Speaking of Liberty

1. Economics

THE MARVEL THAT IS CAPITALISM

[This speech was given before the Adam Smith Club, Campbell University, Buies Creek, North Carolina, April 4, 2002.]

Free-market economics, of which the Austrian School is the preeminent exponent, asserts that every government intervention in the market generates consequences that are deleterious for prosperity and human liberty. However much such interventions may assist one group in the short run, everyone is made worse off in the long run. Government intervention destabilizes economic life in artificial ways, and ultimately does not work to bring about the results that its proponents claim to desire.

Carl Menger, the founder of the Austrian School of economics, was a firm believer in the law of cause and effect. He believed that economic affairs could be analyzed in these terms as well.

Menger’s followers in this tradition of thought, including Ludwig von Mises and Murray N. Rothbard, spelled out the implications of this idea for a huge range of issues that confront us on a daily basis in the world of economics and politics. They focused on universal principles that can be derived from the teachings of economics. The law of supply and demand, for example, cannot be repealed by any legislature or court. Government regulators can impose price ceilings, price floors, or limits to the size of firms like Microsoft, but economic law bites back by yielding shortages, surpluses, and reduced profitability.

It is important that we think of economic life as an intricate global system of exchange, one that works without any central direction, and which generates prosperity and its own form of order within the framework of liberty. This is what is sometimes termed the magic of the marketplace, and we should never underestimate its power. By looking south to Argentina, we can see how a failing economy, one thrown into shock by bad legislation and monetary policy, has destroyed the livelihoods of the entire population.

We are not just talking about the earnings in people’s stock portfolio. We are talking about whether mothers can afford to buy milk for their children, and whether the businesses that deliver milk have the freedom to be entrepreneurial and find the least costly methods to make such deliveries possible. When we speak of economics, we are talking about the health of society, and whether medical equipment is working and affordable, and whether the labor market is sufficiently free to permit everyone a place within the division of labor.

People who dismiss the teachings of economics forget that many of the world’s wars and ethnic slaughters began with economic intervention. Before ethnic warfare broke out in Yugoslavia in the 1990s, the country was afflicted by one of the most extreme hyperinflations in the history of the world. This literally destroyed the standard of living and helped turn a previously settled society into a killing field.

If we look back at history, we can see that many wars began in trade disputes, when governments attempted to reward some producers at the expense of others. This was the origin of the Civil War, for example. Even in our own times, the perception in the Muslim world that US/UN sanctions against Iraq have slaughtered hundreds of thousands of children has fueled hatred that has culminated in terrorism. The general lesson we can draw is that economics is really just a fancy word for the quality of our lives, and that the quality of our lives has no greater enemy than the governments that attempt to restrict economic liberty.

Looking at people’s life spans, we see the hidden history of the rise of economic development. Throughout the first huge period of human history from the beginning until the birth of your father’s great-grandfather, the average life span was 20 to 35 years, and a third to half of all children died before reaching the age of five. Economic conditions before very recently in the history of man could not sustain a world population that rose above a few million. Even by the year 1800, the average life span was only 40.

The standard of living for the average person throughout all but the smallest slice of human history can be aptly summed up in the words of Thomas Malthus: “At nature’s mighty feast there is no vacant cover for him. She tells him to be gone, and will quickly execute her own orders.” That was life as everyone but kings knew it after the Fall and before the Industrial Revolution.

But in the last tiny fragment of the history of the world, life spans have more than doubled and the world population has increased one thousand times. By far the largest improvements in these vital statistics have occurred since 1800, at a time when the division of labor expanded dramatically around the world; when property rights were secure; when capital could be accumulated, invested, and a return paid and reinvested; when technological improvements permitted new forms of productivity. What made this possible was the free market.

We take for granted such luxuries as refrigeration, the air conditioner, the internal combustion engine, and electricity, to say nothing of email, the Web, and fiber-optics. But we rarely reflect on the fact that all of these technologies, so integral to our lives, were absent when our great-great-grandfathers were alive, along with every previous generation in the history of the world. What set this revolution in motion was the world of ideas, when great thinkers began to understand the internal logic of the market economy and its potential for liberating mankind from poverty, dependency, and despotic rule.

Given this history, one might think that everyone would sit and marvel at the products of capitalism. We might think that intellectuals would dedicate their lives to defending this system and explaining its merits. We might imagine that statesmen would dedicate themselves to protecting this system of economic progress from every attempt to curb it or abolish it.

Alas, that is not true. Quite the opposite. The intellectual world often appears to be a conspiracy against market economics, and the media routinely ridicule capitalism. Statesmen spend every waking minute trying to curb, regulate, hamper, or otherwise loot the capitalist system.

Those who attacked the World Trade Center were driven by revenge, but also by a belief that the towering products of the commercial society somehow represent an evil that must be destroyed rather than a virtue that should be emulated. They were merely absorbing a view that is pervasive in our culture today, where the anticapitalistic mentality runs rampant.

In our own times, we have seen the evil produced by this mentality, in the former Soviet Union and in many Third World countries, where politicians do everything possible to keep the entrepreneurial spirit penned up, where property rights are not secure, and where investment for the long term is not permitted. The result is always the same: poverty, despotism, death.

As the founder and president of the Mises Institute, I have a special attachment to the ideas of Mises and to the courageous life he lived in defense of the idea of freedom. He began his career in Vienna, writing about the problem of the business cycle and the role of money and credit in fostering it.

The core point he made in his great 1912 book, the Theory of Money and Credit, was that artificial increases in the money supply are not a substitute for real economic production; indeed such increases cause economic damage that can only be rectified through painful economic contractions. His point has continuing relevance.

His next book, from 1919, sought to defend the idea that governments ought to be small and geographically limited, for the sake of social peace. Next, in 1920 and 1922, he proved that socialism could not work as an economic system because it abolished property rights in capital and thus destroyed the system of profit and loss that allows for economic calculation. His methodological and business cycle writings from the 1930s are some of the most profound in the history of the social sciences. Finally in 1940 and 1949, he produced what is quite possibly the finest product of any economist in history: his monumental treatise called Human Action.

Incidentally, he wrote most of his treatise while in Geneva, in exile from his native Austria. The invading German armies deemed his work dangerous. They entered Mises’s apartment and looted his files and papers. Mises, you see, was against socialism, whether Bolshevik or Nazi. Reflect on that and begin to understand the absurdity of calling communism leftist and Nazism rightist, as if they were polar opposites. They are both varieties of the very opposite of freedom itself.

If I were able to give all college students a reading assignment today, I would recommend Human Action above all else. Yes, at nearly 1,000 pages, it can be intimidating, and you will probably need to read it with a dictionary nearby. But it will open up new vistas of thought for you, and help you to rise above conventional wisdom. I continue to believe that this book points the way for us to bring about rising and sustainable prosperity, and also to guard civilization against its enemies.

The headlines of the business pages have been trumpeting the arrival of recovery from March 2001 until the present—so far, the entire length of the downturn. How do the experts decide when recession has turned to recovery? By looking at the data, which come in packages labeled in various ways: the GDP, the leading indicators, the unemployment rate, industrial production, housing starts, commercial borrowings, office vacancy rates, and a host of other considerations. If these tend in the negative direction, we are said to be entering a downturn. If they move in a positive direction, it is said that we are recovering.

Let’s grant, first, that the larger the data set, the more subject to manipulation it is. We can count housing starts, but measuring something like national productivity is very tricky business. The great scandal of the way that Gross Domestic Product is collected is that it does not measure wealth destruction, as caused by something like the attacks on September 11 or the 40 percent of private wealth consumed by government at all levels every year. Neither does it make a distinction between private production and outright government spending. Because of this, looking at the data alone, without a proper theory of economics, can produce a highly misleading picture.

For many months, the government has been engaged in a serious effort to bring us out of recession through a variety of fiscal and monetary policies. If recovery is really here, can we say that these policies have worked? Not necessarily, because we must establish a firm relationship between cause and effect to draw such a conclusion. The economy might have recovered without such stimulus efforts. In fact, such stimulus efforts might make the recovery weaker than it otherwise might be.

A more serious possibility is that the stimulus efforts have actually created an illusion. While everyone is celebrating the unexpected economic recovery, which is also unexpectedly robust, it serves us to look beneath the surface. There are aspects of this recovery that are highly unstable because they were brought about through artificial means. There are also certain policy trends which suggest that it might not last or that it will not be as robust as it might otherwise be.

The Congressional Budget Office points out that new government spending has surpassed the amounts envisioned in the stimulus measures proposed in 2001 and 2002, exceeding what even the most spendthrift lawmakers dared demand. The spending surge along with consumer debt helps to explain why the recession seemed mild and why everyone is talking about recovery.

A major increase in government spending, which has very quickly redirected $100 billion into the economy, began in October 2001. Outlays went up over 2001’s increases by 13.1 percent. In terms of GDP, it accounts for fully 1 percent. As for consumer spending, it is financed almost entirely by new borrowing fueled by artificially lower interest rates.

Looking even deeper, we can see that Federal Reserve policy has been astonishingly loose since the beginning of 2001, reaching as high as 20 percent per annum by some measures. Let’s say I set out to stimulate economic production in a college classroom. We could all gather together to write some software that is valued by the market, or we could teach each other new skills that increase our labor productivity.

But what if I stood there with a photocopying machine and made a thousand copies of a $20 bill, passed them around, and then announced that we are all $20,000 richer than before? Everyone would be rightly skeptical of this claim. When the Federal Reserve does this same thing with its money-creation machine, we should be skeptical also.

While recognizing that some of the rebound may consist of sustainable investment begun after the great shakeout of 2000, these factors just cited strongly suggest that the current economic recovery consists of more myth than reality. We need to ask ourselves whether and by what means it can be sustained.... The only means for doing so is for it to be supported through strong economic development and sound investment—investment that is borne out in consumer purchases and long-term profits.

It turns out, however, that the federal government has done everything possible to undermine the likelihood of a sustainable recovery. In 2002, the US imposed a 30-percent tariff on steel. The idea here was to help one inefficient, bloated, and pampered industry at the expense of all US consumers of steel, including US businesses, and all producers in Europe, Asia, Brazil, and Australia. This is brazen protectionism, deeply harmful all around, not to mention morally repugnant.

Did it help the steel industry? In the short run, yes. But we have to ask ourselves whether this kind of help is a good thing in the long run. The tariffs permit an inefficient industry to continue to produce inefficiently, and forestall improvements in technology and cutbacks in wages that are necessary if the industry is to adjust to 21st-century realities. There is no virtue to keeping dying and inefficient technology humming along so that workers who would be better employed elsewhere can continue to enjoy fat checks doing outmoded work.

How long must such tariffs remain in place? The steel industry says they are only necessary in order to get it back on its feet. But that belies that question of what, precisely, is going to inspire this sector to clean up its act? Protecting an industry from competition is a method that permits everything wrong with the industry to persist and not change. Either this tariff will have to be in place permanently, or the industry will have to be shaken up.

If you think about it, Soviet socialism survived for 74 years on precisely such policies. The Soviet State protected all its industries from market competition under the alleged need to build socialism. Factories were never closed, and workers were never let go except for political reasons, when their services were employed in the Gulag. The system worked only if the standard was not efficiency but merely the guarding of the status quo. Eventually this system collapsed, as statist systems must, and the Soviets woke up to a world that was backward and decayed.

The steel tariff imposed by the Bush administration is different from Soviet socialism only in degree, not in kind. It is an attempt to circumvent the market process through a centrally administered system of rewards and subsidies for industry to abide by political priorities rather than market dictates. In the meantime, all purchasers of steel, whether consumers or other businesses, are harmed by being forced to pay a higher price for an inferior product.

Also in 2002, the US imposed massive punitive duties on softwood imports from Canada. Why? Because Canada refused to obey a US demand that it place a new tax on its softwood. The new duties raise the price of softwood, used for building nearly every home in America, by 27 percent. This is going to distort the housing market, among many other sectors that use wood. Higher prices for steel and wood put additional pressure on other businesses that use these products in production.

In economic terms, tariffs are indistinguishable from sales taxes. They take people’s property by force by requiring businesses and consumers to pay higher prices for goods than they would otherwise pay in a free market. To that extent, they harm the prospects for economic growth. If anyone says otherwise, he is ignoring hundreds of years of scholarship and the entire sorry history of government interference with international trade.

The repercussions of these two actions are already being felt via damaged relations in Latin America and Europe. The World Trade Organization will likely give the green light for retaliation. Protectionist lobbies all over the world are rushing to take advantage of the opportunity. The EU has imposed tariffs on US steel, and Canada is considering retaliatory measures. This way lies trade war, which is the worst thing that can happen to an economy, other than hot war.

Another policy that endangers recovery is the war on terrorism. I’m not taking issue with the need for justice after September 11, but it seems clear that the government used this tragedy as an excuse to vastly increase spending and regulation over the American and world economy. President Bush, who campaigned on a platform of cutting government, has asked for another $28 billion to pour into the military, even as he is pushing for more regulations on banks and financial privacy in the name of rooting out terrorism. The total increases for 2002 and 2003 could be as high as $300 billion, depending on whom the US plans to conquer next.

Here again, this spending can create the illusion of prosperity, but we must also remember that first lesson of economic science: the world is a finite place where the use of any and all resources are constrained by scarcity. This is just another way of saying that you can’t always get what you want, and when you do, it must come from somewhere. When the government spends resources, it must drain them from the private economy through taxation, borrowing, or inflating the money supply to pay for the new spending.

Economics doesn’t deny that redirecting resources from one sector where they are valued by consumers, to another sector where they are valued by government, can create pockets of expansion. What economics suggests is that this is not an efficient or sustainable use of such resources. Only the unhampered competitive market economy, with its system of market prices, profits, and losses, can reveal to us with any certainty the most desirable destination of economic goods.

But in the examples I have just given, you can see how government intervention is redirecting resources from consumers’ most desired uses to purposes deemed desirable by political planners. The politicians believe that the military needs resources more than you and I, so they take them. They believe that the profits of the steel industry are more important than the international division of labor, so they protect that industry. They believe that the softwood industry deserves to obtain the highest possible prices for its products, so they intervene to hamper imports.

As for the explosion of consumer spending that has taken place over the course of the downturn, this does indeed encourage businesses to expand. If low interest rates are encouraging consumers to dig deep to borrow for and buy new homes, this will encourage more investment in housing on the production side as well, and this too will be encouraged by the interest rates being depressed by the Federal Reserve. Artificially low interest rates also tend to discourage savings, and encourage people to put money back into the stock market where, they hope, it can earn a higher rate of return.

If credit expansion, protectionism, and government spending were a path to prosperity, mankind would have long ago created heaven on earth. But the politicians engaged in these activities have to contend with reality, and the reality is that economic forces in society must be mutually sustaining. To have production and borrowing, there must be savings, which only occur when people forgo consumption today to prepare for tomorrow, and when investment pans out in the form of consumption. Absent such conditions, economic growth lacks a foundation in reality and turns to dust when economic conditions change.

We have seen many examples of this in recent years. The Internet bubble was one such case. There was nothing unreal about technology or its potential to provide massive gains in efficiency, as well as a vibrant new commercial marketplace and information delivery service. Nor was there anything ignoble about investors who pumped money into dot-coms on the promises of future profits. What distorted the picture was too much credit, courtesy of the Federal Reserve, chasing too few capitalized companies.

When the Fed began to reduce the pace of monetary pumping, lenders pulled back, investors pulled out, and dotcoms and their support infrastructure found themselves overextended, well beyond what the market would have borne if it had not been subsidized by a reckless Fed policy.

The collapse of the Nasdaq was nothing more than reality reasserting itself. Some malinvestments were cleaned out and the ground was prepared for new investment.

Dot-coms weren’t the only ones affected by the bubble. Enron is another famed case in point. This company profited and dramatically expanded at a time when investors were encouraged to recklessly purchase stocks without regard to balance sheets. The auditors are catching the blame, but the truth is that Enron profited in a time when portfolio managers weren’t paying very close attention either. The only way such a “cluster of errors” comes to predominate in a market economy is when the central bank unleashes new money and credit beyond anything that the market can sustain for long.

Prior to our own bubble, we saw a similar situation in Asia, and, before that, in Mexico. In each of these cases, what we find is not market failure but a failure of the system of money and credit to provide reliable signals for investors and lenders. It is helpful to think of the interest rate as a price signal, so that Fed attempts to drive down rates simply misprice credit. In the same way that a government price ceiling would cause overconsumption of any good—whether eggs, gas, or electricity—distortions of the interest rate encourage overconsumption of credit.

It is not surprising, then, that we are seeing a spending boom take place today among consumers even as producers are pulling back in many areas. Certain sectors have prospered since the reflation began after mid-2001. Housing, in particular, has boomed all out of proportion to what it would otherwise do in a free market. If any sector is being set up for a fall today, it is this one.

Regardless of the fallout from day-to-day economic affairs, Mises believed that no power on earth is as strong as ideas. You live in the world of ideas, so take your responsibilities very seriously. The achievements of freedom should speak for themselves, but sadly they do not. Freedom needs courageous individuals who are willing to stand apart from the mob and state an unconventional truth.

A SECRET HISTORY OF THE BOOM AND BUST

[This text is drawn from the keynote address at the Sage Capital Management Conference in Houston, Texas, March 12, 2003.]

The Austrian economists tell us that a price is more than a price. It is an objective expression of subjective judgments concerning human wants, now and in the future. It conveys information to us about how we ought to conduct ourselves: where capital should be directed, how much of what should be consumed now or later, which jobs to take and which to pass over. In short, prices provide the roadmap to the successful navigation of the material world.

How striking it is to see stock prices respond so actively to the war on Iraq, the dominant event of the day. Since the war began, prices rose in response to the prospect that war would end soon and sank on the prospect that the war will go on and on. What does this price information convey? Most likely, it reflects an inchoate sense that this war would do nothing to bring us out of economic contraction and into recovery.

That is precisely true. Wars often result in severe setbacks, not only prolonging the contraction, but deepening it as well. To hear official voices talk, however, we have not been going through the longest recession in the postwar period. Instead, we have been through a 24-month “slow recovery.” It is also called a “sagging economy with sound fundamentals.” Greenspan has made references to a “soft patch” in a foundation supposedly as hard as stone.

Indeed, in the effort to avoid using the term recession, the Federal Reserve has become a business-cycle phrase mill. Thus, according to the Fed, this is a “soft economy,” a “sub-par economy,” a “skittish economy,” an economy “weighed down by weak expenditures,” an economy of “persistent weakness,” or, my favorite, an economy facing “formidable barriers to vigorous expansion.” Call it what you want, but don’t call it a recession. As for the D-word, depression, don’t even think it!

With the latest data on the producer price index, the commodity price index, and the increase in oil prices, we are starting to see other tortuous linguistic devices at work. It is not inflation; it is “sector-specific price pressure.” In the old days, rising unemployment, sinking production, and price inflation combined to create what was called “stagflation.” What will it be called this time? Something rather ingenious, no doubt.

The National Bureau of Economic Research officially dates the contraction from March 2001, fully six months before 9–11. Not a day has gone by in the last two years when some commentator hasn’t either denied we are in downturn, claimed we are already out of the contraction, or cited evidence that the recovery is underway and demanded that everyone admit it already. In fact, I believe our time will be recorded as a period of general economic meltdown. How much worse will it get and how much longer will it last? We cannot know for sure, but we do know that right now the government is doing everything in its power to make it worse.

Those of us who warned in the 1990s that the stock-price mania could not last were accused of spreading “gloom and doom.” Our warnings were considered self-evidently ridiculous, because, of course, it was said that we were in a New Economy, and such things as profitability and earnings and savings were old hat and had no bearing on the cyberworld being created before our eyes. Only the Austrian School economists seemed to wonder who or what was behind the frenzy.

In contrast to the 1980s, when everyone was watching the money supply, the markets were suspiciously uninterested in what the Fed was up to in the 1990s. It funded a bailout of Mexico, then a bailout of East Asia, and then a bailout of a crazy Connecticut hedge fund that believed it could predict the future by paying Nobel laureates vast sums to concoct a mathematical model that perfectly predicted the past.

But still, hardly anyone cared. The phrase “money supply” elicited yawns. The Wall Street Journal, meanwhile, ran a few articles explaining why there is no longer any such thing as risk. It was only the Austrians who seemed to take notice when money creation rates began to take off in 1995, and climbed to 15 percent in late 1998 and 1999, taking the bull market on its wildest-ever ride. Monetary expansion rates settled down a bit in 2000, a trend which at first seemed merely inauspicious—like a tiny tap on a domino lined up against a thousand others.

Once the bear market began, there was no turning back, no matter how much the Fed inflated. Instead of stabilizing downward as they had in Clinton’s first term, money-creation rates shot up again, reaching an astounding 22 percent in December 2001 from a year earlier, and then fell back down again, creating a double-dip bear market in the course of a mere 24 months. In these numbers we find the secret history of the great boom and bust of our time. Let me give a brief outline of why, and try to explain why it is that so few seemed to pick up on it.

At the dawn of the century of central banking, an economist named Ludwig von Mises set out to rewrite the theory of what money is and how government can seriously distort its workings. Among the puzzles he sought to solve was one that most economists, including Karl Marx, had noticed: swings in business activity from boom to bust.

Marx said that cycles are endemic to capitalism, and a sign of the final crisis that will sweep in the age of socialism. In contrast, Mises found that the business cycle is a symptom not of the free market but of attempts to manipulate the market through unsound monetary practices. Moreover, he found that these cycles are self-correcting, provided that the government doesn’t attempt to forestall the necessary correction that follows an artificial boom.

Mises concluded by looking carefully at the relationships among the financial sector, money and banking, and the structure of production itself. On the free market, he said, the interest rate reflects the extent to which people are willing to forgo current consumption for later consumption. The more businesses and holders of money are willing to put off consumption, the lower the rate will be. A low borrowing rate for business, which spurs investment, reflects a high rate of consumer savings, which reflects a willingness of consumers to purchase the products made in lengthy production processes.

In testimony the other day, Greenspan claimed the following: “Economists understand very little about how technological progress occurs.” Perhaps he should have said that he, Greenspan, knows little about how technological progress occurs. At least as regards the Austrian economists, his statement is false. Within the framework of the freedom of exchange, entrepreneurs make judgments about what consumers might want in the future, including new technologies.

Capitalists and investors assume the risk, employing private property. Investments that are profitable attract more resources and those that yield losses are shelved.

This is the free-market capital structure at work in a complex economy. It is truly a miracle of coordination—extending through all sectors and across a huge range of time horizons—with no central management, and needing none. It balances human needs with the availability of all the world’s resources, unleashes the amazing power of human creativity, and works to meet the material needs of every member of society at the least possible cost.

It does this through exchange, cooperation, competition, entrepreneurship, and all the institutions that make possible capitalism—the most productive economic system this side of heaven. This system of capital coordination not only works without central management; government’s attempt to manage it creates dislocations across sectors and across time.

Let us never underestimate the social benefits that flow from this seemingly technical mechanism. The market economy has created unfathomable prosperity and, decade by decade, century by century, miraculous feats of innovation, production, distribution, and social coordination.

To the free market, we owe all material prosperity, all leisure time, our health and longevity, our huge and growing population, nearly everything we call life itself. Capitalism and capitalism alone has rescued the human race from degrading poverty, rampant sickness, and early death.

In the absence of the capitalist economy and all its underlying institutions, the world’s population would, over time, shrink to a small fraction of its current size, with whatever was left of the human race systematically reduced to subsistence, eating only what could be hunted or gathered. The institution that is the source of the word civilization—the city—depends on trade and commerce, and cannot exist without them.

And this is only to mention the economic benefits of capitalism. It is also an expression of freedom. It is not so much a social system but the natural result of a society wherein individual freedom is respected, and where businesses, families, and every form of association are permitted to flourish in the absence of coercion, looting, and war.

Capitalism protects the weak from the strong, granting choice and opportunity to the masses, who once had no choice but to live in a state of dependency on the politically connected and their enforcers.

But capitalism has many enemies, among them those who would attempt to gin up economic production through loose credit. What Mises focused on in his book on money was the effects of this particular attack on the free market: expansion of money and credit by the central bank, and, in particular, the attempt to drive down the price of credit to spur business investment.

Doing this through the interest rate requires injections of new money into the economy. One effect of this has been known for centuries: it causes prices to rise. But the other effect Mises discovered: it subsidizes long-term capital investment in a manner that cannot be supported by the patterns of consumption and saving. As one Austrian economist puts it, when the central bank drives down interest rates, it causes the economy to bite off more than it can chew.

The effect of artificially inflating the economy can be rising prices. But as we saw in the late 1920s and other times since, that is not always the case. It often causes a kind of investment euphoria that leads people to believe that nothing can go wrong.

The monetarists, for example, believe that so long as prices remain in check, there is no problem associated with money expansion. The supply-siders, though sound on many issues, have an unfortunate faith in the power of loose credit to make bread from stones.

Mises developed his theory throughout the 1920s and warned of the coming of the 1929 stock market crash. His work was carried forward by F.A. Hayek throughout the 1930s. Hayek later received the Nobel Prize for this. Indeed, the theory was widely embraced until Keynes dreamed up an alternative view that resurrected all the old fallacies about the miracles of money creation and centralized economic management.

Then the Misesian theory languished for decades until the current downturn. Today it is getting new attention as the leading explanation of the insanity of the late 1990s and the current bust. Only the Austrians said all along that reality would strike back.

The Fed and the administration have worked ever since, using the only tools they have—regulation, spending, and credit expansion—to reverse the course of the recession.

When I think of the Fed’s spreading money far and wide, I think of the government in Huxley’s Brave New World handing out soma pills or spreading soma vapors to distract people from reality, drugging them so they will be content despite the surrounding disaster. If they start to resist, out comes the soma until the crowds collapse in kisses and hugs.

It is always an illusion to believe that more money is the answer. The federal funds rate is at a 40-year low, and that hasn’t done the trick. During the 1990s, the Bank of Japan tried again and again to manufacture a recovery through absurdly low rates, but that didn’t work either. There is no evidence from either theory or history that pounding interest rates into the ground can create anything resembling a sustainable prosperity. And yet, people believe it, or want to believe it, because it seems better than the alternative.

This entire affair illustrates the underlying reality of American political and economic life: the State’s ability to create money and credit. All other powers of government—regulatory, fiscal, even military—pale in comparison to this. Despite that, the Fed is the least controversial institution in American political life. Apart from Ron Paul of Texas, no national politician understands how it works. When Greenspan comes before Congress, he is treated like a minor god.

If this worship is ever tempered with skepticism, it is on grounds that he is not inflating enough, that he is somehow being stingy and not spreading the wealth. Tragically, there is no organized constituency in American politics for tighter money, less credit, or sounder finance.

Mises distinguishes three varieties of inflationism, that is, the demand that the State work with the banking industry to flood the economy with credit. The first is naïve inflationism that sees no real downside to monetary expansion; the second is inflationism intended to reward debtors at the expense of creditors; and the third sees disadvantages to an expansionary policy, but believes that the advantages outweigh them.

The US is right now in the grip of the worst form: naive inflationism, which, as Mises says “demands an increase in the quantity of money without suspecting that this will diminish the purchasing power of the money. It wants more money because in its eyes the mere abundance of money is wealth. Fiat money! Let the State ‘create’ money, and make the poor rich, and free them from the bonds of the capitalists!”

And here we are today enduring the longest recession in postwar history, a Nasdaq off 75 percent from its highs and a Dow off 40 percent, and the government is still issuing buy signals.

Imagine if you had used George W. as your portfolio manager. You would have bought stocks when he became president, held onto them through 9-11 and then bought more and more afterwards.

Incidentally, you’ll notice that the official rationale for buying stocks has changed. Whereas once it was said that you should buy because the economy is on a permanent growth path, after September 11, it was said that you should buy to display your patriotism. If that isn’t a sell signal, I don’t know what is.

Of course no one in his right mind would let the president of the United States manage his stock portfolio. Why, then, do we trust his government to spend wisely the $2.5 trillion it will extract from the private economy this year? Of course, we don’t really trust the government to do that, but we do not have much choice in the matter. This money is taken from us through force and is thereby, by definition, directed toward uses that are not those which owners would choose. This is power, not market, at work.

What is striking to note, however, is all the ways in which power is not only destructive but also ineffective against the market economy. The government did not know that firms such as Enron and WorldCom were unviable. All the regulators put together could not anticipate the consequences of what private traders alone were to discover: that these businesses had wildly overextended themselves.

Leaving aside questions of ethical lapses at these companies, the most significant lesson we should learn from their collapse is that the market economy has built within it a fabulous internal check against illusion. Companies that could not sustain themselves on their own merits were simply abandoned by investors. It counts toward the enduring shame of the Bush administration that it attempted to blame the market for the bust of so many companies, rather than having given credit to the market for having discovered the problem in the first place and having done something about it.

But as FDR demonstrated after the Depression, there are political points to be made by skewering the private sector in order to distract from the failures of the public sector. The alleged crime the Bush administration seized on was “accounting fraud”—even though it is not at all clear that what WorldCom, Enron, Computer Associates, Global Crossing, or Qwest did, often with the blessing of respected auditors, amounts to that at all.

In each case, the accusation was similar: their books counted spending as profitable investment before the revenue was in the bag, and when the economic tables turned, their optimistic projections proved unsound and even, in retrospect, absurd.

WorldCom was the worst case of the batch, which is why the government has made such a big deal out of the arrest of two former executives. Their spectacular shifting of a total of $3.8 billion from expenses to capital began small, in mid-2000 as the bust was hitting and their financial statements were starting to appear unimpressive.

No one disputes the facts. WorldCom’s expenses for last-mile leases on other companies’ communications networks were rising very quickly. Managers wanted to move these expenses off of the profit and loss statement and onto the balance sheet, thus reflecting a more profitable appearance.

Now, understand that there was no lying going on, and no graft or theft or anything else of that nature. What we have here is an imprudent reclassification designed to impress investors who, at the height of the bubble, demanded nothing less. Unless you are an accounting whiz, there is no way to say that this is a priori evil. In any case, it didn’t fool everyone. Many skeptics drew attention to the crazy finance of WorldCom’s books. But in the boom times made possible by the Fed, most people didn’t care.

Most of the other cases of corporate fraud that came under the microscope were far less serious than WorldCom, and none are obvious cases of theft or fraud. Mostly it was just bad forecasting reflected in optimistic accounting methods. The supposed damage caused by their behavior was that their dressed-up books kept their stock price rising even as the financial condition of the company deteriorated. That’s probably true, but it is also a short description of what it means to be in a bubble economy. If this is fraud, the entire economic boom was fraud.

Hitting closer to the truth, the New York Times called DC’s antibusiness frenzy “the vital center of the administration’s strategy for reducing the political vulnerability for the White House.” In other words, the Republicans were up to their old trick of behaving even worse than the Democrats in order to keep the Democrats from coming to power. If you disagree with this approach, you must be some sort of libertarian utopian who doesn’t understand the need for compromise.

The underlying assumption was the view that it is always a terrible thing for a business to go under, which in fact it is not. It is merely a reflection of human preference as expressed in buying and selling decisions. The only alternative to going under, in some cases, is to operate uneconomically. But that is precisely what the government had in mind for the steel sector last year.

Recession, inefficiency, and bankruptcy are not the only man-made disasters with which government threatens us. Hardly a day goes by when the government doesn’t issue some maniacal warning about an impending terror attack. And the sense of uncertainty and confusion that follows can only forestall recovery.

How much is real and how much is propaganda or merely bureaucratic risk aversion? We cannot know. They recently urged us to buy duct tape to seal the windows in our house in order to protect ourselves from chemical warfare. They also told us that they may use nuclear bombs against enemies real and imagined.

When the warning was given in February, gullible Americans cleaned out the stores of duct tape. Buried in the news a week later was the fact that the person who gave the tip that led to the orange alert was lying. Of course, the revelation didn’t do the government much harm, and the crisis environment that the tip engendered did much good for our masters, who want to keep us in a relentless state of insecurity, and therefore dependent on them.

That helps them keep doing what they want to do anyway: for example, spend money and inflate away the debt thereby incurred. Politicians say they must run deficits of hundreds of billions of dollars to avert an impending calamity that will make 9-11 look like a warmup. They say this, but have yet to issue a sell signal.

The government continues to downplay the economic calamity before our eyes while talking up the prospects for a calamity that can only be solved, they say, by use of the biggest big-government program of them all: war.

At the end of the Cold War, many of us hoped that normalcy would return, that the US would once again become a peaceful commercial republic. But Bush the elder had a different idea. He decided to bomb Iraq and to impose sanctions that would last 12 years, kill untold hundreds of thousands, inspire terror plots all over the Muslim world, and provide a new rationale for why the US must continue to squander hundreds of billions a year on military public-works programs.

We are often told we must go to war because some swarthy, foreign head of state is not a big fan of the US president. In 2003, the person fitting that description is Saddam Hussein. Before that it was the Mullah Omar. A few years earlier, it was Milosevic. Before that, it was some ward-heeler in Somalia. Moving backward in time, we had to take out the strongmen in Panama and Haiti. The story goes on and on. It seems that the US government is addicted to conflict. It just can’t seem to give it up.

Now, I know there will be plenty of disagreement when I say we ought to be trading with Iraq, not bombing it. But let’s at least be clear on what we are talking about when we refer to the US military machine. The US will spend $400 billion on its military this year—and that doesn’t include VA hospitals, most spying, the atom-bomb building at the Energy Department, the military part of Nasa, or the Pentagon’s huge “black” or secret budget.

The second highest military budget in the world is Russia’s. Going down the list, next comes China, then Japan, then the UK. You have to tick through 27 countries and add their total spending together to equal what the US spends per year. Not since the Roman Empire has a single country been so militarily dominant.

Let’s look at the relative strength of the US versus Iraq in particular. Quantitatively, before the war, Iraq spent one quarter of one percent of what the US government spends on its military. Qualitatively, the Iraqi military machine was already crippled, with no spare parts for its ancient equipment. The soldiers are teenage conscripts in rags with old rifles. The idea that this is a fair fight is a joke.

Those who worry about Iraq over-arming itself ought to look a bit closer to home. As for the shooting war, some military commentators have compared its ease to drowning puppies. Thanks to a combination of misrule and punishing sanctions, this once prosperous country has been reduced to rubble. The US has reduced it further, though in doing so the US faces a difficult foe: the desire of a people not to be invaded by a foreign army, and the unpredictability of political forces.

The longtime emphasis of the old liberal tradition with regard to war is this: even the victor loses. We lose resources. We lose tax dollars. We lose trading relationships and good will around the world. Most of all, we lose freedom. And herein lies the biggest cost of war to us, for there is no way that the US can maintain a free market that is the foundation of prosperity while at the same time attempting to create a global military central plan.

Big government abroad is incompatible with small government at home. To the extent we cheer war, we are cheering domestic socialism and our own eventual destruction as a civilization. But perhaps you do not need persuading on any of these matters. I know many people who look at the economy and the military belligerence of the US government and they react with despair. I reject this posture. For one thing, I am firmly convinced that the government has reached too far.

When you consider the full range of social, economic, and international planning on which it has embarked, you can know in advance that this cannot work. Government is not God, nor are the men who run it impeccable or infallible, nor do they have a direct pipeline to the Almighty. The method they have chosen to bring about security and order is destined toward failure.

The war against terrorism is a good example. Everyone in Washington is terrified of the next attack. To shore up the war, there has been no shortage of rhetoric. No expense is spared on arms escalation. There is no lack of will. The effort has the aid of plenty of smart people. It is backed by threats of massive bloodshed.

What is missing is the essential means to cause the war to yield beneficial results. With all the millions of potential terrorists out there, and the infinite possibilities of how, when, and where they will strike, there is no way the State can possibly stop them.

Behind terrorism is political grievance. This is not speculation. This is the word of the terrorists themselves, from Timothy McVeigh to Osama bin Laden to the suicide bombers.

The pool of actual terrorists (like the pool of the poor in the War on Poverty) is limited and can be known, and they are the ones the State focuses on. But the pool of potential terrorists (and potential poor people) is unlimited, and unleashed by the very means the State employs.

Hence, not only does the State not accomplish its stated goals, it recruits more people into the armies of the enemy, and ends up completely swamped by a problem that grows ever worse, as the target population is able to make a mockery of the State through sheer defiance.

In the War on Poverty, as more and more were added to the ranks of the poor, and the intended beneficiaries of the programs themselves began to mock the State’s benevolence, people began to speak of the failure and collapse of the Great Society. Of course the welfare state still exists, but the moral passion and ideological fervor are gone. In the same way, we will soon begin speaking of the collapse of the War on Terror.

Bin Laden is still on the loose, and everyone knows that there are hundreds or thousands of replacement bin Ladens out there. Terrorism has increased since the war began. Israel suffers daily, and in constantly changing ways, ways in which even the most famous and empowered intelligence and military units cannot anticipate or prevent.

But can’t the State just kill more, employ ever more violence, perhaps even terrify the enemy into passivity? This cannot work. Even prisons experience rioting. A bracing comment from Israeli military historian Martin van Creveld: “The Americans in Vietnam tried it. They killed between two-and-a-half and three million Vietnamese. I don’t see that it helped them much.” Without admitting defeat, the Americans finally pulled out of Vietnam, which today has a thriving stock market.

Can the US just back out of its War on Terror? Wouldn’t that mean surrender? It would mean that the State surrenders its role, but not that everyone else does. Had the airlines been in charge of their own security, 9-11 would not have happened. In the same way that the free market provides for all our material needs, it can provide our security needs as well.

The War on Terror is impossible, not in the sense that it cannot cause immense amounts of bloodshed and destruction and loss of liberty, but in the sense that it cannot finally achieve what it is supposed to achieve, and will only end up creating more of the same conditions that led to its declaration in the first place.

In other words, it is a typical government program, costly and unworkable, like socialism, like the War on Poverty, like the War on Drugs, like every other attempt by the government to shape reality according to its own designs. The next time Bush gets up to make his promises of the amazing things he will achieve through force of arms, how the world will be bent and shaped by his administration, think of Stalin speaking at the 15th Party Congress, promising “further to promote the development of our country’s national economy in all branches of production.” Everyone applauded, and waded in blood, pursuant to that goal, but in the end, even if he did not know it, it was impossible to achieve.

Mises, who was so brilliant when it came to issues of money and credit, also saw the need for a thriving economy to operate amidst an environment of peace. “War,” he said,

is harmful, not only to the conquered but to the conqueror. Society has arisen out of the works of peace; the essence of society is peacemaking. Peace and not war is the father of all things. Only economic action has created the wealth around us; labor, not the profession of arms, brings happiness. Peace builds, war destroys.

Our age is dominated by the state and its errors. The state has given us recession and war, while liberty has given us prosperity and peace. Which of the two paths prevails in the end depends on the ideas we hold about freedom, capitalism, and ourselves.

May we never forget the great truth that our founding fathers worked so hard to impart: tyranny destroys, while liberty is the mother of all that is beautiful and true in our world. I make no apologies for being a champion of prosperity and its source, the free-market economy. It is what gives birth to civilization itself. It is fashionable to reject concerns about the economy as narrow and uninteresting, a merely bourgeois interest. If this attitude comes to prevail, we have great reason to be concerned about our present age.

If, on the other hand, we can educate ourselves about the workings of economic forces, and the way in which they are the foundation of freedom and peace, we will not only emerge from this recession prepared to enter onto a new growth path; we will have gone a long way to protecting ourselves from future assaults on our right to be free.

WHY AUSTRIAN ECONOMICS MATTERS

[Based on a lecture given as part of the Heritage Foundation Resource Bank Series in Washington, DC, December 10, 1995.]

Economics, wrote Joseph Schumpeter, is “a big omnibus which contains many passengers of incommensurable interests and abilities.” That is, economists are an incoherent and ineffectual lot, and their reputation reflects it. Yet it need not be so, for the economist attempts to answer the most profound question regarding the material world.

Pretend you know nothing about the market, and ask yourself this question: how can society’s entire deposit of scarce physical and intellectual resources be assembled so as to minimize cost; make use of the talents of every individual; provide for the needs and tastes of every consumer; encourage technical innovation, creativity, and social development; and do all this in a way that can be sustained?

This question is worthy of scholarly effort, and those who struggle with the answer are surely deserving of respect. The trouble is this: the methods used by much of mainstream economics have little to do with acting people, and so these methods do not yield conclusions that have the ring of truth. This does not have to be the case.

The central questions of economics have concerned the greatest thinkers since ancient Greece. And today, economic thinking is broken into many schools of thought: the Keynesians, the Post Keynesians, the New Keynesians, the Classicals, the New Classicals (or Rational Expectations School), the Monetarists, the Chicago Public Choicers, the Virginia Public Choicers, the Experimentalists, the Game Theorists, the varying branches of Supply Sideism, and on and on it goes.

Also part of this mix, but in many ways apart from and above it, is the Austrian School. It is not a field within economics, but an alternative way of looking at the entire science. Whereas other schools rely primarily on idealized mathematical models of the economy, and suggest ways the government can make the world conform, Austrian theory is more realistic and thus more socially scientific.

Austrians view economics as a tool for understanding how people both cooperate and compete in the process of meeting needs, allocating resources, and discovering ways of building a prosperous social order. Austrians view entrepreneurship as a critical force in economic development, private property as essential to an efficient use of resources, and government intervention in the market process as always and everywhere destructive.

The Austrian School is in a major upswing today. In academia, this is due to a backlash against mathematization, the resurgence of verbal logic as a methodological tool, and the search for a theoretically stable tradition in the madhouse of macroeconomic theorizing. In terms of policy, the Austrian School looks more and more attractive, given continuing business-cycle mysteries, the collapse of socialism, the cost and failure of the welfare-warfare regulatory State, and public frustration with big government.

In its 12 decades, the Austrian School has experienced different levels of prominence. It was central to the price theory debates before the turn of the century, to monetary economics in the first decade of the century, and to the controversy over socialism’s feasibility and the source of the business cycle in the 1920s and 1930s. The school fell into the background from the 1940s to the mid-1970s, and was usually mentioned only in history of economic thought textbooks.

The proto-Austrian tradition dates from the 15th-century Spanish Scholastics, who first presented an individualist and subjectivist understanding of prices and wages. But the formal founding of the school dates from the 1871 publication of Carl Menger’s Principles of Economics, which changed economists’ understanding of the valuing, economizing, and pricing of resources, overturning both the Classical and the Marxian view in the “marginal revolution.”

Menger also generated a new theory of money as a market institution, and grounded economics in deductive laws discoverable by the methods of the social sciences. Menger’s book, said Ludwig von Mises, made an economist of him, and it is still of great value.

Eugen von Böhm-Bawerk was the next important figure in the Austrian School. He showed that interest rates, when not manipulated by a central bank, are determined by the time horizons of the public, and that the rate of return on investment tends to equal the rate of time preference. He also dealt a deadly blow to Marx’s theory of capital and exploitation, and was a key defender of theoretical economics at a time when historicists of every stripe were trying to destroy it.

Böhm-Bawerk’s greatest student was Ludwig von Mises, whose first major project was the development of a new theory of money. The Theory of Money and Credit, published in 1912, elaborated on Menger, showing not only that money had its origin in the market, but that there was no other way it could have come about. Mises also argued that money and banking ought to be left to the market, and that government intervention can only cause harm.

In that book, which remains a standard work today, Mises also sowed the seeds of his business-cycle theory. He argued that when the central bank artificially lowers interest rates, it causes distortions in the capital-goods sector of the structure of production. When malinvestments occur, an economic downturn is necessary to wash out bad investments.

Along with his student F.A. Hayek, Mises established the Austrian Institute for Business Cycle Research in Vienna, and he and Hayek showed that the central bank is the source of the business cycle. Their work eventually proved to be most effective in combating Keynesian experiments in fine-tuning the economy through fiscal policies and the central bank.

The Mises-Hayek theory was dominant in Europe until Keynes won the day by arguing that the market itself is responsible for the business cycle. It didn’t hurt that Keynes’s theory advocating more spending, inflation, and deficits was already being practiced by governments around the world.

At the time of the business cycle debate, Mises and Hayek were also involved in a controversy over socialism. In 1920, Mises had written one of the most important articles of the century: “Economic Calculation in the Socialist Commonwealth,” followed by his book, Socialism. Until then, there had been many critiques of socialism, but none had challenged socialists to explain how their economy would actually work absent free prices and private property.

Mises argued that rational economic calculation requires a profit-and-loss test. If a firm makes a profit, it is using resources efficiently; if it makes a loss, it is not. Without such signals, the economic actor has no way to test the appropriateness of his decisions. He cannot assess the opportunity costs of this or that production decision. Prices and the profit-and-loss corollary are essential. Mises also showed that private property in the means of production is necessary for these prices to be generated.

Socialism holds that the means of production should be in collective hands. This means no buying or selling of capital goods and thus no prices for them. Without prices, there is no profit-and-loss test. Without accounting for profit and loss, there can be no real economy. Should a new factory be built? Under socialism, there is no way to tell. Everything becomes guesswork.

Mises’s essay ignited a debate all over Europe and America. One top socialist, Oskar Lange, conceded that prices are necessary for economic calculation, but he said that central planners could generate prices out of their own heads, watch the length of lines at stores to determine consumer demand, and provide the signals of production themselves. Mises countered that “playing market” wouldn’t work either; socialism, by its own internal contradictions, had to fail.

Hayek used the occasion of the calculation debate to elaborate upon and broaden the Misesian argument into his own theory of the uses of knowledge in society. He argued that the knowledge generated by the market process is inaccessible to any single human mind, especially that of the central planner. The millions of decisions required for a prosperous economy are too complex for any one person to comprehend. This theory became the basis of a fuller theory of the social order that occupied Hayek for the rest of his academic life.

Mises came to the US after fleeing the Nazis and was taken in by a handful of free-market businessmen, preeminently Lawrence Fertig. Here he helped build a movement around his ideas, and most free-market economists acknowledge their debt to him. No one, as Milton Friedman has said, did as much as Mises to promote free markets in this country. But those were dark times. He had trouble finding the paid university post he deserved, and it was difficult to get a wider audience for his views.

During these early years in America, Mises worked to rewrite his just completed German-language treatise into Human Action, an all-encompassing work for English-language audiences. In it, he carefully reworked the philosophical grounding of the social sciences in general and economics in particular. This proved to be a significant contribution: long after the naïve dogmas of empiricism have failed, Mises’s “praxeology,” or logic of human action, continues to inspire students and scholars. This magnum opus swept aside Keynesian fallacies and historicist pretensions and ultimately made possible the revival of the Austrian School.

Until the 1970s, however, it was hard to find a prominent economist who did not share the Keynesian tenets: that the price system is perverse, that the free market is irrational, that the stock market was driven by animal spirits, that the private sector should not be trusted, that government is capable of planning the economy to keep it from falling into recession, and that inflation and unemployment are inversely related.

One exception was Murray N. Rothbard, another great student of Mises, who wrote a massive economic treatise in the early 1960s called Man, Economy, and State. In his book, Rothbard added his own contributions to Austrian thought. Similarly, the work of two other important students of Mises, Hans F. Sennholz and Israel Kirzner, carried on the tradition. And Henry Hazlitt, then writing a weekly column for Newsweek, did more than anybody to promote the Austrian School, and made contributions to the school himself.

The stagflation of the 1970s undermined the Keynesian School by showing that it was possible to have both high inflation and high unemployment at the same time. The Nobel Prize that Hayek received in 1974 for his business-cycle research with Mises caused an explosion of academic interest in the Austrian School and free-market economics in general. A generation of graduate students began studying the work of Mises and Hayek, and that research program continues to grow. Today, the Austrian School is most fully embodied in the work of the Mises Institute.

The concepts of scarcity and choice in a world of uncertainty lie at the heart of Austrian economics. Man is constantly faced with a wide array of choices. Every action implies forgone alternatives or costs. And every action, by definition, is designed to improve the actor’s lot from his point of view. Moreover, every actor in the economy has a different set of values and preferences, different needs and desires, and different time schedules for the goals he intends to reach.

The needs, tastes, desires, and time schedules of different people cannot be added to or subtracted from other people’s. It is not possible to collapse tastes or time schedules onto one curve and call it consumer preference. Why? Because economic value is subjective to the individual.

Similarly, it is not possible to collapse the complexity of market arrangements into enormous aggregates. We cannot, for example, say the economy’s capital stock is one big blob summarized by the letter K and put that into an equation and expect it to yield useful information. The capital stock is heterogeneous. Some capital may be intended to create goods for sale tomorrow and others for sale in 10 years. The time schedules for capital use are as varied as the capital stock itself. Austrian theory sees competition as a process of discovering new and better ways to organize resources, one that is fraught with errors but that is constantly being improved.

This way of looking at the market is markedly different from every other school of thought. Ever since Keynes, economists have developed the habit of constructing parallel universes having nothing to do with the real world. In these universes, capital is homogeneous, and competition is a static end state. There are the right number of sellers, prices reflect the costs of production, and there are no excess profits. Economic welfare is determined by adding up the utilities of all individuals in society. The passing of time is rarely accounted for, except in changing from one static state to another. Varying time schedules of producers and consumers are simply nonexistent. Instead, we have aggregates that give us precious little information at all.

A conventional economist is quick to agree that these models are unrealistic—ideal types to be used as mere tools of analysis. But this is disingenuous, since these same economists use these models for policy recommendations.

One obvious example of basing policy on contrived models of the economy takes place at the Justice Department’s antitrust division. There the bureaucrats pretend to know the proper structure of industry, what kinds of mergers and acquisitions harm the economy, who has too much market share or too little, and what the relevant market is. This represents what Hayek called the pretense of knowledge.

The correct relationship between competitors can only be worked out through buying and selling, not bureaucratic fiat. Austrian economists, in particular Rothbard, argue that the only real monopolies are created by government. Markets are too competitive to allow any monopolies to be sustained.

Another example is the idea that economic growth can be manufactured by manipulating aggregate demand curves through more and faster government spending—considered to be a demand booster instead of a supply reducer or government bullying of the consuming public.

If the hallmark of conventional economics is unrealistic models, the hallmark of Austrian economics is a profound appreciation of the price system. Prices provide economic actors with critical information about the relative scarcity of goods and services. It is not necessary for consumers to know, for example, that a disease has swept the chicken population to know that they should economize on eggs. The price system, by making eggs more expensive, informs the public of the appropriate behavior.

The price system tells producers when to enter and leave markets by relaying information about consumer preferences. And it tells producers the most efficient, that is, the least costly way to assemble other resources to create goods. Apart from the price system, there is no way to know these things.

But rational prices must be generated by the free market. They cannot be made up the way the Government Printing Office makes up the prices for its publications. They cannot be based on the costs of production in the manner of the Post Office. Those practices create distortions and inefficiencies. Rather, prices must grow out of the free actions of individuals in a juridical setting that respects private property.

Neoclassical price theory, as found in most graduate texts, covers much of this territory. But typically, it takes for granted the accuracy of prices apart from their foundation in private property. As a result, virtually every plan for reforming the post-socialist economies talked about the need for better management, loans from the West, new and different forms of regulation, and the removal of price controls, but not private property. The result was the economic equivalent of a train wreck.

Free-floating prices simply cannot do their work apart from private property and concomitant freedom to contract. Austrian theory sees private property as the first principle of a sound economy. Economists in general neglect the subject, and when they mention it, it is to find a philosophical basis for its violation.

The logic and legitimacy of “market failure” analysis, and its public-goods corollary, is widely accepted by non-Austrian schools of thought. The notion of public goods is that they cannot be supplied by the market, and instead must be supplied by government and funded through its taxing power. The classic case is the lighthouse, except that, as Ronald Coase has shown, private lighthouses have existed for centuries. Some definitions of public goods can be so broad that, if you throw out common sense, everyday consumer goods qualify.

Austrians point out that it is impossible to know whether or not the market is failing without an independent test, of which there is none outside the actions of individuals. The market itself is the only available criterion for determining how resources ought to be used.

Let’s say I deem it necessary, for various social reasons, that there be one barber for every 100 people and, as I look around, I notice that this is not the case. Thus I might advocate that a National Endowment for Barbers be established to increase the barber supply. But the only means for knowing how many barbers there ought to be is the market itself. If there are fewer than one per hundred, we must assume that a larger number is not supposed to exist by any reasonable standard of efficient markets. It is not economically proper to develop a wish list of jobs and institutions that stands apart from the market itself.

Conventional economics teaches that if the benefits or costs of one person’s economic decisions spill over onto others, an externality exists, and it ought to be corrected by the government through redistribution. But, broadly defined, externalities are inherent in every economic transaction because costs and benefits are ultimately subjective. I may be delighted to see factories belching smoke because I love industry. But that does not mean I should be taxed for the privilege of viewing them. Similarly, I may be offended that most men don’t have beards, but that doesn’t mean that the clean-shaven ought to be taxed to compensate me for my displeasure.

The Austrian School redefines externalities as occurring only with physical invasions of property, as when my neighbor dumps his trash in my yard. Then the issue becomes crime. There can be no value-free adding-up of utilities to determine subjective costs or benefits of economic activity. Instead, the relevant criterion should be whether economic actions occur in a peaceful manner.

Another area where Austrians differ is how the government is supposed to go about the practical problem of correcting for market failures. Granted that somehow the government can spot a market failure, the burden of proof is still on the government to demonstrate that it can perform the task more efficiently than the market. Austrians would refocus the energy that goes into finding market failures to understanding more about government failures.

But the failure of government to do what mainstream theory says it can is not a popular subject. Outside of the Public Choice schools, it is usually assumed that the government is capable of doing anything it wants to do, and of doing it well. Forgotten is the nature of the State as an institution with its own pernicious designs on society. One of the contributions of Rothbard was to focus Austrians on this point, and on the likely patterns interventions will take. He developed a typology of interventionism, and provided detailed critiques of many kinds of interventions and their consequences.

The question is often asked, in James Buchanan’s famous phrase, What Should Economists Do? Mainstreamers answer, in part: forecast the future. This goal is legitimate in the natural sciences, because rocks and sound waves do not make choices. But economics is a social science dealing with people who make choices, respond to incentives, change their minds, and even act irrationally.

Austrian economists realize that the future is always uncertain, not radically so, but largely. Human action in an uncertain world with pervasive scarcity poses the economic problem in the first place. We need entrepreneurs and prices to help overcome uncertainty, although this can never be done completely.

Forecasting the future is the job of entrepreneurs, not economists. This is not to say that Austrian economists cannot expect certain consequences of particular government policies. For example, they know that below-market price ceilings always and everywhere create shortages, and that expansions of the money supply lead to general price increases and the business cycle, even if they cannot know the time and exact nature of these expected events.

One final area of theoretical concern that distinguishes Austrians from the mainstream is economic statistics. Austrians are critical of the substance of most existing statistical measures of the economy. They are also critical of the uses to which they are put. Take, for example, the question of price elasticities, which supposedly measure consumer responsiveness to changes in price. The problem lies in the metaphor and its applications. It suggests that elasticities exist independent of human action, and that they can be known in advance of experience. But measures of historical consumer behavior do not constitute economic theory.

Another example of a questionable statistical technique is the index number, the prime means by which the government calculates inflation. The problem with index numbers is that they obscure relative price changes among goods and industries, and relative price changes are of prime importance. This is not to say the Consumer Price Index is irrelevant, only that it is not a solid indicator, is subject to wide abuse, and masks highly complex price movements between sectors.

And the Gross Domestic Product statistic is riddled with composition fallacies inherent in the Keynesian model. Government spending is considered part of aggregate demand, and no effort is made to account for the destructive costs of taxation, regulation, and redistribution. If Austrians had their way, the government would never collect another economic statistic. Such data are used primarily to plan the economy.

For Austrians, economic regulation is always destructive of prosperity because it misallocates resources and is extremely destructive of small business and entrepreneurship.

Environmental regulation has been among the worst offenders in recent years. Nobody can calculate the extraordinary losses associated with the Clean Air Act or the absurdities associated with wetlands or endangered species policies. However, environmental policy can do what it is explicitly intended to do: lower standards of living.

But antitrust policy, in contrast to its stated policy, does not generate competitiveness. Such bogeymen as predatory pricing still scare the bureaucrats at Justice, whereas simple economic analysis can refute the idea that a competitor can sell below his cost of production to take over the market and then sell at monopoly prices later. Any firm that attempts to sell below the costs of production will indefinitely suffer losses. The moment it attempts to raise prices, it invites competitors back into the market.

Civil-rights legislation represents one of the most intrusive regulatory interventions in labor markets. When employers are not able to hire, fire, and promote based on their own criteria of merit, dislocations occur within the firm and in labor markets at large. Moreover, civil rights legislation, by creating legal preferences for some groups, undermines the public’s sense of fairness that is the market’s hallmark.

There is another cost of economic regulation: it impedes the entrepreneurial discovery process. This process is based on having a wide array of alternatives open to the use of capital. Yet government regulation limits the options of entrepreneurs, and erects barriers to the exercise of entrepreneurial talent. Safety, health, and labor regulations, for example, not only inhibit existing production, they impede the development of better production methods.

Austrians have also developed impressive critiques of redistributionism. Conventional welfare theory argues that if the law of diminishing marginal utility is true, then total utility can be easily increased. If you take a dollar from a rich man, his welfare is slightly diminished, but that dollar is worth less to him than to a poor man. Thus, redistributing a dollar from a rich man to a poor man increases the total utility between the two. The implication is that welfare can be maximized through perfect income equality. The problem with this, say Austrians, is that utilities cannot be added and subtracted, since they are subjective.

Redistributionism takes from property owners and producers and gives, by definition, to nonowners and nonproducers. This diminishes the value of the property that has been redistributed. Far from increasing total welfare, redistributionism diminishes it. By making property and its value less secure, income transfers lessen the benefits of ownership and production, and thus lower the incentives to both.

Austrians reject the use of redistribution to stimulate the economy or otherwise manipulate the structure of economic activity. Increasing taxes, for example, can do nothing but harm. A shorthand for taxes is wealth destruction. They forcibly confiscate property that could otherwise be saved or invested, thus lowering the number of consumer options available. Moreover, there is no such thing as a strict consumer tax. All taxes decrease production.

Austrians do not go along with the view that deficits don’t matter. In fact, the requirement that deficits be financed by the public or foreign bond holders drives up interest rates and thus crowds out potential private investment. Deficits also create the danger that they will be financed through central-bank inflation. Yet the answer to deficits is not to increase taxation, which is more destructive than deficits, but rather to balance the budget through necessary spending cuts. Where to cut? Anywhere and everywhere.

The ideal situation is not simply a balanced budget. Government spending itself, regardless of deficit or surplus, should be as small as possible. Why? Because such spending diverts resources from better uses in private markets.

We hear talk of this or that “government investment.” Austrians reject this term as an oxymoron. Real investment is taken on by capitalists risking their own money in hopes of satisfying future consumer demands. Government limits the satisfaction of consumer demands by hampering production in the private sector. Besides, government investments are notorious wastes of money, and are in fact consumption spending by politicians and bureaucrats.

Mainstream economists hold that the government must control monetary policy and the structure of banking through cartels, deposit insurance, and a flexible fiat currency. Austrians reject this entire paradigm, and argue that all are better controlled through private markets. In fact, to the extent that today we have serious and radical proposals for having the market play a greater role in banking and monetary policy, it is due to the Austrian School.

Deposit insurance has been on the public mind since the collapse of the S&L industry. The government guarantees deposits and loans with taxpayer money, so this makes financial institutions less careful. Government effectively does to financial institutions what a permissive parent does to a child: encourages poor behavior by eliminating the threat of punishment.

Austrians would eliminate compulsory deposit insurance, and not only allow bank runs to occur, but appreciate their potential as a necessary check. There would be no lender of last resort, that is, the taxpayer, in an Austrian monetary regime, to bail out bankrupt and illiquid institutions.

Much of the Austrian critique of central banking centers around the Mises-Hayek business cycle theory. Both argued that the central bank, and not the market itself, is responsible for the cyclical behavior of business activity. To illustrate the theory, Austrians have undertaken extensive studies of many historical periods of recession and recovery to show that each was preceded by central-bank machinations.

The theory argues that central-bank efforts to lower interest rates below the free-market’s level causes borrowers in the capital goods industry to overinvest in their projects. A lower interest rate is normally a signal that consumers’ savings are available to back up new production. That is, if a producer borrows to build a new building, there is enough savings for consumers to buy the goods and services that will be made in the building. Projects undertaken can be sustained. But artificially lowered interest rates lead businesses into undertaking unnecessary projects. This creates an artificial boom followed by a bust, once it is clear that savings weren’t high enough to justify the degree of expansion.

Austrians point out that the Monetarists’ growth rule ignores the “injection effects” of even the smallest increase in money and credit. Such an increase will always create this business-cycle phenomenon, even if it works to maintain a relatively stable index number, as in the 1920s and 1980s.

What then should policy makers do when the economy enters recession? Mostly, nothing. It takes time to wipe out the malinvestment created by the credit boom. Projects that were undertaken have to go bankrupt, employees mistakenly hired must lose their jobs, and wages must fall. After the economy is cleansed of the bad investments induced by the central bank, growth can begin anew, based on a realistic assessment of the future behavior of consumers.

If the government wants to make the recovery process work faster if, say, there is an election coming up, there are some things it can do. It can cut taxes, putting more wealth into private hands to fuel the recovery process. It can eliminate regulations, which inhibit private-sector growth. It can cut spending and reduce the demand on credit markets. It can repeal antidumping laws, and cut tariffs and quotas, to allow consumers to buy imported goods at cheaper prices.

Central banking also creates incentives toward inflationary monetary policies. It is not a coincidence that ever since the creation of the Federal Reserve System, the value of the dollar has declined 98 percent. The market did not make this happen. The culprit is the central bank, whose institutional logic drives it toward an inflationary policy, just as a counterfeiter is driven to keep his printing press running.

Austrians would reform this in fundamental ways. Rothbardians advocate a return to a 100-percent gold coin standard, an end to fractional-reserve commercial banking, and the abolition of the central bank, while Hayekians advocate a system where consumers select currencies from a variety of alternatives.

Today, Austrian economics is on the upswing. Mises’s works are read and discussed all over Western and Eastern Europe and the former Soviet Union, as well as Latin America and North Asia. But the new interest in America, where the insights of the Austrian School are even more sorely needed, is especially encouraging.

The success of the Ludwig von Mises Institute is testimony to this new interest. The primary purpose of the Institute is to ensure that the Austrian School is a major force in the economic debate. To this end, we have cultivated and organized hundreds of professional economists, provided scholarly and popular outlets for their work, educated thousands of graduate students in Austrian theory, distributed millions of publications, and formed intellectual communities where these ideas thrive.

Every year we hold a summer instructional seminar on the Austrian School, called the Mises University, with a faculty of more than 25, and top-flight students from around the country. We also hold academic conferences on theoretical and historical subjects, and the Institute’s scholars are frequent participants at major professional meetings. The Mises Institute assists students and faculty at hundreds of colleges and universities. We have a program for visiting fellows to complete dissertations, and for visiting scholars to pursue new research, as well as being a major center for graduate students.

New books on the Austrian School appear every few months, and Austrians are writing for all the major scholarly journals. Misesian insights are presented in hundreds of economics classrooms all over the country (whereas just 20 years ago, no more than a dozen classrooms presented them). Austrians are the rising stars in the profession, the economists with the new ideas that attract students, the ones on the cutting edge with a promarket and antistatist orientation.

Most of these scholars have been cultivated through the Mises Institute’s academic conferences, publications, and teaching programs. With the Institute backing the Austrian School, tradition and constructive radicalism combine to create an attractive and intellectually vibrant alternative to conventional thought.

The future of Austrian economics is bright, which bodes well for the future of liberty itself. For if we are to reverse the trends of statism in this century, and reestablish a free market, the intellectual foundation must be the Austrian School. That is why Austrian economics matters.

THE VIABILITY OF THE GOLD STANDARD

[This speech was delivered at the Burton S. Blumert Gold Conference in San Mateo, California, September 14, 2002.]

In the 19th century, notes Murray N. Rothbard, debates on monetary issues were highly public and intensely controversial. Do you favor the national bank? The gold standard? Bimetallism? What is your opinion of the free silver movement? What is most important: a highly liquid money stock that can prop up commodity prices, or a sound dollar that promotes thrift and discourages debt accumulation? Should the monetary system reward debtors or creditors?

These were issues debated in the nation’s newspapers, discussed in political meetings, and raged on in the streets. Every educated man had an opinion. Part of the reason is that, frankly, people were much better educated in those days. It is astonishing to imagine today, but average people had the mental equipment to enable them to understand these complicated issues, if not always to arrive at the right conclusions.

The federal government had long been involved in money precisely because this is one of the first areas a government likes to get its grubby hands on when it takes power. The US government was no exception, despite constitutional provisions that would appear to restrict its monetary power.

Matters are radically different today. It is very rare to ever see an article addressing the money question in the nation’s newspapers. Debates and discussions are left to the academic journals or the self-published tracts of money cranks—with the major exception of the Austrian economists, who continue to believe that the money issue is both academically important and politically crucial.

This is why the Mises Institute has been sponsoring research and writing on the gold standard, and promoting an idea that most public intellectuals find absurdly anachronistic: that a gold standard is better than our current monetary system. What’s more, we not only believe that the gold standard had a better record historically, we believe that we ought to institute a gold standard right now.

Even many libertarians find themselves mystified by our focus. Who cares about these arcane issues of monetary policy? What does it have to do with the fate of human liberty? Could we pick a policy agenda that is more unlikely to come about? Are we just gluttons for political failure? Why not trim our ambitions to political reality?

It is true that not a soul in Washington apart from our heroic Congressman from Texas, Ron Paul, says a word about the gold standard. Even Alan Greenspan, who once wrote that freedom is inseparable from the gold standard, dreads being asked about the subject. To him, it is entirely theoretical with no practical import. In any case, he doesn’t want people looking too closely at the kinds of things he does at the Fed, any more than the Wizard of Oz wanted anyone to pull back the curtain.

Most economists have no interest in the issue. What’s more, the most influential economist of the last century, John Maynard Keynes, hated the gold standard with astonishing intensity, and he considered it his great accomplishment in life to have assisted in its destruction. Even to this day, his influence is immense, with most economists accepting the broad framework he laid out in his work, and sharing his conviction that the worst thing that could befall any society is for the government to lose its power to manage economic life.

There are many objections to the conventional view of the gold standard, but let me just respond to the point about realism. There are a lot of policies which seem unrealistic to promote. We can admit that there is little prospect that the post office will be privatized anytime soon, but that fact does not diminish our responsibility to push the idea. Nothing could be more obvious than admitting that private enterprise would do a better job of delivering letters than the government. But if no one says it—if people are not willing to state what is true, again and again—all hope for change is lost. And sometimes, just stating what is true is enough to bring about change when conditions are ripe for it.

In the debate on the post office, we have the added advantage of being able to point to a superior and very well developed sector of private package and letter delivery. The reason it is thriving is due to loopholes in the law, which these companies exploit. If the letter statutes were repealed, I have no doubt that first-class letters would be deliverable by private enterprise within days. That is precisely why the post office is so anxious to hold onto its legal privileges.

In any case, as with the gold standard, it might be said that advocating privatization is politically unrealistic and therefore a waste of time. What’s more, we might say that by continuing to harp on the issue, we only marginalize ourselves, proving that we are on the fringe. Again, I submit that there is no better way to assure that an issue will always be off the table than to stop talking about it.

This applies to the gold standard too. The case for radical monetary reform is as obvious as the need to sell the post office. Every year or 18 months, the world goes through some sort of monetary convulsion. In the last 10 years, we’ve seen it in Mexico, all through Asia, and now Latin America. To one degree or another, there are few problems of international economics that are not traceable to the grave limitations of a world fiat money system.

This includes the problem of the business cycle itself. In the 2001 and following economic downturn, unlike any I can remember, the Austrian theory of the trade cycle has received a fantastic amount of public commentary and attention. The core idea of this theory is that Fed-created credit is responsible for the boom and bust, and it has been embraced by top economists at some of the largest and most prestigious investment houses.

The Mises Institute has done a fine job in getting the word out about the true cause of the business cycle, but the real reason it is getting such attention is that it provides such a compelling explanation of the 1990s bubble and the later crisis. Neither do most of these economists doubt that financial bubbles would not be a problem under the gold standard, even if they believe the gold standard introduces problems of its own.

Far from being an arcane and anachronistic issue, then, we can see that the gold standard and the issues it raises get right to the heart of the current debate concerning the future of the world economy and its reform. What the critics who denounce gold are really saying is that the government and its friends don’t like the idea of the gold standard, so therefore they are not going to favor one.

Why do the government and its partisans dislike the gold standard? It removes the discretionary power of the Fed by placing severe limits on the ability of the central bank to inflate the money supply. Without that discretionary power, the government has far fewer tools of central planning at its disposal. Government can regulate, which is a function of the police power. It can tax, which involves taking people’s property. And it can spend, which means redistributing other people’s property. But its activities in the financial area are radically curbed.

Think of your local and state governments. They tax and spend. They manipulate and intervene. As with all governments from the beginning of time, they generally retard social progress and muck things up as much as possible. What they do not do, however, is run huge deficits, accumulate trillions in debt, reduce the value of money, bail out foreign governments, provide endless credits to failing enterprises, administer hugely expensive and destructive social insurance schemes, or bring about immense swings in business activity.

State and local governments are awful, and they must be relentlessly checked, but they are not anything like the threat of the federal government. Neither are they as arrogant and convinced of their own infallibility and indispensability. They lack the aura of invincibility that the central government enjoys.

Why is this? You might say it is because the federal government already does these things, but no government has ever been troubled by the prospect of providing redundant services. You might say that state-level constitutions restrict their activities, but our experience with the federal government demonstrates that constitutions can’t restrain a government by themselves. The main reason, I believe, is that the state and local governments do not issue their own currencies controlled by central banks.

It is the central bank, and only the central bank, that works as the government’s money machine, and this makes all the difference. Now, it is not impossible that a central bank can exist alongside a gold standard, a lender of last resort that avoids the temptation to destroy that which restrains it. In the same way, it is possible for someone with an insatiable appetite to sit at a banquet table of delicious food and not eat.

Let’s just say that the existence of a central bank introduces an occasion of sin for the government. That is why, under the best gold standard, there would be no central bank, gold coins would circulate as freely as their substitutes, and rules against fraud and theft would prohibit banks from pyramiding credit on top of demand deposits. As long as we are constructing the perfect system, all coinage would be private. Banks would be treated as businesses, no special privileges, no promises of bailout, no subsidized insurance, and no connection to government at any level.

This is the free-market system of monetary management, which means turning over the institution of money entirely to the market economy. As with any institution in a free society, it is not imposed from above, dictated by a group of experts, but is the de facto result that comes about in a society that consistently respects private-property rights and encourages enterprise.

Money is not something chosen by social managers but the consequence of economic development as society moves from barter to indirect exchange. One commodity that is widely in demand comes to operate as a medium of exchange, a commodity for which any good or service can be traded with the expectation that this commodity will be demanded by others in future exchanges. Precious metals, gold in particular, have traditionally served as the money of choice.

As Rothbard explained, the institutions we call banks serve a dual function in a free-market system. First, they provide safekeeping for one’s money, and offer money substitutes that they certify really do represent money in the vault. And second, they provide credit services, both to savers who would like to see money risked in the loan market and to borrowers who need cash for purposes of consumption or investment. The banks work as brokers between these parties to effect mutually beneficial exchanges.

If any market-chosen commodity can perform the function of money, why are we Austro-libertarians focused on gold? It is often said that we have an obsession with gold and a fixation on the subject of money. To some degree, however, this alleged obsession has been shared by popular culture and by financial markets, as a continuing testimony to the power of the idea of gold as a guarantor of value.

Whenever a writer wants to convey the idea that something sets the highest standard, he refers to it as the gold standard. I was amused the other day to read in the London Daily Telegraph an article on grade inflation in British schools, in which the writer counterpoised the grading gold standard of the past. The metaphor seems quite apt.

As for financial markets, events this year have again underscored the underlying obsession, if you want to call it that, that the world’s financial markets have with gold. It is not a coincidence that gold-mining stocks were the best performing during the bust period of this business cycle. And earlier this summer, we saw spot prices of gold begin to move very rapidly in response to the growing perception that the financial sector was far from bottoming out. Try as it might, the establishment just can’t seem to crush the perception that gold is more reliable than government’s paper money.

Indeed, gold continues to be seen as a standard of soundness, as the commodity to flee to in times of emergency, as the last store of value that can be counted on. Neither are these emergencies unknown in the modern world. In Latin America this summer, we witnessed governments prohibiting withdrawals from banks during financial crises, just as we saw in the early days of the Great Depression in the United States. Gold continues to be perceived as a safe haven from the wiles of political opportunism and violence.

J. Bradford DeLong, former assistant US Treasury Secretary, wrote the following just the other day:

Eighty years ago, John Maynard Keynes argued that governments needed to take responsibility for maintaining full employment and price stability, that the pre-World War I gold standard had not been the golden age people thought it was, and that its successes were the result of a lucky combination of circumstances unlikely to be repeated. Keynes was an optimist in believing that governments could learn to manage the business cycle.

DeLong continues to point out that the record of post-gold currencies has been a disaster as compared with their promise.

In this respect, fiat currency has much in common with socialism. They both failed to live up to their promises, and, indeed, failed miserably by every standard. But they both long outlived their failures, simply because political elites had too much invested in them to change the system, and the intellectual class worked overtime to shore up support for the failed system. Eventually, of course, full-blown socialism collapsed, just as I believe that fiat currency systems will.

Murray Rothbard has written:

It might be thought that the mix of government and money is too far gone, too pervasive in the economic system, too inextricably bound up in the economy, to be eliminated without economic destruction.... In truth, taking back our money would be relatively simple and straightforward, much less difficult than the daunting task of denationalizing and decommunizing the Communist countries of Eastern Europe and the former Soviet Union.

And for all the reasons that gold eventually emerged as the money of choice thousands of years ago, it continues to have the properties that make it the best money of choice today. It is portable, divisible, fungible, durable, and has a high ratio of value per unit of weight. It is as compatible with today’s economy, driven by information technology and lightning quick financial transactions, as it was compatible with the 19th-century economy of heavy industry and agriculture. It is not technical limitations that prevent the dollar from being redefined as a unit weight of gold, but political ones.

The monetary benefits of a gold standard are clear enough, and they include life without inflation, an end to the business cycle, rational economic calculation in accounting and international trade, an encouragement to savings, and a dethroning of the government-connected financial elite.

But it is also political considerations that draw people to support the gold standard. Gold limits the power of the State and puts power back in the hands of the people.

Once you begin to understand the role of the monetary regime in the building of the modern statist enterprise—in providing the means of funding for the entire welfare-warfare state, in generating financial instability, in destroying savings, and undermining living standards—you realize that there is far too little interest in the subject in the mainstream press. You begin to realize that the 19th-century focus on the money issue was entirely appropriate.

Once having read Mises or Rothbard or any number of great monetary theorists, you begin to realize that understanding the monetary regime is the key that unlocks the mysteries of political control in our time. The Fed was created not to scientifically manage the economy—as the journals claimed at the time—but because it met the institutional needs of both the government and the banking industry. The government sought a means of finance that didn’t depend on taxation, and the banking industry sought what Rothbard called a cartelization device. That is to say, the banking industry was seeking some way to prevent competitive pressures between banks from limiting their ability to expand credit.

Well, the central bank fit the bill. A central bank managing a currency that is not tied to anything real fits the bill even better. If a little power to inflate is good for the government and its connected banking and financial interests, a lot of power to inflate is even better. For this reason, it was very likely that the gold standard could not have survived the creation of a central bank, and, for the same reason, the creation of a new gold standard will have to do away with the central bank that would always threaten to bring it down.

The power to create fiat money is the most ominous power ever bestowed on any human being. This power is rightly criminalized when it is exercised by private individuals, and even today, everyone knows why counterfeiting is wrong and knavish. Far fewer are aware of the role of the federal government, the Fed, and the fiat dollar in making possible the largest counterfeiting operation in human history, which is called the world dollar standard. Fewer still understand the connection between this officially sanctioned criminality and the business cycle, the rise and collapse of the stock market, and the continued erosion of the value of the dollar.

In fact, a sizeable percentage of even educated adults would be astounded to discover that the Federal Reserve does more than manage the nation’s money accounts. In fact, its main activity consists in actually creating money that distorts production and creates inflation and the business cycle. In fact, I would go further to suggest that many educated adults believe that gold continues to serve as the ultimate backing of our monetary system, and would be astonished to discover that our money is backed by nothing but more of itself.

We have our work cut out for us, to be sure, mainly at the educational level. We must continue to state the obvious at every opportunity, that the fiat system is exactly what it is, a system of paper money backed by nothing of real value. We must continue to point out that because of this, our economic system is not depression-proof, but rather highly vulnerable to complete meltdown. We must continue to draw attention to the only long-term solution: a complete separation of money and State based on the commodity that the market has always chosen as money, namely, gold.

Apart from making the intellectual case, the biggest obstacle we currently face is that most all theoretically viable plans for radical monetary reform depend heavily on those who are currently in charge of mismanaging our money being the ones to manage a transition. In many ways, this is akin to expecting the politburo to have instituted a free-market economy in Russia before the great counterrevolution. Can we really expect that Alan Greenspan is going to wake up one day and decide to do the right thing? It is possible, but I seriously doubt it.

I recognize that this problem is a real one, but it is no different from the rest of the practical problems of instituting freedom. When we call for spending cuts, we are implicitly calling on Congress to do something that is against its self-interest. When we call for deregulating financial markets, we are expecting the SEC to do the very thing it is least likely to do from a bureaucratic pressure-group perspective. And when we call for sound money, we are similarly expecting those who currently benefit from the present system to have a change of heart and mind, and to act against their own interests.

This takes us back to our original question: is the gold standard history? Is it so preposterously unrealistic to advocate it that we might as well move on to other things? It won’t surprise you that my answer is no. If there is one thing that a long-term view of politics teaches, it is that only the long-term really matters.

Back in 1997–98 you were considered a crabby kook, and behind the times, to warn that the bull market in tech stocks could not last. But economic law intervened, and fashions changed. Back in those days, too, had you suggested that the business cycle had not been repealed, you would have been dismissed out of hand. But economic law intervened.

In the same way, there will come a time when the current money and banking system, living off credit created by a fiat money system, will be stretched beyond the limit. When it happens, attitudes will turn on a dime. No advocate of the gold standard looks forward to the crisis nor to the human suffering that will come with it. We do, however, look forward to the reassertion of economic law in the field of money and banking. When it becomes incredibly obvious that something drastic must replace the current system, new attention will be paid to the voices that have long cast aspersions on the current system and called for a restoration of sound money.

Must a crisis lead to monetary reforms that we will like? Not necessarily, and, for that matter, a crisis is not a necessary precursor to radical reform. As Mises himself used to emphasize, political history has no predetermined course. Everything depends on the ideas that people hold about fundamental issues of human freedom and the place of government. Under the right conditions, I have no doubt that a gold standard can be completely restored, no matter how unfavorable the current environment appears toward its restoration.

What is essential for us today is to continue the research, the writing, the advocacy for sound money, for a dollar that is as good as gold, for a monetary system that is separate from the State. It is a beautiful vision indeed, one in which the people and not the government and its connected interest groups maintain control of their money and its safekeeping.

What has been true for hundreds of years remains true today. The clearest path to the restoration of economic health is the free market undergirded by a sound monetary system. The clearest path toward economic destruction is for us to stop working toward what is right and true.

WHAT CAUSES THE BUSINESS CYCLE?

[This speech was given at the Mises Institute’s “Austrian Economics and Investing” Conference, Vienna, Austria, May 25, 1988. (Some information has been updated.)]

The greatest mystery in the history of economic theory, and still the most unresolved controversy in the economics profession, is the nature and source of the business cycle. Why do recessions occur and why do booms occur? Why do they tend to follow each other with some degree of regularity?

Solving the mystery of the business cycle is a different task than confronted Adam Smith and the classical economists. They sought to answer the question of how economies grow. They concluded that free exchange and capital accumulation are the sources. But the mystery of the business cycle deals with a far more complex problem of why growth seems to occur intermittently. This is a question that only began to absorb economists in the middle of the 19th century.

Part of the reason is that business cycles simply didn’t exist in the prior centuries. We get a clue to the ultimate resolution of this problem by noting that central banks didn’t exist before business cycles began to be noticed. But it took economists a very long time before they put two and two together to understand that it is the activities of the central bank itself that bring about the trade cycle.

Business cycles raise a particular question. It is not why businesses fail. We know that in a vibrant market economy, businesses do fail. Entrepreneurial forecasting ability is not perfect, innovation disrupts plans, and consumer demand is always changing. The only economies where businesses do not fail are stagnant, socialist ones. Thus, to the question of why businesses start and fail, we already have the answer: the market rewards only those who serve the consuming public, and not all businesses do so all the time.

The question that the business cycle asks is different. Why do business errors often occur in clusters? Why do entrepreneurs make mistakes on an aggregate level? Why, if you look at macroeconomic data, do we see these large swings in economic activity that have come to be called booms and busts?

In Karl Marx’s view, the business cycle was an inherent part of the capitalist economic system and a signal of its fundamental instability. He foresaw cycles worsening, with each recession worse than the last, and ultimately leading to the breakdown of capitalism itself. For decades socialists echoed his forecast, and attempted to reinterpret every cycle as a millennial sign that the capitalist system was being trampled by forces of history.

The cycle theories of Marx were far from the only reason his ideas came to be accepted by intellectuals. The real source of attraction to Marxism was its promise of an egalitarian society, one that operated without traditional restraints on economic and sexual behavior. Envy-ridden intellectuals, forever believing themselves to be underpaid and overworked, were attracted to the idea of expropriating the capitalist class and enjoying the proceeds. Since then, these intellectuals have learned they can do this without bringing about the breakdown of capitalism. They can work through Congress and state legislatures to bring about the same result.

The Great Depression seemed to confirm Marx’s view of the business cycle and gave a boost to the socialist cause. Beginning in the early 1930s, a huge debate ensued between market advocates like Henry Hazlitt, author of Economics in One Lesson, and socialist intellectuals writing in the pages of leftist weeklies like the Nation. The socialists pointed to the declining share of the return on capital enjoyed by the workers and the rising profits of the exploiter class. They said that the Great Depression ensued when workers no longer had the means to purchase products of their own making. The only answer, then, is to redistribute property from the capitalists to the workers, and insure that society, as embodied by the State, and not private owners of capital, would control the means of production.

Here again, over time, the socialists learned that it was not necessary to bring about a revolution to achieve this end. Congress, the executive branch, and state legislatures were all that was necessary to prevent owners of capital from controlling the uses of their own property.

For a time, it appeared that the socialist interpretation of the Great Depression was winning out. And even to this day, the interpretation is underscored in John Kenneth Galbraith’s interesting but wrongheaded book on the Great Depression, and in countless PBS documentaries. The fallacy with all of these accounts is that they deal with the downturn, as if it is the only issue worth examining, but not with the larger perspective of the cycle in general. Only by broadening our horizons to understand the boom phase of the cycle as well can we arrive at reasonable conclusions and solid recommendations for minimizing the role of cycles.

In 1936, John Maynard Keynes came out with his General Theory, which came to dominate macroeconomic thinking for decades following. Though his original work is rarely read by professional economists, and virtually never discussed in the classroom setting, the assumptions behind his theory still dominate much of economic thinking.

In Keynes’s theory, like Marx’s, business cycles are an inherent part of the market economy. But he argued it was not necessary to overthrow property and markets in order to control them. The government, working hand in glove with Keynesian economists of course, could pursue policies that would keep business cycles at bay. The problem, said Keynes, was fundamentally twofold.

First, the price system doesn’t work very well or reflect real economic needs. Prices and wages often do not adjust in ways that coordinate the economy. But by manipulating prices, mainly through inflation, the system could be fixed up. Second, the investment sector is fundamentally irrational. Animal spirits periodically sweep through markets, causing businesses to underinvest in things that are needed and overinvest in things that are not.

Keynes offered two ways out of this problem. We can live with the resulting business cycles, but this creates its own problems since the price system is so deeply flawed. Or we can manipulate the demand side of the economy to force it into coordination with the supply side. As a result of this Keynesian-style analysis, the government now had an intellectual justification for the huge New Deal machinery that had been established to manage the economy. After the war, this Keynesian machinery became a permanent part of government policy.

Economists deluded themselves into thinking they could smooth out business cycles by managing countercyclical fiscal and monetary policies. The idea was this: in an economic downturn, the government could goose the money supply and run a deficit to lift the economy back into normalcy. Once recovered, the government would drive up interest rates again and run a budget surplus. It would be as simple as managing the gears on a stick-shift car while driving through mountain terrain.

The result, of course, was far different. In the postwar period, business cycles became progressively worse, with every attempt to manage them seeming to create its own problems, among them inflation, hyperinflation, enormous government debts, and rising deficits. I think we should also include, as a cost of Keynesian policy, the loss of freedom that Americans experience. No longer did we have a government that largely stayed out of economic policy. Rather, we had a government that regarded itself as all-knowing and regarded the market economy as essentially stupid.

It is often said that John Maynard Keynes and the New Deal saved capitalism from itself. In fact, his ideas radically distorted what we call capitalism. The US government is the biggest, most powerful government in human history. To this day, it is involved in every area of American economic life. It has veto power over the hiring and firing decisions of virtually every business in the country. It tells people how old they must be to work, how much they must be paid, what benefits they must be provided, and taxes a third or more of their income. The government regulates, in minute detail, the architecture of every commercial building in the country. With its antitrust laws and taxing power, it can make or break huge corporations. Recently we’ve seen the Justice Department attempt to guide the direction of software development, even threatening to bar the introduction of newer generations of software.

Yet despite all this, the US is widely seen today as the paragon of capitalism. A century-and-a-half ago, all this would have been seen as the embodiment of wild-eyed socialist experimentation. But a century that has been dominated by the State as much as this one has changed everyone’s standards of what constitutes freedom.

Is the business cycle truly a natural part of the free market? Ludwig von Mises explored this question in his 1912 book called the Theory of Money and Credit. He first explored the possibility that discoordinations in gold flows between countries, caused by bad monetary policies, might be the source of booms and busts. And while he concluded that this is the root of international business cycles, he said this doesn’t explain how a business cycle could be created in a single country. In exploring this issue, he went much further in his analysis than any previous thinker.

His resultant theory is called the Austrian theory of the business cycle. The Austrian theory notes that it is crucial to understand the boom times in order to understand the bust. To generate an economic boom, the central bank artificially lowers interest rates, creating the illusion of increased savings. Faced with new credit availability, the business sector borrows to expand production and begin long-term investment projects. The boom continues for as long as interest rates remain artificially held down. Businesses continue to invest in projects for which there is no real, underlying economic demand or rationale. This type of investment is what Mises called malinvestment.

Note that during this period, the increase in money and credit doesn’t necessarily result in higher prices. The monetary inflation is bringing about a fundamental structural change in the economy, but it is not creating any visible ill effects. Production is expanding, unemployment is down, interest rates are low, the stock market is booming, and everyone appears to be getting richer. We can recognize this in the US and Britain in the 1920s, Asia in the 1980s and early 1990s, and quite possibly the US today.

But this boom is not self-sustaining. When businesses bring products to the market at the end of the production process, they are met with consumers who have neither the savings nor the income to purchase them. Once prices eventually do begin to creep up, the discoordinations between the investment and spending sector begin to be revealed. The central bank raises rates to prevent conspicuous declines in the purchasing power of money, and the boom begins to reverse itself. This process can occur over six months or 15 years (Japan). There is no set formula. The timing is largely unpredictable as well, especially in a global economy.

But these business cycles do terrible damage to the economy. They bankrupt businesses that were only trying to follow the market’s signaling devices. Businessmen could not have known with certainty that the Fed was manipulating the signals. Business cycles throw people out of work, not because managers or the owners of businesses were engaged in inefficient production, but because everyone was dealt a bad hand by the money managers at the top of the central bank.

This is essentially what brought about the Great Depression. Throughout the 1920s, the Fed engaged in an expansionist monetary policy, giving stocks, real estate, and heavily capitalized businesses an artificial shot in the arm. When the stock market finally crashed, and the bubble burst, the exaggerated investment was exposed as a fraud. Thus, we can see that it is not the market that is the source of business cycles. Rather, the business cycle is the working out of a market attempting to correct for the failures of central bankers and the government officials who cheer them on.

The central bank has long felt the pressures of politics to keep interest rates unnaturally low. These pressures come from both the president and the Congress. The president, of course, is concerned about keeping rates low before elections. Quite often, presidents are willing to tolerate a recession after election to their first term. But they will not tolerate one leading up to the election itself. The Fed chairman, who frequently proclaims his independence from politics, is in fact utterly dependent on favors from the White House. In order to maintain the Fed’s much ballyhooed independence, it must do what the president wants.

The central bank also faces pressures from its member banks, who profit from the boom created by lower rates.

Congress also has an impact. If we ever see the Fed chairman threatened with investigations into the Fed’s secrecy, or badgered in front of committees, it is nearly always done in times when interest rates are high. Special interest groups—from large manufacturers to farmers—lobby their Congressmen to intervene. There are very few politicians who call the Fed to complain when it is keeping the lid on interest rates.

Of course, the media play a role in the interest-rate conspiracy as well. They are always ready to tell the public about the sad plight of borrowers who are being squeezed by high interest rates. Telling the story of a structure of production that has fallen into misalignment because of artificially low rates just doesn’t make good copy. The media fan the flames during recessions, especially when every business failure is considered to be a national tragedy instead of part of the natural cleansing process of the market economy.

The media also add to the general sense that the boom phase of the cycle is the good phase and the bust is the bad phase. In fact, looked at from an economic perspective, the boom phase is the one that should worry us. It is during these times that borrowers are being misled and economic misalignments are taking place. The bust represents a period of honesty and decency, when at last reality is catching up to the lies that low interest rates have been telling.

The common misperception that economic booms should go on forever is what gives impetus for governments to intervene. But any intervention designed to soften the blow of a recession can only end up prolonging the agony, just as it did during the Great Depression, and as such efforts are doing today in Asia. What should government do during a recession? The short answer is nothing. It should take care to ensure there are no obstacles to the downward adjustment of wages and that the market is free to generate entrepreneurial opportunities, but otherwise it should stay out of the way.

Compare the actions of Warren G. Harding with those of Herbert Hoover. In 1921, the US experienced a major economic downturn, which was a direct result of the inflationized economy of wartime. Unemployment reached 11.7 percent, even as high as 15 percent, and output crashed. This was after unemployment had fallen to 1.4 percent in 1919. Economists generally rank the severity of this depression more extensive than even the one that would follow a decade later.

There was no shortage of advice given to the Harding administration. Henry Ford and Thomas Edison wanted to create fiat money on a huge scale. The secretary of commerce, Herbert Hoover, wanted a massive public-works program. Labor leaders demanded make-work programs.

In the end, however, before these plans could be implemented, the economy began to rebound. By 1922, unemployment was back down to reasonable levels, output was expanding, and the economy was rebounding across the board. This was laissez-faire at work. The politicians could not act fast enough, and thank goodness. The depression was over in a year.

Compare that to the actions of the Hoover administration. Despite his reputation as a do-nothing president, he did far too much. He attempted to keep wages propped up and to stop business failures. He embarked on a massive public works spending program and erected high tariff barriers. He may have been living out a fantasy first developed when he was secretary of commerce, but the economy was the victim. We did not enter recovery as we should have and could have, and instead we got a national socialist as president for four straight terms.

Let me proceed, then, to an analysis of where we are today [1998]. There is no shortage of New Era thinking. The line you read again and again in the pages of the Wall Street Journal is that the business cycle has been abolished, and that we have entered into a new paradigm of permanent prosperity. This kind of talk worries me. It is precisely what we had heard about Asia for the last several years. And it is what was said in 1920s America.

The bottom line is that there ain’t no such thing as a New Era. As long as we live on this earth, there are certain fixed cause-and-effect relationships at work that cannot be repealed. Among them is this: an economy pumped up by artificial credit will eventually enter recession. When it happens and what the effects will be are open questions. But that it will happen should not be in dispute.

Can we know where we are in a cycle? We can get an inkling by looking at the data, particularly Federal Reserve money supply figures, savings rates, and basic stock indicators. We first have to ask ourselves: where are the excesses? Inflation is low and business investment doesn’t appear to be particularly overblown. But look at the stock market. We’ve experienced astounding increases, with stock prices having quadrupled since 1990. The price/earnings ratios are now at a historic high of 28, from a postwar average of 14. At the same time, personal saving has fallen rather dramatically. In 1992, personal saving was 6.2 percent of disposable income. By 1997, it had fallen to 3.8 percent of disposable income. This is the lowest rate since 1946.

Greenspan has not abolished business cycles. But he has been lucky enough to preside over a new era in monetary affairs, one in which the dollar has been catapulted from a regional currency to the world’s reserve currency. The dollar’s hegemonic reign has allowed him to conduct a reckless policy of socializing investment risk while not paying the price. From the end of 1990 to the end of 1996, the Fed used its open market operations to increase the monetary base (MB), which is currency plus bank reserves, by 55 percent. Currency itself increased 60 percent.

As Jeffrey Herbener of Grove City College has pointed out, the dollar-reserve system of the “global economy” of the 1990s is the resurrection of Keynes’s Bretton Woods system without gold. Under the “gold-reserve” system of Bretton Woods, each country’s currency had a fixed exchange rate against the dollar, and foreign governments could redeem the dollar at the US Treasury for gold at the fixed rate of $35 an ounce.

The linchpin of the Bretton Woods agreement was the fixed rate of redemption between the dollar and gold. The Fed undermined this link by accelerating monetary inflation in the 1960s to help finance expenditures for the Great Society and the Vietnam War. From the beginning of 1960 to the end of 1964, the Fed increased the money base 3 percent per year, but from the beginning of 1965 to the end of 1970, the Fed more than doubled the rate of increase to 6.3 percent. The average annual rate of price inflation went from 1.3 percent in the earlier period to 4.2 percent in the latter one.

After increasing the monetary base 8.7 percent per year from 1971 to 1974, the Fed accelerated the rate to 10.4 percent from 1975 to 1981. But after the debacle of the first half of the 1970s, it was difficult to convince foreigners to hold more dollars as reserve. Accelerating monetary and credit inflation by the Fed led to severe domestic price inflation (average annual rates of 11.2 percent), soaring interest rates (peaking in 1981 at a 14 percent 3-month rate), collapsing capital values (from 1976 to 1982, the Dow lost 22 percent and stood at 774 in 1982), and higher unemployment (peaking at 9.7 percent in 1982, a rate not seen since 1941).

This entire scenario is precisely the reverse of the American economy in the 1990s. From 1982 through 1990, the dollar began to regain its status as the world’s reserve currency. The Fed expanded the monetary base 11 percent per year in the 1980s, but the demand to hold dollars overseas helped soak up the monetary inflation, and the American economy experienced economic growth with low levels of price inflation. The annual rate of price inflation was only 5.9 percent. But the improved performance of the economy in the 1980s was only a foretaste of the renaissance of dollar dominance in the world.

American supremacy in the wake of the collapse of communism allowed the Fed to fully exploit the international dollar-reserve system. The new system opened up a vast new vista for overseas dollar holdings. From Russia and Eastern Europe to China and East Asia, the governments of former communist countries began to soak up dollars to hold as official reserves as they became part of the American, “global” system. From the beginning of 1991 to the end of 1996, the Fed increased the monetary base 9.1 percent per year, while price inflation ran only 3.6 percent annually.

Like Bretton Woods, the new regime depends on foreigners’ willingness to hold dollars and use them as the basis for their own domestic monetary inflation and credit expansion. Only with harmonized monetary policies can the system survive.

But therein lies the great danger of the system to the American economy. A rogue nation will be tempted to defend its currency and stave off devaluation by spending its dollar reserves. Any significant disgorging of dollars would threaten to ignite price inflation in America if the dollars were repatriated. Significant domestic price inflation would, at best, bring a repeat of the 1970s, and, at worst, a hyperinflation.

This danger explains the US interest in promoting IMF austerity policies and bailouts. The bailouts are intended to soften the blow of devaluation and price inflation. In exchange for taxpayers subsidizing banks and large corporations, and other key beneficiaries of the system, the IMF can use the bailout money as leverage to impose conditions favorable for the future of the dollar-reserve system.

In the last three years, the system has faced a $50 billion bailout of Mexico, a $57 billion bailout of South Korea, $43 billion for Indonesia, $18 billion for Thailand, for a total of $118 billion in Asia (some estimate that it will eventually rise to $160 billion) to fend off its own destruction. But by delaying the day of reckoning with bailouts, the international mountain of dollars and debt grows, making the inevitable collapse all the more devastating.

The system will not be able to prevent the disgorging of dollar reserves to fend off Asian-style financial debacles in China, South America, Russia, and a repeat performance in Mexico. If the euro becomes the common currency of the EU, its members replace their dollar reserves with euros. And if Japan recovers, the yen will become the reserve currency across Asia. Global dollar hegemony will be at an end.

The Fed has overseen the best of times for the American economy in the 1990s, a period of rapid monetary inflation and credit expansion with current benefits of low interest rates, high earnings, soaring capital values, low unemployment, and steady economic growth. It has come courtesy of foreigners who have absorbed enormous quantities of dollars and, in so doing, kept the business cycle at bay.

Don’t count on that to last forever.

We could abolish business cycles if we had the will. It would require extreme monetary discipline, an end of risky socialism, the abolition of institutions like deposit insurance and fractional-reserve banking that sustain essentially bankrupt banks and investment houses, and finally, the institution of a true world money based on gold. Until then, we can expect that our troubles are far from over. We can only hope that when the inevitable recession does set in that Greenspan won’t do something stupid like bail out the stock market, attempt to defend the dollar internationally, or keep banks from failing. Sadly, given his close working relationship with the White House, and the fecklessness of the GOP, the next downturn of the business cycle is likely to look less like 1921 and 1922 and more like 1931 and 1932.

IS INFLATION DEAD?

[Based on a speech delivered at the Mises Institute Supporters Summit, Palm Springs, California, February, 27, 1998.]

Wall Street remains constantly worried about two forces in American economic life, inflation and deflation. These days, fear of one does not necessarily exclude fear of the other. It seems Wall Street worries about inflation on Monday, Wednesday, and Friday. On Tuesday and Thursday, it worries about deflation. Or perhaps it worries about both at the same time.

Just what is the concern? Of course, inflation is one of the most destructive forces in all of human history. In order for an economy to function, money must be sound and its value must be honestly come by. For most of human history, soundness and honesty were guaranteed because money was just another name for the most valuable commodity, namely gold. Gold was ideal money because it was portable, durable, divisible, fungible, and scarce. Above all, scarce.

Gold has been money throughout most of our nation’s history. The government had little to no control over its supply and therefore its value. But around 1913–1918, in the midst of wartime, the foundation of money in gold began to be frittered away. Over the decades, the link became progressively less secure until, in 1973, the last remnants of the gold standard were done away with. If you put a dollar in a mattress in 1970, and pulled it out today, it would be worth less than a quarter.

Why? The monetary authorities have conducted a 35-year war against the sound dollar, which is precisely what we would expect given that the dollar no longer has any link to gold. The result has been theft on a grand scale. In fact, the government has extracted more from us in inflation than it has in tax increases over this same period. The government and its friends, and not the American people, benefit from inflation, for reasons I’ll explain shortly.

The demise of the gold standard is what made this extortion possible. Under a gold standard, there are strict limits on how much money can be created. Under the paper money standard, there are no limits. It always surprises me when I talk to college students, businessmen, and even to bankers, that not everyone understands this. They do not understand that there is no gold backing up the nation’s currency at all. There is no limit on how much of it must be created by the government and the banking cartel. Thus there is no limit to the extent to which money can continue to be watered down by monetary authorities. The only real restraint on monetary growth today is fear of a backlash by the financial community.

But Wall Street rarely takes the long view. So when inflation worries begin to dominate the market, it is not the fear of what further monetary depreciation might mean to American families that is the primary concern. Rather, traders are often concerned about the Federal Reserve’s response to renewed inflation. They are concerned the Fed might raise interest rates in an effort to counter inflation tendencies. And higher interest rates mean less borrowing, less credit expansion by the banking system, and thus represent a potential end to the decade-long party on Wall Street.

And what about the threat of deflation? This term, which hasn’t been heard in public for many years, first started being drummed lately when the price indexes first recorded a drop in selected consumer and producer prices. In common parlance, dating back to the Great Depression, deflation is supposed to be as much a threat to economic stability as inflation. The reasons the financial markets fear it have as much to do with the new uncertainties widespread deflation introduces, as much as they have to do with the real effects of deflation.

What are the real effects of deflation? A common myth is that it leads to lower profitability, and possibly even recession or depression. Is this true? A good way to tell is to set aside macroeconomic data like the consumer and producer price index, and look at a particular industry. Consider the price of computer hardware. For 20 years, the prices of computers have been falling while quality has been rising, and memory and speed have increased at a breakneck pace. Yet the industry is also among the most profitable.

Falling prices typically signal rising prosperity, just as they did in the latter half of the 19th century. In fact, if we had a truly free market coupled with a gold standard of sound money, falling prices would become the norm. You might be able to keep that dollar in your mattress and pull it out 25 years later only to discover it has more purchasing power than it had when you first squirreled it away. Sadly, this is not a luxury any of us has yet experienced. Even in the midst of all this talk about deflation, we have yet to see any kind of secular slide in prices that has lasted longer than a few weeks.

Part of the reason for this is that Washington apparently hates and fears lower prices. A few years ago, the price of beef took another tumble, causing ranchers around the country to worry about their own profitability. They lobbied Washington, as people are apt to do these days, and persuaded the secretary of agriculture to intervene. He bought up millions of dollars of what the ranchers called excess beef and gave it away to the poor for free.

As a beef lover, I would have loved to have benefited from low priced beef, and would have been even happier to get it for free. Sadly, I have not benefited from the secretary of agriculture’s actions. He was effectively stealing the benefit of lower prices from consumers and handing it over to a special interest group, all at the behest of well-heeled lobbyists in Washington.

I mentioned the Great Depression earlier. This is typically attributed to the falling price level of the 1930s, as if this were a cause of general economic downturn. In fact, falling prices were the one aspect of the Depression that helped mitigate the effects of a deep productivity crash that was brought about and sustained by government intervention in the price system. Falling prices meant that the dollars that people did own were becoming more and more valuable over time. But Washington, in its infinite wisdom, worked for the better part of a decade to pump the price level back up again, thereby ensuring that the real cause of the depression would not be addressed.

Before we leave the general topic of what is inflation, let me say a few words about the great CPI controversy. Early in the second term of the Clinton administration, Treasury Department and Fed officials began to wonder whether the inflation indexes being used to calculate inflation were really telling the truth. They announced that they were pretty sure that the CPI overestimates inflation by nearly a percentage point, or perhaps by as much as two points.

Now, consider what this would mean. The Bureau of Labor Statistics employs thousands of people to do nothing but examine prices paid for goods and services at all levels of industry. They calculate data from every conceivable source, and present it in myriad ways to the public. They break down the data in every conceivable way. But somehow, said the Clinton administration, in the voice of Stanford University’s Michael Boskin, along the way, mistakes are being made. The Bureau of Labor’s statisticians are overestimating inflation.

The question to ask Boskin is: how can you know for sure? To say that you know the BLS is making a mistake is also to say that you know with certainty what the correct inflation rate is. You have to have a benchmark to say that something doesn’t measure up. And if Boskin knew the truth, why not just abolish the BLS once and for all? If we need to know any economic data, we could just email Boskin, and he could consult his astrologer or swami or whomever he relies on for his revelations. Paying him half-a-million per year would save taxpayers billions.

In justifying his view, Boskin spent less time explaining his methodology than attacking the BLS’s own. He pointed out that it doesn’t make very much sense to aggregate prices that are stable and fixed—say for instance those of commodities—with those that change because of technological shifts or changes in relative scarcities. For example, what if I decided to calculate the 10-year inflation rate using three goods: private-school tuition, handheld calculators, and gasoline. I might end up with an index number of 0. Yet that conceals an enormous amount of information. And let’s say I want to throw in the price of real estate in Greenwich Village. We might get a soaring rate of inflation.

Boskin is right that the inflation rate is highly dependent on precisely what is in and what is out. It is difficult to adjust for price changes that come about from technology. The basket of goods that is included in the CPI is constantly changing, but not because science necessitates this. It changes because the BLS watches politics very carefully, and politics necessitates that the government always generate a lower and lower inflation rate.

The purpose of all this data collection is to discover the mysterious and highly elusive thing called the price level. The trouble is that there ain’t no such thing as a price level. Prices do not move up and down like the sea level. They always move relative to each other and in odd and unpredictable ways. Monetary inflation causes many if not most of them to rise, but calculating to what extent is a very tricky business. The only thing we can know for sure about monetary inflation is that it waters down the purchasing power of our money, and does so in an insidious and deadly way. Try to make a science out of finding out precisely how much, and you are headed for trouble.

Economists who favor monetary manipulation have a good reason to always talk about prices instead of purchasing power. It helps distract attention away from the real culprit, the real source of inflation. It’s not a mysterious rise and fall of the price level that can be more precisely measured by better data collection. In fact, the cause of inflation is not mysterious at all. It consists of the nation’s central bank adding to the stock of dollars in the economy by artificial means. The Fed can do this in three ways: lowering the discount rate, buying assets on the open market, and lowering the reserve ratio on bank deposits.

It is impossible to think about the nature of inflation and monetary manipulation in general without understanding what the Fed is all about. If you like conspiracy theories, you’ll love the history of the Fed. When talking about the Fed as a conspiracy against the public interest, however, we are not really talking about theory. We are talking real-world history. When the Fed was set up before World War I, it was designed by the banking and corporate elites, mostly consisting of a collaborative effort between the Morgan and the Rockefeller financial empires, with one purpose in mind: to make possible a more elastic currency. What does elastic currency mean? Well, let’s just say it’s something we would all like to have on a household level. Can’t pay the bills? If your household income is elastic, you just add a zero or two to your bank ledger. Elastic effectively means the ability to print more money when it turns out that you haven’t managed your accounts well.

That is precisely what the Fed was founded to make possible. It cartelized the banking system and allowed for coordinated inflation and credit expansion. It cut the necessary minimum reserve requirements, provided added bailout guarantees, and allowed banks to pyramid loans on top of Fed reserves. This was a tremendous benefit to the banking industry, and to the government which needed financing to enter the world war, but it forecast disaster for the soundness of currency. After the Great Depression, the same elites conspired again to institute new protections for the banking industry, giving us Glass-Steagall, deposit insurance, and watering down the gold standard ever more.

For most of the second half of the 20th century, a debate has raged about who precisely is to blame for inflation. This debate usually began with the assumption that if one party is not to blame it is the Federal Reserve. It is not only Greenspan who has a reputation as a great inflation fighter, but every previous Fed chairman. They are all described in the usual monetary histories as hard-nosed opponents of inflation. But how can this be? There is only one force that can cause the purchasing power of existing dollars to systematically decline, and that force is an expansion of the existing dollar stock through artificial means. There is only one power on earth that brings that about and that is the Federal Reserve.

Has some sneaky guy at the Fed been coming in after hours, after all the members of the board of governors have gone home, to print up money, buy and sell assets, raise and lower discount rates, and generally subsidize certain banks at the expense of others? Not at all. This has been a systematic policy. Large banks enjoy having the power to inflate for the same reason the counterfeiter values his printing machine. And in this, the Fed and its banks work hand in hand with the government.

The loss of the value in the dollar benefits debtors, and there’s no bigger debtor than the federal government. An elastic currency permits the expansion of debt to a huge extent, and makes it possible for the government to be the one and only entity that can make an ironclad promise to make good on its debts. Thus, its bonds carry no risk premium. They will always be paid, but always at someone else’s expense.

Not that the Fed has always intended to bring about large-scale monetary depreciation. It can set out to expand credit without warrant, and to grow the money supply to bring about an economic boom, but the consequences of those actions are not felt immediately and they are not always predictable. Moreover, the Fed is always anxious to separate itself from the effects of its policies.

Even today, Greenspan the Great frequently goes before Congressional committees and solemnly declares to what extent he thinks current rates of economic growth risk setting off inflation. But economic growth itself cannot set off inflation. Economic growth is neither a necessary nor sufficient cause for inflation. In fact, given the economists’ famous equation of exchange, economic growth tends to make goods and services cheaper, since the same amount of money is doing more work.

Why does Greenspan mislead people? The Fed always wants to avoid the tail of price inflation pinned on its own behind. In this, it shares an interest with government generally. Government blames unions. It blames businessmen. In the next round of price inflation, it will undoubtedly blame the soaring stock market, and the regular Americans who threw caution to the wind to invest in booming stocks.

There are generally four schools of thought on whether price inflation is good or bad for the economy. The first is the Keynesian School, which has generally celebrated inflation as a means of bringing markets back into equilibrium when they have been thrown out by the business cycle. In the Keynesian theory, you can reduce unemployment by increasing inflation. You can reduce inflation, but only if you are willing to tolerate higher unemployment. In the choice between people and money, people won every time ... by losing sound money.

Of course this tradeoff ended up being shown to be completely mythical. There is no relationship between inflation and unemployment. Developments of the mid-1970s, in which inflation and unemployment moved up together, dealt a substantial blow to the theory. And today, we’ve witnessed dramatic declines in both; the theoretical apparatus behind Keynesian macroeconomics lies in tatters.

But the soundness of economic theories alone does not determine whether it is useful for the power elite. Keynesian economic theory was well supplemented by a leftist theory that favored redistribution of all wealth, especially taking from producers and giving to nonproducers. Inflation does this, as well as taxation and the welfare state. It punishes savers and makes economic calculation difficult. Inflation shortens time horizons of people in society and thus weans them of bourgeois values. It punishes enterprise with capital and rewards those with debt. This is why egalitarians have always celebrated inflation, and why you are more likely to hear the case for inflation being made by a socialist than a believer in free enterprise.

Yet not all backers of inflation favor redistribution and leftism. The Supply-Siders are great on the need for tax cuts. But if you look at the works of Jude Wanniski, the politics of Jack Kemp, or the recommendations of the editorial page of the Wall Street Journal, you see a single fallacy repeated again and again: economic growth must be backed by monetary growth. Or put in an even more dangerous phrase: restrictive monetary growth holds back economic growth. This is merely another version of the old fallacy that prosperity can come from the printing press.

In a slightly different way, the Chicago School or Monetarist approach advocates a fixed rate of growth for the money supply, neither undershooting nor overshooting the rate of economic growth and thereby achieving a stable price level. Now, as we already discussed, the notion of a stable price level is unachievable. The very nature of prices is that they adjust up and down, relative to each other, to reflect changes in resources, tastes, and technology.

So this supposed ideal of stable money is not only impossible to achieve, but it robs people of the opportunity to experience a rising purchasing power of money. The Monetarist plan also imposes a kind of collateral damage on the economy that the theory doesn’t take account of. All new money injections distort the pricing signal of the interest rate. It causes some industries to undertake borrowing and business expansion they would not otherwise undertake. The new money works as a subsidy for some kinds of projects but not to others. As a result, even the Monetarist proposal sets in motion an artificial boom in some sectors of the economy.

Monetarism can be particularly dangerous in periods of deep recession, when economists of this school typically recommend gunning the money supply, as Milton Friedman recently did with respect to Japan. But gunning the money supply does nothing to correct the underlying structural problems that lead to business downturns in the first place. What an economy in recession needs more than new money is time and freedom. Time and freedom to clean out bad investments, time and freedom for wages to adjust, and time and freedom for the investment sector to align itself with the spending and savings sectors.

But what I’m speaking about here relates more to business cycles than inflation as such. And in order to understand them both, we need a richer and more complete view of the monetary side of the economy. That is where we turn to the writings of Murray Rothbard, Ludwig von Mises, F.A. Hayek, and the Austrian School of economics generally. For most of the 20th century, the Austrian School fought against monetary depreciation and for the gold standard. Only the Austrian School accurately predicted the consequences of fiat money and warned against the perils of inflation, not only its effect but also its cause.

The Age of Greenspan is considered to be one of sound money and low inflation. But consider a more fundamental change that has taken place in the monetary regime in the last decade. The Federal Reserve has long considered the banking system to be too big to fail. But with Greenspan, many more institutions have been added to the list. He intervened in 1987 to pull the stock market up from failure. He has intervened several times since then to bolster buying in the bond market and in the commodity futures market. During the Mexican peso crisis, he committed resources from the Fed to propping up the investments of US banks in Mexico, and then later combed the halls of Congress agitating for a bailout. He intervened after the dot-com bust and September 11. Finally, he has been the major force behind arguing for an expansion of the IMF, along with an implicit promise to bail out the IMF should its resources run dry.

In effect, Greenspan has instituted a too-big-to-fail doctrine for Wall Street and even whole governments. The consequence of this is to dramatically subsidize the willingness of traders and governments to take risks. They can safely assume a bailout will be forthcoming. It is difficult to imagine a more dangerous move on the part of any central banker. If you wonder about the future of inflation, I consider this to be a very strong indicator that we are not done with it yet.

What should the US do now? We should enjoy whatever deflation we can get right now. The government should not try to sustain high prices on any goods or services, but rather let them fall. That will allow us to prepare for a time when the dollar faces a challenge as the world reserve currency, and the monetary expansion of the last 10 years comes home to roost.

If we want to eliminate inflation forever, there is an easy step we can take. We can resecure the dollar to its historical foundation in gold and suppress the issuance of any more artificial money and credit. We could separate the monetary regime from the State entirely, and build a firewall between the dollar and politics. Only that step will provide permanent protection.

Until then, I would not suggest we become sanguine about the prospects of inflation, but prepare ourselves, not only for another bout, but also for the shock that comes with the realization that the laws of economics have not been repealed after all.

THE ECONOMICS OF DISCRIMINATION

[Based on a speech delivered at the Georgia State University School of Law in Atlanta, April 1992.]

The Fabian Society of Great Britain held to three central doctrines of political economy. First, every country must create its own form of socialism. Second, socialism imposed slowly is more permanent than the revolutionary sort. Third, socialism is not likely to succeed in Western countries if it appears undemocratic or authoritarian.

Using this formula, the Fabians achieved their dream in Britain. They used labor unions to socialize the workforce, the state to nationalize basic industries, and social insurance schemes to collectivize the property that was left. In addition, they relied on soft-planning, a government-run medical industry, and middle-class income redistribution to build the state sector. It was still socialism, however, and it nearly destroyed the country.

According to the Fabian formula, the American form of socialism would also need to be different from the Bolshevik model. If you understand this, you can understand the essence of American politics from at least the 1960s.

In the early days of the Clinton administration, White House aides visited Daniel Patrick Moynihan’s Senate office to explain their proposal for so-called empowerment zones. These are sections within major cities targeted for a mass dumping of welfare dollars and business subsidies. When Moynihan heard the plan, he exclaimed: “That sounds Fabian!” The New York Times reported that Clinton’s aides assumed he meant this as a compliment.

No one, certainly not the Clintons, could win the presidency of this country on a program of revolutionary socialism. If the opponents of property and markets are to succeed, they must create a peculiar form. It must be well suited to political and demographic conditions that are distinctively American.

We have little reason to fear nationalized industries or comprehensive planning. Labor union power is on the decline. Americans bristle at any hint of direct controls over production decisions. Environmental socialism has probably peaked. And fully socialized medicine failed last year because of massive public resistance to such a step-up in government power.

We don’t have British socialism. We don’t have the British style. But we do have a problem with socialism. It takes many forms, but the form I’d like to concentrate on today relates largely to labor markets and the rights of business.

First let’s get our terms straight. One sort of property is private. That means it is owned by private individuals and should be controlled by them. This type of property is the basis of all market exchange.

Another kind of property is public property. The term is a misnomer, of course. Public property is sometimes the least accessible to the public. Yet we know what this term means: property owned by the state. It is not subject to market conditions. No individual can choose to use it or to sell it as he sees fit.

But US political culture has created a third and far more insidious type of property. It is called commercial property. It includes all private and public property used for exchange in the free market. Included in this category is most everything but private homes and clubs, and secretive government bureaucracies. This means that the following institutions are so-called commercial property: hotels, restaurants, bookstores, manufacturing plants, computer retailers, universities, and so on.

Being classed in this way subjects this form of property to a variety of civil-rights laws. When examined from a philosophical standpoint, such laws are nothing more than the legal right to trespass. A qualified individual may demand service against the will of the owner. He may demand to be hired, or not to be fired, against the will of the owner. He may demand a higher salary or a promotion, against the will of the owner.

If the free market embodies the idea of contract, civil rights embodies what Barry Smith has called the spromise. A spromise commits a third party to act against his will. As the owner of the business, you may wish to stop paying an employee and terminate his employment. Civil rights say you may not, without the permission of the government.

Civil rights, and the right of trespass it implies, is a major part of American socialism, a carefully tailored product indeed. It is designed to fit with America’s excessive devotion to the ideals of democracy and equality. It is designed to exploit the demographic heterogeneity of America’s population. And its implementation relies on America’s traditionally sanguine view of centralized executive power.

We could argue about when American socialism first took root. Many say it began with the Great Society. Others trace it to the New Deal. There’s a good case to be made for tracing it to the Lincoln presidency, which also used the language of democracy and egalitarianism, exploited America’s heterogeneity, and dramatically centralized power in an imperial executive. That period also provided a test run for inflationary monetary policy and income taxation, two institutions that the Progressive Era entrenched, and which provide the fuel for American socialism today.

The symptoms of American socialism are easy to identify. They appear in legislation like the Americans with Disabilities Act, the limitless amendments to the Civil Rights Act, the Community Reinvestment Act, and all manner of interference with the freedom of association.

In addition, regulatory agencies issue tens of thousands of regulations each year to manage the private lives of citizens and the conduct of private business. Of all the menacing federal agencies, the socialism I am speaking about has been expertly practiced by the Department of Housing and Urban Development, the banking regulators at the Federal Reserve, and the bureaucrats at the Equal Employment Opportunity Commission.

The result has been a degree of tyranny. Civil rights lawsuits are shutting down businesses daily. Many potential capitalists decide not to open businesses for fear of the government’s equality police.

Small companies routinely do anything within the law to avoid advertising for new positions. Why? Government at all levels now sends out testers to entrap businesses in the crime of hiring the most qualified person for a job. Pity the poor real estate agent and the owner of rental units, who walk the civil rights minefield every day. If any of these people demonstrate more loyalty to the customer than to the government, they risk bringing their businesses to financial ruin.

The restaurants Denny’s and Shoney’s, two great examples of capitalism in action, know all about this. In the last two years, they were both hit with class-action suits alleging discrimination. It didn’t matter that the plaintiffs were all trumped up, and the specific cases cited were patently fraudulent. For example, one plaintiff found a foreign object in her hash-browns, and claimed it was put there on grounds of race. Both companies decided to settle out of court, establish extensive quota programs, pay off all plaintiffs, and set up new minority-owned franchises. They did so not because they were guilty, but because the so-called justice system is stacked against them.

Just recently, 99 white male troopers in Maryland collected $3,500 each in back pay on grounds that they had been discriminated against in promotions. I don’t doubt that they were, but I’m suggesting a more peaceful solution. Let’s return to the market all decisions about hiring, firing, promotion, and access. That means getting the government and the courts out of the business of enforcing equality once and for all.

But that solution is nowhere in sight. The courts enforce an egalitarianism that tolerates no acknowledgment of differences among people. This denies the obvious. People do differ radically in their talents and weaknesses, their determinations to succeed, their mental facilities, their attitudes and character, their physical abilities, their environments, and their physical makeup. Moreover, these differences appear not only in individuals but also appear systematically among groups.

Men as a group, for example, are different from women as a group. Northerners are different from Southerners. Californians are different from Texans. Catholics are different from Baptists. Blacks are different from whites. Immigrants are different from natives. The rich are different from the poor. These differences should not be denied, but celebrated, for they are the very source of the division of labor.

Yet our central government attempts to stamp out all these differences by forcing individuals and businesses to act as if they do not exist. The primary means has been the criminalization of our most serious secular sin: discrimination. There can be no actions in American life—save the decision of whom to marry—that discriminates on the grounds of any number of criteria as defined by the government. If anyone commits this sin, he can forget the confessional or forgiveness. The heavy penance is cash handed over to the government and the special interests, with half going to the lawyers who arranged the transfer.

To see just how serious the government takes this sin, and how absurd are the results, consider disabilities law. Most people think of the Americans with Disabilities Act as a law forcing public and private facilities like courthouses and shopping malls to accommodate wheelchairs and the like. In fact, the Act is much broader. Since the ADA went into effect, less than one-quarter of the ADA-related complaints filed with the federal government concern such public and private facilities. The vast majority relate to employment.

Tens of thousands of such complaints, which are threatened lawsuits, have been filed with the EEOC. For example, a Florida district appeals judge was caught shoplifting a remote control, so the Florida Supreme Court dismissed him from the bench. He says this violates the ADA, which indeed it does, for he stole the device because he was depressed that his son was getting bad grades.

Mental illness is protected under the Americans with Disabilities Act. You cannot fire or refuse to hire a person who is “otherwise qualified” by the government’s standards. What is official mental illness? The EEOC suggest we consult the Diagnostic and Statistical Manual of Mental Disorders. According to the DSM, protected symptoms include “confused thinking,” “consistent tardiness or absences,” “lack of cooperation or inability to work with co-workers,” “reduced interest in one’s work,” and “problems concentrating.”

Before the ADA, these were reasons for booting a person off the payroll. Today, they bestow rights against employers, rights that sane people do not have. Nor does it count when, as a result, ADA-afflicted businessmen experience symptoms of DSM mental illness themselves: “anxiety, fear, anger, suspicion.”

The authors and enforcers of the ADA are not concerned with quadriplegics. Their goal is sinister to the core: removing the last vestiges of employers’ legal rights, and replacing them with civil rights, which trump all considerations of private property. Just as landlords no longer have an effective legal right to evict nonpaying tenants, so employers cannot shop for the best workers. In this subtle form of socialism, nearly everyone has a veto over the free choices of the capital owner. The workplace is ruled by a victimocracy.

Unlike the Clean Air Act and similar bills, the ADA is not industry specific. It affects every business in the country with 15 or more employees, forcing owners and managers to pretend that the physically, mentally, and emotionally disabled (and “disabled”) are identical to the nondisabled, and to spend to make it so.

Say you’re a small businessman, barely alive thanks to regulations and high taxes, and a man who can’t see applies for the job of office manager. You cannot turn him down on that ground, even though the job requires some reading, for that would violate his civil rights. You have to hire another employee to read to him. If you hesitate, you pay back wages and, thanks to the Civil Rights Act of 1991, massive damages.

If a supermarket manager refuses to hire a bum to ring the cash register, he can be taken to court. A sales manager may prefer salesmen who can remember customers’ names and preferences, not to mention his own products, but discrimination against those with low IQs or the memory impaired is not allowed.

If a thousand-mile stare makes you uneasy, you’re out of luck, for this is no longer a chilling quirk, but a certified disability. Would you rather not hire a nightwatchman with a history of drug use? If he’s not on crack today, he’s on your payroll. For this reason, drunkards are daily suing for their right to go off on a toot and not be kicked off the payroll.

Say the applicant is a dyslexic with a history of drug addiction who not only has trouble reading, but can’t learn or reason well thanks to minor brain damage. If he applies, you have to hire him, and make what the government calls “necessary accommodations.”

The public accommodations provisions of the ADA are nothing to shake a stick at. A man in a wheelchair, for example, sued for the right to coach third base on a Little League baseball team. A girl with a steel walker sued for the right to skate during prime hours at a public skating rink. A blind man sued for the right to be a firefighter. People of low intelligence are suing for more time to take tests. On and on it goes.

In each of these cases, businesses and other organizations usually settle out of court. They find that’s cheaper than taking the case to trial. But the settlements themselves have caused a wealth loss, which is vast and growing. And with the ADA, there is no way to comply, because there is no way to prepare for every possible contingency, every possible lawsuit, every possible government trick. Doggerel.

Businesses can try to escape some of this by requiring certain abilities in a written job description. But they must be able to show, in a court of law, that the requirements are essential to the job. Businesses do not always know ahead of time what a person will be required to do. So they look for qualities like character and attitude. But these are unquantifiable. To the government, they are irrelevant, as you can tell by visiting any government office.

One way the ADA is enforced is through the use of government and private “testers.” These actors, who will want to find all the “discrimination” they can, terrify small businesses. The smaller the business, the more ADA hurts. That’s partly why big business supported it. How nice to have the government clobber your up-and-coming competition.

How could this nutty and dangerous legislation have passed? In Washington, DC, economics has always taken a backseat to special-interest lobbying. But when something is labeled civil rights, especially when it harms small businessmen and tramples on the freedom to exclude, it flies through Congress. Only four people in the Senate voted against the bill. Editorially, not even the Wall Street Journal spoke out against it when it mattered.

The ADA illustrates an important point about antidiscrimination law. Contrary to myth, rules against discrimination never create a level playing field. Forbidding one form of discrimination must necessarily compel another form of discrimination.

If an owner is forbidden to discriminate in hiring on grounds of sex or race, the government can only discover a violation of the law by looking at who is hired. This compels active discrimination against people on grounds of their sex or race. It is a zero sum game, where one person’s winnings come from another’s losses.

Still fewer are willing to speak openly about what has happened to the banking industry in the last few years. Once upon a time, the credit rating was the primary means by which bankers and other lenders assessed creditworthiness. But this is under assault today. Along with other institutions essential to the functioning of a free market, sound credit standards are being sacrificed on the political altar.

The operative test of a bank’s political correctness is its Community Reinvestment Act (CRA) rating. The ratings, mandated by Congress and the Bush administration in a bill affixed to the S&L bailout legislation in 1989, categorizes lending by race, sex, and income level. Using nebulous CRA requirements, regulatory control, and the threat of merger rejection, government officials exercise remarkable control over the lending policy of banks.

Last year, for example, Shawmut National Corp. of Connecticut wanted to acquire New Dartmouth Bank of New Hampshire. The Federal Reserve Board, which must approve all bank acquisitions, foiled Shawmut’s plans in a split vote.

The banks were not undercapitalized. The proposed merger did not violate antitrust law. There were no allegations of fraud. Instead, Shawmut was under investigation by the Department of Justice for violating fair-lending laws. In the first decision of its kind, the Federal Reserve thwarted the acquisition on those grounds at the behest of the Department of Justice. I guess that’s part of the price for retaining its “independence.”

Shawmut never admitted guilt. But the bank had to spend a minimum of $960,000 on rejected minority applicants. With claims averaging $10,000 to $15,000 per plaintiff, the final price was much higher. In addition, Shawmut was forced to set aside $85 million in loanable funds solely for privileged applicants.

Shawmut is not even allowed to attach a risk premium to interest rates on loans given to questionable applicants so long as they are privileged by government. Instead, it must make these loans at below market rates, therefore subsidizing them with other depositors’ money.

When Fleet Financial Group, New England’s largest bank holding company, fired 3,000 people and reduced its operating expenditures by $300 million, the business pages featured the story. But the media did not ferret out who had downsized the institution. One month before the layoffs, Fleet had suffered a similar shakedown.

A Boston “community activist” and self-described “urban-terrorist” named Bruce Marks heads a group called the Union Neighborhood Assistance Corp. He began making noise when Fleet was planning to buy the failed Bank of New England. Marks noted that Fleet wasn’t directly backing loans in Boston’s Roxbury, Dorchester, and South End. Instead, to comply with the CRA, it subsidized other mortgage companies that lent at higher rates. Marks convinced some people who held these mortgages that they were being ripped off.

Marks then got local reporters, always anxious for a new victim, to make a fuss about the matter. After 60 Minutes ran an attack, Fleet agreed to stop purchasing loans from third-party lenders in the inner city. That, of course, wasn’t enough. Marks and his Union wanted Fleet to make the loans itself—and give the Union cold hard cash.

Over two years, Marks’s band of brigands disrupted luncheons, breakfast meetings, press conferences, and speeches. Once Marks and his Union members burst into a hearing of the Senate Banking Committee where they filled the room and sang gospel songs. It was the kind of display that makes corporate big shots cower, politicians swoon, and regulators cheer. In the end, Fleet had to give Marks a cool $140 million.

Fleet also agreed to set aside $7.2 billion in loans for “low-income” borrowers, plus another $800 million in programs and payoffs for other “inner-city borrowers.” Fleet was attacked for loansharking, but the real sharks were those who looted the bank vault with the permission of government regulators.

Studies that purport to show discrimination rarely look at individual loan applications. Instead, they consider only carefully selected neighborhoods. Typically they fail to count minorities living in predominantly majority areas. And they look only at the lending record of banks and S&Ls, and not other mortgage lenders. However flawed, the studies always make a splash in the dangerous waters of politics.

Another voice added to this cacophony of credit confusion is Ralph Nader’s. Nader likes to cite a now-famous 1992 Boston Federal Reserve study by Alicia Munnell, then director of research and now Clinton’s assistant Treasury secretary for economic policy. It was supposed to adjust for more factors than any other study and still recorded a 6-point lending gap, a 17-percent versus 11-percent turndown rate by race.

Peter Brimelow of Forbes was the only one to call her bluff. He confronted her with the fact that her data also revealed identical default rates, which, he pointed out, implied a racially impartial application of standards of credit-worthiness.

When confronted with the implications of this data, she collapsed. “I do not have evidence,” she admitted. “No one has evidence,” she continued in her own defense. Her admission hasn’t stopped her from continuing to make the charge, and from ordering changes in the way banks make loans.

What’s at stake here is not fairness in lending. Everyone acknowledges as an empirical fact that whites on average are more eligible for credit than blacks on average, just as Asians are more eligible than whites. What’s at issue is the transfer of the welfare function from fiscal policy to banking policy. The pool of loanable funds has become a convenient substitute for direct welfare benefits.

Tens of billions have been doled out to satisfy civil rights groups who cry discrimination. This has an industry-wide chilling effect. It scares banks negotiating reorganizations and freezes up available capital that deserving families need in purchasing new homes.

Civil-rights socialism in banking wastes scarce resources and punishes achievement and responsibility. It harms the very groups it claims to help, by driving away market-specific solutions. Rechanneling funds makes the economy operate less efficiently and rightly angers property owners and depositors.

In a similar way, civil rights lawsuits alleging some kind of racial and sexual discrimination are shutting down businesses every day.

Let’s return to the Denny’s and Shoney’s cases of judicial aggression. Flagship, Denny’s’ parent company, was forced to settle a pile of litigation, including two class-action lawsuits—pushed by a combine of the Justice Department, the NAACP, and a bunch of liberal lawyers—for a total payout of $54 million. The Oakland, California, law firm that handled the largest suit got $8.7 million.

More than 4,300 people signed up as anti-Denny’s plaintiffs. The New York Times even published a toll-free number to dial up and try your chances at some of the loot. Of the thousands of cases of alleged discrimination, news accounts and plaintiffs’ lawyers focused on two of the supposed worst incidents, which supposedly prove the perfidy of Denny’s. In Annapolis, Maryland, in May of 1993, six Secret Service agents were assigned to President Clinton’s security detail for a speech in that city. They entered the local Denny’s restaurant at noon.

Several media outlets said the agents were “refused a table.” The charge was a lie, made possible only because of the lack of accountability in civil-rights suits. The president was speaking nearby, meaning the restaurant was crowded. The agents were seated. The agents were served, but late.

Everyone has experienced late service, even watching someone who came in after us getting their food before we’ve ordered. Yet at the first sign of delay, agent Robin Thompson marched up to the waitress and demanded the food. The waitress said it was on the way. Thompson demanded to see the manager. He was on the phone. The highly paid gun-toting Secret Service agent was yelling, and the waitress was alleged to have rolled her eyes after he left. This was one of the charges that grew into a nationwide class-action suit.

On that very day, Denny’s had settled another suit in California alleging discrimination for $34.8 million, including $6.8 million for that California firm. A federal judge claimed he had to wait for a table, and that diners chanted racial epithets at him.

Regardless of the facts, how is this Denny’s’ fault? It’s one of the peculiar aspects of civil rights laws under commercial property.

As part of the settlement, Denny’s had to hire a full-time civil rights monitor, introduce a system of private spies to ferret out any internal “discrimination,” run re-education programs for all nonminority employees, turn over a set number of franchises to minorities for free, and put a hostile person on its board of directors. As part of the same suit, the NAACP pressured Denny’s to spend at least $1 billion to find and hire minority managers and turn over restaurants to them.

Why couldn’t Denny’s have told the agitators to hit the road? In a word: fear. Business can no longer risk taking these cases to trial. Even huge settlements like these are likely to be less expensive.

The cost to the overall economy is incalculable. How many companies will refuse to go public for fear that it makes them easy pickings for liberal lawyers? How many people, shocked by the gross unfairness of this ruling, will choose not to expand their businesses? How many potential entrepreneurs will be turned off from business altogether? When whole businesses are looted, the country is not safe for free enterprise.

We cannot have free labor markets so long as we don’t have the freedom to hire and fire. It is as essential that women’s health clubs be allowed to exclude men as it is for Korean restaurants to be able to hire and promote only Koreans. These are the rights and privileges that come with private property. If we limit them, we destroy markets and replace them with civil rights socialism.

In Forbidden Grounds, University of Chicago law professor Richard Epstein refutes some of the myths of civil rights. Epstein points out an obvious fact that somehow goes unnoticed: antidiscrimination laws intervene in the freedom of contract, the legal right to use one’s own property as one sees fit. Additionally, there is no reason to think that such legal restrictions generate any social benefit.

Epstein uses the methodology of the Chicago School, whose theory of welfare attempts to derive social utility mathematically. But the question can also be approached, and far more effectively, from the deductive standpoint of the Austrian School.

Free exchange produces the highest social utility, since both parties benefit to the maximum extent possible, or the exchange would not have taken place. If the most-preferred choice on a person’s rank of preferences is outlawed as discriminatory, maximum benefit is denied to him.

Consider this example. John is an employer who wants to hire Jim, and Jim wants to be hired. This is probably because John values Jim’s labor, but it may also be because they are old college buddies. Jane wants the job too, but she is passed over, and she thinks the exchange between John and Jim injures her right to partake in the exchange.

In the free market, it is not enough to assert your right to be hired; Jane would have to offer some conditions of exchange to make herself relatively more attractive to John than is Jim. For example, Jane could lower the price of her labor to make it more competitive. If Jane’s labor is of no value or even negative value to John, then she would have to consider an apprentice relationship or possibly even offer a negative wage, that is, pay John to let her work. Or she could just give up and take a job somewhere else at what she regards as her true market worth.

No matter how the transaction ends up in this free market—whether John hires Jim or Jane—two parties are definitely better off, and the nonparticipating third party no worse off than he or she would be otherwise. We cannot know by how much John and the hired employee are better off, since utility is purely subjective and cannot be added and subtracted. We can only know that with voluntary market arrangements, and a free-floating wage system in this case, social utility is maximized no matter who is hired.

But say that Jane is passed over, and demands that the government step in on the grounds that John should not be allowed to discriminate in favor of Jim. Compelled to do so, John hires Jane, even though her services are less in demand and Jim, whose services are more in demand, is left out in the cold.

Under this compulsion model, John is coerced into hiring someone he prefers less, Jim is forcibly shut out of the exchange, and only Jane gets her way. We cannot know mathematically how much Jane benefits from the exchange. We can only know that in this example she would not have been hired in the absence of government intervention, and that when she is hired by force, John and Jim are made worse off. The lower valued labor has been employed over the higher valued labor. We can definitely say that overall social utility in this three-person economy is diminished.

Civil rights laws force a similar outcome. They compel exchanges that would not have taken place under a voluntary system. We can thus immediately cut through the claims of civil-rights supporters that antidiscrimination laws guarantee rights, but do not themselves discriminate. By their own logic, civil rights laws compel discrimination.

The language of Title VII of the 1964 Civil Rights Act seems innocuous, but it is enough to bring serious harm to the social order and the free market. The law reads:

It shall be an unlawful employment practice for an employer to fail or refuse to hire or to discharge any individual, or otherwise to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment, because of such individual’s race, color, religion, sex, or national origin.

The Civil Rights Act ostensibly did not allow government to change the private pattern of employment. The assurances of Senator Hubert H. Humphrey (D.-Minn.) were especially powerful:

Employers may hire and fire, promote and refuse to promote for any reason, good or bad, provided only that individuals may not be discriminated against because of race, religion, sex or national origin.

On another occasion, Humphrey made a famous promise:

If the Senator [George Smathers] can find in Title VII ... any language which provides that an employer will have to hire on the basis of percentage or quota related to color, race, religion, or national origin, I will start eating the pages one after another.

But the authors of the law did not state their aims openly; they opted for a more subtle form of egalitarian behavior control. The civil rights legislation did not explicitly outlaw certain market outcomes, but only made actionable certain subjective states of mind: people cannot discriminate “on the basis of” or “on the grounds of” some physical attribute. It is not the action itself which is made illegal, but the motive.

Let’s say that Congress is disgusted by the number of divorces in the nation. It concludes that many result from shotgun marriages. So it decides to pass the following law: “All marriages contracted by parties under the age of 26 must be based on love, not mere infatuation.” The law is actionable in court, and enforced by a $5,000 penalty.

What happens? Does the divorce rate go down? Perhaps, but not because young marriages are more loving. It is because people decide to play it safe. They wait until the age of 26 to get married.

What’s being outlawed here is not an action as such, but a motivation. But to keep the motivation from being detected, people change their behavior. For this same reason, antidiscrimination law has led to quotas. For fear of the government, people change their behavior.

To illustrate further how civil rights laws are logically inseparable from reverse discrimination, quotas, and government control of labor markets, consider this additional thought experiment. Say a Catholic requests a job, but is told: no Papists need apply.

In announcing his policy, the employer reveals his motivation for not hiring the man. The government then passes a law making such a motivation illegal, so the employer knows he must hide his true feelings. He assures the authorities that he has had a change of heart about Catholics, whom he now regards as deserving of equal rights. Then he rejects a long series of applicants on the grounds that he doesn’t like the look in their eyes. But it turns out that all the rejected applicants were Catholics. Even so, he assures the authorities, that is not why they were rejected.

The trouble for the authorities is that the employer seems to be fulfilling the language of the law—he is no longer discriminating “on grounds” of a person’s belonging to the Catholic Church—yet Catholics are still not being hired in this person’s firm. Allowing the situation to continue would defeat the purpose of the law, since there would have been no point in its having been passed if it were only going to produce the same result.

Predictably, the authorities conclude that he is still engaging in illegal discrimination. They further conclude that in the future he will be evaluated in terms of how many Catholic employees he has hired and promoted, and fined heavily and perhaps jailed if he does not comply. To comply, the employer realizes, he must reject non-Catholics in favor of Catholics. In effect, he has been forced to establish de facto hiring quotas. Catholics now have privileges and non-Catholics are discriminated against. We can’t expect any other outcome.

But what if it turns out that the reason the employer disliked Catholics, though he had never thought about it before, was that most Catholics do indeed have a funny look in their eyes? In other words, he was using their Catholicism as a proxy for other behaviors he found unattractive.

In fact, the Catholics he discriminates against may have many traits that link them besides their religion: unassimilated ethnicity, hard-to-understand accents, chips on their shoulders, or whatever. These traits do not have to apply to every Catholic; they need only apply to the ones he has known. In fact, they need not apply even to a majority of those he has known. Because all economic decisions take place on the margin—that is, he makes choices among several seemingly desirable ends—he has only to find one characteristic that falls along group lines to make his discriminatory decision rational.

So the authorities must either outlaw discrimination on every possible ground that links Catholics together as a group, or they can specify that only certain criteria are legal in decisions to hire, fire, pay, and promote. Furthermore, these criteria must be distributed relatively evenly among Catholics and non-Catholics. Given the tendency of groups to have much in common that will be marginally job relevant, or else they would not be considered a group in need of protection, this could be difficult.

Say the authorities choose the criterion of education as a worthy hiring standard. If, over time, it turns out that education is not distributed evenly among Catholics and non-Catholics, the authorities must select a new criterion. Or they could claim that educational institutions are guilty of discrimination, and enact draconian controls over them. If the differences persist, the authorities will have to undertake increasingly extreme measures to bring about the desired result.

Whatever path is taken, to the extent that the original form of discrimination was rational and pervasive, the authorities will be forced to seek a near-total takeover of the labor markets to ensure “fairness” for Catholics. A law mandating “religion-blind” hiring must be enforced as “religion-conscious” hiring if it is to have any effect. This follows from the simple act of forbidding discrimination on grounds of religion.

There is no rational ground on which to exclude civil rights laws from the same sort of analysis. Their goal was not a level playing field; that was already in place in the labor markets. The goal was to redistribute wealth through government from one group to another group, and to enhance government control over the labor markets.

Civil rights laws, moreover, may actually increase discrimination. Employers forced to pay or promote people out of fear of the government will tend to avoid hiring them in the first place. And those who do get hired under such circumstances will be the cream of the labor pool, further marginalizing the least skilled and least experienced.

There is good reason to question the alleged policy ideal of sameness throughout the economy. Consider living arrangements. Good sense tells us that retired people sometimes want to live in adult-only complexes. Running, yelling children can pose a physical danger or just get on older people’s nerves. So Congress passed a law in 1988 that makes it illegal to discriminate in housing against families with children, even though such discrimination can be perfectly rational.

Civil rights laws are one of the paths to socialism because they overthrow the freedom of association and the employers’ freedom to choose. How crucial are these to preserving prosperity, freedom, and civilization itself? We’ll find out if the central government succeeds in stamping them out entirely.

If we are ever to reverse our current course, we must pay closer attention to the wisdom of Edmund Burke, Alexis de Tocqueville, John C. Calhoun, John Randolph of Roanoke, Lord Acton, Helmut Schoek, Bertrand de Jouvenel, Ludwig von Mises, Murray N. Rothbard and all the others who have taught that liberty and equal outcomes are incompatible goals. One always comes at the expense of the other. For a variety of reasons, this lesson has been forgotten in our times.

The free-market economy has a record like no other of offering economic advancement for everyone no matter what his station in life. However, it does not offer equality of result or even equality of opportunity. The free market offers not a classless society, but something of much greater value: liberty itself.

No reform of these laws will get to the root of the problem unless it is the repeal of all civil rights laws.

We are all familiar with Joseph Schumpeter’s paradoxical prediction that socialism would win out over capitalism. We also thought that the events of 1989 disproved him. In light of our present situation, let’s revisit Schumpeter.

The capitalist or commercial society, he says, is defined by two elements: first, private property in the means of production; second, regulation of the productive process by private contract, management, and initiative. By Schumpeter’s definition, we only have capitalism in the first sense. We have private property, but no longer can we govern the productive process by private contract, management, and initiative. The government exercises veto power over all matters of economic management.

By socialist society, he further writes, he means an institutional pattern in which the control over the means of production is vested with a central authority, or as a matter of principle, the economic affairs of society belong to the public and not to the private sphere.

Which does our society most closely resemble: Schumpeter’s commercial society or Schumpeter’s socialist society? Whatever our answer, we know where the trend line is pointing.

We need to reevaluate Schumpeter’s famous prediction about the US:

It is only socialism in the sense defined in this book that is so predictable. Nothing else is. In particular there is little reason to believe that this socialism will mean the advent of the civilization of which orthodox socialists dream. It is much more likely to present fascist features. That would be a strange answer to Marx’s prayer. But history sometimes indulges in jokes of questionable taste.

MEDICINE AND THE STATE

[This speech was delivered before the Association of American Physicians and Surgeons in St. Louis, Missouri, on October 26, 2000.]

Throughout the 19th century, socialist ideology gained ground among intellectuals who were attempting to revive ancient dreams of a total State that managed every aspect of people’s lives. The critics, too, weighed in to explain that socialism has ethical and practical limitations. If you abolish private property, which socialism proposes to do, you abolish economic exchange, which is a source of social peace. In addition, you eliminate the profit motive, which is a major factor in spurring people on to work and produce.

The major limitation to this dominant mode of criticism is that it was narrowly focused against the idea of completely eliminating private property. In addition, the 19th-century economic criticisms of socialism did not get to the heart of the matter, which is that any attempt to curb the workings of economic exchange forces resources into uneconomic uses. An economy is defined as a system in which human energies and resources are employed toward their most productive purposes, according to consumers’ spending. Not only socialism, but all interventions in the free market redirect resources in ways that are counterproductive—away from the voluntary sector of society and into the State sector.

The history of socialist theory is bound up with policies toward the medical marketplace. To control people’s access to medical care is to control their very lives, so it is no wonder that this is the goal of every State. In the course of a century we have taken a long march from a largely free system of medical provision to one dominated by unfree programs and mandates.

And yet, I’m sorry to report, the US, despite huge interventions on a scale unimaginable in an era of free markets, remains freer than most places in the world. Privatization of medical provision isn’t on the radar screen of the world’s politicians, even after manifest failures. Even after the collapse of all-out collectivism in the Soviet Union and Eastern Europe, there has been precious little movement toward reform in the medical sector.

We are a long way from clear thinking on the subject of medical care (the realization that the provision of medical services of every kind is best left to the forces of the market economy and the charitable sector than placed in the hands of the regulating, taxing, intruding State).

Ludwig von Mises was socialism’s greatest critic, having written the decisive attack in 1922. His book, Socialism, is usually credited for proving why Soviet-style socialism could never work. But less known is the fact that he attacked the entire panoply of what he called “destructionist” policies, which included the medical policies of the social welfare states in the German-speaking world at the time. Mises had a way of getting to the heart of the matter, so his comments on socialized health insurance apply to our own situation. Reviewers at the time noted his opposition and decried them as the ravings of an extreme classical liberal. If so, I am happy to rave myself.

Allow me to quote his remarks in full:

To the intellectual champions of social insurance, and to the politicians and statesmen who enacted it, illness and health appeared as two conditions of the human body sharply separated from each other and always recognizable without difficulty or doubt. Any doctor could diagnose the characteristics of “health.” “Illness” was a bodily phenomenon which showed itself independently of human will, and was not susceptible to influence by will. There were people who for some reason or other simulated illness, but a doctor could expose the pretense. Only the healthy person was fully efficient. The efficiency of the sick person was lowered according to the gravity and nature of his illness, and the doctor was able, by means of objectively ascertainable physiological tests, to indicate the degree of the reduction of efficiency.

Now every statement in this theory is false. There is no clearly defined frontier between health and illness. Being ill is not a phenomenon independent of conscious will and of psychic forces working in the subconscious. A man’s efficiency is not merely the result of his physical condition; it depends largely on his mind and will. Thus the whole idea of being able to separate, by medical examination, the unfit from the fit and from the malingerers, and those able to work from those unable to work, proves to be untenable. Those who believed that accident and health insurance could be based on completely effective means of ascertaining illnesses and injuries and their consequences were very much mistaken. The destructionist aspect of accident and health insurance lies above all in the fact that such institutions promote accidents and illness, hinder recovery, and very often create, or at any rate intensify and lengthen, the functional disorders which follow illness or accident....

Feeling healthy is quite different from being healthy in the medical sense, and a man’s ability to work is largely independent of the physiologically ascertainable and measurable performances of his individual organs. The man who does not want to be healthy is not merely a malingerer. He is a sick person. If the will to be well and efficient is weakened, illness and inability to work is caused. By weakening or completely destroying the will to be well and able to work, social insurance creates illness and inability to work; it produces the habit of complaining—which is in itself a neurosis—and neuroses of other kinds. In short, it is an institution which tends to encourage disease, not to say accidents, and to intensify considerably the physical and psychic results of accidents and illnesses. As a social institution it makes a people sick bodily and mentally or at least helps to multiply, lengthen, and intensify disease.

Thus spake Mises. He was observing that there is a moral hazard associated with socialized and subsidized medicine. Because there is no clear line between sickness and health, and where you stand on the continuum is bound up with individual choice, the more medical services are provided by the State as a part of welfare, the more the programs reinforce the conditions that bring about the need to make use of them. This one insight helps explain how socialized medicine takes away the incentive to be healthy, and maximizes the problem of overutilization of resources. Hence, socialized medicine must fail for the same reasons all socialism must fail: it offers no system for rationally allocating resources, and instead promotes the overutilization of all resources, ending in bankruptcy.

And now consider the presidential campaign of the year 2000. The most medically dependent group in the country is seniors, who also happen to be, at once, the most government-addicted and financially well-off members of society. Their medical care is largely paid through public dollars. And yet this group is nearly united in the claim that it is not enough. They demand that their drugs be free or at least be as cheap as fruits and vegetables at the grocery store. And the candidates respond not by pointing out the unreality and illegitimacy of their demands, but by competing to see who can provide free drugs more quickly through one or another central plan.

Can anyone doubt that Mises was right, that socialized medicine has led to a sickly frame of mind that has swept and now dominates the culture? The habit of complaining is endemic to this sector of society. Never have so many rich people who have been given so much by government demanded so much more. And the politicians are not pilloried for pandering to them but rewarded to the degree that they can dream up central plans that accommodate the complaining class through ever more freebies.

And when does it stop? When the coffers run dry. Until then, the subsidies work to distort the market and distort people’s sense of life’s limits. And no one has pointed out during this presidential campaign what this program would mean for drug manufacturers. It would essentially nationalize them by mandating that they work first for the government that is subsidizing drug purchases and only second for the consumer. But this is the path that all steps toward socialized medicine take: instead of physicians and patients engaging in cooperative exchange, we get government standing between them and dictating medical care.

Now, it is sometimes said that medical care is too important to be left to the market, and that it is immoral to profit from the illnesses of others. I say medical care is too important to be left to the failed central plans of the political class. And as for profiting from providing medical care, we can never be reminded enough that in a free society, a profit is a signal that valuable services are being rendered to people on a voluntary basis. Profits are merely a by-product of a system of private property and freedom of exchange, two conditions which are the foundation of an innovative and responsive medical sector.

In the recent century, however, these institutions have been attacked and subverted at every level. In the medical-care market, the process began in the late 19th century with the policies of Germany’s Otto von Bismarck, who sought a third way between the old liberalism and communism. As the originator of national socialism designed to foil international socialism, he claimed credit for being the first to establish a national health care system—thus adopting the very socialism he claimed to be combating.

Politicians ever since have followed this lead, continuing with Emperor Francis Joseph of Austria-Hungary, Wilhelm II of Germany, Nicholas II of Russia, Lenin, Stalin, Salazar of Portugal, Mussolini of Italy, Franco of Spain, Yoshihito and Hirohito of Japan, Joseph Vargas of Brazil, Juan Peron of Argentina, Hitler, and FDR. What a list! As individuals, most have been discredited and decried as dictators. But their medical-care policies are still seen as the very soul of compassionate public policy, to be expanded and mandated, world without end.

In each case, the national leader advertised the importance of centralized medical welfare for the health of the nation. But what was always more important was the fact that such policies reward the politicians and parties in power with additional control over the people, while dragging the medical profession—an important and independent sector that is potentially a great bulwark against State power—into a government system of command and control.

Before coming to power, Hitler’s party, for example, made statements condemning socialized medicine and compulsory social insurance as a conspiracy to soften German manhood. But once in power, they saw the advantages of the very programs they condemned. As Melchior Palyi argued, Hitler saw that the system was actually a great means of political demagoguery, a bastion of bureaucratic power, an instrument of regimentation, and a reservoir from which to draw jobs for political favorites. By 1939, Hitler had extended the system of compulsory insurance to small business and tightened the system in Austria. One of his last acts in 1945 was to include workers from irregular types of employment in the system, socializing medical care even in his last days.

After the war, the Social Democratic Party charged with de-Nazification immediately expanded his system to further centralize the medical sector. On the medical care front, Hitler may yet achieve his 1,000-year Reich.

The Soviet Union adopted a more radical course. This was the first country to adopt all-round socialized medical care—the dream of the Democratic Party in this country. In 1919, Lenin signed a decree that said every Soviet citizen had a right to free medical care. By 1977, this right had dramatically expanded to become the right to health itself—language now regularly employed by US politicians.

During the in-between years, the Soviet Union became host to one of the most backward, murderous, and coercive systems of medical provision ever concocted. The country trained more doctors than any in the world, but the vital statistics showed a more complete picture. Lifespans averaged 10 to 20 years less than in western countries. Infant mortality was twice as high. By the time of the collapse of socialism, 80 million people were said to have chronic illnesses, and up to 68 percent of the public was health-deficient by international standards. Mental retardation afflicted nearly a quarter of the children—a consequence of serious deprivation.

It was impossible for ordinary people to gain access to decent drugs. Stores carried only the most primitive medicines. However, the country was flooded with penicillin, as ordered in the central plan, a plan which was not altered even after the citizens became resistant to it. The hospitals housed 12 to 16 patients per room. More than a third of rural hospitals had no running water. Syringes were reused an average of 1,000 times. To keep up with the planned death rate, hospitals routinely threw people out before they died so that the hospital wouldn’t go beyond its quota of corpses.

Of course most real care went underground, where bribing for anaesthesia was common. Former Soviet economist Yuri N. Maltsev points out that this method was even used in the case of abortion, which was the most common surgical procedure in the Soviet Union. After Maltsev emigrated to the US, he was astonished to see that the US was adopting many of the principles that drove the old Soviet system. But in the US, it is not called socialism or communism. It is called insurance.

All Western systems have been based on a deeply flawed notion of insurance. After Hillary’s outrageous medical plan came out in 1993, I appeared on panels at National Review and the Claremont Institute on the subject, and explained what insurance is and what it is not. Hillary’s plan was not insurance. It was regimentation through welfare. Other panelists were aghast that I was criticizing not just Hillary’s plan but the very principle of government insurance, dating back to Bismarck. So that we are not confused, let me explain.

The world is full of risks, among which are those that are inherent in the nature of things, and those which can be increased or decreased according to human will. The risks against which you can insure yourself are those over which you can have no control. You can’t stop a hurricane from destroying your house. The chances of this happening to a pool of homeowners are calculable. Hence you can be protected against losses through insurance with reasonable rates, set according to the risk factor. If you take actions that bring about the destruction of yourself and try to collect, however, you are committing insurance fraud. That is because outcomes that can be directly controlled by the insured are not insurable.

The risk of getting sick combines random and nonrandom variables. Catastrophic illnesses occur predictably in groups and thus can be insured against. But routine maintenance follows many predictable lines that must be reflected in premiums. The most cost-effective way to pay for medical care is the same way car maintenance is paid for: a fee for service. In a free market, this would be the dominant way medical care is funded. Prices would be aboveboard and competitive, and there would be a range of quality available for everyone. There would be no moral hazard. This was largely the system before the Blues (Blue Cross and Blue Shield), of course.

What is called health insurance in the US consists of two types: one provided by employers in which the insurer is not permitted to discriminate too severely in light of individual risks. The other is not insurance at all but a straight-out welfare payment mandated by the State: this is Medicare, Medicaid, and the huge range of programs delivering aid to individuals. None has much to do with a free-market provision of medical services.

As a result, the consumer has fewer rights than ever. Physicians are caught up in an awful web of regulations and mandates. Business is saddled with huge burdens that have nothing to do with satisfying consumer demands. And innovation is limited by an array of penalties, subsidies, and regulations. The failures of the present system create constant pressure for ever more legislation that further socializes the system, which produces more failure and so on and so on.

For the most part in the US, the long march toward medical socialism has taken the path of least political resistance. Public outrage at the Hillary Clinton health plan of 1993 was a beautiful thing to behold, and with the help of the Association of American Physicians and Surgeons (AAPS), this outrage forced the administration to back down. But in the meantime, the regulatory State has taken steps toward imposing some of the mandates Hillary favored.

In some ways, the Republicans are as bad as the Democrats. For instance, throughout the 1990s the GOP has backed legislation that can best be described as Hillary-lite, complete with restrictions on the ability of insurers to discriminate, premium caps on some groups, penalties for noncompliance, mandatory portability, and on and on. As bad as the legislation passed in the 1990s has been, we can be thankful that gridlock prevented a comprehensive plan from passing.

Government intervention in the US medical market began in the late 19th century, first in the form of government regulations on medical schools. No one dreamed where this would eventually lead. Moreover, no one would have thought to call such intervention a species of socialism.

Socialism, it was believed, was Plato. It was Marx. It was not the American Medical Association. The AMA was about insuring quality, not equalizing wealth or expropriating the expropriators.

In fact, the empowerment of this physician cartel was the original sin of American medicine. Through its ability to limit supply and outlaw competition, organized medicine has punished its customers, although the word is never used so as to disguise what is, after all, an economic relationship.

Competition among providers leads to rational pricing and maximum consumer choice. But this is exactly what the AMA has always sought to prevent. The AMA, founded in Philadelphia in 1847, advanced two seemingly innocent propositions in its early days: that all doctors should have a “suitable education” and that a “uniform elevated standard of requirements for the degree of MD should be adopted by all medical schools in the US.” These were part of the AMA’s real program, which was openly discussed at its conventions and in the medical journals: to secure a government-enforced medical monopoly and high incomes for mainstream doctors.

Membership in the new organization was open only to “regular” physicians, whose therapies were based on the “best system of physiology and pathology, as taught in the best schools in Europe and America.” Emphatically not included among the “best” were the homeopaths. How the “regulars” came to crush the homeopaths and other competitors, and penalize patients in the process, is a story of deception and manipulation, of industry self-interest and State power. The organization knew it needed more than persuasion to secure a monopoly, so it also called for a national bureau of medicine to oversee state licensing and other regulations.

In those limited-government days, however, the idea went nowhere. But in the statist Progressive Era after the turn of the century, anticompetitive measures became respectable, and the AMA renewed its drive for a cartel, spurred on by the popularity of self-medication and the increasing number of medical schools and doctors. Then the AMA’s secretary N.P. Colwell helped plan (and some say write) the famous 1910 report by Abraham Flexner. Flexner, the owner of a bankrupt prep school, had the good fortune to have a brother, Simon, who was director of the Rockefeller Institute for Medical Research.

At his brother’s suggestion, Abraham Flexner was hired by the Rockefeller-allied Carnegie Foundation, so that the report would not be seen as a Rockefeller initiative. AMA-dominated state medical boards ruled that in order to practice medicine, a doctor had to graduate from an approved school. Post-Flexner, a school could not be approved if it taught alternative therapies, didn’t restrict the number of students, or made profits based on student fees.

The Flexner Report was more than an attack on free competition funded by special interests. It was also a fraud. For example, Flexner claimed to have thoroughly investigated 69 schools in 90 days, and he sent prepublication copies of his report to the favored schools for their revisions. So we can see that using lies to advance political goals long predated the Gore campaign.

With its monopoly, the AMA sought to fix prices. Early on, the AMA had come to the conclusion that it was “unethical” for the consumer to have any say over what he paid. Common prices were transmuted into professional “fees,” and the AMA sought to make them uniform across the profession. Lowering fees and advertising them were the worst violations of medical ethics and were made illegal. When fees were raised across the board, as they frequently could be with decreased competition, it was done in secret.

Then there was the problem of pharmacists selling drugs without a doctor’s prescription. This was denounced as “therapeutic nihilism,” and the American Pharmaceutical Association, controlled by the AMA, tried to stamp out this low-cost, in-demand practice. In nearly every state, the AMA secured laws that made it illegal for patients to seek treatment from a pharmacist. But still common were pharmacists who refilled prescriptions at customer request. The AMA lobbied to make this illegal, too, but most state legislatures wouldn’t go along with this because of constituent pressure. The AMA got its way through the federal government, of course.

By the end of the Progressive Era, the AMA had triumphed over all of its competitors. Through the use of government power, it had come to control education, licensure, treatment, and price. Later it outcompeted fraternal medical insurance with the state-privileged and subsidized Blue Cross and Blue Shield. The AMA-dominated Blues, in addition to other benefits, gave us the egalitarian notion of “community rating,” under which everyone pays the same price no matter what his condition.

When you see the bait, expect a trap. A cartelized profession is one that is easier to control and nationalize. Thus, the New Deal brought us massive national subsidies. The Great Society brought us the disastrous welfare systems of Medicare and Medicaid. There were also the HMO subsidies from the Nixon administration’s monstrous Health Care Financing Administration. The employer-mandates that make life so difficult for small business and led to the creation of more HMOs resulted from the lobbying of large corporations wanting to impose higher costs on their competitors, and labor unions attempting to cartelize the labor force and keep out low-price labor services.

And today, both major parties say all this apparatus is wonderful and should be protected and expanded until the end of time. It is true that there are some wonderful efforts afoot to resist further socialization of medical care. But there are no active political movements alive that are making any progress toward a fully free market in medicine, toward a full de-Nazification, a complete de-Sovietization, and a total de-AMAization.

Several years ago, in the midst of the early 1990s’ medical care battles, UNLV economist Hans-Hermann Hoppe developed a plan that is extreme in its simplicity and radical in its implication. Let me present that plan to you today.

1. Eliminate all licensing requirements for medical schools, hospitals, pharmacies, and medical doctors and other medical-care personnel. This would cause the supply to increase. Prices would fall, and a greater variety of medical care services would appear on the market, many provided the way they are now but others provided through innovative new techniques. Many underground treatments would appear above ground.

And, yes, quackery would thrive. But as with other professions, competing voluntary accreditation agencies would take the place of compulsory government licensing, because consumers care about reputation, and are willing to pay for it. Consumers can make discriminating medical-care choices, just as they make discriminating choices in every other market.

2. Eliminate all government restrictions on the production and sale of pharmaceutical products and medical devices. This means no more Food and Drug Administration, which presently hinders innovation and increases costs. Costs and prices would fall, and a wider variety of better products would reach the market sooner, particularly through online delivery sources. The market would force consumers to act in accordance with the market’s risk assessment. And competing drug and device manufacturers and sellers, to safeguard against product liability suits as much as to attract customers, would provide increasingly better product descriptions and guarantees.

3. Deregulate the medical insurance industry. A person’s health or lack of health lies increasingly within his own control, thanks to the proliferation of health information. Instead of subsidizing uninsurable risks, “insurance” would involve the pooling of individual risks. “Winners” and “losers” are distributed according to the law of large numbers. There would be unrestricted freedom of contract: a health insurer would be free to offer any contract whatsoever, to include or exclude any risk, and to discriminate among any group of individuals. On average, prices would drastically fall, and the reform would restore individual responsibility in medical care.

Also, patients would be free to sign contracts with their doctors agreeing not to sue except in the case of real negligence, and never for a less-than-happy outcome.

4. Eliminate all government subsidies to the sick or unhealthy. As Mises said, subsidies create more of whatever is being subsidized. Subsidies for the ill and diseased breed illness and disease, and promote carelessness, indigence, and dependency. If we eliminate them, we would strengthen the will to live healthy lives, and to work for a living. In the first instance, that means abolishing Medicare and Medicaid. Because medicine is an economic service, rules of demand and supply apply to it as they do to everything else.

As long as those choices are made in an unhampered market, and as long as people needing medical care can freely choose among alternatives, the system will work as smoothly as any other market. The so-called crisis in medicine stems not from any peculiarities in the service itself but rather from the way that politicians have decided that medical care will be both produced and distributed.

We need to reject the principles that drive socialized medicine. These include the ideas of equality and universal service as mandated by the State, as well as the view that it is the responsibility of business and not that of the individual to pay the costs of medical care. Above all, we need to understand that medical care is a right only in this sense: the right of provider and patient to negotiate. Every service should be protected as this kind of right. Medical care is no different.

What about those who cannot afford much needed services? During the campaign, George W. had finished his speech and a hand shot up from a young lady who proceeded to complain that she could not afford a special device that would permit her to overcome her visual disability. Still relatively new to the campaign trail, Bush asked her how much the device would cost. She responded that it would cost about $400. W. then asked for someone in the audience to help this girl with the expenses, and in a few minutes, there was enough money pledged to make it possible for the girl to purchase the device.

The national press hooted and howled at the incident. They claimed that he missed the point, which was not to provide for the girl’s particular need but rather to develop a national plan using the girl as a political prop. Actually, I liked Bush’s idea better. He was suggesting that the girl had no natural right to the device. He believed it ought to be provided in the way all such luxuries are provided in a free market—through purchase or charity.

Judging from his more recent behavior, I don’t believe we are justified in being optimistic about his plans for medical care. Neither do I believe that there is much hope in reforms that pretend to use market principles to better distribute medical care in the present system. Realistically, the best we can hope for is legislative gridlock, based on the principle that, first, do no more harm. To live by this principle means that you must ignore the partisan slogans that dominate the rhetoric of any proposed reform. Instead, you must live by this rule: carefully read any legislation before you offer your support.

Quite often some reforms sound great in principle—and I’m thinking here of gimmicks like educational vouchers and social security privatization—but once you look at the details, you find that the legislation would make the present system even worse. This was the case with the Republican health bill of the mid-1990s, which the AAPS fought so valiantly. I have no doubt the same is true of various proposals for Medical Savings Accounts. The power elite love nothing better than to turn a good reform idea into a cover for an increase in State power. Keep a watchful eye, and never believe the rhetoric until you see the bill itself.

Oh, yes, I am pessimistic about the legislative process. However, in the long term, I am cautiously optimistic about our overall situation. The exploding power of the market economy, and its ability to outrun and outperform the planners, is as evident in medical care as in every other industry. We’ve already begun to see the way in which the Web has presented serious challenges to conventional forms of medical-care delivery.

The future will offer other opportunities. And we should seize each one, on the principle that all forms of welfare and state regulation deserve to be tossed in the dustbin of history along with the ideological system that gave birth to them. Until that day, if you want to stay out of the trap, ignore the bait.