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Bitcoin: One of the Greatest Economic Experiments of All Time

Whether you love or hate Bitcoin and cryptocurrencies you have to admit that it is one of the greatest economic experiments of all time.[1]  It is very rare in economics to have a well-defined and controlled experiment.  I learned about this experiment in a decentralized private currency with a limited supply by 2012.  At the time it was not clear if this experiment would ever really get off the ground.  Bitcoin was valued at about $13, with a market capitalization around $15 million.  In addition, it was difficult to buy and sell Bitcoins.  Despite this I had conversations with people about the questions Bitcoin posed, particularly about the nature of money.  There had been other cryptocurrencies before Bitcoin and when they got traction governments shut them down.

Now it is clear that Bitcoin, cryptocurrencies, and the underlying technology (decentralized, trustless, blockchains) are here to stay.  A single Bitcoin is valued at over $6,300.00 and the total market capitalization of cryptocurrencies is around $181 billion.  This is small compared to the FOREX market, but too large to ignore, which means the economic experiments will be played out.  Here are just some of the questions posed by this experiment.

 

1) What is money?

Bitcoin and most cryptocurrencies do not actually have a physical or even computer coin or token.  They are in fact just ledgers where the “coin” is the unit of value.  The ledgers show who paid whom what and a positive account shows that you have provided value and are owed (or at least hope to) obtain value from the community in the future.  If Bitcoin is successful it will show that money is not a thing, it is really just an accounting system that is it is just information.

It will also show that money is technology.  Andreas Antonopoulos points out that the last real upgrade to that technology was the credit card, introduced by Dinner’s Club in 1950.

2) Does Money Have Inherent Value?

Or stated another way does money need to have an inherent value?  Bitcoin does not have inherent value and in fact nothing has inherent value.  For something to have value means it has to have value to someone.  Value cannot be separated from the valuer.  The only things that even come close to having inherent value to humans are food, water, and air.  If Bitcoin succeeds it should settle the question of inherent value.

3) Do We Need Legal Tender Laws for Money to Work?

Most people seem to assume that money must be backed by a government or it will not work.  Legal tender laws are laws that state you must accept the legal tender as settlement for any debts public or private.  Of course, there are many examples in history where people used gold and silver as money that was not endorsed or backed by any government.  The United States did not have any legal tender laws from the Constitution until the Civil War.  If Bitcoin succeeds then it will be clear that money can be private, i.e., not backed by a government and legal tender laws.  If you want to know more about legal tender laws in the U.S. see Money and Banking.

4) Is a Low Rate of Inflation Good for the Economy?

The Federal Reserve and most central banks argue that a little inflation is good for the economy.  We are warned that without inflation we might fall into deflation, which caused the Great Depression.  In the United States the target inflation rate is 2% per year, which means the purchasing power of a dollar today would be ¼ of what it will be in 70 years later.  Even Milton Friedman argued that the money supply should grow at the same rate as the economy.  According to Friedman this would keep the value of the dollar stable.  This means if the economy grows at 3% per year then according to Friedman the money supply would grow at 3% per year.  One question Friedman does not answer is who benefits from this growth in the money supply?  The answer is the Federal Reserve and the U.S. government, essentially get 3% of the value of the economy in this example for doing nothing.  Also note that the U.S. was in a deflationary period in the 1880s and 1890s and it was a time of extraordinary economic and technological growth.

Bitcoin has an inflation rate (supply increase) that is used to pay the miners during the start-up years.  Presently the supply increase is about 4% per year.  In order to convert this into an inflation rate the way the term is commonly used in the United States, we would have to subtract out the growth rate of the economy.  The expected growth rate of the U.S. economy this year is 2.7%.  Thus the inflation rate for Bitcoin is 1.3%, which is less than the Federal Reserve’s target rate.  Also Bitcoin’s inflation rate slows down overtime and the total number of Bitcoins that can ever be produced is 21 million.

If Bitcoin succeeds, we will see whether a little inflation is good for the economy.  We will also see if private citizens prefer to hold a devaluing currency or value increasing currency.

5) Do We Need Central Banks?

Central Banks are a fairly recent phenomenon.  The United States did not have a central bank until the creation of the Federal Reserve in 1913.  The U.S. did have national banks, but these were not central banks.  A central bank has control over the currency of a nation and through convoluted processes creates and destroys money to “manage” the economy and to fund the government.  For more see How Central Banks Create Inflation.  The record of the Federal Reserve of “managing” the economy is very checkered including the Great Depression, the inflation and high unemployment of the 1970s, and losing 95% to 97% of the purchasing power of the dollar during its existence.

If Bitcoin succeeds, it will end the power of or at least significantly diminish the power of central banks.  We will then see if a central bank is necessary to create prosperity and smooth out the ups and downs of the economy.

6) Do We Need Securities Regulations – the SEC in the U.S.?

Securities like stocks and bonds were mainly regulated by common law fraud and contract law until the 1920s in the United States.  The justification for securities regulations have always been to protect investors.  There have been a number of studies on point and not one of them has shown that investors have done better because of securities laws and some have shown they do worse.

Bitcoin’s technology has the potential to create stocks, bonds and other securities.  However, it is not as clear that these can escape the regulatory rules in the way that Bitcoin can.  Already we have seen crypto-assets created that bypass both Venture Capitalists, Wall Street, and securities regulations.  Before the creation of the SEC in the United States in the 1930s this was quite common.

If Bitcoin’s technology can escape securities regulations, we will see if securities regulations help investors or if they just entrench large Wall Street banks.

7) Is a Financial Sector that Takes Up 20% of the GDP Good for the Economy?

Cash is almost dead in most modern economies, which means we pay for goods and services with credit or debit cards.  This “convenience” costs at least 3% of the transaction price assuming the bill is paid immediately.  It also puts the banks and government in between almost every transaction.  Securities regulations and banking regulations are so complicated that people are forced to use financial intermediararies for almost any financial transaction.  In 1947 the financial sector was only 10% of the United States GDP.  Finance does not create wealth, it just greases the wheels of transactions.  For instance, money is just a way for one person to sell their “time” and buy goods.

Bitcoin and Bitcoin’s underlying technology if they succeed may significantly shrink the financial sector.  For instance, by allowing everyone to be their own bank or credit card company or loan originator the fees to the financial sector will be severely undercut.  If Bitcoin succeeds we will see if the large financial sector was creating wealth or consuming it.

8) Do We Need Income Taxes?

Bitcoin has the potential to severely undermine income taxes and capital controls.  Do people think they get value for their income taxes?  Are income taxes a method of raising revenue or a system for punishing the politically un-connected or unpopular?

9) Can Bitcoin Decentralize the Internet?

The Internet was built on a series of decentralized technologies.  Because of the inefficiencies of our financial sector, the only way to monetize the Internet was with centralized systems like Google, eBay, Youtube, Amazon, etc.  Efficient micropayments that can be implemented using Bitcoin technology have been postulated as a way to decentralize the Internet and return it to its origins.  Only time will tell.

10) Do We Need the NSA to Protect Us?

The technology behind Bitcoin has the potential to store and transfer information that is not trackable and cannot be hacked.  These systems are just being developed.  If they are successful, we will find out if the NSA was just a boondoggle or if it was truly protecting us, not the government.

 

 

[1] Unless you are an Austrian Economist and then you do not think experiments and therefore observation are relevant to economics, which means you are not doing science.

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October 31, 2017 Posted by | -Economics, -History | , , , , | Leave a comment

Property Rights: The Foundation of Freedom

In the United States, we tend to study the Constitution to secure and understand our freedoms.  This is a bit strange as our freedom throughout history has been secured mainly by property rights.  This was understood by the founders and many others.

 

There is a “diversity in the faculties of men, from which the rights of property originate…. The protection of these faculties is the first object of government.”[1]

James Madison’s Federalist 10

 

“The reason why men enter into society is the preservation of their property.” John Locke

 

“No other rights are safe where property is not safe.”

Daniel Webster

 

“Ultimately property rights and personal rights are the same thing.”

Calvin Coolidge

 

Without property rights, no other rights are possible.

Ayn Rand “Man’s Rights,” The Virtue of Selfishness, 94, http://aynrandlexicon.com/lexicon/property_rights.html

 

“Property rights … are the most basic of human rights and an essential foundation for other human rights.”[2]

Milton Friedman

 

Property rights in the United States were a matter of state law for most of its history, with the minor exception of the Fifth Amendment.  Thus to gain a better understanding of how our freedom is secured, we need to study property rights.  This is a big subject and this post will focus on the historical development and the philosophical foundations of property rights.

The concept of property rights started with some sense of ownership of food and personal possessions among nomadic people.  People had the idea of a superior moral claim to the apple they picked or the deer they killed or the clothes they made and wore compared to other people.  With the advent of the Agricultural Revolution people began to think they had a superior moral claim to the land they cultivated and the crops grown on this land, which was the beginning of the idea of property rights in land.  However, these were not real property rights, because the King or other political body almost always reserved the power to trample peoples’ property rights when it was politically expedient.  In the Middle Ages “property rights” were thought to reside ultimately in the King or the sovereign.  Legal realists still hold onto this idea.  During the Renaissance legal theorist worked on a rational basis for property rights, starting with Hugo Grotius in the early 1600s.  Adam Mossoff has written an excellent paper explaining the historical development of property rights theory including the major theories today, called What is Property? Putting the Pieces Back Together.[3]

After Grotiuss, John Locke continued the work of developing a rational theory of property rights.  Locke’s formulation is that anything in a state of nature (unowned) that someone makes useful, results in them having a property right in the item they made useful.  So if you shoot a deer you have property rights in the deer or if you plant olive trees on some ownerless land you have a property right in the land and the trees.  This is true according to Locke because you have an exclusive moral claim over yourself (body and mind) and anything you create value in gives you property rights in the item.  This is commonly summarized as having property rights in one’s self.

It is important to understand that all of law is based on property rights logically (and historically).  Some libertarians have tried to postulate systems where property rights are some sort of contract.  You cannot have a contract unless you have an exchange and you cannot exchange something you do not own.  You also need to have property rights over yourself to enter a contract.  Contract law presupposes property rights law and to reverse the process results in nonsense.  Tort law makes no sense without property rights.  If you do not own yourself or some property how can you claim to have been harmed.  This is true of all other areas of law also.

Property rights law was developed in common law countries and in the United States along Locke’s theoretical formulation for at least a century or more.  For instance, in the United States the Homestead Act (of 1862) provided that any adult who had not taken up arms against the U.S. could acquire 160 acres of land by farming and living on the land for five years.  The Act made the implicit assumption that the land was in a “state of nature” and that people could obtain property rights by making it more valuable.  This is almost an exact formulation of Locke’s theory of property rights, except that the land had to be surveyed first and the acquirer had to put in an application.

There are several interesting things about the Homestead Acts.  One is that they were first proposed before the U.S. Constitution was ratified and many other homestead acts were passed after the one in 1862.  The Homestead Act of 1862 was clearly passed as part of the politics of the Civil War in the U.S.  Another interesting point is the Homestead Act implies that land grants by Kings did not result in valid property rights.  For instance, the land grants to George Washington for his military service from the British Crown did not confer valid property rights in the land.  Washington had problems with squatters on this land, who seemed to understand that Washington’s property rights in this land were invalid since he did nothing to create value in the land.[4]

Another interesting thing about the Homestead Act is that the surveyed plats were separated by roads.  There were no taxes to create or maintain these roads, so they were un-owned land or land in which no one could have property rights in.  It is important to note that property rights in land that cannot be accessed make those rights meaningless.  An essential element of all property rights in land includes access to and from the land and the rest of the world.  This does not mean that the owner of the land cannot exclude people from their land, but it does mean that property rights in land cannot interfere with reasonable travel.  This is one of those questions in law where the philosophy lays out the general theory, but the law has to work out some practical realities in which there is no exact answer.  In the Homestead Act, they decided that roads had to exist around every square mile block of privately owned land (one mile grid).  This obviously would have to be modified sometimes for terrain and another distance or pattern for the roads could have been selected without violating the general principles.

It would also be an abridgement of people’s right to travel if property rights in land could imprison people.  People exercised the right to travel over land before there were any property rights in land.  Thus property rights in land that unduly impinge on the ability of travel violate other people’s rights.

It appears the Romans understood this.  In the twelve ancient Roman tablets that set out the law, tablet seven appears to require land owners to maintain the roads.  “1. Let them keep the road in order. If they have not paved it, a man may drive his team where he likes.”[5]  Table eight requires “Where a road runs in a straight line, it shall be eight feet, and where it curves, it shall be sixteen feet in width.”[6]  Tablet nine requires “When a man’s land lies adjacent to the highway, he can enclose it in any way that he chooses; but if he neglects to do so, any other person can drive an animal over the land wherever he pleases.”[7]  The Roman tablet eight also require space between buildings, “A space of two feet and a half must be left between neighboring buildings.”[8]  This last law could have been for travel or to keep fires from spreading through the city.  Unfortunately, there does not appear any commentary to let us know.

Some people have suggested that this ownerless land for roads in the Homesteading Act is inconsistent with Ayn Rand’s Objectivism: “Capitalism is a social system based on the recognition of individual rights, including property rights, in which all property is privately owned.”[9]  This mistake is based on a misunderstanding.  There is no such thing as property.  There are property rights and things in which people may have property rights.  In informal language we often use the shorthand property to refer to something in which we or other people have property rights.  Unfortunately, this shorthand results in confusion.  Correctly interpreted what Rand’s statement is saying is that governments cannot have property rights in land or anything else only people can.  What the government has is a custodial duty.  The government cannot have a moral claim to have made something useful, only individuals can do this.  Rand explained it this way with respect to the Homestead Act of 1862:

Thus, the government, in this case, was acting not as an owner but as the custodian of ownerless resources who defines objectively impartial rules by which potential owners may acquire them.[10]

Rand did not directly address the concept of property rights, however she laid out many of her ideas in two articles in Capitalism: The Unknown Ideal: 1) The Property Status of Airwaves, and 2) Patents and Copyrights.  Rand echoes Locke when she explains the origin of property rights, “Any material element or resource which, in order to become of use or value to men, requires the application of human knowledge and effort, should be private property—by the right of those who apply the knowledge and effort.”[11]  Rand is stating that because you made/created something valuable you have a moral claim to the item that is greater than other peoples’.  Rand’s main refinement over Locke is to make it clear that this includes mental effort (in a way Locke leaves more ambiguous), “thus the law establishes the property right of a mind to that which it has brought into existence.”[12]

One important point that should be clear from this discussion is that dead people cannot have property rights.  Property rights are a moral and legal relationship between a person and an item (tangible or intangible).  A related point is that when someone abandons their property rights by no longer making something useful, then it is ownerless again and therefore in a state of nature.  This means that someone else can come in and make the item productive again and therefore acquire property rights in the item.  This is a very complicated subject and covering it in even a cursory way could be a whole book, however I will point to some examples.  In common law there is something called adverse possession, which “is a situation when a person who does not have legal title to land (or real property) occupies the land without the permission of the legal owner” and gains legal title to the land.[13]  Another complicated situation where these principles come into play is when a person dies or estates law.  A dead person cannot have property rights in anything, so suddenly those items they had property rights in are ownerless.  Property rights in land do not go on forever as many people assume.  A detailed- discussion of this issue is beyond the scope of this article.

We have talked about how property rights arise, but not what they are.  Many people think that their property rights in their land are unlimited that they go up infinitely into the sky and down to the center of the Earth and they can do anything they want on their land.  Why do they think this?  Did they create value 500 feet below the surface of their land?  Did they create value 500 feet into the air above their land?  Of course not.  The property rights you obtain are related to the value you created.  The most common form of property rights is called “fee simple” in the law.  Fee simple allows you (ignoring building codes) to farm/ranch and have a house (building), run a business, etc. on your land.  It does not allow you to put a commercial hog sty on your farm next to your neighbor’s house.  This would violate nuisance laws, which ensure that you have reasonable enjoyment and use of your land.  On the other hand, you cannot buy a farm and then build a house next to your neighbor’s pig sty and then sue them for nuisance.

In addition, there are other groups of property rights such as mining rights, which come in two varieties, lode and placer.  Lode mineral rights are designed to ensure that the person who discovers a vein of say gold is the owner of the whole vein.  Otherwise it would be easy for other people to say they discovered the obvious other end of the vein and profit at the expense of the true discoverer of the vein.  These rights may not include any rights to the surface land above them, while a place type of mineral rights does.  There are also grazing rights, water rights, easements, trademark rights, property rights in chattel, copyrights, patent rights (inventions), trade secrets, etc.  All of these property rights are different and come with different rights of action and rules, based on the value that was created.

The property rights you obtain are related to the value you created

Property rights are not monolithic as many people seem to believe.  As Adam Mossoff explains in his paper, Why Intellectual Property Rights? A Lockean Justification:

As Locke first explained, property is fundamentally justified and defined by the nature of the value created and secured to its owner … To wit, different types of property rights are defined and secured differently under the law.

Some property rights come with the right to exclude, however grazing rights do not include a right to exclude unless the person is interfering unreasonably with the grazing rights owner’s ability to graze the land.  Even with “fee simple” ownership of land your right to exclude is limited to using reasonable means to exclude people who are interfering with you enjoyment and use of your land.  This means you cannot shoot someone for crossing your land.

Property rights are a vast and complex area of law of which this article just touches on.  Property rights are the most important area to securing our freedoms and all law starts with and builds on property rights.  The key philosophical foundations of property rights are:

Property rights is the foundation of all law

Property rights are a moral and legal claim to take action with respect to an object

Property rights arise when a person creates value

The rights obtained with property rights depend on the value created

– they are not monolithic.

Property rights are the foundation of all our freedoms and

much more important than the Constitution in securing our freedoms.

 

[1] The Economic Principles of America’s Founders: Property Rights, Free Markets, and Sound Money, Paul Ermine Potter and Dawn Tibbetts Potter, accessed 4/15/17,  http://www.heritage.org/political-process/report/the-economic-principles-americas-founders-property-rights-free-markets-and#_ftnref3

[2] Milton Friedman’s Property Rights Legacy, Forbes, Ken Blackwell, accessed 4/15/17 https://www.forbes.com/sites/realspin/2014/07/31/milton-friedmans-property-rights-legacy/#238d1416635d

[3] Mossoff, Adam, What is Property? Putting the Pieces Back Together. Arizona Law Review, Vol. 45, p. 371, 2003. Available at SSRN: https://ssrn.com/abstract=438780 or http://dx.doi.org/10.2139/ssrn.438780

[4] George Washington, Covenanter squatters, http://explorepahistory.com/hmarker.php?markerId=1-A-28F accessed April 30, 2017.

[5] http://www.historyguide.org/ancient/12tables.html, accessed May 7, 2017.

[6] http://www.constitution.org/sps/sps01_1.htm, accessed May 7, 2017

[7] http://www.constitution.org/sps/sps01_1.htm, accessed May 7, 2017

[8] http://www.constitution.org/sps/sps01_1.htm, accessed May 7, 2017

[9] “What Is Capitalism?”Capitalism: The Unknown Ideal, 19 Ayn Rand Lexicon, http://aynrandlexicon.com/lexicon/capitalism.html accessed May 7, 2017.

[10] Ayn Rand, Capitalism: The unknown Ideal, The Property Status of Airways, p. 132.

[11] Ayn Rand Lexicon, “The Property Status of the Airwaves,” Capitalism: The Unknown Ideal, 122

[12] Ayn Rand, Capitalism: The Unknown Ideal, Patents and Copyrights, p. 141.

[13] https://en.wikipedia.org/wiki/Adverse_possession, accessed May 7, 2017.

May 20, 2017 Posted by | -History, -Legal, Legal Philosophy | , , | 2 Comments

Money and Banking (Intellectual Capitalism Part 3)

There are a lot of misconceptions about money and banking.  Often people either think these are the root of all our problems or the solution to all our problems.  Both seem to believe that once money enters the equation in economics magic happens.  This paper will focus on how money and banking work in a free market and then examine the distortions caused by government manipulation of money and banking.

 

Money

If you examine an economics book on money it will tell you money is a medium of transaction, a store of value, and a unit of account.  Some economist say that money being a medium of exchange is the real function (definition) and the other two functions follow from money’s primary purpose.  I agree and therefore in this paper the definition of money is a medium of exchange.

All sorts of things have served as money including sea shells, tobacco leaves, grain, large immovable stones, tea leaves, cigarettes, silver, gold, paper, and computer bits (entries).  Why money is a useful invention is usually explained by way of an example.  Suppose that you raise cows for a living and you wanted to buy a loaf of bread.  If you tried to trade your cow to the butcher, you would want several hundred loaves of bread in return.  Most of the bread would spoil before you can eat it, so you only want two loaves of bread now.  On top of this, the baker wants chickens not a cow.  Under a bartering system these transaction will not occur, however with the addition of money you can sell your cow to the butcher and he will give you money.  You can then use the money to buy two loaves of bread, which the baker can use the money to buy chickens.

It is likely that money originally grew out of an IOU (I Owe yoU) system.  For instance, in the example above it is possible that once the rancher and the baker agree that the cow is worth 300 loaves of bread, then the baker would give the rancher two loaves of bread and an IOU for 298 loaves of bread.  The rancher intends to present the IOU to the baker every week for his two loaves of bread.  At which time the baker will give him two loaves of bread and an amended (new) IOU.

Unfortunately, the rancher gets sick and needs a doctor.  The doctor agrees to accept the baker’s IOU in payment for his services.  Now the baker’s IOU has acted as medium of exchange, which means it is money.

Money is just a generally accept IOU.  In other words many people will accept it as a general IOU that they can “redeem” from most people.  In the example above the doctor would have to worry that the baker might not make good on his IOU.  Now some people will argue that only paper fiat money is a generalized IOU.  However, even gold is functioning as a generalized IOU.  It is commodity money and as a result may have value in the market separate from its use as an IOU, but the person accepting it as money does not need it as a commodity.  He is planning on trading it with other people for goods and services.  On a deserted island (with no hope of rescue) you could have a ton of gold, but it would useless and you would not be better off with it than without it.  This also shows that wealth is not the same thing as having money.

One of the advantages of this point of view on money as an IOU is that it makes it clear that money is not wealth, even gold. The Spanish Kings and Queens found out this point when they brought back tons, literally, of gold and silver but still ended up going bankrupt.  The gold was not wealth and they spent their gold on things that did not create wealth.  Wealth is the things and knowledge that solve the objective problems of life (inventions).  I added the knowledge part because if you give an aboriginal person living in the Brazilian rain forest a super-computer, or an MRI machine, or even a bulldozer they are not wealthier because they do not know how to use these things (inventions) or even trade them.  Wealth is also about the objective problems of life, the most fundamental ones being air, water, and food.  These are still problems for many people in the third world.  Even in wealthy first world countries people have real objective problems, such as health problems, safety, etc.  It might not be as obvious why cruise control or smart phones solve objective problems, however if you think about it both do.

The idea that money is not wealth is important because it immediately makes the fallacy of Mercantilism apparent, which Adam Smith spent 100s of pages on.  In addition, it makes it clear that we cannot become wealthier by manipulating the money supply.  The only way to become wealthier on a per capita basis is to create new things that are more efficient at solving the objective problems of life or solve new objective problems of life, in other words create new inventions.

People often argue about the differences between money, currency, real money, commodity money, debt money, paper money, and fiat money.  Currency is generally defined as something that is specifically designed to function as money, such as coins.  Commodity money is when the money is a commodity such as silver, gold, grain, or is backed by a commodity.  Now real money can mean several different things, however I am talking about people who argue that only gold (silver) is real money.  By this they seem to mean that gold is a commodity money and all other currencies are to be measured against gold.  All commodity moneys have the advantage that they are more difficult for the government to devalue, however bitcoin also has this feature.  The other point is that gold has a long tradition as a widely recognized money.  This is true but does nothing to enlighten what money is or what its function is.

Fiat money is money that is not backed by a commodity.  Usually it is paper money although more and more it is just electronic entries in a computer and often it is legal tender, which will discuss in more detail shortly.  Paper money is self-explanatory.  Debt money can have several meanings, but usually means the money “created” when a person (entity) takes out a loan.  Many people argue that debt money is evil or somehow costs us interest just to have money.  Since all money is essentially an IOU, all money is created by a debt, i.e., a claim to future goods and services.

 

Proto Banking

Banking and money have been closely linked at least since the Agricultural Revolution about 11,000 year ago.  The Agricultural Revolution was a series of inventions that provided man with access to a huge increase in the number of calories per acre.  As a result, the human population expanded enormously and the territory of humans also expanded.  These excess calories were converted into population increases until the number of calories collected/created by the human population were roughly equivalent to the number necessary to support that population.

The grains that were the major source of these extra calories had to be stored, because the grains ripened all at once.  While the grain was stored, it needed to be protected from water and vermin.  If the grain ran out before the next harvest, people starved to death.  Efficient, effective storage of grains reduced the chances of running out grain before the next harvest.  A centralized grain storage (grain silos) was more effective than econgrowth.smallindividual storage of grains.  When a farmer deposited their grain they received a receipt (clay tablet) for the grain.  Eventually people started to use these receipts to pay for other goods (services).  For instance, if you wanted to buy a chicken instead of going to the grain silo and taking out enough grain to pay for the chicken, you just handed over some of these clay tablets to the owner of the chicken.  In other words these receipts became money.

In ancient Mesopotamia, as long ago as 5000 B.C.E., clay tablets were used to represent beer or grain.[1]  These clay tablets functioned as money.  Gold also started functioning as money about the same time, but was probably only used for large or long distance payments and therefore was not used by average people.[2]  These clay tablets were “created out of thin air” in the vernacular of today.  After a harvest there would be a lot of these clay tablets around and we would say the money supply increased.  As people withdrew grain, the grain bank would redeem these receipts.  We do not know if the “bank” destroyed these clay tablets, which would have been the logical thing to do or if they stored them for the next harvest.  Either way the money supply would shrink until the next harvest.  In fact the number of clay tablets (in circulation) would have shrunk to almost to zero just before the next harvest.  We know this is the case because of evolution.  Population expands until it takes up the available food supply, which is known as the Malthusian Trap.  This means the grain would be almost gone by the time the next harvest rolled around.

If you eliminate money (clay tablets) this does not change the economic situation.  Until the Industrial Revolution people lived on the edge of starvation and it was common for families to have to ration their food and even pick who would get food and who would not.  Because the healthy adults were the only way any of them would survive through the next year, the old, the young, and the sick were the first one’s whose food was cut off.  This is a grim reminder that economics is not just a game, but has real world consequences.

If we replaced the clay tablets with coins (e.g., silver, gold), then the money supply would not go up and down.  However, the price of food (and other goods) would go up and down.  After a harvest the price of food would be cheap and just before the harvest food would be very expensive.  The monetary system would not change the underlying economic situation one bit.

This is what we have learned about money in a free market:

1) Money is a medium of exchange

2) Money is a generalized IOU

3) The money supply can vary in a free market without fractional reserve banking.

4) Many things can function as money and only the market should “decide” what is money.

5) Money is not magic and does not allow magic in economics.

Now we are going to introduce some government (non-free market) distortions to money.  Going back to our clay tablets, someone probably realized that it did not make sense to destroy the clay tablets when people withdrew grain, since they would have to make new clay tablets after the harvest.  The “bank” probably started storing them and this of course led to the temptation of stealing the clay tablets.  Also the government probably decreed that taxes had to be paid in these clay tablets, which was the first step to making them legal tender.

We are going to skip forward to Roman times.  The Roman’s used silver coins as their currency.  The main unit of money was the denarius, which was between the size of a modern nickel and dime and equivalent to a day’s worth of wages for a skilled laborer.[3]  As late as 68 C.E. the silver in a denarius was almost 100%, but then it started to decline.  People balked at using this debased money, however the government declared the new, lower silver coins legal tender.  By 265 C.E. the silver content in coins was down to 0.5%.  Not surprising the Roman Empire suffered huge inflation.  The Roman’s minted so many coins that even today you can buy several Roman coins of standard quality for twenty dollars or so.[4]  For clarity later on I am going to call this “simple inflation”.

An important point here is that legal tender laws are always the first step towards inflation.  The only reason for a government to pass a legal tender law is so that they can “print” money.  In other words, the government is undertaking an endeavor that would get any private citizen throw in jail.  With the end of the Roman Empire legal tender laws and banking died out during the Dark Ages.  Coins were mainly used by the rich during this period.

By the 1700s legal tender laws were being seen again in Europe.  France experimented with legal tender laws, allowing The Mississippi Company in the 1710s to have control over its legal tender with disastrous results.  Supposedly, the French swore off paper money and modern banking for years after this.  Some historians have even argued that this backwardness in France’s finance system was part of why they were beaten by the English.  This is a fascinating story, but beyond the scope of this article.

The British followed suit in 1833 making banknotes issued by the Bank of England (a private bank at the time) legal tender.[5]  The United States had no legal tender laws (after the Constitution) until 1862 during the American Civil War.  The North printed $450,000,000 under this law to help finance the war.  Eventually this law was declared unconstitutional in Hepburn v. Griswold, 75 U.S. 603 (1870).  The Court reasoned that the Constitution allowed the federal government to coin money, but not the power to make paper legal tender.  The government argued that since it had the power to carry out war and the issuance of the legal tender was necessary for carrying on the war, then legal tender laws fell under the “necessary and proper’ clause of the Constitution.  The Court rejected this argument and also pointed to the fact that the Constitution prohibited the states from interfering with contracts.  The Constitution did not specifically, prohibit the federal government from interfering with private contracts, but it would be against the spirit of the Constitution to allow the federal government to do so.  In one of the stranger twists in history, Salmon P. Chase helped push the legal tender legislation through as Lincoln’s Secretary of Treasury, then he was appointed Chief Justice of the Supreme Court and lead a 5-3 decision to declare the law unconstitutional.  Unfortunately, this case was quickly overruled by the Knox v. Lee, 79 U.S. 457 (1871) Supreme Court decision.

Multiple competing bank notes were the norm at that time.  According to the Cato Institute, “the government did not entirely monopolize issuance of notes until 1935, but the laws that made the monopoly possible date from the Civil War.”[6]  Today the legal tender law in the US is 35 USC § 5103 which states:

United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues. Foreign gold or silver coins are not legal tender for debts.

Legal Tender laws are necessary for government counterfeiting[7] to be successful.  Without legal tender laws, people would quit accepting the money printed by the government.  The key point is that legal tenders are necessary to create inflation.  Any further investigation of money will require that we first examine how banks work.

 

Banking

The first banks in Europe after the Dark Ages were goldsmiths.  Because goldsmiths were working with valuable materials they needed vaults.  Wealthy patrons would often give some of their gold or other valuables to the goldsmith to secure in their vault.  The goldsmith would give the patron a receipt for their gold.  Overtime, just like the clay tablets for grain, people started to trade the receipts instead of taking out gold and paying with the gold.

Some of the customers also started asking for loans.  The goldsmiths wanted to reduce their risk if the customer defaulted on the loan, so they asked for collateral.  Originally, they probably asked for jewelry or other things made of silver and gold, since they knew they could liquidate (sell) these items fairly easily.  The goldsmiths could have given the customer gold out of their gold reserve (capital) and they probably did initially.  Most likely many customers then gave the gold back to the goldsmith and took receipts for the gold.  If the goldsmith’s receipts were trusted enough, they could skip this step and just give the customer receipts.  If the customer failed to pay the loan back, the jewelry (collateral) became the property of the goldsmith.

Or the goldsmiths could have given the borrower gold on deposit from other customers, which is the way most people think of banking working.  In that case then the gold the goldsmith had on hand (deposit) was less than the amount of the receipts outstanding for the gold, which is fractional reserve banking (assuming the goldsmith had no gold capital or the loan(s) were greater than the goldsmith’s gold capital).  Fractional reserve banking is defined as:

a banking system in which only a fraction of bank deposits are backed by actual cash on hand and are available for withdrawal.[8]

Most customers probably deposited the borrowed gold with the goldsmith and took receipts.  Again the goldsmiths probably began to skip the step of giving the borrower actual gold (silver) and just gave them receipts for the gold.  At this point it might appear that the goldsmith is “creating money out of thin air”, however the receipts in this case are backed by the collateral, jewelry in this example.  Actually, all the outstanding receipts are now backed by the gold on hand and the collateral the goldsmith has for loans.

At this point the goldsmith risks all the holders of these receipts asking for their gold and the goldsmith does not have enough gold to fulfill all these demands.  However, the goldsmith does have enough capital to fulfill the demands, because the collateral, jewelry and gold on deposit in this example.  It is likely that initially most of these loans were “callable”, meaning that the goldsmith could demand the borrower pay them back in full (gold or receipts) at any time.  If the borrower paid up, then the goldsmith had no problem paying off the receipts.  If the borrower did not pay up, then goldsmith became the owner of the collateral (jewelry) and could sell it to fully back the receipts.[9]

Eventually the goldsmiths realized it was not only jewelry (gold and silver items) that had value and could act as collateral.  For instance, arable farmland was one of the most valuable assets that people could own for most of history since the Agricultural Revolution.  The goldsmith could not put the farmland in his vault, however he could have a legal claim to the land.  That claim stated that if the borrower did not pay back the loan, then the goldsmith owned the farmland.  Of course it takes longer to liquidate farmland than jewelry and farmland might be more subject to market fluctuations.  As a result, the amount the goldsmith would lend against the farmland was lower than for gold and silver items.

At first goldsmiths probably made loans against farmland that someone owned outright.  Eventually, they figured out that they could make loans on farmland that was being purchased, as long as there was a big enough down payment (the equivalent of loaning less than the value of collateral).  What the goldsmith is doing is securitizing assets other than gold.  When the goldsmiths created receipts for gold and silver deposits they were securitizing gold (and silver).  “Securitize is a pooled group of financial assets that together create a new security”[10] or banknote in this case.  This means that goldsmiths receipts (banknotes) are backed by not only gold deposits but the other assets that they hold as collateral.

This is exactly what a company does when it sells bonds (stock).  The bond is backed by the assets (collateral) of the company.  The bonds are usually very liquid and can be sold or traded in exchange for goods and services, i.e., the bonds are money.

These goldsmiths became fractional reserve banks once they started securitizing assets other than gold.  Fractional reserve banking is an important invention and is created (exists) in a free market.  A fractional reserve bank is doing something analogous to what engineers have done with the telephone system.  The backbone that connects two people together on a phone line does not have the capacity to allow everyone to make a call at the same time.  The engineers know that only a certain fraction of people will normally be on their phones at the same time.  By designing a system to handle this level of usage plus a margin, the cost of the telephone system is reduced.  Of course occasionally, like in the time of an emergency, everyone wants to use their phone at the same time and then you receive a message like ‘all circuits are busy, please try your call again later.’  Another example is the time sharing of resources is done by computers.  Before the 1980s this was done by having a number of computer terminals all connected to one large computer that time shared its resource among these terminals.  This is still done within your computer when it runs multiple programs.  The processing power of the microcontroller is time shared among these programs.

Banks know that only a small number of people will want gold at the same time.  Most of the time people will be happy with banknotes or just accounting entries.  However, if people lose confidence in the bank, then they will all want to withdraw gold (cash) at the same time.  This is called a ‘run on the bank’ and is the same thing as everyone trying to make a telephone call at the same time.  Note that this is a cash flow issue and can happen even to a bank that is profitable.  Usually, banks that were clearly profitable could borrow gold from other banks to weather the run.

When a fractional reserve bank (hereinafter bank) initiates a loan against an asset, let’s say a farm, the bank creates a security (banknotes or an entry in a ledger) equal to the amount of the loan.  In this process it “creates money” equal to the loan.  At one time this might have been done by printing a bunch of banknotes, but now it is an electronic entry in the banks accounting system.  An article entitled “Money Creation in the Modern Economy” published by the Bank of England explains “whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”[11]  This article also points out that “money creation in practice differs from some popular misconceptions — banks do not act simply as intermediaries, lending out deposits that savers place with them, and nor do they ‘multiply up’ central bank money to create new loans and deposits.”[12]  According to the article, “Money in the Modern Economy: an Introduction”, there are three main sources of money in modern economies, currency, bank deposits (loans by commercial banks) and central bank reserves.[13]  This article also points out that most money in the economy is created by banks initiating loans.  [14]

Some people call this debt money and argue it is bad for the economy.[15]  They imply that this system of money creation requires we pay interest to have money.  First, it is important to point out that this sort of money creation happens in a free market.  Second, the only one paying interest is the person who took out the loan.  In a free market there would also be other forms of money, such as gold, silver, bitcoin etc.

When loans are paid back money is destroyed, just like the case of the clay tablets being destroyed (taken out of circulation) when people turned them in for their grain.  The bank no longer has access to the collateral (e.g., farmland, jewelry, etc.).  As a result, the banknotes (electronic entries) are destroyed.  Note that money is also destroyed if the borrower defaults on the loan.

In a free market (for this discussion most importantly means no legal tender laws and no central bank) banks’ ability to ‘create money’ is limited by the value of the assets used as collateral.[16]  The bank is not creating money, it is securitizing assets and the banks’ ability to create money is then limited to the assets that can be securitized.

If the banks create too many loans that cannot be paid back, then they will tighten their lending standards.  This will result in fewer loans and less money being created.  When the economy is growing banks will fund more loans and create more money.  However, the amount of money in the economy will be proportional to the assets that can be collateralized in the economy.

As a result, in a free market fractional reserve banks do cause variations in the money supply, but do not cause inflation or deflation.  Note that the United States had fractional reserve banks from before the revolution and the United States did not have any periods of inflation.  The banks were constrained in how much money they could create.  Now prices did vary widely sometimes, particularly in times of war.  However it is necessary to separate out the fluctuation in prices due to changes in supply and demand from those due to changes in the quantity of money.  During a war (crop failure) there is an increase in the demand for goods and services, particularly food.  Men are off fighting instead of planting their fields and the war itself often destroys the crops on large tracks of land.  This increase in the price of food will mean that farmland that is not threatened by the war will be more valuable.  As a result, it is likely banks will be willing to lend more money against these farms.  This will result in some increase in the money supply.  However, when the war ends the prices of the farm goods will fall and so will the value of the farmland, which will reduce the number of loans outstanding, reducing the amount of money in the economy.  Averaged out over time money grows at the same rate as the economy and prices are roughly stable.[17]

 

This is what we have learned about banking in a free market:

1) Fractional reserve banking exist in and our an invention of a free market.

2) Fractional reserve banks do create and destroy money, however the amount of money created is proportional to the assets in an economy.  

3) Fractional reserve banks do not cause inflation.

 

(I wanted to include a discussion of central banks, however this article is already too long.  So I will post on central banks and their effects in another article)

[1] Peter Dockrill, This 5,000-year-old artefact shows ancient workers were paid in beer, http://www.sciencealert.com/this-5-000-year-old-clay-tablet-shows-ancient-mesopotamians-were-paid-for-work-in-beer; and

Rachelle Samson, History of money: From clay tablets to legal tenders

History of money: From clay tablets to legal tenders, http://www.versiondaily.com/the-history-of-money-from-clay-tablets-to-legal-tenders/.

[2] Wikipedia, History of money, https://en.wikipedia.org/wiki/History_of_money, accessed 11 November 2016.

[3] Jeff Desjardins, Currency and the Collapse of the Roman Empire, http://money.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/, accessed 11 November 2016.

[4] coins  https://www.amazon.com/Lot-10-Uncleaned-Ancient-Bronze/dp/B001BMWATA?SubscriptionId=AKIAIKBZ7IH7LXTW3ARA&&linkCode=xm2&camp=2025&creative=165953&creativeASIN=B001BMWATA&tag=wwwbookcompar-20&ascsubtag=5820b98a48308f0454a513ac

[5] A. Andreades, History of the Bank of England 1640 to 1903, http://socserv2.socsci.mcmaster.ca/econ/ugcm/3ll3/andreades/HistoryBankEngland.pdf,

[6] Schuel, Kurt, Cato Journal, Vol. 20, No. 3 (Winter 2001) p 454.

[7] Counterfeiting in an economic sense is any currency that is not backed by productive or creative effort that someone willing exchanged their creative effort for.  Gold is clearly not counterfeit money, since it requires productive effort to mine gold.  Buy paper money presents a problem.  It takes productive effort to make and print paper, but no one would trade twenty dollars of their effort for someone who printed a twenty dollar bill.  Economic counterfeiting is really a fraud where someone believes the other person has provided value that they did not provide and purposely withheld this fact from the other party.

[8] Fractional Reserve Banking Definition | Investopedia http://www.investopedia.com/terms/f/fractionalreservebanking.asp#ixzz4QUDQvzpR, accessed November 19, 2016.

[9] The collateral is usually worth more than the loan to deal with market fluctuations.  This is why people used to say that a bank would only loan you money if you were already rich.

[10] Securitize Definition | Investopedia http://www.investopedia.com/terms/s/securitize.asp#ixzz4QVLtJy4H, accessed on November 19, 2016.

[11] Michael McLeay, Amar Radia and Ryland Thomas, Money creation in the modern Economy, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf, accessed November 19, 2016.

[12] Michael McLeay, Amar Radia and Ryland Thomas, Money creation in the modern Economy, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf, accessed November 19, 2016.

[13] Michael McLeay, Amar Radia and Ryland Thomas, Money in the modern economy: an introduction, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q101.pdf, accessed November 19, 2016.

[14] Michael McLeay, Amar Radia and Ryland Thomas, Money in the modern economy: an introduction, http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q101.pdf, accessed November 19, 2016.

[15] Debt-Based Money vs. Sovereign Money, http://positivemoney.org/our-proposals/debt-based-money-vs-sovereign-money-infographic/, accessed November 19, 2016.

[16] Credit cards and personal loans may seem to violate this, but a person’s willingness to work is an asset.

[17] JOSH ZUMBRUN, A Brief History of U.S. Inflation Since 1775,  http://blogs.wsj.com/economics/2015/12/14/a-brief-history-of-u-s-inflation-since-1775/, accessed 12/3/2016.

January 2, 2017 Posted by | -Economics, -History, Intellectual Capitalism | , , , | 5 Comments

Philosophical Foundations of Carl Menger

There has been a lot of interest in the philosophical foundations of Carl Menger.  Many Objectivist writers have emphasized Menger’s Aristotelian training, while other have suggested that Menger’s ideas align with Kant and Popper.  Most scholars agree that Franz Brentano, who was an Austrian Philosopher, had a big influence on Menger.

Carl Menger was an Aristotelian although not a pure one. He read Aristotle and studied the works of Franz Brentano (1838-1917), a contemporary of Menger at the University of Vienna, who taught Aristotelian philosophy there. Brentano has been considered to be the leading Austrian philosopher of the late nineteenth century.

In order to obtain a better understanding of Menger’s philosophy, it is important to understand Franz Brentano’s philosophical ideas.  Brentano’s work focused mainly on the philosophy of psychology.  Sigmund Freud was his student and highly influenced by Brentano.[1]

Brentano argued that philosophy should be scientifically rigorous, as rigorous as the natural sciences.[2]  However, Marx and many others Mengerhave said they were doing science.

He emphasized that all our knowledge should be based on direct experience. He did not hold, however, that this experience needs to be made from a third-person point of view, and thus opposes what has become a standard of empirical science nowadays. Brentano rather argued a form of introspectionism: doing psychology from an empirical standpoint means for him to describe what one directly experiences in inner perception, from a first-person point of view.[3]

This passage starts strong with knowledge based on direct experience, but then shifts making the observer part of the experiment and then it redefines empirical to mean “inner perception”.  This inner perception is the means to absolute truths according to Brentano.

Brentano argues, “that they (mental phenomena) are only perceived in inner consciousness, while in the case of physical phenomena only external perception is possible” (Psychology, 91).  According to Brentano, the former of these two forms of perception provides an unmistakable evidence for what is true.

Brentano says that it (inner perception) is the only kind of perception in a strict sense.[4]

According to Webster’s Dictionary, science is “knowledge about or study of the natural world based on facts learned through experiments and observation.”  By observation, Webster’s does not mean inner perception.  While Einstein was famous for his “thought experiments”, they were a way of conceptualizing a problem in physics.  They were not actual experiments nor did they substitute for actual experiments.  Brentano is not doing or proposing to do science, despite his statement.

Brentano is widely regarded as Aristotelian and studied Aristotle extensively.  He also was fascinated with the Scholastics and Descartes, but disliked Kant and the German idealists.[5]  Brentano and Aristotle appear to agree on Universals, which Peikoff explained as:

Universals, he (Aristotle) holds, are merely aspects of existing entities, isolated in thought by a process of selective attention; they have no existence apart from particulars. Reality is comprised, not of Platonic abstractions, but of concrete, individual entities, each with a definite nature, each obeying the laws inherent in its nature. Aristotle’s universe is the universe of science. The physical world, in his view, is not a shadowy projection controlled by a divine dimension, but an autonomous, self-sufficient realm. It is an orderly, intelligible, natural realm, open to the mind of man.[6]

Brentano’s rejection of Platonic abstractions may have accounted for his distaste for Kant.

Despite the appearance of agreement with Aristotle on metaphysics, Brentano’s position in epistemology significantly differs from Aristotle.  Brentano rejects that our senses are how we initially obtain knowledge about the world.

In fact he maintained that external, sensory perception could not tell us anything about the de facto existence of the perceived world, which could simply be illusion. However, we can be absolutely sure of our internal perception. When I hear a tone, I cannot be completely sure that there is a tone in the real world, but I am absolutely certain that I do hear. This awareness, of the fact that I hear, is called internal perception.

External perception, sensory perception, can only yield hypotheses about the perceived world, but not truth. Hence he and many of his pupils (in particular Carl Stumpf and Edmund Husserl) thought that the natural sciences could only yield hypotheses and never universal, absolute truths as in pure logic or mathematics.

Franz Brentano maintained that our senses were invalid and could not tell us anything about the world. [7]

This is the exact opposite of Aristotle.

[H]e (Aristotle) thinks that we can and do have knowledge, so that somehow we begin in sense perception and build up to an understanding of the necessary and invariant features of the world. This is the knowledge featured in genuine science (epistêmê).

Brentano and Aristotle are completely opposite on one of the most fundamental points of epistemology.  Because this issue is foundational, it will affect everything else the two men have to say on science and philosophy.  I think it is a mistake to argue that Brentano was Aristotelian.

With this background this paper will examine Menger’s epistemological positions.  Menger lays out his epistemology in a book entitled Investigations into the Method of Social Sciences.[8]  Lawrence H. White in the introduction to the book, explains.

Fortunately, Menger draws and even emphasizes a suitable distinction between the “realist-empirical orientation of theoretical research” and the “exact” orientation (p. 59). The search for so-called, ”exact laws” alone is more appropriately considered the task of purely theoretical research in economics. We can make sense of “exact laws” as theoretical propositions which (necessarily) take an “if-then” form: if conditions A and B hold, then condition C must also obtain. Menger rightly insists (pp. 70, 215) that realist-empirical generalizations (e.g., A and B are usually accompanied by C) can by their nature never attain the strictness that necessarily characterizes logical implications. The two sorts of “laws” are on different epistemological planes. So without too much dissent from Menger’s thought we may divide economic theory from economic history where he divided strict theory from what he considered an empirical sort of theory. What is empirical is really historical, and this accounts for its different status from what is deductive.[9]

Lawrence H. White goes on to explain:

But this is not because, like some economists, he (Menger) sees empiricism or positivism or falsificationism as the only proper method for both social science and natural science. Instead he argues (p. 59 n. 18) that both the search for empirical regularities and the formulation of non-empirical, non-falsifiable (“exact”) theories are methods common to both economics and such natural science fields as chemistry. In viewing theoretical research in every field as having a non-empirical proposition at its core, Menger’s position bears some resemblance to that of modern philosophers of science. [10]

Menger is arguing that science involves a theoretical side that is impervious to empirical data.  This sounds a lot like Brentano’s idea of “inner perception”, which “provides an unmistakable evidence for what is true.”  Menger says there is a second side of economics (science) which is empirical and never provides “exact” true theories in economics or science generally.  This is very similar to the explanation of Brentano’s ideas on empirical evidence: “External perception, sensory perception, can only yield hypotheses about the perceived world, but not truth.”[11]

Brentano’s and Menger’s ideas match up fairly well.  Neither of their positions fit Aristotle’s epistemological ideas.  Both of them have misappropriated the word science.  In science reality is always the final judge.  There is nothing that man knows that did not start with our perceptions and nothing in science that is “exactly true”, i.e., independent of empirical observation.

While Bentano and Menger appear to be opposed to Kant, their epistemological positions are a lot closer to Kant than Aristotle.  Menger’s theoretical-empirical split fits Kant’s noumenal and phenomenal realm when translated to epistemology, which results in the analytic-synthetic distinction.  “Analytic propositions are true by virtue of their meaning, while synthetic propositions are true by how their meaning relates to the world.”[12]

Menger and Brentano’s empirical side is a precursor to Karl Popper’s mistaken ideas on science.  Popper appeared to accept David Hume’s skepticism of induction and his response is the same as Menger’s and Brentano’s, which is that empirical evidence never gives us the truth, just closer approximations.  This is not the philosophy of science and is based in-part on an incorrect understanding of what knowledge is.  Knowledge does not mean being omniscient or having “perfect knowledge”.  It is impossible to gain knowledge by just thinking about things (Without reference to the reality).

Menger’s ideas are inconsistent with Objectivism.  They undermine science and economics.

 

 

[1] http://plato.stanford.edu/entries/brentano/#method,  Stanford Encyclopedia of Philosophy, Franz Brentano (First published Wed Dec 4, 2002; substantive revision Tue Aug 26, 2014)

[2] http://plato.stanford.edu/entries/brentano/#method,  Stanford Encyclopedia of Philosophy, Franz Brentano (First published Wed Dec 4, 2002; substantive revision Tue Aug 26, 2014)

[3] http://plato.stanford.edu/entries/brentano/#method,  Stanford Encyclopedia of Philosophy, Franz Brentano (First published Wed Dec 4, 2002; substantive revision Tue Aug 26, 2014)

[4] http://plato.stanford.edu/entries/brentano/#method,  Stanford Encyclopedia of Philosophy Franz Brentano (First published Wed Dec 4, 2002; substantive revision Tue Aug 26, 2014)

[5] http://plato.stanford.edu/entries/brentano/#method,  Stanford Encyclopedia of Philosophy, Franz Brentano (First published Wed Dec 4, 2002; substantive revision Tue Aug 26, 2014)

[6] Leonard Peikoff, The Ominous Parallels, 29, http://aynrandlexicon.com/lexicon/aristotle.html.

[7] https://en.wikipedia.org/wiki/Franz_Brentano, accessed November 11, 2015, Wikipedia, Franz Brentano

[8]https://mises.org/sites/default/files/Investigations%20into%20the%20Method%20of%20the%20Social%20Sciences_5.pdf ,  INVESTIGATIONS INTO THE METHOD OF THE SOCIAL SCIENCES WITH SPECIAL REFERENCE TO ECONOMICS

[9]https://mises.org/sites/default/files/Investigations%20into%20the%20Method%20of%20the%20Social%20Sciences_5.pdf ,  INVESTIGATIONS INTO THE METHOD OF THE SOCIAL SCIENCES WITH SPECIAL REFERENCE TO ECONOMICS, Introduction, p. xi.

[10]https://mises.org/sites/default/files/Investigations%20into%20the%20Method%20of%20the%20Social%20Sciences_5.pdf ,  INVESTIGATIONS INTO THE METHOD OF THE SOCIAL SCIENCES WITH SPECIAL REFERENCE TO ECONOMICS, Introduction, p. xiii, Lawrence H. White.

[11] https://en.wikipedia.org/wiki/Franz_Brentano, accessed November 11, 2015, Wikipedia, Franz Brentano

[12] Wikipedia, Analytic–Synthetic Distinction, Accessed  October 21, 2016, https://en.wikipedia.org/wiki/Analytic%E2%80%93synthetic_distinction.

December 6, 2016 Posted by | -Economics, -History, philosophy | , , , , , , | 1 Comment

The ‘Great Ideas are Dime a Dozen’ Myth

There is a popular myth that great ideas are a dime a dozen (see here, here, and here).  I don’t know what a great idea is.  Is a Dick Tracey watch or a nuclear powered rocket a great idea?  No, not if you don’t know how to implement them, then it is just a fantasy and unless you have plot with it, it is not even a good fantasy story.  However, I do know what a great invention is and they are not a billion dollars a dozen.  A great invention takes incalculable intellectual skill, years of training, years of hard work, and significant resources.

Pendulum of Justice, the first Hank Rangar Thriller, discusses this exact point.

“Hey Mike—we’ve heard your ‘good ideas are a dime a dozen’ speech before. The electric light bulb, the cotton gin, the polio vaccine, the microcontroller, hell, the CAT scan, were all a dime a dozen”

It is my opinion that this sort of nonsense is usually spread by people in finance, who are looking to improve their negotiation position or are just too intellectually challenged to really know when an invention is great.  It also inflates their self-importance.

SchumpterThe reality is that most people do not create much more than they consume in their lifetimes and this includes many people in finance, even if they personally get rich.  It is only by raising our level of technology that we increase our per capita wealth and only inventors increase our level of technology.  Great inventors create incalculable wealth and even if they become wealthy, what they receive in payment is a pittance to what they provided.

I think this nonsense of “great ideas are a dime a dozen” is a spin out from the Austrian Economist Joseph Schumpeter who made a nonsensical distinction between innovation and invention, while denigrating inventions and inventors.

According to Wikipedia:

Following Schumpeter (1934), contributors to the scholarly literature on innovation typically distinguish between invention, an idea made manifest, and innovation, ideas applied successfully in practice

There is nothing inherently wrong with the distinction above, but the way it is applied blurs together a number of different skills.  Blurring skills together shows a  misunderstanding of the process of innovating.  Broadly speaking, innovation can be broken into two distinct sets of skills: creation and dissemination.  By creation I mean creating something new, not production – creating something old.

A subset of creation is invention.  An invention is a creation with an objective repeatable result.  A creation that is not an invention has a subjective result, such as the effect of a painting on a viewer, or the effect of a book on a reader.  Many activities combine both a subjective creation and an invention, such as architecture.  However, we can separate out the invention from the other creative elements and this helps our understanding of the process.

Dissemination may include a number of processes, such as education (marketing, sales), manufacturing, finance, and management.  This is not to say that marketing cannot be creative, it clearly often is very creative.  However, the creative part of marketing can be separated out from the dissemination or execution part of marketing.  The same is true of manufacturing, which can definitely include inventing.  But an invention related to manufacturing is part of the creation step not part of the dissemination step.

Finance can also have inventions.  For instance, the invention of a fractional reserve bank is clearly an invention.  It has the objective result of securitizing assets and turning them into loans and currency.  A fractional reserve bank will securitize land and turn it into a loan and currency.  Despite this, it is important to understand that the first person to develop the fractional reserve bank is inventing and the person operating the fractional reserve bank is disseminating.

All real per capita economic progress is the result of inventing.  This is not to say that it is unnecessary to disseminate inventions, but if there were no new inventions there would not be any economic progress. We would be stuck in static world once all the inventions had been completely disseminated.  Of course, if we stop all dissemination activities we will quickly starve to death.

It is my opinion that business and economic professors have focused on “innovation” instead of “invention” because they have no idea how to invent or how the process of inventing works.  They concentrate on what they know, i.e. business and economic practices.   As a result, the focus is on dissemination,  under-appreciating the importance of inventing.  In addition, it results in misleading business theories, such as:

– Management teams are more important than the quality of the invention.

– Execution is everything; patents and other IP do not matter.

– Get Big Fast.

The truth-test of these theories is directly related to the strength of the patent laws at the time the company is created.  When patent laws are weak, these theories are more true and when patent laws are strong, these theories are less true.  Unfortunately, when patent laws are weak these theories do not overcome the disincentive to invest in risky new technologies.  Management teams do not build revolutionary or disruptive technologies, they just disseminate these technologies. These sorts of teams are like large companies and generally can produce a return with less risk by NOT developing high-risk technologies.  They tend to focus on incremental technologies or on stealing someone else’s technology.  While this may be good business advice in a period of weak patents, it is bad for our country’s competitiveness and our standard of living.

Technological progress (i.e., inventing), in the long run, is the only competitive business advantage.  The best management team in the world selling buggy whips at the turn of the century could not overcome the technological advance of the automobile and stay a buggy whip company.  The best management team in the world selling vacuum tubes in the 1940s, could not overcome the advance of transistors and semiconductors and stay a vacuum tube company.  This country is littered with companies that had great management teams that were overwhelmed by changes in technology.  For instance, Digital Computers had a great management team, but they could not overcome the advance of the personal computer.  Digital Computers, Inc. failed to invent fast enough to overcome the onslaught of small inexpensive computers.  US steel was not able to overcome the onslaught of mini-mills, aluminum, and plastics.  This was not because they did not have a good management team, it was because the management team under- prioritized invention and over-prioritized execution or dissemination skills.  Ford & GM have not become walking zombies because they did not have strong management teams, but because they have not invented.  As a result, they have antiquated production systems and weak technology in their products.  86% of the companies in the Fortune 500 in 1959 are no longer there.  Some of these companies disappeared because of bad management, but most companies disappeared because they did not keep up with changing technology.  In other words, they did not invent.

Inventions(i.e., advances in technology) are the ONLY WAY to increase real per capita incomes and the only long term business advantage.

 

Schumpeter – another Austrian School of Economics Failure.

 

June 30, 2016 Posted by | -Economics, -History, Innovation, Patents | , , , | Leave a comment

Can “Dignity” Explain the Industrial Revolution: A Review of Deirdre McCloskey’s Economic Ideas

Dr. McCloskey is a Distinguished Professor of Economics, History, English, and Communication at the University of Illinois at Chicago.  Her ideas on what caused the Industrial Revolution and economic growth are being widely touted.  She has written a number of books (Bourgeois Equality, Bourgeois Dignity, and The Bourgeois Virtues) explaining her position in detail.

McCloskey’s work focuses on the causes of the Industrial Revolution.  She does an excellent job of debunking the idea that capital accumulation or exploitation is the cause of the Industrial Revolution.  She has a keen grasp of economic history.  Unfortunately, the ability to criticize other ideas is not the same thing as putting forth a coherent theory.

McCloskeyThis article is based on a talk that McCloskey gave at George Mason, an interview that she gave after this talk, and a review of her book Bourgeois Dignity: Why Economics Can’t Explain the Modern World by Arthur M. Diamond, Jr. a professor of economics from University of Nebraska at Omaha.

One of the most enduring myths of economics is that increases in capital are responsible for our increasing standard of living.  McCloskey shows that for almost all of human history the average person lived at a subsistence level (edge of starvation aka “the Malthusian Trap”).  She cites two exceptions, the Agricultural Revolution that occurred about 10-11 thousand years ago in the Fertile Crescent and the Industrial Revolution.  The increase in real per capita incomes that happened after the beginning of the Agricultural Revolution did not last.  According to McCloskey the reason it did not last was because human population expanded to absorb the excess calories that were initially created by the Agricultural Revolution.

The Industrial Revolution was the first time in history that average peoples’ incomes began to grow consistently.  In the U.S. we have incomes that are 100 times greater than that of people before the Industrial Revolution and across the World as a whole our incomes are 30 times larger than people living at a subsistence level.  McCloskey stresses that capital increases cannot explain this increase in our wealth.[1]  At best it could explain a factor of 2 or 3.

She also argues that “property rights” cannot explain the Industrial Revolution.

Though property rights are important, she noted, Genghis Khan enforced property rights rigidly, and as a result people fled to his domain for its political protections; nonetheless, little in the way of an industrial revolution resulted. China likewise had a good property rights system for centuries without innovation, indicating that it is clearly not a sufficient condition by itself.

Property rights, she said, are “commonplace” without progress, though they are important if progress is to be had.[2]

McCloskey also argues that scientific progress is not the cause of this increase in wealth.

[T]he Scientific Revolution did not suffice. Non‐ Europeans like the Chinese outstripped the West in science until quite late. Britain did not lead in science—yet clearly did in technology. Indeed, applied technology depended on science only a little even in 1900.[3]

So what did cause this explosion in wealth associated with the Industrial Revolution according to McCloskey?  Innovation.  She does not define exactly what she means by innovation.  It clearly includes invention, however like Schumpeter she sees inventors as just a small part of the overall puzzle.  According to a reviewer, McCloskey thinks invention is on autopilot.

She expresses the view that since roughly 1900 the process of invention has become “routine” which would also be consistent with a view that patents are not necessary. (footnote 9 on p. 454)[4]

She also dismisses the patent system as the cause of this increase in wealth and innovation.  However, professor Arthur M. Diamond, Jr. suggests her argument in unconvincing.

I also have one substantive concern. McCloskey rejects a little too quickly and a little too strongly one important possible cause: patents.[5]

The answer for McCloskey is liberty and dignity.  In various places she says this is key for inventors, or innovators (Schumpter), or Bourgeois virtues.  It is hard to see how this leads to any specific policies or even how you can measure the dignity portion of her answer.  While her critique of standard economics is brilliant and she is focused on the right questions, her answers are confused and contradictory.

For instance, in some places she emphasizes invention not social attitudes and in other places she says inventions just occur and inventors are unimportant.  She never explains why the Industrial Revolution starts in Great Britain and the U.S. but not in France for instance.  She does point out that it is not scientific advancement, because France was at least if not more sceintifically advanced than Great Britain at the beginning of the Industrial Revolution.

McCloskey hints that she is sympathetic to the Austrian School of Economics.  For instance, in the talk at George Mason she says “economics is what goes on between our ears.”  She emphasizes her agreement with the Austrian’s radical subjectivism when she says “its subjective value all the way down” and “we can’t be sure that people experience red the same as us.”

Despite this she seems to align with Joseph Schumpeter more than she does with Mises or Hayek.  Her critique of the capital theory of wealth creation is totally inconsistent with Mises and Hayek.  Her interest in economic history is totally inconsistent with Mises and she never once mentions, banks, fractional reserve banks, or central banks.  Her emphasis on dignity seems to resonate with Hayek’s idea of ‘cultural evolution’ and her distinction between inventors and innovators is pure Schumpeter.

In the final analysis McCloskey’s critique of the standard explanations for the Industrial Revolution is excellent and the fact that she is asking the right questions in economics is also laudable.  However, her answers are contradictory and confused.  Instead of following the evidence, she tries to cram her preconceived ideas about economics onto the evidence, including the irrational radical subjectivism of the Austrian School of Economics.

 

 

 

[1] “Transportation improvements cannot have caused anything close to the factor of 16 in British economic growth.  By Harberger’s (and Fogel’s) Law, an industry that is 10% of national product, improving by 50 percent on the 50% of non‐natural routes, results in a mere one‐time increase of product of 2.5% (= .1 x .5 x .5), when the thing to be explained is an increase of 1500%.  Nor is transport rescued by “dynamic” effects, which are undermined by (1.) the small size of the static gain to start them off and (2.) the instable economic models necessary to make them nonlinear dynamic.” http://www.economia.unam.mx/cladhe/docs/McCloskey-Keynotespeak.pdf

[2] http://themendenhall.com/2016/04/24/notes-deirdre-mccloskey-mercatus/

 

[3] http://www.economia.unam.mx/cladhe/docs/McCloskey-Keynotespeak.pdf

 

[4] http://www.artdiamond.com/DiamondPDFs/McCloskeyBourgeiosDignityReviewH.pdf

[5] http://www.artdiamond.com/DiamondPDFs/McCloskeyBourgeiosDignityReviewH.pdf

May 22, 2016 Posted by | -Economics, -History, Innovation | , , , | 3 Comments

Hayek: Friend or Foe of Reason, Liberty and Capitalism?

I have been accused of taking the Austrian School of Economics out of context.  Rather than range all over the topic, I will address one Austrian economist, Friedrich Hayek, primarily with respect to his epistemology.  However, his sense of ethics follows directly from his epistemology so this will be discussed.  As well, his metaphysics will be touched on.

My criteria of whether Hayek is a friend or foe will primarily focus on whether he is an advocate for reason (logic and evidence) as best defined by Rand and Locke.  I focus primarily on Hayek’s Theory of Cultural Evolution, which lays out his ideas on epistemology.  There are dozens of papers on this subject and below I will provide quotes from a number of papers that analyze Hayek’s theory.

 

Austrian economist, political philosopher, and winner of the 1974 Nobel memorial prize –[Hayek] spent a good part of his career developing a theory of cultural evolution. According to this theory, rules, norms and practices evolve in a process of natural selection operating at the level of the group. Thus, groups that happen to have more efficient rules and practices tend to grow, multiply, and ultimately displace other groups. The theory, of which Hayek himself was proud, is on all accounts central to his economic, social, and political project. In the present paper, I explore the history of this theory of cultural evolution. (Emphasis Added)

http://institutoamagi.org/download/Angner-Erik-The-history-of-Hayeks-Theory-of-cultural-Evolution.pdf

The History of Hayek’s Theory of Cultural Evolution, Erik Angner

Dept. of History and Philosophy of Science

 

It is clear from the quote above that ethics is a group level, not at the individual level.  The ethics of a group are random and the dominate ethical rules are determined by some sort of evolutionary success.  According to the paper this is not a side issue or something Hayek scribbled out that is separate from the rest of his ideas.

It is hard to believe that Rand or Locke would have been impressed with the idea that ethics are determined by the success of groups.

 

According to Hayek, reason was not the driving force behind cultural evolution, but rather co-evolved in the course of this process.  (Emphasis Added)

http://www.bath.ac.uk/economics/staff/horst-feldmann/feldmann-2005-hayek-theory-of-cultural-evolution.pdf

Hayek’s Theory of Cultural Evolution a Critique of the Critiques, by Horst Feldmann

 

This paper suggests that reason is the result of cultural evolution just like ethics.  It is hard to see Rand or Locke agreeing with this.

 

 

Hayek argues, however, that the demand for rational, conscious (“political”) control of the concrete particulars of social life is based upon a misunderstanding of the process of cultural evolution and on a hubristic and dangerous overestimation of the capacity of the conscious reasoning intellect. As we have seen, Hayek contends that civilization is not the creation of the reasoning mind, but the unintended outcome of the spontaneous play of innumerable minds within a matrix of nonrational values, beliefs, and traditions. The desire of modern constructivists to “make everything subject to rational control” represents for Hayek an egregious “abuse of reason” based upon a failure to recognize the limits to reason’s sphere of competence.63 Such limits, again, stem from the fact that reason is confronted by an immovable epistemological barrier: its irremediable ignorance of most of the particular, concrete facts that determine the actions of individuals within society. The constructivist’s main error is the refusal to recognize that reason is only competent in the realm of the abstract. Hayek observes that the “rationalist . . . revolt against reason is . . . usually directed against the abstractness of thought [and] against the submission to abstract rules” and is marked by a passionate embrace of the concrete. He sums up the constructivist error in this way: “constructivist rationalism rejects the demand for the discipline of reason because it deceives itself that reason can directly master all particulars; and it is thereby led to a preference for the concrete over the abstract, the particular over the general, because its adherents do not realize how much they thereby limit the span of true control by reason.”64 (Emphasis Added)

http://www.firstprinciplesjournal.com/articles.aspx?article=1513&theme=home&page=3

Hayek on the Role of Reason in Human Affairs, Linda C. Raeder, Palm Beach Atlantic University

 

“Matrix of nonrational values, beliefs, and traditions” are responsible for civilization?  It is clear that Hayek does not think there is anything special about Natural Rights or the United States or any other country or their values.  The best we can say is that it is the best based on its success at this time.

“Rejects the demand for the disciple of reason”?  This sounds like it comes straight from an environmentalist or a modern socialist.  It is clear that Hayek is not just talking about the limits of the knowledge of a central planner, he is attacking reason itself.  The best possible spin is that Hayek is only attacking reason with respect to knowledge of human affairs, i.e., economics, social sciences, ethics, law, political structures, literature and the arts.

It is clear from Hayek’s rejection of reason that he does not agree with an Aristotelian or Objectivist idea of an objective reality that is knowable.  At best Hayek’s metaphysics is consistent with Plato’s theory of forms, where we can only get a vague glimpse of reality.

 

“The picture of man as a being who, thanks to his reason, can rise above the values of civilization, in order to judge it from the outside . . . is an illusion.”83 For Hayek, morals, values, and reason are entirely natural phenomena, evolutionary adaptations which have enabled man to survive and flourish in his particular kind of world.

 

http://www.firstprinciplesjournal.com/articles.aspx?article=1513&theme=home&page=3

Hayek on the Role of Reason in Human Affairs, Linda C. Raeder, Palm Beach Atlantic University

 

Does the first sentence above sound like Howard Roark or Ellsworth Toohey?  Hayek is pushing the worst sort of collectivism.  It is a collectivist attack on the mind itself, on the independence of the mind based on reason.  Hayek would have stood hand and hand with the Catholic Church in condemning Galileo to death.

 

For Hayek, the rules of morality and justice are the same as they were for David Hume: conventions that have emerged and endured because they smooth the coordination of human affairs and are indispensable, given the nature of reality and the circumstances of human existence, to the effective functioning of society.87 For Hayek as for Hume the rules of morality and justice are not the products of reason and they cannot be rationally justified in the way demanded by constructivist thinkers. And since our moral traditions cannot be rationally justified in accordance with the demands of reason or the canons of science, we must be content with the more modest effort of “rational reconstruction,” a “natural-historical” investigation of how our institutions came into being, which can enable us to understand the needs they serve.88

 

http://www.firstprinciplesjournal.com/articles.aspx?article=1513&theme=home&page=3

Hayek on the Role of Reason in Human Affairs, Linda C. Raeder, Palm Beach Atlantic University

 

Morality is not based on reason according to Hayek, it is based on convention.  David Hume was the philosopher that came up with the ‘is-ought” problem in ethics that is the basis for moral relativism.  Solving the “is-ought” problem was one of the major accomplishments Rand’s ethics.

Hume also attacked cause and effect and therefore reason, arguing that the best we can say about events is that they are closely related or probablistic.  I consider Hume worse than Kant, partly because he is more understandable than Kant and because he inspired Kant.  Here is what Rand had to say about Hume.

“If you observe that ever since Hume and Kant (mainly Kant, because Hume was merely the Bertrand Russell of his time) philosophy has been striving to prove that man’s mind is impotent, that there’s no such thing as reality and we wouldn’t be able to perceive it if there were—you will realize the magnitude of the treason involved.”

 

F.A. Hayek was the chief conduit through which Hume’s moral, political, and social theory entered the mainstream of modern libertarian thought. In his article “The Legal and Political Philosophy of David Hume” (originally presented as a lecture at the University of Freiburg on July 18, 1963), Hayek bemoaned the fact that Hume’s legal and political philosophy had been “curiously neglected.” In addition to being “one of the founders of economic theory” and the greatest British legal philosopher before Bentham, Hume “gives us probably the only comprehensive statement of the legal and political philosophy which later became known as [classical] liberalism.”

http://www.libertarianism.org/columns/self-interest-social-order-classical-liberalism-david-hume  Self-Interest and Social Order in Classical Liberalism: David Hume, by George Smith, formerly Senior Research Fellow for the Institute for Humane Studies, a lecturer on American History for Cato Summer Seminars, and Executive Editor of Knowledge Products. Smith’s fourth book, The System of Liberty, was recently published by Cambridge University Press.

 

This clearly shows that David Hume was a big part of Hayek’s philosophical background.  Bentham is Jeremy Bentham, who is considered the father of utilitarianism and is known for being an intellectual father of the utopian socialist movement in England.

 

Perhaps no other area of Burke’s and Hayek’s thought is as congruent as their understanding of the role of reason in human affairs; their views are so close as to suggest that Hayek’s thought on this issue is merely an elaboration, although quite an extensive one, of Burke’s theme. Hayek developed several of Burke’s most crucial insights: 1) the priority of social experience (or “tradition”) over reason; 2) the notion that inherited social institutions embody a “superindividual wisdom” 22 which transcends that available to the conscious reasoning mind; and 3) the impotence of reason to ‘design’ a viable social order. (Emphasis Added)

http://www.nhinet.org/raeder.htm

The Liberalism/Conservatism Of Edmund Burke and F. A. Hayek:A Critical Comparison, Linda C. Raeder is Associate Editor of HUMANITAS and a Research Associate at the National Humanities Institute

 

Here is another attack on reason, an appeal to collective reasoning and another statement that reason is impotent.

 

Burke and Hayek, then, shared a common enemy as well as a common understanding: Enlightenment rationalism. Perhaps the most characteristic attribute of Enlightenment thought was its cavalier dismissal of ‘irrational’ tradition as mere superstition and prejudice.

http://www.nhinet.org/raeder.htm

The Liberalism/Conservatism Of Edmund Burke and F. A. Hayek:A Critical Comparison, Linda C. Raeder is Associate Editor of HUMANITAS and a Research Associate at the National Humanities Institute

This statement makes it clear that Hayek was anti-reason and anti-enlightenment.

 

Hayek, by contrast, is a critic of what he calls ―constructive rationalism.‖2 His concept of rationalism is somewhat idiosyncratic, and is not equivalent to Rand‘s conception of reason. Nevertheless, it leads him to claim that ―no universally valid system of ethics can ever be known to us,‖3 which is obviously not consistent with her view. For Hayek, moral rules have a status lying ―between instinct and reason.‖4 (Emphasis Added)

 

http://www.reasonpapers.com/pdf/33/rp_33_1.pdf

Symposium: Rand and Hayek on Cognition and Trade

Rand versus Hayek on Abstraction

David Kelley The Atlas Society

 

This is another case discussing how Hayek did not think that ethics were based on reason or that reason could ever tell us anything about ethics.

This case for market freedom is essentially negative. Hayek seems to think that if socialist planning were possible, socialism might be the morally ideal system. But the inescapable ignorance of would-be planners excludes that possibility: ―If there were omniscient men, if we could know not only all that affects the attainment of our present wishes but also our future wants and desires, there would be little case for liberty.‖10

 

http://www.reasonpapers.com/pdf/33/rp_33_1.pdf

Symposium: Rand and Hayek on Cognition and Trade

Rand versus Hayek on Abstraction

David Kelley The Atlas Society

 

Hayek is not pro-liberty, at best he is pro-tradition, which is why it is not surprising to see so many religious people affiliated with the Austrian School of Economics.  He is anti-reason and specifically bases his justification for ‘free markets’ on the limitations of reason generally and on the inability of reason to create or understand morals.  His defense of the pricing mechanism of free markets is based not on liberty but on the idea of spontaneous order.  More fundamentally, Hayek bases his justification of the pricing mechanism on tradition and utilitarian grounds.

Hayek’s metaphysics appear to be Platonic, which is incompatible with Rand and Locke.  His epistemology is more consistent with Hume or Kant than Rand or Locke.  You might argue that Hayek was only discussing the limits of reason with regard to social sciences, however at the least he applies it to all areas of human interaction, which includes ethics, the law, and the political realm.  This means he is against Natural Rights and Locke, which means he is against capitalism.  Capitalism is the economic system that arises when the law protects people’s natural rights, particularly their property rights.  Hayek does not recognize property rights, at best he recognizes societies’ property conventions, which means he cannot understand capitalism.  This is more than enough for me to damn Hayek as an enemy of capitalism and a foe.

In my opinion, Hayek’s esteem of Hume, Bentham, and Burke point to a much deeper antipathy to reason.  His ethics is essentially majority rules with the modifier of natural selection.  He specifically thinks it is the most absurd folly to think any one person can use reason to judge a society.  This is consistent with his intellectual compatriots Hume and Burke.  Hayek’s ethics is perfectly consistent with the moral relativists that say we cannot judge and an ISIS or a USSR or christianity.  His ethics are antithetical to Rand’s and Locke’s.  Hayek is clear that he does not think Natural Rights can be justified by reason and that Natural Rights cannot claim any special place in the world.  Hayek is not a friend of reason, liberty, or capitalism.  Rand’s estimation of Hayek is similar to mine, although I think I have spent much more time analyzing the issue.

 

 

 

 

I am willing to entertain any serious evidence that I have mischaracterized Rand or how the sources I am citing mischaracterized his arguments.  I am not interested in unsubstantiated claims that I have misunderstood or mischaracterized Hayek.  Do not complain that my standard is Rand and Locke, I told you that upfront.  I am not interested in arguments that talk about other leading figures in the Austrian School of economics.  Stick to the subject and provide actual evidence.

 

March 4, 2015 Posted by | -Economics, -History | , , , , , , , , , , | 3 Comments

The Austrian Business Cycle Debunked

This video, The Austrian Theory of the Business Cycle | Roger W. Garrison, from the Von Mises University does a good job of explaining the Austrian Business Cycle Theory (ABCT).  The key point is that increasing the rate of savings (capital) results in increased economic growth in the future.  The theory was worked out by Von Mises and Hayek.  The foundation of the theory is very similar to classical economics, which held that economic growth was the result of increases in capital.  The video has a number of charts and graphs to make it look more scientific, however no empirical evidence is provided to support the theory.  Other work may provide empirical evidence, but I know of counter evidence as well.

This article will first discuss ABCT of recessions and some small errors in the theory.  Then I will show that ABCT is incorrect about what causes economic growth and its failure to explain economic history, particularly the Industrial Revolution.

Austrians are always focused on showing that Keynes economic theories are wrong, and they are certainly right about this.  Austrians argue that there is a trade between investment and consumption, which they call the sustainable Production Possibilities Frontier.  Keynesian theory would say there is no difference between consumption and investment.  Certainly there is a trade between investment and consumption.  The Keynesians somehow argue that by eating your seed corn you will be wealthier.  However, a minor problem with ABCT is that it equates savings with investment.  The two are not necessarily the same.

ABCT then states that recessions are caused by Central Banks (the Federal Reserve in the US) arbitrarily lowering interest rates below the market rate, which causes mal-investment and reduces the saving rate.  Unless we narrowly define saving as putting money in a bank, savers have a number of choices which are not directly affected by interest rates.  For instance, savers can put their money in stocks or corporate bonds.  The return on stocks and corporate bonds is more related to the success of the underlying company than the interest rate set by the Central Bank, so the disincentive to save is not a strong as suggested by the ABCT.  The second question is why does this cause mal-investment but increased saving does not.  In both cases the investment intermediary is a commercial bank.  Now if we were talking about direct government spending then the case is clear.  In that case the government is not subject to the market.  However, commercial banks are subject to the market.  If interest rates are lower because of additional savings or because the Central Bank set them lower does not change their loan approval process.  In addition, the ABCT completely ignores tax and regulatory policy.  Are Austrians really saying that recessions can only be caused by Central Banks setting interest rates too low?  Why not too high?  This is why Austrians are obsessed with what Central Banks are doing and seem somewhat oblivious to other issues.

These are not my real complaints with the ABCT however.  My real complaints are 1) recessions happened before there were Central Banks and 2) economic growth is not caused by increases in capital.  Central Banks are a fairly new creation and fractional reserve banks did not exist in the world until around 1650s.  The United States did not have a Central Bank until 1913, but there were recessions before that in the US.  There were certainly recessions in the world before there were banks, including one huge one called the Dark Ages.  ABCT fails to explain the source of all recessions, including the recession of 2001.

ABCT is also wrong on what causes economic growth.  Robert Solow did an econometric study of the US economy to determine how much of the growth was due to increases in labor, how much was due to increases in capital, and how much was due to increasing levels of technology.  According to Wikipedia

[This] technique has been applied to virtually every economy in the world and a common finding is that observed levels of economic growth cannot be explained simply by changes in the stock of capital in the economy or population and labor force growth rates. Hence, technological progress plays a key role in the economic growth of nations, or the lack of ithttp://en.wikipedia.org/wiki/Growth_accounting

Robert Solow won the Nobel Prize in economics for this work.  (This is not an endorsement of everything Solow says)

I would change the bolded part to state that the only way to obtain real per capita increases in wealth is through increasing levels of technology.  This becomes more apparent if you look over longer timeframes.  If we had the same technology as our ancestors in 1600, even with today’s total capital, would we be any wealthier than our ancestors?  We would not live longer, we would not be able to produce any faster, the only difference might be that we had more savings to fall back on or disseminate existing technologies.  However there was very little technological change at the time, so the increase in technological dissemination would have been small.  As a result, we would be essentially no wealthier than our ancestors.  Our standard of living is defined by our level of technology.  I discuss this in much more detail in my upcoming book, “Source of Economic Growth.”

Note that the ABCT does not account for technological change.  As a result, the theory should hold up in a technologically static world.  However, this is totally inconsistent with economic history.  The Industrial Revolution started in Great Britain and the United States.  There is no evidence that these countries had larger savings or capital stocks than say France or China or Holland or Japan.  The Industrial Revolution was really a perpetual invention machine, driven by inventions not by capital.  The source of all wealth is the human mind.  The application of the human mind to problems of survival is called inventing, which is how we increase our technological level.

Austrian Business Cycle Theory does not hold up under scrutiny.  Austrians have misidentified the source of economic growth and have a defective model for what causes recessions. Naturally they prescribe the wrong medicine.  Austrian Economics is not pro-capitalism, it is not consistent with the enlightenment, reason, and science, which I have described in other posts.

 

 

PS: I mentioned above that the Austrians misdiagnosed the recession of 2001.  They love to say that Greenspan created a bubble economy, which implies that in fact there was no real economic growth in the late 1990s.  The narrative that Greenspan created a credit bubble by holding interest rates too low does not fit the facts.  The economic growth of the late 1990s was built on new technologies that have made our life immeasurably better.  Real incomes and industrial production rose significantly in the late 1990s.  In addition, the effective Fed funds rate in the late 1990s was between 5.5 and 6.5%, which looks tight by today’s standards.  The Federal Reserve’s balance sheet was stable.  There was an inverted yield curve in 2000, which happened as Greenspan was increasing interest rates.  The commodities index was falling slightly in 1999 and rose slightly in 2000.  M1 was essentially flat in the late 1990s and M2 was growing slowly.  The evidence is overwhelming that the recession of 2001 was not caused by Federal Reserve “printing” too much money.  In fact the evidence points to the idea that Greenspan was too restrictive and caused an inverted yield curve in his desire to cause the stock market to cool off, which caused the recession.  It is true that the stock market had gotten ahead of earnings, but recent experiments in economics show this is a common with new investors and is not necessarily the result of easy credit.

 

 

February 15, 2015 Posted by | -Economics, -History, Innovation | , , , , | 7 Comments