The Free Market Reader

 

1 FUNDAMENTALS

Ten Great Economic Myths

Murray N. Rothbard

Our country is beset by a large number of economic myths that distort public thinking on important problems and lead us to accept unsound and dangerous government policies. Here are ten of the most dangerous of these myths and an analysis of what is wrong with them.

Myth #1: Deficits are the cause of inflation; deficits have nothing to do with inflation.

In recent decades we always have had federal deficits. The invariable response of the party out of power, whichever it may be, is to denounce those deficits as being the cause of our chronic inflation. And the invariable response of whatever party is in power has been to claim that deficits have nothing to do with inflation. Both opposing statements are myths.

Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.

On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy 100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion on old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect “print” new money to pay for the federal deficit.

Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.

Some policymakers point to the 1982-83 period, when deficits were accelerating and inflation was abating, as a statistical “proof” that deficits and inflation have no relation to each other. This is no proof at all. General price changes are determined by two factors: the supply of, and the demand for, money. During 1982-83 the Fed created new money at a very high rate, approximately at 15% per annum. Much of this went to finance the expanding deficit. But on the other hand, the severe depression of those two years increased the demand for money (i.e. lowered the desire to spend money on goods), in response to the severe business losses. This temporarily compensating increase in the demand for money does not make deficits any the less inflationary. In fact, as recovery proceeds, spending will pick up and the demand for money will fall, and the spending of the new money will accelerate inflation.

Myth #2: Deficits do not have a crowding-out effect on private investment.

In recent years there has been an understandable worry over the low rate of saving and investment in the United States. One worry is that the enormous federal deficits will divert savings to unproductive government spending and thereby crowd out productive investment, generating ever-greater long-run problems in advancing or even maintaining the living standards of the public.

Some policymakers have once again attempted to rebut this charge by statistics. In 1982-83, they declare deficits were high and increasing while interest rates fell, thereby indicating that deficits have no crowding-out effect.

This argument once again shows the fallacy of trying to refute logic with statistics. Interest rates fell because of the drop of business borrowing in a recession. “Real” interest rates (interest rates minus the inflation rate) stayed unprecedentedly high, however—partly because most of us expect renewed heavy inflation, partly because of the crowding-out effect. In any case, statistics cannot refute logic; and logic tells us that if savings go into government bonds, there will necessarily be less savings available for productive investment than there would have been, and interest rates will be higher than they would have been without the deficits. If deficits are financed by the public, then this diversion of savings into government projects is direct and palpable. If the deficits are financed by bank inflation, then the diversion is indirect, the crowding-out now taking place by the new money “printed” by the government competing for resources with old money saved by the public.

Milton Friedman tries to rebut the crowding-out effect of deficits by claiming that all government spending, not just deficits, equally crowds out private savings and investment. It is true that money siphoned off by taxes could also have gone into private savings and investment. But deficits have a far greater crowding-out effect than overall spending, since deficits financed by the public obviously tap savings and savings alone, whereas taxes reduce the public’s consumption as well as savings.

Thus, deficits, whichever way you look at them, cause grave economic problems. If they are financed by the banking system, they are inflationary. But even if they are financed by the public, they will still cause severe crowding-out effects, diverting much-needed savings from productive private investment to wasteful government projects. And, furthermore, the greater the deficits the greater the permanent income tax burden on the American people to pay for the mounting interest payments, a problem aggravated by the high interest rates brought about by inflationary deficits.

Myth #3: Tax increases are a cure for deficits.

Those people who are properly worried about the deficit unfortunately offer an unacceptable solution: increasing taxes. Curing deficits by raising taxes is equivalent to curing someone’s bronchitis by shooting him. The “cure” is far worse than the disease.

For one reason, as many critics have pointed out, raising taxes simply gives the government more money, and so the politicians and bureaucrats are likely to react by raising expenditures still further. Parkinson said it all in his famous “Law”: “Expenditures rise to meet income.” If the government is willing to have, say, a 20% deficit, it will handle high revenues by raising spending still more to maintain the same proportion of deficit.

But even apart from this shrewd judgment in political psychology, why should anyone believe that a tax is better than a higher price? It is true that inflation is a form of taxation, in which the government and other early receivers of new money are able to expropriate the members of the public whose income rises later in the process of inflation. But, at least with inflation, people are still reaping some of the benefits of exchange. If bread rises to $10 a loaf, this is unfortunate, but at least you can still eat the bread. But if taxes go up, your money is expropriated for the benefit of politicians and bureaucrats, and you are left with no service or benefit. The only result is that the producers’ money is confiscated for the benefit of a bureaucracy that adds insult to injury by using part of that confiscated money to push the public around.

No, the only sound cure for deficits is a simple but virtually unmentioned one: cut the federal budget. How and where? Anywhere and everywhere.

Myth #4: Every time the fed tightens the money supply, interest rates rise (or fall); every time the fed expands the money supply, interest rates rise (or fall).

The financial press now knows enough economics to watch weekly money supply figures like hawks; but they inevitably interpret these figures in a chaotic fashion. If the money supply rises, this is interpreted as lowering interest rates and inflationary; it is also interpreted, often in the very same article, as raising interest rates. And vice versa. If the Fed tightens the growth of money, it is interpreted as both raising interest rates and lowering them. Sometimes it seems that all Fed actions, no matter how contradictory, must result in raising interest rates. Clearly something is very wrong here.

The problem here is that, as in the case of price levels, there are several causal factors operating on interest rates and in different directions. If the Fed expands the money supply, it does so by generating more bank reserves and thereby expanding the supply of bank credit and bank deposits. The expansion of credit necessarily means an increased supply in the credit market and hence a lowering of the price of credit, or the rate of interest. On the other hand, if the Fed restricts the supply of credit and the growth of the money supply, this means that the supply in the credit market declines, and this should mean a rise in interest rates.

And this is precisely what happens in the first decade or two of chronic inflation. Fed expansion lowers interest rates; Fed tightening raises them. But after this period, the public and the market begin to catch on to what is happening. They begin to realize that inflation is chronic because of the systemic expansion of the money supply. When they realize this fact of life, they will also realize that inflation wipes out the creditor for the benefit of the debtor. Thus, if someone grants a loan at five percent for one year, and there is seven percent inflation for that year, the creditor loses, not gains. He loses two percent, since he gets paid back in dollars that are now worth seven percent less in purchasing power. Correspondingly, the debtor gains by inflation. As creditors begin to catch on, they place an inflation premium on the interest rate, and debtors will be willing to pay. Hence, in the long-run anything which fuels the expectations of inflation will raise inflation premiums on interest rates; and anything which dampens those expectations will lower those premiums. Therefore, a Fed tightening will now tend to dampen inflationary expectations and lower interest rates; a Fed expansion will whip up those expectations again and raise them. There are two, opposite causal chains at work. And so Fed expansion or contraction can either raise or lower interest rates, depending on which causal chain is stronger.

Which will be stronger? There is no way to know for sure. In the early decades of inflation, there is no inflation premium; in the later decades, such as we are now in, there is. The relative strength and reaction times depend on the subjective expectations of the public, and these cannot be forecast with certainty. And this is one reason why economic forecasts can never be made with certainty.

Myth #5: Economists, using charts or high speed computer models, can accurately forecast the future.

The problem of forecasting interest rates illustrates the pitfalls of forecasting in general. People are contrary cusses whose behavior, thank goodness, cannot be forecast precisely in advance. Their values, ideas, expectations, and knowledge change all the time, and change in an unpredictable manner. What economist, for example, could have forecast (or did forecast) the Cabbage Patch Kid craze of the Christmas season of 1983? Every economic quantity, every price, purchase, or income figure is the embodiment of thousands, even millions, of unpredictable choices by individuals.

Many studies, formal and informal, have been made of the record of forecasting by economists, and it has been consistently abysmal. Forecasters often complain that they can do well enough as long as current trends continue; what they have difficulty in doing is catching changes in trend. But of course there is no trick in extrapolating current trends into the near future. You don’t need sophisticated computer models for that; you can do it better and far more cheaply by using a ruler. The real trick is precisely to forecast when and how trends will change, and forecasters have been notoriously bad at that. No economist forecast the depth of the 1981-82 depression, and none predicted the strength of the 1983 boom.

The next time you are swayed by the jargon or seeming expertise of the economic forecaster, ask yourself this question: If he can really predict the future so well, why is he wasting his time putting out newsletters or doing consulting when he himself could be making trillions of dollars in the stock and commodity markets?

Myth #6: There is a tradeoff between unemployment and inflation.

Every time someone calls for the government to abandon its inflationary policies, Establishment economists and politicians warn that the result can only be severe unemployment. We are trapped, therefore, into playing off inflation against high unemployment, and become persuaded that we must therefore accept some of both.

This doctrine is the fallback position for Keynesians. Originally, the Keynesians promised us that by manipulating and fine-tuning deficits and government spending, they could and would bring us permanent prosperity and full employment without inflation. Then, when inflation became chronic and ever-greater, they changed their tune to warn of the alleged tradeoff, so as to weaken any possible pressure upon the government to stop its inflationary creation of new money.

The tradeoff doctrine is based on the alleged “Phillips curve,” a curve invented many years ago by the British economist A. W. Phillips. Phillips correlated wage rate increases with unemployment, and claimed that the two move inversely: the higher the increases in wage rates, the lower the unemployment. On its face, this is a peculiar doctrine, since it flies in the face of logical, commonsense theory. Theory tells us that the higher the wage rates, the greater the unemployment, and vice versa. If everyone went to their employer tomorrow and insisted on double or triple the wage rate, many of us would be promptly out of a job. Yet this bizarre finding was accepted as gospel by the Keynesian economic establishment.

By now, it should be clear that this statistical finding violates the facts as well as logical theory. For during the 1950s, inflation was only about one to two percent per year, and unemployment hovered around three or four percent, whereas nowadays unemployment ranges between eight and 11%, and inflation between five and 13%. In the last two or three decades, in short, both inflation and unemployment have increased sharply and severely. If anything, we have had a reverse Phillips curve. There has been anything but an inflation-unemployment tradeoff.

But ideologues seldom give way to the facts, even as they continually claim to “test” their theories by acts. To save the concept, they have simply concluded that the Phillips curve still remains as an inflation-unemployment tradeoff, except that the curve has unaccountably “shifted” to a new set of alleged tradeoffs. On this sort of mind-set, of course, no one could ever refute any theory.

In fact, inflation now, even if it reduces unemployment in the short-run by inducing prices to spurt ahead of wage rates (thereby reducing real wage rates), will only create more unemployment in the long run. Eventually, wage rates catch up with inflation, and inflation brings recession and unemployment inevitably in its wake. After more than two decades of inflation, we are all now living in that “long run.”

Myth #7: Deflation—falling prices—is unthinkable, and would cause a catastrophic depression.

The public memory is short. We forget that, from the beginning of the Industrial Revolution in the mid-18th century until the beginning of World War II, prices generally went down, year after year. That’s because continually increasing productivity and output of goods generated by free markets caused prices to fall. There was no depression, however, because costs fell along with selling prices. Usually, wage rates remained constant while the cost of living fell, so that “real” wages, or everyone’s standard of living, rose steadily.

Virtually the only time when prices rose over those two centuries were periods of war (War of 1812, Civil War, World War I), when the warring governments inflated the money supply so heavily to pay for the war as to more than offset continuing gains in productivity.

We can see how free-market capitalism, unburdened by governmental or central bank inflation, works if we look at what has happened in the last few years to the prices of computers. A computer used to have to be enormous, costing millions of dollars. Now, in a remarkable surge of productivity brought about by the microchip revolution, computers are falling in price even as Iwrite. Computer firms are successful despite the falling prices because their costs have been falling, and productivity rising. In fact, these falling costs and prices have enabled them to tap a mass market characteristic of the dynamic growth of free-market capitalism. “Deflation” has brought no disaster to this industry.

The same is true of other high-growth industries, such a electronic calculators, plastics, TV sets, and VCRs. Deflation, far from bringing catastrophe, is the hallmark of sound and dynamic economic growth.

Myth #8: The best tax is a “flat” income tax, proportionate to income across the board, with no exemptions or deductions.

It is usually added by flat-tax proponents, that eliminating such exemptions would enable the federal government to cut the current tax rate substantially.

But this view assumes, for one thing, that present deductions from the income tax are immoral subsidies or “loopholes” that should be closed for the benefit of all. A deduction of exemption is only a “loophole” if you assume that the government owns 100% of everyone’s income and that allowing some of that income to remain untaxed constitutes an irritating “loophole.” Allowing someone to keep some of his own income is neither a loophole nor a subsidy. Lowering the overall tax by abolishing deductions for medical care, for interest payments, or for uninsured losses, is simply lowering the taxes of one set of people (those that have little interest to pay, or medical expenses, or uninsured losses) at the expense of raising them for those who have incurred such expenses.

There is furthermore neither any guarantee nor even likelihood that, once the exemptions and deductions are safely out of the way, the government would keep its tax rate at the lower level. Looking at the record of governments, past and present, there is every reason to assume that more of our money would be taken by the government as it raised the tax rate back up (at least) to the old level, with a consequently greater overall drain from the producers to the bureaucracy.

It is supposed that the tax system should be roughly that of pricing or incomes on the market. But market pricing is not proportional to incomes. It would be a peculiar world, for example, if Rockefeller were forced to pay $1,000 for a loaf of bread—that is, a payment proportionate to his income relative to the average man. That would mean a world in which equality of incomes was enforced in a particularly bizarre and inefficientmanner. If a tax were levied like a market price, it would be equal to every “customer,” not proportionate to each customer’s income.

Myth #9: An income tax cut helps everyone because not only the taxpayer but also the government will benefit, since tax revenues will rise when the rate is cut.

This is the so-called “Laffer curve,” set forth by California economist Arthur Laffer. It was advanced as a means of allowing politicians to square the circle; to come out for tax cuts, keeping spending at the current level, and balance the budget all at the same time. In that way, the public would enjoy their tax cuts, be happy at the balanced budget, and still receive the same level of subsidies from the government.

It is true that if tax rates are 99%, and they are cut to 95%, tax revenue will go up. But there is no reason to assume such simple connections at any other time. In fact, this relationship works much better for a local excise tax than for a national income tax. A few years ago, the government of the District of Columbia decided to procure some revenue by sharply raising the District’s gasoline tax. But, then, drivers could simply nip over the border to Virginia or Maryland and fill up at a much cheaper price. D.C. gasoline tax revenues fell, and much to their chagrin and confusion, they had to repeal the tax.

But this is not likely to happen with the income tax. People are not going to stop working or leave the country because of a relatively small tax hike, or do the reverse because of a tax cut.

There are some problems with the Laffer curve. The amount of time it is supposed to take for the Laffer effect to work is never specified. But still more important: Laffer assumes that what all of us want is to maximize tax revenue to the government. If—a big if—we are really at the upper half of the Laffer Curve, we should then all want to set tax rates at that “optimum” point. But why? Why should it be the objective of every one of us to maximize government revenue? To push to the maximum, in short, the share of private product that gets siphoned off to the activities of government? I should think we would be more interested in minimizing government revenue by pushing tax rates far, far below whatever the Laffer Optimum might happen to be.

Myth #10: Imports from countries where labor is cheap cause unemployment in the United States.

One of the many problems with this doctrine is that it ignores the question: why are wages low in a foreign country and high in the United States? It starts with these wage rates as ultimate givens, and doesn’t pursue the question why they are what they are. Basically, they are high in the United States because labor productivity is high—because workers here are aided by large amounts of technologically advanced capital equipment. Wage rates are low in many foreign countries because capital equipment is small and technologically primitive. Unaided by much capital, worker productivity is far lower than in the United States. Wage rates in every country are determined by the productivity of the workers in that country. Hence, high wages in the United States are not a standing threat to American prosperity; they are the result of that prosperity.

But what of certain industries in the U.S. that complain loudly and chronically about the “unfair” competition of products from low-wage countries? Here, we must realize that wages in each country are interconnected from one industry and occupation and region to another. All workers compete with each other, and if wages in industry A are far lower than in other industries, workers—spearheaded by young workers starting their careers—would leave or refuse to enter industry A and move to other firms or industries where the wage rate is higher.

Wages in the complaining industries, then, are high because they have been bid high by all industries in the United States. If the steel or textile industries in the United States find it difficult to compete with their counterparts abroad, it is not because foreign firms are playing low wages, but because other American industries have bid up American wage rates to such a high level that steel and textile cannot afford to pay. In short, what’s really happening is that steel, textile, and other such firms are using labor inefficiently as compared to other American industries. Tariffs or import quotas to keep inefficient firms or industries in operation hurt everyone, in every country, who is not in that industry. They injure all American consumers by keeping up prices, keeping down quality and competition, and distorting production. Tariff or an import quota is equivalent to chopping up a railroad or destroying an airline—for its point is to make international transportation artificially expensive.

Tariffs and import quotas also injure other, efficient American industries by tying up resources that would otherwise move to more efficient uses. And, in the long run, the tariffs and quotas, like any sort of monopoly privilege conferred by government, are no bonanza even for the firms being protected and subsidized. For, as we have seen in the cases of railroads and airlines, industries enjoying government monopoly (whether through tariffs or regulation) eventually become so inefficient that they lose money anyway, and can only call for more and more bailouts, for ever more of a privileged shelter from free competition.

Creative Economic Semantics

Murray N. Rothbard

If the federal government’s economists have been good for nothing else in recent years, they have made great strides in what might be called “creative economic semantics.” First they redefined the seemingly simple term “budget cut.” In the old days, a “budget cut” was a reduction of next year’s budget below this year’s. In that old-fashioned sense, Dwight Eisenhower’s first two years in office actually cut the budget substantially, though not dramatically, below the previous year. Now we have “budget cuts” which are not cuts, but rather substantial increases over the previous year’s expenditures. “Cut” became subtly but crucially redefined as reducing something else. What the something else might be didn’t seem to matter, so long as the focus was taken off actual dollar expenditures. Sometimes it was a cut “in the rate of increase,” other times it was a cut in “real” spending, at still others it was a percentage of GNP, and at yet other times it was a cut in the sense of being below past projections for that year. The result of a series of such “cuts” has been to raise spending sharply and dramatically not only in old-fashioned terms, but even in all other categories. Government spending has gone up considerably any way you slice it. As a result, even the idea of a creatively semantic budget cut has now gone the way of the nickel fare and the Constitution of the United States.

Another example of creative semantics was the “tax cut” of 1981-1982, a tax cut so allegedly fearsome that it had to be offset by outright tax increases late in 1982, in 1983, in 1984, and undoubtedly on and on into the future. Again in the old days, a cut in income taxes meant that the average person would find less of a slice taken out of his paycheck. But while the 1981-82 tax changes did that for some people, the average person found that the piddling cuts were more than offset by the continuing rise in the Social Security tax, and by “bracket creep”—a colorful term for the process by which inflation (generated by the federal government’s expansion of the money supply) wafts everyone into higher money income (even though a price rise might leave them no better off) and therefore into a higher tax bracket. So that even though the official schedule of tax rates might remain the same, the average man is paying a higher chunk of his income.

The much-vaulted and much-denounced “tax cut” turns out, on old-fashioned semantics, to be no cut at all but rather a substantial increase. In return for the dubious pleasure of this non-cut, the American public will have to suffer by paying through the nose for years to come in the form of “offsetting,” though unfortunately all-too-genuine, tax increases. Of course, government economists have been doing their part as well to try to sugar-coat the pill of tax increases. They never refer to these changes as “increases.” They have not been increases at all; they were “revenue enhancement” and “closing loopholes.” The best comment on the concept of “loopholes” was that of Ludwig von Mises. Mises remarked that the very concept of “loopholes” implies that the government rightly owns all of the money you earn, and that it becomes necessary to correct the slipup of the government’s not having gotten its hands on that money long since.

Despite promises of a balanced budget by 1984, we find that several years of semantically massaged “budget cuts” and “tax cuts” as well as “enhancements” have resulted in an enormous, seemingly permanent, and unprecedented deficit somewhere around $200 billion. Once again, creative semantics have come to the rescue. One route is to use time-honored methods to redefine the deficit out of existence. The Keynesians used to redefine it by claiming that in something called a “full employment budget” there was no deficit, that is, that if one subtracts the spending necessary to achieve full employment, there would be no deficit, perhaps even a surplus. But while such a sleight-of-hand might work with a deficit of $20 billion, it is a puny way to wish away a gap of $200 billion. Still, the government’s economists are trying. They have already redefined the “deficits” as a “real increase” in debt, that is, a deficit discounted by inflation. The more inflation generated by the government, then, the more it looks as if the deficit is washed away. On the very same semantic magic, the apologists for the disastrous runaway German inflation of 1923 claimed that there was no inflation at all, since in terms of gold, German prices were actually falling! And similarly, they claimed, that since in real terms the supply of German marks was falling, that the real trouble in Germany was that there was too little money being printed rather than too much.

There is no general acceptance for the idea that, based on some legerdemain, the deficit doesn’t really exist. But there is acceptance of the view that a tax increase constitutes a “down payment” on the deficit. Again, in the old days, a “down payment” on a debt meant that part of the debt was being paid off. Washington’s creative economists have managed to redefine the term to mean a hoped-for reduction of next year’s increase in the debt—a very different story indeed.

Competition at Work: Xerox at 25

Murray N. Rothbard

Alittle over 25 years ago a revolutionary event occurred in the world of business and in American society generally. It was a revolution accomplished without bloodshed and without anyone being executed. The Xerox 914, the world’s first fully-automated plain-paper copier, was exhibited to the press in New York City.

Before then copiers existed, but they were clumsy and complex, they took a long time, and the final product was a fuzzy mess imprinted on special, unattractive pink paper. The advent of Xerox ushered in the photocopying age, and was successful to such an extent that within a decade the word “xerox” was in danger of slipping out of trademark and becoming a generic term in the public domain.

Many people, and even some economists, believe that large, highly capitalized firms can always outcompete small ones. Nothing could be further from the truth. In the pre-Xerox age, the photography industry was dominated, at least in the United States, by one giant, Eastman Kodak. And yet it was not Kodak or any other giant business or massive research facility that invented or even developed the Xerox process. It was invented, instead, by one man, Chester Carlson, a New York City patent attorney, who did the initial experiments in the kitchen of his apartment home in 1938. Carlson then looked around for a firm that would develop a commercial product from his invention. He first thought of Eastman Kodak, but Kodak told him it would never work, that it was too complex, would be too costly to develop, and, most remarkably of all, would have only a small potential market! The same answer was given to Carlson by 21 other large firms such as IBM. They were the “experts”; how could they all be wrong?

Finally, one small firm in Rochester took a gamble on the Xerox project. Haloid Co., a photographic paper manufacturer with annual sales of less than $7 million, bought the rights to the process from Carlson in 1947, and spent $20 million and 12 years before the mighty Xerox 914 came on the market in the fateful fall of 1959. Horace Becker, who was chief engineer on the Xerox 914, explains that “technically, it did not look like a winner. . . . That which we did, a big company could not have afforded to do. We really shot the dice, because it didn’t make any difference.” Small business can outcompete, and outinnovate, the giants.

Haloid Co., then Haloid Xerox Co., and finally Xerox, became one of the great business and stock-market success stories of the 1960s. By the early 1970s, it had captured almost all of the new, huge photocopier market, and its 1983 revenues totaled $8.5 billion. But by the mid 1970s, Xerox, too, was getting big, bureaucratic, and sluggish, and Japan invaded the photocopy market with the successful Savin copier. As competition by new originally small firms accelerated, Xerox’s share of the market fell to 75% in 1975, 47% in 1980, and less than 40 percent in 1982. As one investment analyst commented, “They had an aging product line. They were caught off guard.”

In the world of business, no firm, even the giants, can stand still for long. In trouble, Xerox fought back with its new and improved 10 Series of “Marathon” copiers, and in 1983 the company increased its share of the photocopy market for the first time since 1970; and its record considerably improved in 1984.

So, Happy Birthday Xerox! The Xerox success story is a monument to what a brilliant and determined lone inventor can accomplish. It is a living testimony of how a small firm can innovate and outcompete giant firms, and of how a small firm, become a giant, can rethink and retool in order to keep up with a host of new competitors. But above all, the Xerox story is a tribute to what free competition and free enterprise can accomplish, in short, what people can do if they are allowed to think and work and invest and employ their energies in freedom. Human progress and human freedom go hand in hand.

Looking Beneath the Surface

Llewellyn H. Rockwell, Jr.

Ilearned two lessons from my years on Capitol Hill as Congressman Ron Paul’s chief aide: 1) Every act of government deliberately benefits an interest group coalition at the expense of the rest of us; and 2) The government and the interests always lie about it.

During the gasoline crisis, for example, Congress passed the “windfall profits” tax on oil. The politicians and their lapdogs in the media trumpeted this as a deserved comeuppance to Big Oil.

Seen from the inside, it was just the opposite. The large, multi-national oil companies, in cahoots with Jimmy Carter’s Department of Energy, designed the tax and actively lobbied Congress for it. Why? Because it was to their comparative advantage. More money for energy programs flowed to the Establishment companies through such corporate welfare as the synfuels program, and the tax harmed only small domestic producers. The windfall profits tax is collected in Texas, not in Saudi Arabia.

So the imposition of this vicious tax served two interest groups: the government and the multinational oil companies, against U.S. oil producers and consumers.

Virtually every single act of government can be analyzed in this way. Since the Federal Reserve Act of 1913 cartelized the banking industry and allowed the banks to inflate together with the government, at the expense of the rest of us, we can assume—using interest-group analysis—that the industry promoted the bill. And in fact, Rockefeller and Morgan-connected commercial and investment banking interests wrote the act, lobbied for it, and staffed the resulting agency. Even today, Paul Volcker is a former vice president of Chase Manhattan Bank.

Teddy Kennedy is pushing for an increase in the minimum wage “to help the poor.” In fact, the very existence of a minimum wage harms the poor, since it means that anyone whose production is worth less than that figure, plus Social Security and other business taxes, will remain unemployed. And in fact that is its purpose. It makes it harder for new, small businesses to start up, and—by outlawing low-wage competition—enables labor unions to continue to get higher-than-market wages through federal coercion. That is why labor unions love the minimum wage, and why their bought-and-paid-for Congressmen and Senators work to raise it.

The Reagan administration has spent more on foreign aid than all previous administrations from Eisenhower to Carter combined. But not to help the poor in foreign lands. Foreign aid is a massive subsidy to U.S. bankers with loans to foreign governments, and to U.S. exporters whose products are purchased with the funds. And—no surprise—it is big banks and exporters that push for foreign aid. As to the poor in foreign lands, they are made worse off as corrupt, dictatorial governments are cemented in power; the American taxpayer is impoverished by unconstitutional spending.

When looking or listening to the government, assume the reverse of what it claims, and look to see who is getting the cash. Only this way of looking beneath the surface, which Mises called “caste-conflict” analysis, helps explain government actions so clearly, or—when exposed—helps rally the people against further injustices.

The Fraud of GNP

Llewellyn H. Rockwell, Jr.

The Gross National Product grew at an annual rate of 4.4% for the first quarter of 1987,” the Commerce Department recently said. But corporate profits and people’s earning dropped. We’re all supposed to be better off when the GNP grows. Why aren’t we? The reason, as shown by Professor Murray N. Rothbard, is that the GNP is a phony statistic.

The GNP records the dollar amount of goods and services produced in the economy during a period. But it equates government spending with private spending. And it ignores the wealth and potential growth destroyed by taxation.

Imagine that the economy consisted of two small, productive towns. The government decides to destroy one of them—a hotbed of tax resistance—by aerial bombardment, and to tax the other to pay for the clean-up. After a year, the destroyed town is restored. Calculating the net effect of this process, the Commerce Department would say that the GNP of the two-town economy grew by 50%.

GNP records the money spent on goods and services, not the wealth destroyed by bombs, taxation, regulation, or other government activities. So GNP would act as if a third town had been added to the economy, when in fact one had been deducted.

As Professor Rothbard has pointed out, subtracting government spending from GNP, and then adjusting for taxation, gives us a much better idea of the real economy. His “Private Product Remaining (to Producers)” or PPR does exactly that.

Working from Professor Rothbard’s thesis, Professor Robert Batemarco of Manhattan College computed the PPR from 1960 to 1985 for an article in the first issue of the Institute’s Review of Austrian Economics.

The gap shown on the chart between GNP and PPR represents the horrendous growth of government. And the gap is huge and growing, despite promises to get Washington off our backs.

The growth in GNP is almost all attributable to increased government spending, which represents capital consumption, not progress. As shown by the PPR the economy has barely moved, thanks to the government’s incredible taxation, deficits, welfare, borrowing, subsidies, and controls.

Real growth in the U.S. registered a mere 1.3% last year. On the average, the GNP figure is about 52% higher than real growth. And the more government grows, the higher that percentage.

Always be wary of government statistics. They are usually designed to mislead, and GNP is part of that game.

Racial Discrimination vs. the Free Market

Mark D. Hughes

Not long ago I saw a poster at George Mason University advertising a talk on “The Development of Racism Under Capitalism.” Sponsored by SCAR (the Student Coalition Against Racism), the implied position was wrong; it is capitalism that hinders racism.

“The term ‘discrimination’ has acquired an unambiguously negative meaning,” writes Dr. Walter Block. “It conjures up the image of racial and sexual prejudice. Strictly speaking, however, the term is neutral.”

As human beings, we face an unavoidable scarcity of time and resources: that is, we cannot have everything we want or need whenever we want or need it. To cope with this scarcity, we ration our time, skill, knowledge, and wealth.

This process must involve discrimination. For example, if I choose to read Mises’s Human Action rather than the collected poetry of Keats, I am discriminating against Keats. And my choosing to read at all means I am discriminating against every other use of my time.

Different ways of rationing resources have emerged over the centuries. The barbarism of ancient times involved grabbing what you could, when you could, and however you could. In the barbarism of modern times, these same activities are carried out by governments.

But the best and only peaceful method for rationing scarce resources is the price system. Respecting private property and individual rights, the price system puts the power of choice into the hands of the person whose scarce resources are to be rationed.

If the owner of a resource wishes to exchange it with others, and he sets the price at zero, then people who discriminate in favor of it, by choosing to consume it, will want more of it than the owner wishes to exchange. The owner will therefore ration his resource by giving it a positive price. As the price of the resource rises, more and more people will choose to discriminate against it in favor of a less costly resource.

Their desire for the resource has not changed, but the cost of discriminating in favor of it has increased. For example, I will have the same desire for a European sports car regardless of its price, but its price makes discriminating in its favor too costly for me.

The more scarce and desirable a resource, the higher its price. But at some point, the owner will arrive at a price where the total discrimination in favor of it is just equal to the quantity he is willing to exchange.

Prices and the right of ownership give individuals the ability to increase or decrease the level of discrimination against their resources. This is the mechanism that makes free market competition work. And only this competition gives individuals control over their own scarce resources.

A consumer who refuses to purchase resources from a person (i.e. discriminates against that person) solely because of the color of that person’s skin is discriminating. The act of discrimination itself is neither good nor bad, but the underlying values can be considered unethical.

Does the person who suffers because of racism have any recourse? He could try to use government power to force an exchange by coercion. But there is a better way: he can use the price system.

If I feel someone is discriminating against me for unethical reasons, then I can make his choice costly by lowering the price I charge. His discrimination then becomes more costly. A person discriminating against me can only continue to do so if he is willing to pay a higher relative price for his choice. I can’t change his values, but I can make them more costly to hold.

This very process occurs every day. When a member of a minority group opens a new grocery store in an unfriendly neighborhood, say a Korean in a black area of Washington, D.C., he is likely to be discriminated against. Instead of demanding that the government force shoppers to buy from his store, he chooses the peaceful method: he reduces his prices. This increases the cost to consumers of discriminating against him, because they are now paying a premium to shop somewhere else. As a result, they begin to patronize his store. Racists may still be racists, but they no longer discriminate unethically.

But if the government had set the grocer’s prices at the same level as other stores not owned by minorities, there would be no cost to consumers for racially discriminating against him. They would simply continue shopping at Safeway.

Henry Hazlitt wrote in his unforgettable book Economics in One Lesson:

A wage is, in fact, a price. It is unfortunate for clarity of economic thinking that the price of labor’s services (labor’s scarce resource) should have received an entirely different name from other prices. This has prevented most people from recognizing that the same principles govern both.

Like the consumer of any resource, an employer will pay a wage no higher than the production the worker can generate. If the worker accepts a job paying less than his production, other employers will recognize they can profit by offering a higher wage. Eventually the worker receives a wage equal to the value he contributes.

If the government imposes a minimum wage, anyone who cannot add more than the minimum to the employer’s business will not be hired. No employer can pay out more than his business produces for very long. The government’s minimum wage law discriminates against the less productive members of society.

According to Professor Walter E. Williams of George Mason University, author of The State Against Blacks:

As late as 1948, black youth labor market participation was higher than that of white youths and their unemployment rate was less. But with each and every increase in the level and coverage of the minimum wage law, that picture was changed. Now the very opposite is the case.

When the state imposes minimum wage laws, it reduces the cost for employers to discriminate racially. It also takes away a minority person’s best weapon: the right to lower prices and make racially based discrimination costly.

Suppose there are two young women, one white and one black, both equally qualified. They are the only two people who have applied for a hostess’s job in a restaurant owned by a white racist. The employer is willing to pay up to $5.00 per hour. The white woman has been offered a job she likes better at another business at $4.50 an hour, and will accept the restaurant job only if she can get $5.00 per hour.

The black woman knows the boss is a racist. She realizes that her only hope of getting the job is to ask for less than $5.00 per hour. And the less she asks for, the greater her chances of getting the job. If she lowers her price to $4.50, the employer must now pay 50 cents per hour to discriminate racially against her. And at some wage it will be too costly for him to continue his racial discrimination, and he will hire the black woman.

The story is different when the state imposes a minimum wage of $5.00 per hour. Far from aiding the black woman, it forbids her from competing with her white rival. The government has in effect made it illegal for the black woman to work at that restaurant.

This brings us back to “The Development of Racism Under Capitalism.” SCAR and groups like it demand that the government intervene in the free market to eliminate racial discrimination. But the free market tends to reduce unethical discrimination; it is the state through its fettering of free enterprise that promotes racism.

Mises Contra Marx

David Gordon

If asked to name the foremost critic of Marxism, most economists sympathetic to the free market would name Eugen von Böhm-Bawerk, who in his treatise Capital and Interest and his separate brochure Karl Marx and the Close of his System demolished the labor theory of value, the linchpin of Marxist economics.

But the labor theory is but one part of Marxism: what about the remainder of the system? Here one must turn to the work of Böhm-Bawerk’s greatest student, Ludwig von Mises, whose devastating analysis of Marxism is of surpassing excellence. His contribution to the critique of Marxism is principally to be found in two of his books: Socialism and Theory and History. (Both are available from the Mises Institute.)

The Communist Manifesto (1848) famously states: ‘The history of all hitherto existing society is the history of class struggles.” Each social system, in the Marxist view, is characterized by a different variety of class conflict. In the capitalist system, of course, the protracted conflict finds capitalists opposed to proletarians. In the course of the social struggle between the classes, members or friends of each class elaborate theories of various sorts to advance the interests of that class. These theories, whatever they may claim, do not stem from the search for objective truth. Like all “ideological” thought, economic, social, and political theories reflect class interest.

Mises, more forcefully than any other critic of Marx, at once penetrates to the essence of this fallacious view. If all thought about social and economic matters is determined by class position, what about the Marxist system itself? If, as Marx proudly proclaimed, he aimed at providing a science for the working class, why should any of his views be accepted as true? Mises rightly notes that Marx’s view is self-refuting: if all social thought is ideological, then this proposition is itself ideological and the grounds for believing it have been undercut. In his Theories of Surplus Value, Marx cannot contain his sneering at the “apologetics” of various bourgeois economists. He did not realize that in his constant jibes at the class bias of his fellow economists, he was but digging the grave of his own giant work of propaganda on behalf of the proletariat.

Mises never tired of emphasizing a theme he expresses tersely in Liberalism: “Man has only one tool with which to fight error: reason.” By “reason,” he meant a logical procedure claiming universal validity. To deny the power of reason is in effect to refute oneself. If reason must be subordinated to some other faculty, whether class interest, hermeneutic understanding, or whatever nonrational intellectual fad one pleases, the result can be nothing other than stultifying. Without logic, what reason can be given for the acceptance of the postulated account?

Mises did not confine his assault on Marxism to the essential, yet arcane, area of epistemology. He also analyzed in detail the principal themes of Marx’s interpretation of history. According to Marx, the key to history lies in the forces of production. (Very roughly, the forces of production of a society consist of the society’s technology.) These forces, throughout history, have a constant tendency to develop. As they do so, they compel changes in the relations of production, i.e., the economic and social system existing in a particular society. At one time, e.g., feudalism was best adapted to develop the forces of production. When it ceased to be the most efficient system, capitalism replaced it, breaking what Marx called the “fetters” on production imposed by the manorial economy of feudalism. In turn, at the dictate of the forces of production, capitalism will be replaced by socialism, a system Marx anticipated would be enormously more productive than its predecessor.

Mises in Theory and History posed a simple query that proved lethal to the alleged “science of historical materialism.” As just explained, growth of the forces of production is supposed to explain all else of importance. But what determines this very growth? As Mises often reminds us, only individuals act: classes, “forces of production,” “relations of production,” etc., are in themselves but abstractions. Apart from the action of human beings, they are void and powerless. Like Hegel’s Geist (Spirit), Marx’s forces of production are a self-developing phenomenon governing human will. Marx never bothers to explain how such forces, in themselves the effects of human action, can exclusively determine all important human action.

Once one has grasped the point that it is individuals, not the forces of production, who act, the entire Marxist scheme of historical evolution falls by the wayside. If human beings create by their acts the forces of production, rather than the forces determining these acts, then nothing is inevitable about the transition from one economic system to another. Such changes will take place as persons act to create them, no more and no less. If one objects that there are laws determining human action, perhaps the objector would be good enough to produce them for inspection. That the results of what persons create may not be to their liking is another matter.

Marxism, as the Stalinist “philosopher” M. B. Mitin liked to declare portentously, is “a guide to action.” And the action the Marxists have in mind is of course the replacement of capitalism by socialism. In a famous passage in Volume III of Capital, Marx foresees a rosy day ahead under the blessings of socialism in which people will be able to devote most of their time to leisure. Work for mere survival will become a thing of past.

Such is the Marxist promise: the reality, Mises demonstrated, was quite another matter. In his argument, Mises did not principally rely on the results of attempting to turn socialism from idea to reality in Soviet Russia. Instead, as those acquainted with his praxeological method will have anticipated, Mises offered proof that socialism was of its nature impossible.

He presented his argument in a famous article appearing in 1920 that, with much elaboration, was incorporated into his great work Socialism (1922). Characteristic of Mises, his point is in essence a simple one: the great Austrian economist had an unerring instinct for the heart of any issue of theory he considered. Given a list of goods to produce, whether those desired by the members of society in their roles as consumers or those on an agenda concocted by a dictator, any developed economy must have a way to decide how to employ its resources in the best possible way to produce the desired goods.

Under capitalism, this challenge receives a response fully adequate to the difficulty it poses. Resources, whether land, labor, or capital, exist subject to ownership by individuals. These persons, in a fashion elaborated in minute detail in Mises’s Human Action and Murray N. Rothbard’s Man, Economy, and State, will trade in markets. Doing so will enable them to price production goods according to their most efficient use in securing the desired consumption goals.

The details of the process cannot be here elaborated, and in any event, no one seriously denies that the free market can perform the task of economic calculation I have briefly described. The gravamen of Mises’s indictment of socialism, and the controversial aspect of his argument, is his contention that only capitalism can solve the calculation problem. Socialism in particular cannot.

Again without descending into detail, the main point of Mises’s reasoning can be quickly comprehended. Socialism by definition consists of the centralized direction of the economy, its main means of production being under “public,” i.e. government, ownership. How can a centralized system, in the absence of markets, decide whether a use of resources to produce a good is more efficient than a rival use? Any “prices” the director of the economy imposes will be arbitrary and of no value for genuine calculation. (One technicality ought to be mentioned, lest the argument be misunderstood: it is production goods, not first-order or consumption goods, that Mises maintains a socialist system lacks the means to calculate.)

We can at once see how Mises’s argument administers the coup de grace to Marxism. That system claims that socialism will arrive because the development of the forces of production will demand its institution. Even if one were to neglect Mises’s point, that the growth of the forces of production is not inevitable, one can see that Marx’s view is laughably inept. It is capitalism that is not only the most efficient economic system, but the only economic system that is efficient. If the forces of production did, per impossible inevitably grow of their own accord, it is not socialism but capitalism that they would establish.

Continuing his assault on Marxism, Mises explored Marx’s reasons for not considering the problem of efficiency. Here Mises’s answer admits of no dispute. Marx said nothing about the calculation problem because he devoted virtually no attention whatever to the economic institutions of socialism. To do so, he thought, would be to establish “blueprints” for the future, in the style of the Utopian socialists he was quick to scorn. With complete intellectual irresponsibility, he preached the overthrow of the intricate economy of capitalism he himself acknowledged as the most productive in history in order to establish a scheme whose institutions he had not bothered to analyze.

When one considers the responses of Mises’s socialist critics, however, perhaps Marx’s policy of averting his eyes from the problems of socialism was wiser than he knew. Mises had little difficulty in refuting all the attempted socialist solutions of his calculation problem. Some looked to mathematics: a system of simultaneous equations would enable the necessary prices to be discovered. How, in a regime of constant change, these equations were to operate, the proponents of this approach left unsaid. The most popular response to Mises, though, lay elsewhere. The Polish economist Oskar Lange, long resident in the United States until, following the Second World War, the blandishments of Communist Poland proved too much for him to resist, claimed that a socialist economy need not abandon the market. Though to some “market socialism” has little more sense the a “square circle,” Lange was of course not among them. But his proposal, though original, fared no better than the others. Mises subjected it to withering attack, the details of which I leave the interested reader to explore in Mises’s work. In particular, his illuminating discussion of his critics in Human Action should be consulted.

Mises exposed several irremediable and crucial errors in Marxism. A reader of his criticism cannot help but apply to Marxism the well-known line from “Ozymandias”: “Round the decay of that colossal wreck, . . . /The lone and level sands stretch far away.”

Keynesian Myths

Murray N. Rothbard

Inflation and Idle Capacity

The Keynesians have been caught short again. In the early and the late 1970s, the wind was taken out of their sails by the arrival of inflationary recession, a phenomenon which they not only failed to predict, but whose very existence violates the fundamental tenets of the Keynesian system. Since then, the Keynesians have lost their old invincible arrogance, though they still constitute a large part of the economics profession.

In the last few years, the Keynesians have been assuring us with more than a touch of their old hauteur, that inflation would not and could not arrive soon, despite the fact that “tight-money” hero Paul Volcker had been consistently pouring in money at double-digit rates. Chiding hard-money advocates, the Keynesians declared that, despite the monetary inflation, American industry still suffered from “excess” or “idle” capacity, functioning at an overall rate of something like 80%. Thus, they pointed out, expanded monetary demand could not result in inflation.

As we all know, despite Keynesian assurances that inflation could not reignite, it did despite the idle capacity, leaving them with something else to puzzle over. Inflation has risen this year from approximately 1 % in 1986 to 6% now, interest rates are rising again, the fall of the dollar has raised import prices, and gold prices are rising again. Once again, the hard-money economists and investment advisors have proved far sounder than the Establishment-blessed Keynesians.

The best way to explain where the Keynesians went wrong is to turn against them their own common reply to their critics: that anti-Keynesians, who worry about the waste of inflation or government programs, are “assuming full employment” of resources. Eliminate this assumption, they say, and Keynesianism becomes correct in the through-the-looking-glass world of unemployment and idle resources. But the charge should be turned around, and the Keynesians should be asked: why should there be unemployment (of labor or of machinery), at all? Unemployment is not a given that descends from heaven. Of course, it often exists, but what can account for it?

The Keynesians themselves create the problem by leaving out the price system. The hallmark of crackpot economics is an analysis that somehow leaves out prices, and talks only about such aggregates as income, spending, and employment.

We know from “microeconomic” analysis that if there is a “surplus” of something on the market, if something cannot be sold, then the only reason is that its price is somehow being kept too high. The way to cure surplus or unemployment of anything, is to lower the asking price, whether it be wage rates for labor, prices of machinery or plant, or of the inventory of a retailer

In short, as Professor William H. Hutt pointed out brilliantly in the 1930s, when his message was lost amid the fervor of the Keynesian Revolution: idleness or unemployment of a resource can only occur because the owner of that resource is deliberately withholding it from the market and refusing to sell it at the offered price. In a profound sense, therefore, all unemployment and idleness is voluntary.

Why should a resource owner deliberately withhold it from the market? Usually, because he is holding out for a higher price, or wage rate. In a free and unhampered market economy, the owners will find out their error soon enough, and when they get tired of making no returns from their labor or machinery or products, they will lower their asking price sufficiently to sell them. In the case of machinery and other capital goods, of course, the owners might have made a severe malinvestment, often due to artificial booms created by bank credit and central banks. In that case, the lower market-clearing price for the machinery or plant might be so low as to not be worth the laborer’s giving up his leisure—but then the unemployment is purely voluntary and the worker holds out permanently for a higher wage.

A worse problem is that, since the 1930s, government and its privileged unions have intervened massively in the labor market to keep wage rates above the market-clearing wage, thereby insuring ever higher unemployment among workers with the lowest skills and productivity. Government interference, in the form of minimum wage laws and compulsory unionism, creates compulsory unemployment, while welfare payments and unemployment “insurance” subsidize unemployment and make sure that it will be permanently high. We can have as much unemployment as we pay for.

It follows from this analysis that monetary inflation and greater spending will not necessarily reduce unemployment or idle capacity. It will only do so if workers or machine owners are induced to think that they are getting a higher return and at least some of their holdout demands are being met. And this can only be accomplished if the price paid for the resource (the wage rate or the price of machinery) goes up. In other words, greater supply or use of capacity will only be called forth by wage and price increases, i.e. by price inflation.

As usual, the Keynesians have the entire causal process bollixed up. And so, as the facts now poignantly demonstrate, we can and do have inflation along with idle resources.

The New International Money Scheme

Ever since the Western world abandoned the gold coin standard in 1914, the international monetary system has been rocketing from one bad system to another, from the frying pan to the fire and back again, fleeing the problems of one alternative only to find itself deeply unhappy in the other. Basically, only two alternative systems have been considered: (1) fiat money standards, each national fiat currency being governed by its own central bank, with relative values fluctuating in accordance with supply and demand; and (2) some sort of fixed exchange rate system, governed by international coordination of economic policies.

Our current System 1 came about willy nilly in 1973, out of the collapse of Bretton Woods System 2 that had been imposed on the world by the United States and Britain in 1944. System 1, the monetarist or Friedmanite ideal, at best breaks up the world monetary system into national fiat enclaves, adds great uncertainties and distortions to the monetary system, and removes the check of external discipline from the inflationary propensities of every central bank. At worst, System 1 offers irresistible temptations to every government to intervene heavily in exchange rates, precipitating the world into currency blocs, protectionist blocs, and “beggar-thy-neighbor” policies of competing currency devaluations such as the economic warfare of the 1930s that helped generate World War II.

The problem is that shifting to System 2 is truly a leap from the frying pan into the fire. The national fiat blocs of the 1930s emerged out of the System 2 pound sterling standard in which other countries pyramided an inflation of their currencies on top of inflating pounds sterling, while Britain retained a nominal but phony gold standard. The 1930s system was itself replaced by Bretton Woods, a world dollar standard, in which other countries were able to inflate their own currencies on top of inflating dollars, while the United States maintained a nominal but phony gold standard at $35 per gold ounce.

Now the problems of the Friedmanite System 1 are inducing plans for some sort of return to a fixed exchange rate system. Unfortunately, System 2 is even worse than System 1, for any successful coordination permits a concerted worldwide inflation, a far worse problem than particular national inflations. Exchange rates among fiat moneys have to fluctuate, since fixed exchange rates inevitably create Gresham’s Law situations, in which undervalued currencies disappear from circulation. In the Bretton Woods system, American inflation permitted world-wide inflation, until gold became so undervalued at $35 an ounce that demands to redeem dollars in gold became irresistible, and the system collapsed.

If System 1 is the Friedmanite ideal, then the Keynesian gold is the most pernicious variant of System 2. For what Keynesians have long sought, notably in the Bernstein and Triffin Plans of old, and in the abortive attempt to make SDRs (special drawing rights) a new currency unit, is a World Reserve Bank issuing a new world paper-money unit, replacing gold altogether. Keynes called his suggested new unit the “bancor,” and Harry Dexter White of the U.S. Treasury called his the “unita.” Whatever the new unit may be called, such system would be an unmitigated disaster, for it would allow the bankers and politicians running the World Reserve Bank to issue paper “bancors” without limit, thereby engineering a coordinated world-wide inflation. No longer would countries have to lose gold to each other, and they could fix their exchange rates without worrying about Gresham’s Law. The upshot would be an eventual world-wide runaway inflation, with horrendous consequences for the entire world.

Fortunately, a lack of market confidence, and inability to coordinate dozens of governments, have so far spared us this Keynesian ideal. But now, a cloud no bigger than a man’s hand, an ominous trial balloon toward a World Reserve Bank has just been floated. In a meeting in Hamburg, West Germany, in late June of two hundred leading world bankers in an International Monetary Conference, bankers urged the elimination of the current volatile exchange rate system, and a move towards fixed exchange rates.

The theme of the Conference was set by its chairman, Willard C. Butcher, chairman and chief executive of Rockefeller’s Chase Manhattan Bank. Butcher attacked the current system, and warned that it could not correct itself, and that a search for a better world currency system “must be intensified” (New York Times, June 23, 1987).

It was not long before Toyo Gyoten, Japan’s vice-minister of finance for international affairs, spelled out some of the concrete implications of this accelerated search. Gyoten proposed a huge multinational financial institution, possessing “at least several hundred billion dollars,” that would be empowered to intervene in world financial markets to reduce volatility.

And what is this if not the beginnings of a World Reserve Bank? Are Keynesian dreams at least beginning to come true?

Liberty and Property

Ludwig von Mises

The pre-capitalistic system of production was [based on] military conquest. The victorious kings had given the land to their paladins. These aristocrats were lords in the literal sense of the word, as they did not depend on the patronage of consumers buying or abstaining from buying on the market. On the other hand, they themselves were the main customers of the processing industries which under the guild system were organized on a cooperative basis.

This scheme was opposed to innovation. It forbade deviation from the traditional methods of production. The number of people for whom there were jobs even in agriculture or in the arts and crafts was strictly limited. Under these conditions, many a man, to use the words of Malthus, had to discover that at “nature’s mighty feast there is no vacant cover for him,” and that “she tells him to be gone.” But some of these outcasts nevertheless managed to survive, begot children, and made the number of the destitute grow hopelessly more and more.

But then came capitalism.

It is customary to see the radical innovations that capitalism brought about as substitution of the mechanical factory for the more primitive and less efficient methods of artists and shops. This is a rather superficial view. The characteristic feature of capitalism, that distinguishes it from pre-capitalistic methods of production, was its new principle of marketing.

Capitalism is not simply mass production, but mass production to satisfy the needs of the masses. The arts and crafts of the good old days had catered almost exclusively to the wants of the well-to-do. But the factories produced cheap goods for the many. All that the early factories turned out was designed to serve the masses, the same strata that worked in the factories. They served them either by supplying them directly, or indirectly by exporting, and providing for them foreign food and foreign raw materials.

This principle of marketing was the signature of early capitalism as it is of present day capitalism. These employees themselves are the customers consuming the much greater part of all goods produced. They are the sovereign customers who are always right. Their buying or abstention from buying determines what has to be produced, in what quantity, and of what quality. In buying what suits best they made some enterprises profit and expand and made other enterprises lose money and shrink. Thereby they are continually shifting control of the factors of production into the hands of those businessmen who are most successful in filling their wants.

Under capitalism, private property of the factors of production is a social function. The entrepreneurs, capitalists, and land owners are mandatories, as it were, of the consumers, and their mandate is revocable. In order to be rich it is not sufficient to have once saved and accumulated capital. It is necessary to invest it again and again in those lines in which it best fills the wants of the consumers. The market process is a daily repeated plebiscite, and it ejects inevitably from the ranks of profitable people, those who do not employ their property according to the orders given by the public.

Big business, the target of fanatical hatred on the part of all contemporary governments and self-styled intellectuals, acquires and preserves bigness only because it works for the masses. The plans that cater to the luxuries of the few, never attain big size.

The shortcoming of 19th-century historians and politicians was that they failed to realize that the workers were the main consumers of the products of industry. In their view, the wage earner was a man toiling for the sole benefit of a parasitic leisure class. They labored under the delusion that the factories had impaired the lot of the manual workers. If they had paid any attention to statistics, they would have easily discovered the fallaciousness of their opinion. Infant mortality dropped. The average length of life was prolonged. The population multiplied, and the average common man enjoyed amenities of which even the well-to-do of earlier ages did not dream.

However this unprecedented enrichment of the masses was merely a by-product of the industrial revolution. Its main achievement was the transfer of economic supremacy from the owners of land to the totality of the population. The common man was no longer a drudge, who had to be satisfied with the crumbs that fell from the tables of the rich. The three pariah castes which were characteristic of the precapitalistic ages—the slaves, the serfs, and those people whom patristic and scholastic orders, as well as British legislation from the 16th through the 19th century, referred to as the poor—disappeared. Their scions became, in this new setting of business, not only free workers, but also customers. This radical change was reflected in the emphasis laid by business on markets. What business needs first of all, they repeated again and again, is markets and again markets. This was the watchword of capitalistic enterprise.

Markets mean patrons, buyers, consumers. There is under capitalism one way to wealth: to serve the consumers better and cheaper than other people do. But in the shop and factory, the owner—or in the corporations, the representative of the shareholders, the president—is the boss. The mastership is merely apparent and conditional. He is subject to the supremacy of the consumer. The consumer is king—the real boss—and the manufacturer is done for if he does not outstrip his competitors in best serving the consumers. It was this great economic transformation that changed the face of the world. . . .

What vitiates entirely the socialist economic critique of capitalism is its failure to grasp the sovereignty of the consumers in the market economy. They see only hierarchical organization of various enterprises and plans, and are at a loss to realize that the profit system forces business to serve the consumers.

In their dealings with their employers, the unions proceed as if malice and greed prevent what they call management from paying higher wage rates. Their shortsightedness does not see anything beyond the doors of the factory. They and their henchmen talk about the concentration of economic power, and do not realize that economic power is ultimately vested in the hands of the buying public, of which the employees themselves form the immense majority. Their inability to comprehend things as they are, is reflected in such inappropriate metaphors as industrial kingdoms and dukedoms. They are too dull to see the difference between a sovereign king or duke who could be dispossessed only by a more powerful conqueror, and the chocolate king who forfeits his kingdom as soon as the customers prefer to patronize another supplier.

This distortion is at the bottom of all socialist plans. If any of the socialist chiefs had tried to earn his living by selling hot dogs, he would have learned something about the sovereignty of the consumers. . . .

Socialism substitutes the sovereignty of the dictator, or committee of dictators, for the sovereignty of the consumers. . . . Freedom is indivisible. He who has not the faculty to choose among various brands of canned food or soap, is also deprived of the power to choose between various political parties and programs and to elect the office-holders. He is no longer a man; he becomes a form in the hands of the supreme social engineer. . . .

The socialists have engineered a semantic revolution in converting the meaning of terms into their opposite. . . . Freedom implies the right to choose between assent and dissent. But in Newspeak it means the duty to assent unconditionally, and the strict interdiction of dissent. This reversal of the traditional connotation of all words of the political terminology, is not merely a peculiarity of the language of the Russian communists, and their fascist and Nazi disciples. The social order that in abolishing private property deprives the consumers of their autonomy and independence, and thereby subjects every man to the arbitrary discretion of the central planning board, could not win the support of the masses if it were not to camouflage its main character.

The socialists would have never duped the voters if they had openly told them that their ultimate end is to cast them into bondage. For exoteric use, they were forced to pay lip-service to the traditional appreciation of liberty. It was different in the esoteric discussions among the inner circles of the great conspiracy. There the initiated did not dissemble their intentions concerning liberty. . . .

Freedom is to be found only in the sphere in which government does not interfere. Liberty is always freedom from the government. . . . In a free country nobody is prevented from acquiring riches by serving the consumers better than they are served already. What he needs is only brains and hard work. . . . Economic power, in the market economy, is in the hands of the consumers. . . . But the politicians and other would-be reformers see only the structure of industry as it exists today. They think that they are clever enough to snatch from business control of the plans as they are today, and to manage them by sticking to already established routine. But the ambitious newcomer, who will be the tycoon of tomorrow, is already preparing plans for things unheard of before. All they have in mind is to conduct affairs along tracks already beaten.

There’s no record of an industrial innovation contrived and put into practice by bureaucrats. If one does not want to plunge into stagnation, a free hand must be left to those, the unknown men, who have the ingenuity to lead mankind forward on the way to more and more satisfactory conditions. . . . Private property of the material factors of production is not a restriction of the freedom of all other people to choose what suits them best. It is, on the contrary, the means that assigns to the common man, in his capacity as a buyer, supremacy in all economic affairs. It is the means to stimulate a nation’s most enterprising men to exert themselves to the best of their abilities in the service of all of the people. . . .

It is a gratuitous pastime to belittle the material achievements of capitalism by observing that there are things that are more essential for mankind than bigger and speedier motorcars, and homes equipped with central heating, air conditioning, refrigerators, washing machines, and television sets. . . . It is not the fault of capitalism that the masses prefer a boxing match to a performance of Sophocles’s Antigone, jazz music to Beethoven symphonies, and comics to poetry. But it is certain that by precapitalistic conditions, as they still prevail in the much greater part of the world, makes these goods things accessible only to a small minority of people. Capitalism gives to the many a favorable chance of striving after them. . . .

We are inaugurating tonight the ninth meeting of the Mont Pelerin Society. It is fitting to remember on this occasion that meetings of this kind in which opinions opposed to those of the majority of our contemporaries and to those of their governments are advanced, are possible only in the climate of liberty and freedom that is the most precious mark of Western civilization. Let us hope that this right to dissent will never disappear.1

The Interest Rate Question

Murray N. Rothbard

The Marxists call it “impressionism”: taking social or economic trends of the last few weeks or months and assuming that they will last forever. The problem is not realizing that there are underlying economic laws at work. Impressionism has always been rampant; and never more so than in public discussion of interest rates. For most of 1987, interest rates were inexorably high; for a short while after Black Monday, interest rates fell, and financial opinion turned around 180 degrees, and started talking as if interest rates were on a permanent downward trend.

No group is more prone to this day-to-day blowin’ with the wind than the financial press. This syndrome comes from lack of understanding of economics and hence being reduced to reacting blindly to rapidly changing events. Sometimes this basic confusion is reflected within the same article. Thus, in the not-so-long ago days of double-digit inflation, the same article would predict that interest rates would fall because the Fed was buying securities in the open market, and also say that rates would be going up because the market would be expecting increased inflation. Nowadays, too, we read that fixed exchange rates are bad because interest rates will have to rise to keep foreign capital in the U.S., but also that falling exchange rates are bad because interest rates will have to rise for the same reason. If financial writers are mired in hopeless confusion, how can we expect the public to make any sense of what is going on?

In truth, interest rates, like any important price, are complex phenomena that are determined by several factors, each of which can change in varying, or even contradictory, ways. As in the case of other prices, interest rates move inversely with the supply, but directly with the demand, for credit. If the Fed enters the open market to buy securities, it thereby increases the supply of credit, which will tend to lower interest rates; and since this same act will increase bank reserves by the same extent, the banks will now inflate money and credit out of thin air by a multiple of the initial jolt, nowadays about ten to one. So if the Fed buys one billion dollars of securities, bank reserves will rise by the same amount, and bank loans and the money supply will then increase by 10 billion dollars. The supply of credit has thereby increased further, and interest rates will fall some more.

But it would be folly to conclude, impressionistically, that interest rates are destined to fall indefinitely. In the first place, the supply and demand for credit are themselves determined by deeper economic forces, in particular the amount of their income that people in the economy wish to save and invest, as opposed to the amount they decide to consume. The more they save, the lower the interest rate; the more they consume, the higher. Increased bank loans may mimic an increase in genuine savings, yet they are very far from the same thing. Inflationary bank credit is artificial, created out of thin air; it does not reflect the underlying saving or consumption preferences of the public. Some earlier economists referred to this phenomenon as “forced” savings; more importantly, they are only temporary. As the increased money supply works its way through the system, prices and all values in money terms rise, and interest rates will then bounce back to something like their original level. Only a repeated injection of inflationary bank credit by the Fed will keep interest rates artificially low, and thereby keep the artificial and unsound economic boom going; and this is precisely the hallmark of the boom phase of the boom-bust business cycle.

But something else happens, too. As prices rise, and as people begin to anticipate further price increases, an inflation premium is placed on interest rates. Creditors tack an inflation premium onto rates because they don’t propose to continue being wiped out by a fall in the value of the dollar; and debtors will be willing to pay the premium because they too realize that they have been enjoying a windfall. And this is why, when the public comes to expect further inflation, Fed increases in reserves will raise, rather than lower, the rate of interest. And when the acceleration of inflationary credit finally stops, the higher interest rate puts a sharp end to the boom in the capital markets (stocks and bonds), and an inevitable recession liquidates the unsound investments of the inflationary boom.

An extra twist to the interest rate problem is the international aspect. As a long-run tendency, capital moves from low-return investment (whether profit rates or interest rates) toward high-return investments until rates of return are equal. This is true within every country and also throughout the world. Internationally, capital will tend to flow from low-interest to high-interest rate countries, raising interest rates in the former and lowering them in the latter.

In the days of the international gold standard, the process was simple. Nowadays, under fiat money, the process continues, but results in a series of alleged crises. When governments try to fix exchange rates (as they did from the Louvre agreement of February 1987 until Black Monday), then interest rates cannot fall in the United States without losing capital or savings to foreign countries.

In the current era of a huge balance of trade deficit in the U.S., the U.S. cannot maintain a fixed dollar if foreign capital flows outward; the pressure for the dollar to fall would then be enormous. Hence, after Black Monday, the Fed decided to allow the dollar to resume its market tendency to fall, so that the Fed could then inflate credit and lower interest rates.

But it should be clear that that interest rate fall could only be ephemeral and strictly temporary, and indeed interest rates have already resumed their inexorable upward march. Price inflation is the consequence of the enormous monetary inflation pumped in by the Federal Reserve for several years before the spring of 1987, and interest rates are therefore bound to rise as well. Moreover, the Fed, as in many other matters, is caught in a trap of its own making; for the long-run trend to equalize interest rates throughout the world is a drive to equalize not simply money, or nominal, returns, but real returns corrected for inflation. But if foreign creditors and investors begin to receive dollars worth less and less in value, they will require higher money interest rates to compensate—and we will be back again, very shortly, with a redoubled reason for interest rates to rise.

In trying to explain the complexities of interest rates, inflation, money and banking, exchange rates and business cycles to my students, I leave them with this comforting thought: Don’t blame me for all this, blame the government. Without the interference of government, the entire topic would be duck soup.

How the Market Creates Jobs and How the Government Destroys Them

Walter Block

The Creation of Jobs

If the media tell us that “the opening of XYZ mill has created 1,000 new jobs,” we give a cheer. When the ABC company closes and 500 jobs are lost, we’re sad. The politician who can provide a subsidy to save ABC is almost assured of widespread public support for his work in preserving jobs.

But jobs in and of themselves do not guarantee well-being. Suppose that the employment is to dig huge holes and fill them up again? What if the workers manufacture goods and services that no one wants to purchase? In the Soviet Union, which boasts of giving every worker a job, many jobs are just this unproductive. Production is everything, and jobs are nothing but a means toward that end.

Imagine the Swiss Family Robinson marooned on a deserted South Sea island. Do they need jobs? No, they need food, clothing, shelter, and protection from wild animals. Every job created is a deduction from the limited, precious labor available. Work must be rationed, not created, so that the market can create the most product possible out of the limited supply of labor, capital goods, and natural resources.

The same is true for our society. The supply of labor is limited. We must not allow government to create jobs or we lose the goods and services which otherwise would have come into being. We must reserve precious labor for the important tasks still left undone.

Alternatively, imagine a world where radios, pizzas, jogging shoes, and everything else we might want continuously rained down like manna from heaven. Would we want jobs in such a utopia? No, we could devote ourselves to other tasks—studying, basking in the sun, etc.—that we would undertake for their intrinsic pleasure.

Instead of praising jobs for their own sake, we should ask why employment is so important. The answer is, because we exist amidst economic scarcity and must work to live and prosper. That’s why we should be of good cheer only when we learn that this employment will produce things people actually value, i.e., are willing to buy with their own hard-earned money. And this is something that can only be done in the free market, not by bureaucrats and politicians.

The Destruction of Jobs

But what about unemployment? What if people want to work, but can’t get a job? In almost every case, government programs are the cause of joblessness.

Minimum Wage. The minimum wage mandates that wages be set at a government-determined level. To explain why this is harmful, we can use an analogy from biology: there are certain animals that are weak compared to others. For example, the porcupine is defenseless except for its quills, the deer vulnerable except for its speed.

In economics there are also people who are relatively weak. The disabled, the young, minorities, the untrained—all are weak economic actors. But like the weak animals in biology, they have a compensating advantage: the ability to work for lower wages. When the government takes this ability away from them by forcing up pay scales, it is as if the porcupine were shorn of its quills. The result is unemployment, which creates desperate loneliness, isolation, and dependency.

Consider a young, uneducated, unskilled person, whose productivity is $2.50 an hour in the marketplace. What if the legislature passes a law requiring that he be paid $5 per hour? The employer hiring him would lose $2.50 an hour.

Consider a man and a woman each with a productivity of $10 per hour, and suppose, because of discrimination or whatever, that the man is paid $ 10 per hour and the woman is paid $8 per hour. It is as if the woman had a little sign on her forehead saying, “Hire me and earn an extra $2 an hour.” This makes her a desirable employee even for a sexist boss. But when an equal-pay law stipulates that she must be paid the same as the man, the employer can indulge his discriminatory tendencies and not hire her at all, at no cost to himself.

Comparable Worth. What if government gets the bright idea that nurses and truck drivers ought to be paid the same wage because their occupations are of “intrinsically” equal value? It orders that nurses’ wages be raised to the same level, which creates unemployment for women.

Working Conditions. Laws which force employers to provide certain types of working conditions also create unemployment. For example, migrant fruit and vegetables pickers must have hot and cold running water and modern toilets in the temporary cabins provided for them. This is economically equivalent to wage laws because, from the point of view of the employer, working conditions are almost indistinguishable from money wages. And if the government forces him to pay more, he will have to hire fewer people.

Unions. When the government forces businesses to hire only union workers, it discriminates against non-union workers, causing them to be at a severe disadvantage or permanently unemployed. Unions exist primarily to keep out competition. They are a state-protected cartel like any other.

Employment Protection. Employment protection laws, which mandate that no one can be fired without due process, are supposed to protect employees. However, if the government tells the employer that he must keep the employee no matter what, he will tend not to hire him in the first place. This law, which appears to help workers, instead keeps them from employment. And so do employment taxes and payroll taxes, which increase costs to businesses and discourage them from hiring more workers.

Payroll Taxes. Payroll taxes like Social Security impose heavy monetary and administrative costs on businesses, drastically increasing the marginal cost of hiring new employees.

Unemployment Insurance. Government unemployment insurance and welfare cause unemployment by subsidizing idleness. When a certain behavior is subsidized—in this case not working—we get more of it.

Licensing. Regulations and licensing also cause unemployment. Most people know that doctors and lawyers must have licenses. But few know that ferret breeders, falconers, and strawberry growers must also have them. In fact, government regulates over 1,000 occupations in all 50 states. A woman in Florida who ran a soup kitchen for the poor out of her home was recently shut down as an unlicensed restaurant, and many poor people now go hungry as a result.

When the government passes a law saying certain jobs cannot be undertaken without a license, it erects a legal barrier to entry. Why should it be illegal for anyone to try their hand at haircutting? The market will supply all the information consumers need.

When the government bestows legal status on a profession and passes a law against competitors, it creates unemployment. For example, who lobbies for the laws which prevent just anyone from giving a haircut? The haircutting industry—not to protect the consumer from bad haircuts, but to protect themselves against competition.

Peddling. Laws against street peddlers prevent people from selling food and products to people who want them. In cities like New York and Washington, D.C., the most vociferous supporters of anti-peddling laws are established restaurants and department stores.

Child Labor. There are many jobs that require little training—such as mowing lawns—which are perfect for young people who want to earn some money. In addition to the earnings, working also teaches young people what a job is, how to handle money, and how to save and maybe even invest. But in most places, the government discriminates against teenagers and prevents them from participating in the free enterprise system. Kids can’t even have a street-corner lemonade stand.

The Federal Reserve. By bringing about the business cycle, Federal Reserve money creation causes unemployment. Inflation not only raises prices, it also misallocates labor. During the boom phase of the trade cycle, businesses hire new workers, many of whom are pulled from other lines of work by the higher wages. The Fed subsidy to these capital industries lasts only until the bust. Workers are then laid off and displaced.

The Free Market. The free market, of course, does not mean utopia. We live in a world of differing intelligence and skills, of changing market preferences, and of imperfect information, which can lead to temporary, market-generated unemployment, which Mises called “catallactic.” And some people choose unemployment by holding out for a higher paying job. But as a society, we can insure that everyone who wants to work has a chance to do so by repealing minimum wage law, comparable worth rules, working condition laws, compulsory union membership, employment protection, employment taxes, payroll taxes, government unemployment insurance, welfare, regulations, licensing, anti-peddling laws, child-labor laws, and government money creation. The path to jobs that matter is the free market.

The National Bureau and Business Cycles

Murray N. Rothbard

Not only is there confusion about whether or not a recession is imminent, but some economists think that we’re already in one. Thus, Richard W. Rahn, chief economist for the U.S. Chamber of Commerce, recently declared: “The economic slowdown is not coming: it’s here, and soon it will be gone.” Not knowing whether or not we’re in a recession is not as silly as it sounds. It takes a while for data to come in, and then to figure out if a decline is a mere glitch or if it constitutes a new trend. But the natural confusion is compounded by the thrall in which virtually all economists, statisticians, and financial writers have been held by the National Bureau of Economic Research.

Everyone waits for the National Bureau to speak; when the oracle finally makes its pronouncement, it is accepted without question. Thus, in 1966, the economy slowed down and receded to such an extent that I, for one, concluded that we were in a recession. But no, GNP had not declined quite long enough to meet the Bureau’s definition of a recession, and that, unfortunately, was that. And since we were not in what the Bureau called a “recession,” we by definition continued to be in a “boom.” The reason is that, by the Bureau’s peculiar and arbitrary standards and methods, the economy cannot be just sort of lolling along, in neither a boom nor a recession. It has to be in one or the other.

To say that the Bureau is fallible should go without saying; but instead, its pronouncements are taken as divine writ. Why is that? Precisely because the Bureau was cleverly designed, and so proclaimed, to be an allegedly value-free, purely “scientific” institution.

The Bureau is a private institution, supported by a large group of associations and institutions, business and union groups, banks, foundations, and scholarly associations, which confer upon it an almost painful respectability. Its numerous books and monographs are very long on statistics, short on text or interpretation. Its proclaimed methodology is Baconian: that is, it trumpets the claim that it has no theories, that it collects myriads of facts and statistics, and that its cautiously worded conclusions arise solely, Phoenix-like, out of the data themselves. Hence, its conclusions are accepted as unquestioned holy “scientific” writ.

And yet, despite its proclamations, the National Bureau’s procedures themselves necessarily manipulate the data to arrive at conclusions. And these procedures are not free of theory, indeed they rest on faulty and questionable theoretical assumptions. Hence, the conclusions, far from being strictly “scientific,” are skewed and misshaped to the extent that they are determined by the procedures themselves.

Specifically, the Bureau selects “reference cycles,” of the general economy, and then examines “specific cycles” of particular prices, production, etc. and compares these with the reference cycles. Unfortunately, all depends on the Bureau’s dating theory, that is, it picks out only the trough and peak months, first for the general cycles, and then for each specific cycle. But suppose, as in many cases, the curve is flat, or there are several peaks or troughs close to each other.

In these cases, the Bureau, purely arbitrarily, takes the last month of the plateau, or the multi-peak or trough period, and calls that the peak or trough month. There is no earthly economic reason for this; why not take the whole period as a peak or trough period, or average the data, or whatever? Instead, the Bureau takes only the last month and calls that the peak or trough, and then compounds that error by arbitrarily squeezing the distance between the designated “peak month” and “trough month” into three equal parts, and assuming that everything in between peak and trough is a straight line of expansion or contraction, boom or bust.

In other words, in the real world, any given time series, say copper prices, or housing starts in California, might have dawdled near the trough, gone quickly upward, and stayed at a plateau or multi-peak for many months. But on the Procrustean rack of National Bureau doctrine, the activity is squeezed into a single, one-month trough; a straight line expansion, divided into three parts by time; reaching a single-month peak; and then going down in a similar linear, jagged-line contraction. In short, National Bureau methods inevitably force the economy to look falsely like a series of jagged, sawtoothed, straight lines upward and downward. The triumphant conclusion that “life is a series of sawtooth lines” is imposed by the way the Bureau massages the data in the first place.

That massaging is bad enough. But then the Bureau compounds the error by averaging all the specific cycles, its leads and lags, etc. over numerous specific cycles, as far as the data will go back, say from the 1860s to the 1980s. It is from that averaging that the Bureau has developed its indices of “leading,” “coincident,” and “lagging” indicators, the first of which are supposed to (but not very successfully) forecast the future.

The problem with this averaging of cycle data over the decades is that it assumes a “homogeneous population,” that is, it assumes that all these cycles, say for copper prices or housing starts in California, are the same thing, and operate in the same context over all these decades. But that is a whopping assumption; history means change, and it is absurd to assume that the underlying population of all this data remains constant and unchanging, and therefore can be averaged meaningfully.

When the National Bureau set forth this methodology in Arthur F. Burns and Wesley C. Mitchell, Measuring Business Cycles (National Bureau of Economic Research, 1946), it was correctly criticized by a distinguished econometrician for being “Measurement without Theory” in the Journal of Political Economy, but still it quickly swept the board to achieve oracular status.

Particularly irritating were the claims of the Bureau that those of us who held definite business cycle theories were partial and arbitrary, whereas the Bureau spoke only from the facts of hard, empirical reality. Yet the Bureau has had far less respect for empirical reality than have allegedly “anti-empirical” Austrians. Austrians realize that empirical reality is unique, particularly raw statistical data. Let that data be massaged, averaged, seasonals taken out, etc. and then the data necessarily falsify reality. Their Baconian methodology has not saved the Bureau from this trap; it has only succeeded in blinding them to the ways that they have been manipulating data arbitrarily.

________________

2The Institute thanks Margit von Mises for her gracious permission to print excerpts from this 1957 talk. ed.

• 1*The Institute thanks Margit von Mises for her gracious permission to print excerpts from this 1957 talk. ed.
• 2We are inaugurating tonight the ninth meeting of the Mont Pelerin Society. It is fitting to remember on this occasion that meetings of this kind in which opinions opposed to those of the majority of our contemporaries and to those of their governments are advanced, are possible only in the climate of liberty and freedom that is the most precious mark of Western civilization. Let us hope that this right to dissent will never disappear.*