpretations and understandings.

Whatever the textual explanation accompanying the game, the score on the screen could mean something different to the various players. The payoffs for the representative agents in the game were not the same as the payoffs in the minds of the human players. In a sense, my partner and I were unwittingly playing different games (although I lost within either rules of the game!).

When we engage with the social world, it is not only the case that our interests may not align with other people. Social interaction is open-ended. We do not know all the possible moves in the game, and we do not know much about the preference set of everyone else who is playing. Indeed, neither they nor we know what a ‘complete’ set of preferences and payoffs would look like, even of our own. We can map out a few options and likely outcomes through reflection and experience but even then we may face outcomes we do not anticipate. As Peter Boettke explains: ‘we strive not only to pursue our ends with a judicious selection of the means, but also to discover what ends that we hope to pursue.’

In addition, the rules of the game themselves are not merely exogenous impositions on us as agents. They are constituted inter-subjectively by the practices, beliefs and values of the actors that are also participants in the social game. As agents, we do not merely participate in the social world. We also engage in its creation through personal lifestyle experimentation, cultural innovation, and establishing shared rules and structures. The social world thus presents inherent uncertainty and change that cannot be captured in a formal model that assumes fixed rules of the game and the given knowledge of the players.

It is these two ideas, both borrowed from the Austrian notion of catallaxy, that makes robust political economy distinct. First, neither our individual ends, nor means of attaining them, are given prior to participation in a collective process of trial and error. Second, the rules that structure how we interact are themselves not given but subject to a spontaneous, evolutionary process of trial and error.

I try to set out these ideas in a recent symposium in Critical Review on Mark Pennington’s book, and in ‘Why be robust?’ in Interdisciplinary Studies of the Market Order edited by Peter Boettke, Chris Coyne and Virgil Storr. The symposium article is available on open access and there is a working paper version of my chapter is available at the Classical Liberal Institute website.

AEM Europe and PCPE in Prague, April 21-24 2016

I have recently returned home from 4 days of Prague, Czech Republic, where I attended two conferences: Austrian Economics Meeting Europe and the Prague Conference on Political Economy. After having been secluded from Austrian economists and Libertarians for almost 2 years, it felt like a homecoming to be surrounded again by people who share similar thoughts. This was after all the only place in the last two years where I was able to fully express my (´controversial´) ideas about society. Being surrounded by tremendously smart people – you have to be rather smart and geeky to give up part of your free time or professional work in order to visit conferences and discuss philosophy, politics and economics – within the beautiful city of Prague made it a wonderful experience.

The AEME came about after the summer of 2014 when those from Europe who visited Mises University that year decided to come together again to discuss classical liberal ideas in the spirit of Carl Menger, Ludwig von Mises, Friedrich von Hayek and Murray Rothbard. The first AEME event took place in 2015 in Vienna, Austria, the city where the Austrian School of economic thought emerged from the works of Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, and others. The Austrian School is famous for its methodological struggle against the Prussian Historical School and their idea that economics is culture- and time-specific and therefore does not contain universal validity. The Austrian School is also famous for such theoretical contributions as the subjective theory of value (as opposed to Marx’ labour theory of value), theory of marginal utility, opportunity cost doctrine, Austrian business cycle theory, the time structure of production and consumption, methodological individualism and the economic calculation problem that was first formulated by Ludwig von Mises in 1920 and later expanded upon by Friedrich von Hayek to show that pricing systems in socialist economies were necessarily deficient. From a socio-political perspective, the School argues for limited government and some even for libertarian anarchism.

AEME pub
AEME participants sharing their last evening in Prague in a local pub

What was great about the second AEME is that it took place right before the PCPE conference at the CEVRO Institute. Most of us who attended AEME have stayed two extra days to attend the PCPE conference as well. The CEVRO Institute is a private university founded in 2005 that is located in the very centre of the city of Prague. The university prides itself in its emphasis on freedom, markets, and its innovative character that is for example manifested in its PPE (Philosophy, Politics, Economics) programme taught by such international illustrious professors as Michael Munger who is also director of Duke University’s PPE programme, Peter Boettke who is the director of the F.A. Hayek Program at George Mason University, David Schmidt who is director of the Center for the Philosophy of Freedom at the University of Arizona, Boudewijn Bouckaert who was the former dean of the Faculty of Law at the University of Ghent, and Josef Sima who is the president of the CEVRO Institute. The institute has invited several prominent speakers for its conference. Prof. Mark Pennington (London School of Economics) was for example invited to present “Why most things should probably be for sale”. Prof. Benjamin Powell who is the director of the Free Market Institute at Texas Tech University, the University to which I almost applied to to pursue my PhD in the academic year of 2015 but eventually decided to work as a software engineer, was there as well to speak about “Migration, Economic Calculation, and the European Situation.” Prof. Mario Rizzo (New York University) had the honour to be the keynote speaker and spoke about “The four pillars of new paternalism” which was followed by commentaries from Prof. Pascal Salin, former president of the Mont Pelerin Society.

PCPE 2016
Mario Rizzo’s welcome speech to PCPE

The second day of the PCPE conference, there were 27 speakers spread over 9 sessions on such topics as economic theory, anarcho-capitalism, the Austrian School, entrepreneurship, cryptocurrencies, the role of family and more. I was one of the speakers and spoke on the “Philosophical investigation of seasteading as the means to discover better forms of social organization”. The thesis of my talk was that one core focus of political philosophy is to deal with the realities of value pluralism and political disagreements. I contended that the most common form of social organization, representative democracy, does not satisfactorily deal with these realities. Therefore, we should look for political possibilities beyond representative democracies and that in order to discover these possibilities, we should experiment with new forms of social organizations. By approaching the issue from a meta-system level perspective and realizing that governments are resistant to structural societal changes we should then introduce competition into the industry of governments. Seasteading, the creation of habitable dwellings on the oceans, could serve as a means to introduce more competition in the industry and lessen political tensions between citizens who hold different comprehensive doctrines.

Chhay Lin - PCPE
Me speaking at PCPE about Seasteading as the means to deal with such political realities as value pluralism and political disagreements

If I could mention one thing that has made the most remarkable impression on me, it would be the warning issued by Prof. Stephen Baskerville (Patrick Henry College, USA) that the most immediate threat to our liberties is feminism and the social justice movement. He maintained in his talk that there is an ensuing crisis of the family which is perpetuated by the state. According to Prof. Baskerville, family courts can enter homes uninvited, take away people’s children, confiscate their property, and incarcerate them without trial, charge or counsel. With over 50% of all first marriages ending in divorce and more than half of all these divorces involving children, the greatest threat to our liberties is the colluding social work state bureaucracies with radical feminism. These groups have colluded to suppress information on such injustices. Listening to Baskerville’s talk, I felt the great urgency to engage in an intellectual battle against feminism and the social justice movement.

Other than the many intellectually invigorating moments, the city itself provided many magnificent sites. To mention several sights: we visited a beer garden, experienced a classical music concert at the Mirror Chapel, walked over the Charles Bridge, and visited the Prague Castle.

Prague Charles Bridge
The beautiful Charles Bridge crossing the river Vltava

All in all, the city of Prague, AEME and PCPE were an unforgettable experience! It has already been decided that next year’s AEME conference will take place in Krakow, Poland. The conference will be open for anyone who is interested in Austrian economics and libertarianism. For more information on AEME and the papers that were presented in the previous editions, you can find our website here. In case you are interested in studying at the CEVRO Institute and its MA PPE programme with specializations in “Austrian Economics”, “Studies of Transition”, and “International Politics”, you can visit their website here.

Economics in the ancient world?

Part of my research is located between philosophy and specific disciplines in the humanities and social sciences. I’m currently working on a project on several facets of economic life in the ancient Near East. I’m very serious about it, and even did some study in Akkadian, Sumerian, and Hebrew to understand some of the debates on the interpretation of primary sources.

Some crucial questions that anybody in my situation have to ask relate to theory: Was there any such thing as an economy, to begin with? Okay, the answer is straightforward: people were indeed allocating scarce resources, trading them, producing them, and so on. I don’t know of anyone who doubts that, and in case anyone tries, I’d point them to the enormous amount of ancient Mesopotamian contracts, receipts and court cases dealing with the issue, not to mention the famous “law codes” of Hammurabi and other kings.

The answer to next question, though, is less obvious: Can we apply contemporary economic theory to interpret, understand, explain, model, etc. economic behaviour in the ancient world? So far, I’ve identified three schools of thought on this matter in the field of Ancient Near Eastern Studies.

First, there are those who focus on particulars on the “micro” level. Their research is predominantly concerned with the publication, translation, and commentary on hundreds and hundreds of inscribed clay tablets containing valuable information about everyday life in the ancient world. These scholars won’t have much to say in terms of generalisation, because the questions they address are a degree further removed from the questions we tend to ask, say, in economics or sociology.

A common type of research in this line (and, frankly, a type of research I wouldn’t mind executing someday) looks at the complete set of cuneiform tablets found in a specific place and tries to elucidate some patterns within that set of texts. I’ve heard, for example, of someone who did his PhD on the archives of a certain family in Babylon which was involved in trade. That scholar didn’t stop at telling the story of that family, but also synthesised a considerable amount of information about economic transactions and the everyday struggles for that town in that particular period. He also pointed out some interesting linguistic features present in the contracts, letters, and receipts that he transcribed, translated and published as part of his thesis.

In this kind of research, the emphasis is on detailed observation and description, and on a modest type of generalisation to a mid-range view of the local situation. It doesn’t really deal with the economy in general and, arguably, doesn’t make much room for any of today’s economic theories to be used.

The second school of thought borrows from economic sociologists and anthropologists the idea that any economy is intrinsically linked to the way a specific society operates in a given period of history. The works of Karl Marx, Max Weber and, more recently, Karl Polanyi and Immanuel Wallerstein are examples of broad statements of this thesis. Polanyi, in particular, has applied some of this thinking to ancient economies, arguing that, in the ancient Near East, there was no such thing as a “market” in the modern sense. If that’s indeed the case, then the task is to develop a new economics (or at least a new economic theory) to account for phenomena which are particular to that historical context.

In this second kind of research, a key procedure is to ask what the ancients thought they were doing when they were engaged in economic activity. This is analogous to the anthropologist’s “thick description” of a culture in its own terms. Hermeneutics and interpretation should play a major role. We’d need to read those primary sources in search for clues about the ancient view of the economy. Did they imagine the economy as we imagine it today? Or was it something different in their view? What were the words and notions they used to describe economic activity? And so on.

However, how would we know what to look for in the first place? Wouldn’t the very notion of an “economy” be alien to the ancient mind, at least until much later with the Greeks and Romans? Because of this tricky implication, people in this line of research may choose to ignore any subjective or discursive features and may opt instead for a reduction of ideas to material factors, perhaps driven by a Marxist philosophy.

Then, thirdly, there’s the view that presupposes the applicability of contemporary economics to ancient economies. So far, I’ve come across two lines of research, both of which seem underexplored because of the lack of interest of economists in the ancient world, or lack of ability to tackle primary sources. The first line of research looks at the relationship between institutions and the general operation of the economy. I’d place this within the broader approach of neo-institutional economics, or also the so-called law and economics tradition of economic thought.

One interesting question that has been asked in this line of research has to do with the impact of government regulations in the everyday functioning of the economy. For example, how clear were property rights? If we look at the “law codes” of ancient Mesopotamia, we see a large number of definitions of what was allowed and what was forbidden, but were those rules enforced? Were they simply a suggestion? Sometimes, there’s a contrast between what the law code says and what local judges decided in a concrete court case. This way of researching ancient economies, in my view, is more productively executed as teamwork, with an economist and a specialist in ancient texts, languages, and archaeology joining forces.

A second way of applying contemporary economic science to ancient economies resembles the mainstream way of doing research. A model is constructed on the basis of some initial hypothesis, and then the hypothesis is tested against “data”. An important problem with this is that there’s a dearth of concrete and unambiguous information amenable to this sort of treatment. However, this is not the case for all periods. As a matter of fact, we do happen to have access to sizeable sets of information about prices and wages for Babylonia in the Hellenistic period. The crucial source is a set of records that people made correlating the position of the stars and planets with all sorts of information, including economic information. Some preliminary analysis of those series has suggested that prices, for example, behaved more or less like a mainstream economist would expect them to behave.

This issue of the dearth of data leads me to the following thought. I believe that even a mainstream economist should be open to the possibility of another style of economics in the study of ancient economies. I don’t think economists should give up studying them altogether. Some cross-theoretical dialogue with those engaged in other ways of thinking about ancient economies may be in order. However, I understand that many on both sides of the attempted dialogue will feel uncomfortable. After all, a mainstream economist and a Marxist don’t just disagree on method. They also disagree on politics, ethics, the meaning of life, and a number of other issues.

As a possible avenue of research, then, I’d like to suggest a more deductive approach in theory construction and a more discursive approach in the study of historical patterns. From the deductive system we’d know how an economy works in general, even if there are historically-specific possibilities to tackle. From the discursive approach we’d be able to make the most of the “data” that we do have in abundance – thousands of clay tablets with textual information – and with that illustrate the general points.

In my view, this would look like a combination of Austrian political economy with rigorous philological use of primary sources. It would be the sort of research programme to be tackled with a team of people, good libraries, near a museum and in constant dialogue, learning, and interaction. Both fields could potentially benefit from the original interdisciplinary research programme that would emerge.

Riding Coach Through Atlas Shrugged: Part 4 – Governor’s Ball

Pages 48 – 53

Chapter Summary – A group of industrialists sit around a shadowy table plotting the downfall of our favorite rugged individualist.

[Part 3]

I love how cliché this chapter is. Four figures sitting around a table, their faces shrouded in darkness as they scheme over the fate of the world, the sycophant politician sniveling his consent to their plans. This is one of those times where I am not quite sure if the fiction created the trope or the fiction is following the trope but it is okay either way, it is delightful to read.

We have at our table:

James Taggert: Who is far less whiny when not in the presence of his sister.

Orren Boyle: Our socialist-industrialist representative in the story.

Wesley Mouch: Our aforementioned politician, in the pay of Hank Rearden but in the pocket of Orren Boyle.

And finally –

Paul Larkin: The man at Rearden’s dinner party last chapter.

Essentially they spend the chapter plotting against Hank Rearden and promoting a philosophy of non-competition among businesses. From a historical standpoint this is essentially what happened with Hoover and the industrialists leading up to the great depression. A series of price and wage controls were set up that distorted normal market activity leading to the boom-and-bust cycle as described by Ludwig von Mises. As a side-note it is an interesting historical misconception that Hoover “did nothing” during the great depression. Hoover was arguably the most meddling president up to that point in regards to the economy except perhaps for Abraham Lincoln, but total economic warfare is hard to beat.

But to get back on track here, for what it lacks in literary creativity this chapter makes up for with pure economic and political insight that is delightful to read. The most illuminating part is a speech, or perhaps rant, by Orren Boyle that goes as follows, some of Taggert’s responses are edited out for brevity:

“Listen Jim…” He began heavily.

“Jim, you will agree, I’m sure, that there’s nothing more destructive than a monopoly.”

“Yes.” Said Taggart, “on the one hand. On the other, theres the blight of unbridled competition.”

“That’s true. That’s very true. The proper course is always, in my opinion, in the middle. So it is, I think, the duty of society to snip the extremes, now isn’t it.”

“Yes,” said Taggart, “it isn’t fair.”

“Most of us don’t own iron mines: How can we compete with a man who’s got a corner on God’s natural resources? Is it any wonder that he can always deliver steel, while we have to struggle and wait and lose our customers and go out of business? Is it in the public interest to let one man destroy an entire industry?”

“No,” said Taggart, “it isn’t.”

“It seems to me that the national policy ought to be aimed at the objective of giving everybody a chance at his fair share of iron ore, with a view towards the preservation of the industry as a whole. Don’t you think so?”

“I think so.”

This exchange is a fantastic summary of the process involved when the government gives special privileges to favored industries under the guise of regulation. Essentially Rearden is out-competing his fellow steel producers and since they cannot compete under market conditions they intend to compete politically by ham-stringing his business through the legal process.

This process has happened time and time again throughout history and the ironic part is that these actions have almost universally been heralded as “anti-business” when in fact it is the businesses itself that propose this regulation. The first anti-monopoly laws in America were lobbied for by the competitors of the successful oil, rail, and steel businesses which resulted in the *rise* in prices of those goods. It seemed the “natural” monopolies were pro-consumer while the regulation was pro-business.

There are also historical comparisons to be made to the great depression. The whole concept of “protecting an industry” at the expense of a single, productive, individual was the cornerstone of “Hoover-nomics” especially in the farm industry. The industrial revolution brought about a massive increase in farming productivity which naturally led to a decline in prices and a surplus of labor in that industry that came to a head during the “dirty thirties”.

The natural course of the market would be for inefficient firms in that industry to liquidate; with the entrepreneurs and workforce moving to other industries. This would cause a short period of transitional unemployment as workers moved into similar or growing industries while the more efficient firms and prospective entrepreneurs would buy the liquidated capital goods of the inefficient businesses at a discount.

Consumer goods prices would fall to equilibrium where only firms able to produce goods below that price would be able to maintain production. This would have the net effect of expanding the labor pool and be a net gain for society as new areas of production would be made available by the increases in productivity. Instead, Hoover organized industrial cartels that maintained price and wage controls over the entire economy propping up inefficient businesses that continued to waste and malinvest resources resulting in what we know today as the great depression.

To summarize, this chapter is a fantastic must read five page tour de force of economic insight.

Next chapter: More Dagny, more snark, and more family drama.

Tamny on Fractional-Reserve Banking: Right Conclusion, Faulty Analysis

John Tamny has posted a long and thought-provoking piece entitled “The Closing of the Austrian School’s Economic Mind.” He begins with a cogent critique of the anti-fractional-reserve stance of certain Austrian economists at the Mises Institute. Unfortunately, he follows that with a discussion of fractional reserves, the money multiplier, and other issues in which he goes badly astray.

As Tamny says, it is only some Austrians who have a problem with fractional-reserve banking. I consider myself an Austrian but I do not share the view of fractional reserves of the Mises Institute contingent, whom I prefer to call hard-money advocates.

The alleged problem, as the hard money people have it, is that under fractional reserves it appears that two people have a claim on the same dollar. This, they say, is fraud. But it is not fraud if the arrangement is disclosed to all parties. There are problems with our present-day fractional-reserve system, which I discuss below, but fraud is not one of them. (Incidentally, Tamny scores a point when he wonders about the hard money people calling in the state to crush the alleged fraud, but I believe most of them are anarchists and would have private protection agencies do the job. Just how this might work is beyond me.)

Tamny recognizes that fractional-reserve banking is the norm in all modern societies but he goes a little too far when he says fractional-reserve banking is a tautology. Modern banks do offer warehousing of money to those few who want it, via safe-deposit boxes. Anybody can rent one and stuff it full of currency or near-money assets like gold coins, and of course pay an annual fee. This is a minor sideline for banks, but it exists, so there is no tautology.

Also, contrary to Tamny, it is possible for a well-run business to fail for lack of money. This can happen if the supply of money in an economy falls short of the demand to hold it. (We must not mistake the demand to hold money with the demand to acquire money for spending. We all want to hold a certain level of cash, enough to cover emergencies or unexpected bargains but not so much as to pass up good opportunities for spending or investing it.) Money supply can get out of balance with money demand when there is a monopoly supplier, as there is in all modern economies, which has no market forces to tell it how much money to issue. There would be such forces in a free banking system, which is a topic for another time.

I promised to mention problems with fractional-reserve banking. The first is that government control of the banking system has short-circuited market forces that would signal to bank managers the amount of reserves they ought to keep on hand. If managers keep too little in reserves, they risk a liquidity crisis, or short of that, fear of a crisis on the part of depositors or would-be depositors. If they keep too much, they pass up profit opportunities and dis-serve their shareholders. The safety of a fractional-reserve bank depends critically on its reputation for prudence in lending. Without government interference in the forms of both controls (among them reserve requirements, capital requirements, and asset restrictions) and support (two that come to mind are Federal deposit insurance and the privilege of borrowing from the Federal Reserve), managers would very likely be more prudent about lending, and even more, about maintaining their reputation for prudent lending. Depositors would come to understand banks as something more like a mutual fund than a piggy bank.

This first point is not a strike against fractional reserves, but the government’s failure to let a free-market fractional-reserve system work honestly and efficiently.

The second problem is the flip side of the first. Federal Deposit Insurance relieves depositors of any incentive to question the soundness of their bank’s lending process. Depositors have no reason to look beyond the FDIC sticker in the window. Such is not the case with mutual funds which bear some resemblance to fractional-reserve banks. Most fund investors look carefully at ratings before investing. FDIC insurance does not eliminate risk, it socializes it, wreaking all sorts of distortions in the process.

I agree with Rothbard that occasional bank failures, leaving depositors and shareholders as well as other bank creditors empty-handed, should be welcomed because they put the fear of God into managers and depositors alike.

An advantage of a fractional reserve system over a 100% gold-backed system is that the latter would suck almost all the world’s supply of gold into underground vaults leaving very little for industrial or ornamental uses. Fractional reserves free up a lot of that gold for these uses, more so over time as the reserve levels needed to maintain confidence in the system fall as the system works well and confidence increases.

Tamny next takes up the money multiplier, and in so doing goes wildly off the rails. He cites the textbook example:

  • Someone deposits $1,000 cash in bank A
  • Bank A lends out $900 and keeps $100 cash as reserves
  • The recipient of the $900 deposits it in bank B which loans out $810 and keeps $90 cash as reserves
  • The $810 is deposited in bank C, and on it goes.

Textbooks use this example to show how money is created by fractional-reserve banks via a multiplier which approaches 1/r where r is the fraction of deposits maintained as reserves by each bank, 1/0.1=10 in the example. The new money is categorized as M1, which includes currency and travelers’ checks in addition to demand deposits (checking account balances).

So is M1 really money? Most definitely, because it fits the definition perfectly: a generally accepted medium of exchange. Is there anyone reading this piece who does not keep much more of his money in a checking account than in cash? How often do we pay cash these days? We use our debit cards, paper checks, or on-line transfers instead of currency. Or we use credit cards which we pay off by on-line transfer or check. All this is M1 money, all created by private banks under the aegis of fractional reserve banking. Notwithstanding the problems cited above, it all works rather well.

Tamny will have none of it. He goes through the same textbook exercise, imagining a group of friends in a room instead of a sequence of banks. He is wrong to say that no money is created in the process. To be sure, the amount of currency in circulation has not increased but he fails to notice that M1 money has increased. That’s because each loan recipient has, in addition to some currency, a bank balance that he correctly believes he can spend without ever converting it into currency: M1 money. Tamny could give each borrower in his thought experiment an old-fashioned bank book as evidence of the new money. We have here the nub of Tamny’s problem: his failure to recognize that M1 money (or rather the demand deposits that dominate that category) is real spendable money.

Tamny says money doesn’t grow on trees, but he’s wrong. The Fed creates base money out of thin air, as I’m sure Tamny agrees, but most money creation is done by private banks via the multiplier. And in truth, a fractional reserve system does create real wealth in the long run relative to a 100% reserve system because it increases the efficiency of the money and banking system, freeing up resources for alternate productive uses.

Is the fractional-reserve system inflationary? Yes, when currency flows into banks and is multiplied, it is. The reverse process is deflationary. But if overall bank reserve levels hold steady no price inflation is triggered, other things being equal.

Tamny’s use of NetJets as an analogy to fractional-reserve banking is flawed. The same jet plane cannot be in two different places at the same time. But two dollars of checking account money, each having its origin in the same dollar of currency deposited, can both be spent. Yes, money does grow on fractional-reserve trees. No, real wealth does not.

Tamny asks, if banks can multiply money, why can’t the same be done by “enterprising entrepreneurs eager to quickly turn $1,000 into $10,000 without doing anything?” They can actually, but they must do a lot of work first, like raising capital, setting up an office and web site, rounding up depositors and borrowers. To see details, go to www.startabank.com. The barriers to entry caused by licensing and such are actually rather modest.

Incidentally, the failure to recognize demand deposits as money goes back at least to the Currency School in 1840’s England. This school of thought held that bank notes should be backed 100% by gold but failed to understand that checks payable on demand were also money and required backing.

“Credit is not money,” says Tamny. What is it, then? “Credit is real resources.” But this is a wide departure from the accepted meaning of the term and one that leads to all sorts of confusion. The common definition of credit is a willingness or commitment of lenders to provide loans to certain parties under certain conditions. Businesses often carry lines of credit with banks. Individuals have credit limits on their credit card accounts. No, credit is not money, but it comes close. We feel reassured by credit commitments which we can tap into when needed. Credit is a way to buy stuff, not the stuff itself. I should add that later in the same paragraph Tamny calls credit access to real resources (my emphasis). This is closer to the mark but is not the defining characteristic of credit. Stuff can be bought on credit or with currency or barter. Again, credit is the willingness or commitments of lenders to loan money. But later in the piece Tamny flips back to credit as “resources in the real economy.”

At one point he says true inflation is “devaluation of the dollar.” No, devaluation refers to a drop in exchange rates for a particular currency relative to other currencies. Devaluation is often but not always accompanied by inflation. I’ll give him a pass on this and assume he means true inflation is a drop in the dollar’s purchasing power.

Elsewhere he denies any role for Fed-induced “easy credit” in the housing bubble. It may not have been the dominant factor, and it may have been overpowered by countervailing factors in the examples he cites, but can there be any doubt that lower interest rates stimulate the quantity of housing demanded, other things being equal? Don’t mortgage payments consist almost entirely of interest in the early years? Exercise for the reader: how much more house can you afford given $3,000 per month to spend on a 30-year mortgage if the rate drops from 5% to 4%? Answer: a lot more.

Another Tamny claim is that a growing economy always needs more money. This seems right, since growth generally means more of everything. But as clearing and payment system efficiencies increase, as we turn more to debit cards, credit cards, PayPal, and whatever comes next, our desire to hold money declines. This countervailing tendency could cancel out most or all of the effects of growth on money demand.

Tamny calls government oversight of money “horrid” and wishes for abolition of the Fed. Amen to both, but how can he be sure that, as he claims, credit would soar as a result? It probably would in the long run as sound money prompted increased confidence, but in the short run there could be liquidation of mal-investments and a general hesitation to save and invest pending clarification about where things were headed under the new setup.

John Tamny is correct: the anti-fractional-reserve crusade of the hard-money people is misguided. That case has been made repeatedly, deftly, and at length by Larry White and George Selgin, two of the best contemporary monetary economists. Sad to say, Tamny’s analysis, riddled as it is with errors and confusions, falls far short of their work.

Where the World’s Unsold Cars Go To Die [Zerohedge]

I don’t have time to comment a ton on this (Life has just been absurd lately) but wanted to make sure more people saw this.

The guys over at Zerohedge noticed a surprising sight on google maps in the city of Sheerness, United Kingdom. West coast, below the River Thames and next to River Medway. Left of A249, Brielle Way. A car lot full of unsold, brand new cars. Zerohedge claims these are all new cars that cannot fit on overcapacity dealer lots. If true this would be a prime example of malinvestment spurred on by government bailout and subsidies. Quite literally a textbook case of the Austrian Business Cycle.

Further research is needed since I do not know whether these lots are standard practice or a new feature of our post-2008 crash world. It is possible that these are merely staging grounds for cars before they ship to dealers but at first glance I tend to agree with Zerohedge’s conclusion that “There is proof that the worlds recession is still biting and wont let go. All around the world there are huge stockpiles of unsold cars and they are being added to every day. They have run out of space to park all of these brand new unsold cars and are having to buy acres and acres of land to store them.”  

Something to keep an eye on regardless.

The Canons of Economics

by Fred E. Foldvary

A “canon” is a set of items which are regarded by the chiefs of a field to be the accepted elements of the domain. Every religion, for example, has a canon of accepted ideas and documents such as the established books of the Bible. Every scientific field has a canon of propositions and facts accepted as genuine by the experts and by those in authority such as editors of the major journals and most members of the departments of the prominent universities.

The canon of economics consists of the propositions, methods, and historical facts accepted as true and applicable by most scholarly economists. This canon appears in textbooks and in the articles of the prominent journals. The ideas and methods outside the canon are referred to as heterodox economics, in contrast to the mainstream or orthodox canon. There have been articles and organizations about the mainstream and alternative canons, but they have not laid out what the canons consist of. Here is my attempt.

The canon of orthodox neoclassical economics consists of 1) supply and demand; 2) graphical curves of equal utility, inputs, and output; 3) marginal analysis (additional amounts of utility, inputs, outputs); 4) the factors or input variables of capital goods and labor; 5) the price level; 6) equations of production and utility; 7) the government-influenced money supply and the market-based velocity of the circulation of money; 8) economic and accounting profit; 9) market failure and government corrections; 10) equilibrium; 11) maximizing and minimizing within constraints; 12) the premises of subjective values, self-interest, scarcity, unlimited desires, and the uncertainty of the future; 13) the “time preference” for present day good relative to future goods; 14) the trade-off between goods and leisure; 15) the trade-off between equity and efficiency; 16) diminishing marginal utility; 17) diminishing marginal products; 18) theory from mathematical models; 19) econometric testing of hypotheses; 20) the producer and consumer surplus.

Neoclassical economics is divided into several sub-schools for macroeconomic theory. The major schools and their canons are:
1) Keynesian or demand-side economics, with the canons of the consumption function, spending multiplier, and the determination of output from autonomous spending and the multiplier.
2) The Monetarist school, its canon being the equation of exchange: Money times velocity equals the price level times real output, hence monetary inflation generally causes price inflation.
3) The New Classical school with its canon of rational expectations, which makes inflationary policy ineffective.
4) The New Keynesian school with its canon of wages, prices, and interest rates stuck above equilibrium; it accepts New-Classical rational expectations but claims that contracts and other rigid conditions make expansionary policy effective in increasing output.

The heterodox Austrian economic school of thought accepts these elements of neoclassical economics:1, 3, 4, 7, 8, 12, 13, 14, 15, 16, 17, 20. Austrians reject the excessive emphasis on 6, 9, 10, 11, 18, 19. The canons of the Austrian school that have not been absorbed into the mainstream are: 1) the time and interest-based structure of capital goods; 2) market dynamics rather than equilibrium; 3) dispersed knowledge; 4) discrete marginal utility based on diminishing importance; 4) axiomatic-deductive theory (praxeology); 5) entrepreneurship as both discovery and creative reconstruction; 6) free-market money and banking; 7) roundabout production; 8) the market as spontaneous order; 9) the failure of government intervention; 10) the evenly rotating economy that illustrates the role of entrepreneurship in the real world of uncertainty and change.

The Marxist school canon includes 1) class struggle, 2) the labor theory of value; 3) the surplus from labor taken by the capitalists who dominate labor; 4) benefits from socializing wealth.

The Georgist or geo-classical school has these canons: 1) land and its rent as major elements of the economy; 2) the margin of production as the least productive land in use; 3) land speculation and the movement of the margin raising rent and reducing wages; 4) the creation of land rentals from public goods; 5) depressions resulting from land-value bubbles; 6) economic effects of replacing market-hampering market-hampering taxes and subsidies with land-value taxation; 7) the surplus as land rent; 8) the ethics of labor and land; 9) harmony between equity and efficiency, and 10) the social behavioral effects of economic justice.

There is also a school of thought called “public choice,” which has been accepted by neoclassical economics as well as by other schools, as a side branch. Its canon includes: 1) self-interest in politics; 2) the rational ignorance of voters; 3) transfer-seeking and getting due to concentrated interests and spread-out costs; 4) vote trading by representatives; 5) bureaucrats maximizing their power and comfort; 6) the primacy of the median voter; 7) constitutional versus operational choice; 8) clubs that provide collective goods to their members.

The classical economics canon, before it turned neoclassical, included these elements: 1) Say’s law, that production pays factors that enable effective demand; 2) the division of labor; 3) economic growth from unhampered production and free trade; 4) the margin of production as the least productive land in use; 5) population growth pushing the margin to less productive land; 6) the three factors of production as land, labor, and capital goods.

A problem in economics today is that each canon excludes the useful elements of other schools. Economics needs a universalist canon that integrates the best elements from all schools of thought. However, economists disagree on what the canon should be. In my judgment, the most glaring omission in the mainstream canon is the neglect of the Austrian-school time-structure of capital goods, its neglect of the creation of land rent by public goods, and its neglect of the benefits of a prosperity tax shift, the replacement of market-hampering taxes with market-enhancing payments of land rent and pollution charges.

Note: This article first appeared in the Progress Report.