Anyways, my logic/philosophy teacher is pretty ballin' and we often have discussions about politics, economics, and other issues relevant to philosophy. Basically, he's a really cool teacher. Sometimes, I stay after class and talk to him. Today, he asked me how my "laissez-faire" beliefs can respond to the recent economic crisis and how such a crisis would be avoided in a free market society.
I explained the role that Fannie & Freddie regulators at the HUD played (by requiring large amounts of purchases of subprime loans) and how rising housing prices actually create an incentive for banks to give bad loans and people to take them (if you default, the bank gets a house worth more than the loan, if you're lucky you can sell the house for significantly more than you bought it or you can refinance). I also mentioned ABCT and the Austrian school of economics, but since passing time was close to an end, I told him I'd send him an email.
The email could help some noobs trying to understand the Austrian theory of the business cycle and why credit expansion in all forms (including fractional reserve banking) is bad.
Here it is:
Hey Mr. [redacted],
I'll start off with some good links on the subject and then provide a shortened
version of the Austrian theory of the business cycle. The so-called "Austrian
school" of economics has a good website dedicated to its chief 20th century
proponent, Ludwig von Mises, at mises.org. The Austrian school had a strong
presence in the academic world in the early 20th century, before the "Keynesian
revolution," when Austrian and classical theories were swept aside without much
debate.
But to cut to the chase, here are some good audio files from the Ludwig von
Mises Institute about the Austrian theory of the business cycle, which is
sometimes called the monetary theory of the business cycle, due to its focus on
the effects of credit on the productive structure of an economy:
http://mises.org/multimedia/mp3/Salerno2/Salerno-10.mp3
http://mises.org/multimedia/mp3/audioarticles/3038_Thornton.mp3
http://mises.org/multimedia/mp3/Thornton-ASSC-11-02-2007.mp3
Some good online books that deal with business cycles, among other things (you
can also purchase them from the Mises Institute store):
Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto:
http://mises.org/books/desoto.pdf
The Austrian Theory of the Trade Cycle and other essays, edited by Richard
Ebeling: http://mises.org/pdf/austtrad.pdf
Failure of the "New Economics" by Henry Hazlitt:
http://www.mises.org/books/failureofneweconomics.pdf
Economics for Real People by Gene Callahan:
http://mises.org/books/econforrealpeople.pdf
If you read any of these, I would recommend "Money, Bank Credit, and Economic
Cycles" by de Soto as the first book you read. The first part of the book deals
with the legal implications of fractional reserve banking, but it isn't really
relevant to what we're discussing. The part dealing with business cycles starts
around chapter four and five, so that's where I suggest you begin reading. If
you prefer to read physical copies of books, you can either print the PDF,
purchase the book for $50 at the Mises store or $45 at Amazon, or I can let you
borrow my copy for a while. I also have "The Austrian Theory of the Trade Cycle
and other essays," but it's such a short book that you might as well read it
online (though you can borrow it if you want to). "Failure of the 'New
Economics'" deals mainly with the failure of Keynesian doctrines, though it does
explain the Austrian viewpoint, while "Economics for Real People" is a really,
really good and readable introduction to basic Austrian th
eory, which I recommend you read some time.
Anyways, on to my own, shortened explanation of why business cycles are not
inherent in free markets:
In order to understand why business cycles occur, I think one first has to
understand how a normal economy grows. A normal economy grows when people defer
consumption so that they can save. Saving takes the form of buying CDs, bonds,
stocks, etc. The more people save, the more loanable funds there are in an
economy, and thus, interest rates are lower. These saved funds have two
functions: they can be used by the saver to purchase "higher order" goods or
they can be used by a borrower who utilizes the lower interest rates to purchase
higher order goods. Higher order goods are goods that require many stages to
plan - things like houses, cars, machinery, factories, etc. Often times,
economists will call these goods "capital goods" because most higher order goods
are capital goods, though obviously houses and cars can't be considered capital
in the true sense.
In any case, an increase in saving means that there will be an increase in the
purchase of these higher order goods. Likewise, an increase in saving would mean
an acceleration of economic growth, since businesses would have more money to
purchase capital goods via loans and the stock market. Here we see three things
happening:
1. Interest rates go down/loanable funds increase, causing an increase in the
demand for higher order goods.
2. Wages and consumer prices begin to depress since less people are purchasing
consumer goods.
3. Entrepreneurs begin building more higher order goods, due to the higher
demand/profits. By doing so, they begin to bid wages back up to their original
pre-saving levels.
When all of the above happens, consumer prices actually experience deflation*,
first because of a drop in demand, and second because of an increase in capital
goods allowing businesses to produce consumer goods at a lower price than
before.
Keynesians might reply that falling wages are bad, but this is only in an
economy burdened by government regulation. In a free market, wages and prices
are flexible, since there are no minimum wages or unions setting wages above the
market-clearing wage rate. Thus, when consumption falls, wages readjust.
However, in an economy where the government heavily favors unionized workers,
minimum wages and three year union contracts prevent wages from falling, and
thus force employers to lay off their least productive employees, which
obviously isn't very conducive to increasing economic prosperity.
The above pretty much sums up how a normal economy grows. Everything so far is
just dandy. However, when government steps in by encouraging credit creation,
either by setting up a central bank or by encouraging fractional reserve
banking, the way the economy grows changes dramatically.
Basically, the new money created by banks acts as if it were saving. The real
(inflation adjusted) interest rate falls, thus making certain business decisions
more profitable than before. Since there is an increase in loanable funds,
businesses can purchase more capital goods, entrepreneurs can start businesses
more easily, and individuals can purchase more houses, vehicles, and other
higher order consumer goods. So everything seems dandy: the economy begins to
become better as it becomes more capital intensive, jobs are created, and more
products can be produced.
However, something happens that could not have happened without the introduction
of new credit into the banking system. Prices, instead of falling, begin to
rise. Since consumption wasn't sacrificed for saving, wages and prices never
actually fall. The new entrepreneurs who produce the capital goods necessary to
feed the expanding economy thus face a problem when the wages and prices they
were originally expecting to pay begin to rise. In order to be able to fund
their projects, they are forced to take even more loans.
Basic economics tells us that the price is where supply and demand meet. An
increase in the demand for loanable funds due to inflation forces banks to raise
interest rates. Before the original credit expansion, real interest rates could
have been something like three or four percent. During the credit expansion,
real interest rates might fall to something like two percent. But as the demand
for loanable funds rise**, interest rates rise, and all of a sudden demand for
higher order goods begins to fall. Why this fall? Well again, basic economics dictates that the
higher the price the lower the demand will be. When interest rates (prices on
credit) begin to rise, less people will purchase less houses, cars, machinery,
factories, etc. This, combined with the fact that now entrepreneurs producing
the higher order goods need more loanable funds to offset price inflation, means
that a large number of investments need to be "liquidated." Businesses that
produce higher order goods will be forced to either shut down, lay off workers,
or lower wages (or perhaps some combination like shutting down certain plants,
laying off workers at some other
plants, and lowering wages overall, like we've seen happen with the auto
industry here in Michigan). This is the start of the recession. Wages begin
rapidly depressing and there also generally occurs a monetary contraction as
banks begin to stockpile higher reserves to pay people who are taking money out
of savings accounts.
At some point (up to a year in the worst case scenario), the businesses that produce "higher order goods"
liquidate enough assets, and the market clears as wages and employment begin to
return to their normal levels. However, this is only in the scenario that
government decides to keep relatively free markets. If, as happened during the
Great Depression, government decides to step in with subsidies, price controls,
bailouts, more regulation, union favoritism, etc., wages and prices cannot fall,
employment will spiral out of control, and it will take more time for the market
to clear.
As a "layman follower" of the Austrian school, I really do hope that we do not
have a new New Deal. Their corporatist/semi-socialist policies, ones that were
based on the failed economic policies of Benito Mussolini, caused the Great
Depression to be truly great. Previous depressions in the 20s never lasted more
than a year because the government didn't do much to prevent the market from
clearing. But as soon as Smoot-Hawley and a plethora of other legislation passed, the economy took a turn for the worse.
* It's important to differentiate between secular price deflation, which is what
I'm talking about, and monetary contraction. Oftentimes, economists say that
deflation is bad, though they are actually referring to monetary contraction,
which is sometimes also called deflation. Monetary contraction is when money is
destroyed, though this does mean a higher purchasing power per monetary unit, it
also means higher interest rates, which hurt the economy. However, secular price
deflation (that is price deflation w/o contraction) is good since it allows the
economy to grow and real wages to rise.
** An increase for the demand for loanable funds is not the only reason interest
rates increase. Banks will often want to hedge themselves for inflation, because
sometimes price inflation is so high that real interest rates actually go
negative - in which case banks will obviously want to raise their interest rates
so they wouldn't be losing purchasing power. Similarly, people will stop buying CDs, bonds, etc. if real interest rates
become negative or too low, causing a contraction in the actual supply of
loanable funds. At the same time, demand for capital goods might fall even more
than I discussed, not only due to an increase in interest rates, but also due to
an increase in inflation. If price inflation is running high, businesses that
previously purchased capital goods, might find it more profitable to hire
workers instead of purchasing more capital - further causing "higher order"
businesses to go bankrupt.
Sincerely,
Alex
Mises Community Natural Rights Discussion Group
Nice. You almost have too much stuff, there, but if he's a cool guy -- and that's a rare thing as a professor -- I would imagine is pretty curious to have all of this new stuff even if this isn't resolved right away.
Plus, you have a lot of material there that even I haven't read (which isn't saying much in terms of economics) so you look to be presenting "the goods" so to speak pretty well and demonstrating a good working knowledge of it.
That's actually pretty good, perhaps Rothbard's America's Great Depression would have been good also?
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
Technically speaking, he's a teacher, not a professor. I'm still in high school (I'm 17, which means it's my senior year, woot woot!) and he only has a major in philosophy.
But yeah, I didn't want to put too much. Then again, I really couldn't have put any less. I mean, if I would've left anything out of what I wrote, I would have left a few huge gaping holes in our discussion. He's been talking about the bailout a bit during the class (for some reason we talk more about economics in my logic class than in my economics class) and he repeatedly states things like "I'm not sure - I'm looking for what the answer is to all of this." So even the end about the failures of the New Deal was necessary, because I'm trying to point out that imposing rigidities on the free market causes mischief and grief for normal people. Basically, I'm saying: "If we let the markets clear we'll be fine in a few months, but if we intervene, we'll prevent businesses that need to go bankrupt from going bankrupt, and thus we'll simply prolong our problems."
He is a really cool teacher though, so I think he'll read it with an open mind. He'll probably question some specific points and ask me for more evidence, in which case I'll do so.
GilesStratton: That's actually pretty good, perhaps Rothbard's America's Great Depression would have been good also?
I knew I missed something. Is Rothbard's book about the Panic of 1819 available for free as well? Asking because it's usually pointed out as the first time we had a depression and it is used as an example of why "free markets" are bad.
EDIT: I just found both books online for free. I'll send them to him later.
Wow, I'm amazed that you're in high school.
For two reasons: you're incredibly well-read and write so well by any standard. And that they are teaching logic/philosophy of any sort.
I also wrestle and run long distance track. Haha, enough of my ego trip. I have not-so-great grades and only a 26 on the ACT (go figure, perhaps I should study once in a while). But yeah, my high school is really good. It scores really high on the ACT, MEAP, MME, etc. Not to mention the 6000 students and scores of different classes one can take.
Oh, and I also have the bad habit of writing in "Midwestern," not proper English.
That's a little much, haha.
Remember that for people to refrain from saving, they resort to consumption, which is another factor bidding up consumer prices during the boom.
Great job. Very impressed that we have such scholarly high schoolers.
Check my blog, if you're a loser
Nice. I'd be interested to hear if your teacher answers back.
Eduard - Gabriel Munteanu: Nice. I'd be interested to hear if your teacher answers back.
He didn't reply via email, he told me in class that he's looking at some of the links I provided and whatnot. Today's topic of discussion was the existence of monopolies in free markets.
My email to him today was:
Well, I might start this email off like I did the others, with links and then follow up with my own input at the end:Here is an article from "The Free Market" that deals specifically with Microsoft:http://mises.org/freemarket_detail.aspx?control=95Here is a quite long article by economist Dominick T. Armentano, adapted from his two books about antitrust cases:http://mises.org/story/2694Here's an excellent article is by one of my favorite economists, George Reisman, who has attempted to unify the classical (which included Bastiat, Adam Smith, Ricardo, etc.) and the Austrian schools of thought:http://mises.org/story/48Here's one article about antitrust law in general:http://mises.org/story/1555This is another article by D.T. Armentano, at the Future of Freedom Foundation website:http://www.fff.org/freedom/0592c.aspHere is a two part article by Gregory Bresiger (the second part is linked at the top of the webpage):http://www.fff.org/freedom/fd0609e.aspHere's another article on the Mises website:http://mises.org/story/764Since reading things on the internet can hurt your eyes, I'll spare your eyesight and provide you with this youtube video featuring Ron Paul and Dominick T. Armentano before I was even born talking about antitrust laws:http://www.youtube.com/watch?v=8C4gRRk2i-MMy input is this:I honestly think that people believe that "monopolies are the natural outcome of free markets" simply because it's been drilled into their heads by schools, the media, etc. I do not think that one can make a reasonable argument proving that monopolies can exist, nor can one use evidence without proving that governments often create monopolies, not free markets.No time in history has a business been able to gain a monopoly. It is, in fact, impossible for a business to develop to a proper size to actually monopolize the market. Businesses can only grow so large before they start becoming inefficient due to "diseconomies of scale" (basically, becoming too bureaucratic). Therefore, businesses cannot monopolize the entire world's market for a product. If any business ever tried to achieve anything close to monopolizing the world market, it would suffer from bureaucratic inefficiencies and thus lose market share. This leads us to the conclusion that businesses can only grow so large, therefore, there are bound to be numerous competitors in various nations (like we have with the auto industry, for example). Thus, even if a company were able to somehow pull of the miracle of monopolizing an entire national market, it would face competition from foreign companies as long as there wouldn't be prohibitive trade barriers like high tariffs or quotas.Another thing is that venture capitalists aren't afraid to lay down HUGE sums of money for start ups. IIRC, one venture capital firm laid down billions of dollars when Sun Microsystems first started. If some entrepreneurs have a really good idea and no established businessman is picking up on it, venture capitalists are often willing to risk a large sum of money for large future gains.Let's take your first example of Microsoft. Consider this:1. The only reason Microsoft was in the position it was in was because it provided a product that people wanted to purchase. This wasn't forced upon anyone. The businesses that were angry about Microsoft (e.g. Netscape) were the ones who were, in fact, uncompetitive and were not able to provide a product that consumers desired. 2. There were plenty of other software companies besides Microsoft that had a decent amount of market share (Apple and Sun Microsystems come to mind). Microsoft was not able to drive these competitors out of the market simply because they were providing higher quality products to specific types of consumers, and thus, these companies found their niche in the software industry. Microsoft could not hope to completely drive these competitors off of the market because they would just become too large and bureaucratic in the process, losing their economy of scale, due to the fact that filling so many different specific niches would be too much for a single company to handle. If Microsoft began to monopoly price, it would simply lose market share to their competitors.3. Saying, "but Microsoft had lower quality products" is only a rational argument if you are implying that you want to force consumers to buy higher quality products. People purchased Microsoft products because they were cheaper than their competitors and simply because most consumers didn't need high quality software for their day-to-day work. So unless you want to prevent voluntary transactions between consumers and Microsoft from occurring, you should not use this argument.As for your second example of an innovator not being able to gain a market in the auto industry, please consider this:You are a big-time stock holder in one of the major auto companies like Ford, GM, Chrysler, Toyota, Mercedes-Benz, etc. Someone approaches you with a great new idea you think might be profitable. Will you:a) Reject his/her offer even though your competitors might get the idea?b) Accept the offer so you can outcompete the other auto industries and gain market share?It's rational to assume that profit-driven firms will innovate and accept new ideas in order to be successful competitors. You are right that it is hard to enter the auto industry today, due to the businesses already present and the large amount of capital required to create a start-up. However, as Paul pointed out in class, there are a few small and successful start ups. Also, the reason it's hard to enter the market is that the competition is so tough - the big, successful companies already in the business are competing for market share and are thus providing goods that consumers want. Since consumers are satisfied with these products, it makes no sense to argue that government intervention is somehow needed to prevent these established auto companies from selling their products.
I wouldn't hold up Microsoft as a good example if I were you.
Or Wal-Mart (just in case...)
-Jon
To darkness I condemn you...
Paul: I wouldn't hold up Microsoft as a good example if I were you.
Well, obviously, intellectual property is bound to be discussed with the case of Microsoft, but Microsoft definitely wasn't a monopoly. AND I LOVE WALMART.
Yeah but Wal-Mart is known for clamouring for MW increases, eminent domain &c. MS benefits from IP. They're both firms that use the government to their advantage, even if they're not monopolies. In fact it's pretty difficult to think of major firms that don't benefit in this way from governments.
So you think it's just better to argue against IP in the first place?
Nah don't get bogged down in tangential discussions. Just try think of firms that rely little on the state when using them as examples. Ones like MS or Wal-Mart are too controversial for one who is uninitiated (like your professor) to discuss.
The problem being that everyone always brings up Microsoft when it comes to monopolies.
I suppose just say it isn't one in the way a monopoly is commonly conceived.
turn it around on them -> governments are coercive monopolies over geographic areas. The larger its sphere of influence on society, the more forcefully monopolized society is.
Socialists would turn this around and say that the people desired such a monopoly. Capitalists could use the same argument for non-coercive monopolies, applied to consumer desire. Yet consumers have much more power over a non-coercive monopoly than a commoner does over a powerful socialist state.
A better question is still to ask which socieities produce more refugees? Which societies have more often collapsed? It seems when it comes to economics, voluntarism is preferable to coercion.
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