Category Archives: Law of Markets

Modern economics is such junk

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I was once again reminded about the multitudinous things that are wrong with economics today by two stories this morning. The first: Fed: US consumers have decided to ‘hoard money’. And then there was this: Cramped seats and angry passengers lead to diverted flights. Let me start with the first.

“Hoarding money” amongst all of the Keynesian idiocies is the most idiotic. Q: Why are people not spending? A: Because they are hoarding money. Q: What does it mean to “hoard money”? A: People are literally hanging onto cash rather than spend. And literally means literally. It means keeping money on hand and not even putting it into a bank.

It was idiocy in the 1930s when Keynes said it even though bank failures were not uncommon in the US. It has been a stupidity ever since as a cause of anything, and so far as I know, most textbooks tend to overlook this notion because it is so stupid. But not the Federal Reserve of St Louis:

One of the great mysteries of the post-financial crisis world is why the U.S. has lacked inflation despite all the money being pumped into the economy.

The St. Louis Federal Reserve thinks it has the answer: A paper the central bank branch published this week blames the low level of money movement in large part on consumers and their “willingness to hoard money.” The paper also cites the Fed’s own policies as a reason for consumers’ unwillingness to spend. . . .

“Why did the monetary base increase not cause a proportionate increase in either the general price level or (gross domestic product)?” economist Yi Wen and associate Maria A. Arias asked in the St. Louis Fed paper. “The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.”

These people are clueless about what’s going on, absolutely clueless. The lack of real income is crushing the American economy as the ersatz version driven by government spending has replaced the real kinds of income that are based on value adding production.

So what’s this got to do with the cramped seating on planes? Inflation means that what a unit of currency will buy diminishes. The same things cost more money, or the same amount of money will buy you fewer things. If you think of an airplane seat as a specific amount of room on an aircraft as you go from place to place, the inflation is coming in the form of less legroom and reduced space. On a cost per inch basis, prices have rocketed, but the CPI will never pick such things up.

The other way that the suppressed inflation is affecting things is in the way out capital structure is being run down. Again invisible using the national accounts or the CPI, but if you have travelled on an airplane in the US, just to give you one example, you can see just how decrepit the stock of capital in the US is becoming. The US, along with the rest of us, are finding our living standards declining because we are drawing down rather than building up.

Economic theory is such junk! But on a brighter note, the 2nd ed of my Free Market Economics will be released at the end of the month.

There but for the Grace of God

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I have just reached home and happy I am to be here but I must say seldom has any trip of mine been so complete. All my interests – economic, political and historical – came together so seamlessly that I only wish life was always like this.

Economically, the meeting on J.-B. Say and the Entrepreneur was an outstanding success. This being the first such meeting, it is of major significance that there is a casting about for some kind of successor paradigm to the fault-ridden neo-classical synthesis so accurately represented by Paul Krugman and Joe Stiglitz. As just a minor point, what became evident is that economists are useless at predicting the future so have substituted GDP estimates for actually knowing anything at all about the economy. If I tell you that Australia over the past twenty years grew by 50% and China by 150%, you would not have any idea about what either was really like, the kinds of economy each is or what is actually going on. Economists have substituted statistics for actual knowledge. It is all pretty useless, but if your aim is to pull wool over people’s eyes about what is taking place, GDP is a great number since it is almost meaningless as a statement about anything of significance.

Politically, it has been amazing to be here for the transition to a more market-oriented socialist Prime Minister. Every country is a hopeless case since the freeloaders have now overrun the productive. But if you are trying to manage the place, even the most dense political leader trying to re-engineer a recovery cannot help noticing that only those who make a net contribution to output actually create more value than they use up. A tremendous amount of capital to run through in our Western economies, but we are managing to do it. Fascinating to see it all in action in a place you would not normally expect it.

Historically, there are two sides to it. In relation to why I am here, I am part of a group that is trying to save Jean-Baptiste Say’s factory in Auchy-les-Hesdins for posterity. There are not many – any – places in the world that are actually historical sites in which economic issues are at the forefront. Auchy is astonishing in that it combines an ancient cotton mill – where the waterfall that ran the mill can still be seen – with the writings of one of the greatest economists of all time. If you are in France in the north-west around Calais or Normandy, and you have any interest in these things at all, you must come visit. The website I am told is coming but you should see it for yourself. The best way to describe the positioning of Auchy is to note that it is half way between Azincourt and Crecy. See all three, but if you have an interest in economics and its history, this place will astonish you. There is nothing like it on the planet and, as with everything related to Say, is only now in the process of being rediscovered.

Lastly there has been my following the trail of historical battles, with the last few days on the WWI battle fronts. Went to Villers-Brettoneaux yesterday which is the Australian Vimy Ridge. Very moving places both of them. Two things I found particularly noteworthy. The first was the direction finder in the tower pointing out various places of significance on the Somme battle grounds. But amongst the 20 miles to this and 30 miles to that was the arrow that pointed to 14,235 miles to Canberra. It was a long way from home for those young Australians who lie buried in the fields of France.

The other was a grave to some young lad who died on this battlefield in 1918. His name was S. Keates. It was quite a strange moment. It is truly the case that there but for the grace of God go we all.

Words have consequences

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Theodore Dalrymple on an unfamiliar topic for him, how the meaning of words applies to “austerity”:

I was irritated rather by the fact that the author of the article accepted that the policy of the present British government can properly be described as one of austerity. What the alleged austerity amounts to is this: that in the current year the government will borrow only one in six of the pounds it spends instead of one in five, as it did last year. As to the reasons for this less than startling decline in its borrowing requirements, it was not because the government was spending less but because it was receiving more taxes, from the speculative housing bubble which it has done much to fuel. . . .

One would not say of a man who passed from smoking sixty cigarettes a day to fifty that he had given up smoking, or that he had exercised great self-denial. And one would not, or rather should not, say of an organization that had balanced its budget once in fifty years (the British government) that it was practicing austerity merely because it had to borrow a slightly lower percentage of what it spent than it did the year before. This is to deprive words of their meaning.

But the word “austerity” is not used by those who support balanced budgets but by its enemies. Why anyone still believes high levels of public spending can do anything but harm for the nation overall remains a mystery.

The absence of the entrepreneur in economic theory

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It was a choice either to come to France and to the meeting on J.-B. Say or go to Hong Kong and to the Mt Pelerin Society meeting. With some racing across France and then an all-night flight I might have made it for the last three days, one of which was an excursion to Macau, where I have already been. So here I went, not without some regrets, but this conference has been so exceptional and I will feed off the things I learned for a long time to come.

My own presentation was on the absence of the entrepreneur in the economics of the English speaking world, a problem few notice and about which there is generally little comment or even the slightest general recognition that it matters.

• the dominance over the past century of the economics of the English speaking countries

• the absence of discussion of the entrepreneur in the economic literature written in English

• the meaning of “entrepreneur” comes from the French entreprendre which means to undertake with the word for entrepreneur in English having literally been “undertaker” which has its other more common meaning as someone who buries people for a living – a morbid connection

• interestingly as a sidelight, the German word to undertake is unternehmen and therefore the German for entrepreneur is Unternehmer but in this case with none of the morbid connectivity of English

• John Stuart Mill in 1848 was discussing the need for an English equivalent of entrepreneur and lamented that no such term existed

• Schumpeter’s notion of an entrepreneur embeds innovation

• the Kirzner version of an entrepreneur is someone who exploits opportunities others have overlooked

• the meaning that is missing with such overtones is the plain notion of an entrepreneur as a factor of production that exists along with land, labour and capital – someone who runs a business and brings the other factors together in a productive profit making enterprise

• all such entrepreneurs are almost certainly creative in their own way, some more than others, but it is the notion of the organiser of a business that is needed

• economic theory has, however determined that it must follow physics in depending on external non-human forces, such as demand or utility with human decision making almost invisible

• the use of MC=MR as the profit-maximising position is paradigmatic in that no actual human decision making is visible other than to follow the dots to the highest possible profit

• although this is the essence of the theory of the firm, what is omitted is the possibility of novelty and innovation not to mention time

• an innovative entrepreneur is inconsistent with economics-as-physics since it opens up the possibility of discontinuity

• discontinuity via innovation makes mathematically-based economics a limited approach to understanding the dynamics of economic change since the future cannot be expected to be like the past.

The one point that was underscored for me at this conference is the importance of defining capitalism as an economic system in which economic decisions are made by entrepreneurs who are defined as a self-selected group who run businesses to earn their living. They are not chosen by governments or funded by governments but live or fail based on their own capabilities in providing buyers with the things they want. If you want to distinguish a true market-based economy from amongst the many fakes that now exist, just find out who owns their businesses and how such individuals ended up running such firms.

The new French government and the economics of J.-B. Say

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The forces of J.-B. Say seem to have overtaken France in the last couple of days. The front page of Le Figaro is filled with the Prime Minister (not the President – Republic anyone?) doing over his economic ministers and installing someone from the more market oriented side of politics. This Keynesian-socialist stuff is not working so they are about to embark on something new. These are my (free as in best guess) translations from the front page:

The Heads of Industry Applaud these Changes and Now Wait for Some Follow-up Action

And:

The Beliefs of the Prime Minister have Exasperated the Left

And:

Survey: the French Have No Confidence in the New Government

And:

The Unemployment Rate has Reached a New Record

There is Hollande who will go down with the ship one way or another but at least he seems to be trying to do the right thing. I, of course, am in the midst of a conference in which at least some of those are thinking the right way. The conference organisers have just put out a journal which is devoted to “Jean-Baptiste Say: et la liberation des forces de production”. Odd as it may seem, I have never been in the company of anyone at all who has had a strong appreciation of J.-B. Say and for the past two days I have been in rooms filled with them. Incroyable!

Say lives

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I don’t know about the rest of the economics world, but where else but here at the J.-B. Say Congress would one find this:

Entrepreneurship has become a specific field of research in Economics since the beginning of the 1980s. This period was characterised by two linked phenomena: (1) the end of economic growth (“The Glorious Thirty 1945-1975”) and (2) the failure of Keynesian policies. A new economic dynamics should be ensuing from a radical economic and political change. Thus, the challenge was to find a new economic dynamics based on a new institutional structure, aimed to promote free markets and private initiative.

This is from an editorial in the local research institute into industry and innovation newsletter, Innov.doc No. 54 dated Septembre 2014. The spirit of Jean-Baptise Say has not yet been extinguished, although it has been exiled to the far north west of France, as had Say himself.

Visiting the battlefields of France

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We have just been off to a couple of the battlefields of France which have great meaning to me. Yesterday it was Azincourt and today Crecy, 1415 and 1346 respectively. Not great successes for the French but the museum at Azincourt was the best of its kind I have yet seen (and I have seen many). If, for example, you would like to find out what the field of vision was for someone wearing armour or how heavy one of the broadswords was, this is where you can find out. Not many French visitors, as you can imagine, but both were very well served.

Now onto a different kind of historic site, Jean-Baptiste Say’s cotton mill and his local historian, M. Zephyr Tilliette. They are trying to preserve Say and his memory in Auchy–les-Hesdin where the factory is. Longer story than the one I currently know, but I will know much more later on.

On the road in northern France

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Here I am in the far north west of France, on my way today to Auchy-des-Hesdins, the home of J.-B. Say where he went to set up and run his factory making textiles after being exiled by Napoleon for refusing to endorse his centralised economic policies. That Napoleon also offered him an immense amount of money, in the form of an appointment as a tax commissioner, which he indignantly knocked back, may be the single most principled act in the history of economics. See who else would refuse something like ten times the average wage, and especially someone who could have you arrested at will, because he did not agree with what he was asked to write. But such as he was.

I might add that virtually my last act before heading off was to do the final touches of the 2nd ed which will be out in September. I like to tell those here in France that my Free Market Economics is Say’s sixth edition as it combines emphasis on the entrepreneur, uncertainty and Say’s Law. I am looking forward to the factory tour tomorrow.

Central bank policy

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Central banking has as many different approaches as there are central bankers. The aim of central banks is to provide oversight and stability to the financial system which gathers in national savings and disperses those savings to those who can make the most productive (that is, profitable) uses of them. Saving is undertaken individually by putting money aside for future use. But from a national economic perspective, saving is precisely the use of resources to strengthen the economy through productive investment. Watching the two separate streams – the money stream and the real resources stream – and keeping them separate while at the same time being aware of how they interact, is crucial if one is even to have the most basic understanding of the processes involved.

There are real resources (bricks and mortar, labour and machines) that can be used in a variety of productive (and non-productive) enterprises. But the only way for a business to get their hands on these resources is first to get the money that will allow it either to buy, hire or rent the inputs it needs. Thus, what the financial system does is lend money as the intermediary to securing the various resources needed.

There are no end of various financial intermediaries who receive money with the promise to return an even greater amount of money at a later date. Banks, insurance companies, superannuation funds, building societies, share markets and the list goes on. Money comes in because there is an expectation that an even greater amount of money will come out later.

Lots of people want to take your money, and will do that with the promise that they will give it back with interest. The only way they can do that is to lend the money to others who use that money in a value adding productive profitable way. They then repay the financial institution from their receipts which then repays the people from whom they had initially received the funds. The economy grows so long as the people who took the money have used those funds to build productive profit-making assets.

Financial institutions that do not lend to businesses which make a positive return, find they have lent to businesses who cannot repay their loans. The businesses go bankrupt, and for financial institutions, if enough of their borrowers fail to repay their debts, the financial institution will also go bankrupt.

Central banks keep an eye on the entire process, but their two major roles in every economy have always been (1) to keep solvent those financial institutions that run into temporary difficulty and (2) ensure that the financial system itself does not collapse because of a failure of enough liquidity to allow commercial transactions to take place. The role of central banks during the GFC was exemplary. Just what was needed.

Central banks have now taken on an additional role which is to adjust interest rates to affect economic activity. Interest rates will, of course, be generated without a central bank so its role is totally superfluous so far as interest rates are concerned. But many like this role since it seems to provide a form of stability. For myself, the stability is illusionary. They only provide a talking point but can never really do what is needed since they cannot know with sufficient detail about the future state of economic activity. No one else does either, which is why it should be left to the market to sort out all of the contrasting sentiments found across the economy.

But now central banks also adjust rates with the intention of stimulating economic activity and sometimes even slowing it down to slow inflation. Low interest rates are seen as a positively good thing since supposedly it will stimulate investment. But it is noxiously misguided because low interests have all of the following effects:

  • reduces the supply of saving
  • reduces the flow of real resources into the economy
  • misdirects investment since low interest rates allow borrowers with low productivity investments to secure funds ahead of others with riskier but more productive investments
  • lenders are able to choose their friends to lend to since there is an excess supply of funds relative to the period when rates were kept higher
  • money goes into the purchase of readily available forms of assets such as housing or shares
  • governments, who are almost invariably low productivity borrowers, find it easier and cheaper to borrow.

The result of such low interest rates:

  • price bubbles in share markets, housing or other types of value-holding fixed assets
  • higher inflation which may come in the form of higher prices, or if prices are unable to rise, a crumbling asset base across the economy leading to an ageing and decaying capital base
  • slower growth
  • higher unemployment
  • a fall in living standards.

Unnaturally lower rates of interest lead to prolonged periods of depressed economic activity which, given the useless way we teach economics nowadays, hardly anyone understands, while at the same time there is no political constituency for a rise in rates since those who borrow become infuriated at any government that happens to be there when interest rates begin to rise.

For a more detailed discussion, see Chapters 16 and 17 of my Free Market Economics. The 2nd ed will be even clearer on this than the first.

The death of Keynesian economics another step closer

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You would think the Japanese would at least have absorbed the lessons from the catastrophic results of their first stimulus. Such was not the case so they tried another. Didn’t work again.

The economy of Japan, long stagnant, has taken a sharp turn for the worse: It contracted nearly 7 percent (annualized and inflation-adjusted) in the quarter ending in June. By way of comparison, consider that the U.S. contraction in the quarter ending in June 2009, when we were feeling the worst of the financial crisis, was 4 percent; the worst quarter of the 1982 recession saw a contraction of 2.6 percent. You’d have to go back to the 1940s to see a quarter with a 7 percent contraction in the United States.

As a kind of kiss of death, Paul Krugman was full of praise for the policies adopted, called Abenomimcs after the Japanese Prime Minister Shinzo Abe. This is what Professor Krugman said a year ago:

The really remarkable thing about “Abenomics” — the sharp turn toward monetary and fiscal stimulus adopted by the government of Prime Minster Shinzo Abe — is that nobody else in the advanced world is trying anything similar. In fact, the Western world seems overtaken by economic defeatism.

Another great victory for Keynesian stimulus. A few more victories like that and we will be at poverty levels not known since the 1930s. Possibly as remarkable as the outcome in Japan is that even the commentator at National Review Online doesn’t actually understand it himself. He doesn’t really know why these policies didn’t work and can only say something vague about the mathematisation of economic theory and the difficulties in applying policies that might work in one country to another.

Strangely, the policy adopted in Japan included increases in consumption taxes which I am incredulous that anyone would believe would lead to a recovery. Raising taxes in a recession is dead set dumb, as dumb as raising public spending. Next time they should try lower taxes and lower public spending to see how that works out for a change. I know it’s out of fashion, but you never know what might happen then.

[Via Instapundit]