From Mike Davis:

With the rise of gas prices above the $3 a gallon psychological level, and the record quarterly profits of Exxon Mobil, accusations of price fixing, price gouging and profiteering abound. Big-oil CEO’s have been called before a congressional committee to answer for this “obscene greed”. In a television interview following hurricane Katrina, Senator Schumer, one of the usual mouthpieces, opined – “I don’t see why California gas prices should go up because refineries in the Gulf are shut down”.

This is not the first time that this issue has come up. In March 17th 2003, gas prices in California rose above $2 a gallon for the first time. A California Congressman wrote a letter to the Office of Oil and Gas of the Energy Information Association (EIA), an independent statistical and analytical agency within the DOE, requesting an investigation. The full text can be found here:
While this report is about something that happened more than two years ago, it makes some excellent points, showing that the price movements were driven entirely by market and regulatory forces and not by “price gouging” following the invasion of Iraq. Here are some of the key points (some taken verbatim from the report):

Gas prices can be broken down into various components: crude oil prices, refining costs and profits, distribution/marketing costs and profits, and taxes.

The crude oil price, a global market factor, should be subtracted out. With the price of oil removed, the price spikes were no greater than those observed historically

.

The major contributing factor to the price run-up was legislation mandating the partial phase-out of the carcinogenic and water supply polluting additive methyl tertiary butyl ether (MTBE) from California gasoline, and its replacement with ethanol, The following local factors contributed to the shortage

• The California refinery system runs near its capacity limits, which means there is little excess capability in the region to respond to unexpected shortfalls;
• California is isolated and lies a great distance from other supply sources (e.g., 10 days travel by tanker from the Gulf Coast), which prevents a quick resolution to any supply/demand imbalances;
• The region uses a unique gasoline that is difficult and expensive to make, and as a result, the number of other suppliers who can provide product to the State are limited.

Originally, California was scheduled to ban MTBE starting in January 2003, but a number of factors caused Governor Gray Davis to delay the ban for one year. However, many California refiners chose to switch from MTBE to ethanol in January 2003. As a result:

• The market became segmented into two non-fungible products, since ethanol-blended gasoline cannot be mixed with other gasolines during the summer, to assure compliance with emission requirements.

• The price increase in crude oil occurred about the time California refiners were changing from winter-grade gasoline to summer-grade, which is harder to produce and, when using ethanol, requires a change in procedures or timing to assure that uncontaminated summer-grade product is located at terminals on time.

The MTBE changeover had much more severe implications:

1. The MTBE formulated gasoline contained 89 % gas and 11% MTBE. The winter grade ethanol based fuel contained %94 gas and 6% ethanol. Thus, refineries operating near capacity were faced with the prospect of producing another 5% after the changeover.

2. The summer grade refined gasoline component had to be further refined to eliminate volatile hydrocarbons such as butanes and pentanes. Thus in the summer, the baseline refined gas output was 10% short, (and the refining costs were increased).

3. More refinery downtime, due to unscheduled maintenance and modification.

There are many more interesting discussions going into the market segmentation produced by separate MTBE and ethanol-based refineries.
The report shows that the internal workings of the market can be very complex and that there is no basis for the simplistic price gouging accusations.

From an Austrian perspective, the notion of price gouging does not exist – the gasoline is the gas station owner’s property and he/she is under no obligation to sell it for any particular price, nor am I, as a consumer, obligated to buy. (In fact, I often buy 89 octane gas instead of 91 – I don’t notice a sufficient difference in engine performance to warrant the 20 cent a gallon differential.)
Even among those who agree in principle with market based pricing, the price gouging mentality has gained a foothold – even conservative radio talk show hosts have caught the disease.

The concept most people, seem to have most difficulty with is the replacement cost argument – the refinery or gas station bases it prices on what it expects to pay for its next delivery and not to recoup the cost of the last one. People understand that nobody will sell them 1000 shares of Google for 10% above last January’s price, or a Pacific Heights apartment for 20% above its 2000 price, and consider that this is perfectly reasonable.

Yet the same people expect a gas station owner, who paid $2.50 a gallon for the gas now selling at the pumps, to be morally bound (and in some states legally bound) to sell it for a “fair price”, $2.58 a gallon, even though the cost of the next shipment from the refinery will be $2.75 a gallon.

From Zenohockey

The Encyclopedia Britannica, once synonymous with knowledge, is apparently feeling threatened by the spread of free information on the Internet — including sites like Wikipedia, where literally anyone can contribute anything. Britannica’s brilliant idea for returning to the zenith of its prestige and influence? Says the Boston Globe) “[N]aming an advisory board, whose 15 members top editor Dale Hoiberg calls ‘some of the smartest people on earth.’”
If it seems absurd that fourteen Ivory Tower-types, such as Nobel-Prize winners David Baltimore and, from the “they could do worse” department, Amartya Sen — can hope to compete with the collected knowledge of millions of people around the globe, that’s because it is. The very existence of markets, including those in information such as Wikipedia, serves as a testament to the ability of average “schmucks” to combine their expertise, which individually may well amount to near nothing, into something marvelous.

The fact that the Britannica hopes to compete with the combined intellect of the masses with fourteen academics shows a remarkable combination of naivete and superciliousness. Perhaps the first article the new advisory panel should look at is the one on F.A. Hayek, who seems to have saw this coming: “If most people are not willing to see difficulty, this is mainly because, consciously or unconsciously, they assume that it will be they who will settle these questions for the others, and because they are convinced of their own capacity to do this.”

A weblog titled “The Neighborhood Retail Alliance” offers what it calls the “Conservative Case Against Wal-Mart in NYC“, an economic study for the case against Wal-Mart, which being served from a small business alliance, should make the reader question the inherent bias and accuracy in which they present the issues The “study” engages in the trade-deficit fallacy when discussing how the dollars are exported and thus diverted from the local economy.

That aside, they do make one compelling point regarding the subsidization of Wal-Mart’s employment costs which happens because of existing nanny-state freebies such as healthcare, food programs, housing subsidies, etc (which absent of, the argument goes, Wal-Mart would have to raise salaries substantially to compense). Whether you hold that against Wal-Mart is an area of discussion I expect Austrians, libertarians and mutualists to clash ideas over.

If anyone is interested in preparing a rebutal, I would love to see it.

From John Dolce:

Classic article: the airlines are blaming governments for their oil related losses, while Southwest has turned a tidy profit by hedging against rising oil prices.

From Dan Bowden

Is Dubai a Hoppean monarchical paradise? Not exactly, but (according to this Forbes piece) the Prince of this tiny Arabian country does seem to be managing his assets (which are basically the same as the government’s) well. He’s instituted a number of free-market programs which have helped the country become rich from industries other than oil. This article from Forbes magazine also notes that nightclubs and bars coexist with synagoges and mosques, with nary a suicide bomber in sight. Oh the wonders of capitalism!
Some quotes (registration required to read article):

“Dubai is a place of intriguing contrasts. Fewer than 15% of its 1 million residents are nationals; most of its immigrants hail from Pakistan, India, Iran, Egypt and other Arab nations. Women in black burkas revealing only their eyes stroll on Sheikh Zayed Road past a line of sequined halter tops waiting to get into the smoky Zinc nightclub, where booze is served. While muezzins call the faithful to prayer, you can hear bells ringing at the Catholic church. Tourists with Israeli stamps in their passports breeze through customs. “We want to be the one place in the world which offers the best option for everything–business opportunities, world-class sporting and entertainment events,” says Mohammed.”

“How did this castle in the sand arise? A century ago enterprising merchants turned to Dubai’s tiny port to avoid taxes at the Persian port of Lingah. Fifty years later Dubai was a hapless British colony with a diminishing pearl trade and ship traffic. Mohammed’s father, Sheikh Rashid, dredged and modernized the port. The Jebel Ali port is now the largest man-made harbor in the world and a tax-free zone. With fees from port traffic, he laid down the nation’s first airstrip. Today Dubai International serves 105 airlines connecting 250 destinations. Tourism is 20% of GDP.”

Submitted by Scott Reamer:

Dear Mr. Roach,

I read with great interest your open letter to Alan Greenspan published Friday February 26th; your decidedly non-consensus macro views since the popping of the asset bubble in 2000 have given you a singular gravitas among your peers on the sell-side. Bravo for employing that gravitas in the service of a long overdue discussion about the efficacy of the Fed’s current monetary policy stance. Let us hope it sparks the necessary debate among investors, economists, public policy advocates, politicians, and Federal Reserve officials themselves to determine the costs of an excessively easy monetary policy.
In your letter, as well as the many missives you have written for Morgan Stanley over the last 2 years, you highlight the principle risks of a continued low interest rate policy by the Fed, specifically that such a policy (1) leaves them little stimulus “ammunition” in the case of some macroeconomic shock and (2) creates another opportunity for moral hazard to alter the risk-taking appetites of financial market participants, thus creating more asset bubbles like the one that most world equity markets witnessed in the late 1990s.

Your prescription for reducing these macro risks, namely raising the Fed Funds rate to 3% from its current 1% level, would undoubtedly alter the perception of and appetite for risk among financial market participants while allowing the Fed to “re-load” the monetary policy cannon. On this point there can be little debate.

Of little debate too would be the Fed’s response (were they to ever offer one) to your missive: faced with declining inflation and still-massive slack in the economy, the Fed believes they have plenty of time to reverse current policy stimulus should inflationary forces start to appear in official aggregate measures of price inflation. In light of both that resource slack and the lack of inflationary pressures, the risk of asset bubbles and/or limited policy options remains small relative to a double dip recession or worse. After all, the “intellectual end-zone dance” that Chairman Greenspan made in his speech to the American Economic Association in January suggests he believes he could reflate his way out of any subsequent bubbles that might appear from a continued easy policy. And Gov. Bernanke’s November 2002 “printing press” speech speaks directly to the Fed’s willingness to use unconventional policy tools should they need them. It would seem that, to your very real risks, the Fed would reply: “We could still deal with them.”

To your credit, you have been a vocal critic of Fed policy for the last several years; pointing out the perils of a loose monetary policy. However, your debate with the Fed ultimately revolves around the timing and size of monetary policy changes; you believe an excessively easy monetary policy should be reversed based on the risks. The Fed does not.

I believe that you are both wrong.

Your comment to Mr. Greenspan that “…you know better than anyone that a central banker’s work is never done. There are always unexpected problems that require forceful policy responses…” suggests that you stand decidedly in favor an activist central bank. Yours would just be an activist bank that should be raising rates by now rather than keeping them low.

Suggesting that the Fed’s job is to micromanage the US economy in this way furthers the classically illiberal idea that a central bank can and should attempt to control the economy; that a central economic authority can and should attempt to alter the nature of the business cycle to fit some preconceived ideal. And it furthers the notion that such efforts at economic central planning have only benefits and no costs to the economic and social fabric of the nation.

Such nostrums of course belie common sense: every public policy has costs and benefits, both of the short term variety and the long. Keeping interest rates excessively low incents consumption over production, favors debtors over savers, and decreases the cost of capital relative to labor. And raising interest rates, too, has benefits and costs. You have aptly laid out two of them in your suggestion for raising the Fed funds rate to 3%.

The larger point that manipulating interest rates – in either direction – has costs, both intended and unintended, can be brought into full relief by scratching the surface of the historically anemic job growth in the current US recovery. To your credit, you have made much of the curious lack of job growth in this particular cyclical recovery. Your suggestion that a new global labor “arbitrage” is underway – a combination of technology and the maturation of Chinese and Indian manufacturing and service platforms transferring jobs overseas – surely plays an important role in keeping job growth depressed.

But I would argue that at least as strong a force is a domestic labor arbitrage of sorts: that between capital and labor. The Fed’s excessively easy monetary policy (combined with the administration’s capex tax credit) has created substantial disincentives to employ labor and created substantial incentives to deploy capital equipment. After all, a Dell server, a Cisco router or some other piece of plant and equipment doesn’t need a 401K plan or health insurance. Employees do. Businesses are simply taking advantage of capital that is, relatively speaking, far less expensive than labor; choosing instead to invest in capex instead of investing in employees.

But employment growth (or lack thereof) per se is not the thrust of my argument; it is that an activist central bank will always – always – manifest unintended economic consequences from the policies they pursue. And the more vigorously they pursue them, the greater the likelihood and intensity of those unintended consequences. The history of central banking is a catalog of unintended consequences. Almost all of them costly.

The root of the problem with current monetary policy, then, isn’t that it is too loose, too tight, or even just right. Rather, the problem is that the Fed has become more activist than ever, opting to intervene in the economy at the slightest hint of financial distress, whether that distress be of a domestic (LTCM) or foreign (variously the Mexican, Asian, Russian crises) origin. That these serial interventions have taken the form of reflationary policies matters little from a philosophical perspective. An aggressively interventionist central bank creates distortions in the perception of and appetite for risk taking, both at the asset-market level and the entrepreneurial level. In short, an aggressive central bank can impair the equilibrium forces of the free market.

I think you can agree that the current Fed is defined by their appetite for monetary activism. Having pursued the most aggressive reflationary policies in its history, the Fed has shown itself to be reflexively interventionist. And worse still, there appetite seems to know no bounds nor no logical end.

The 2000 equity asset bubble may in fact be joined in the history books by the 2004 bubbles you describe: in housing, junk bonds, and equities. But not because the Fed didn’t follow your advice and raise rates fast enough in 2004. The 2004 bubbles will join the greatest asset bubble in financial history because of a decades-long, increasingly aggressive desire by the Federal Reserve to manage the business cycle; to keep the booms going without ever having to suffer even the slightest of busts. One need not be a strict adherent to the Austrian school to understand the impossibility of such a policy. One need only have common sense.

When it comes to monetary policy, whether one takes the Paul Volcker approach to inflation, the Alan Greenspan approach to disinflation, or the Steve Roach approach to recovery, each of these policy prescriptions rests on the flawed assumption that a group of central bankers can better direct the economic cycle, better direct time preferences for consumption and saving, than each economic actor working for his own behalf. Economic history has proven this to be a false assumption. Time will ultimately tell if it turns out to be a tragic one.

Yours,
Scott Reamer
Portfolio Manager
Union Tree Capital
Senior Writer, Minyanville.com

From Eric Knauer:

In the preface of Randy Barnett’s new book, Restoring the Lost Constitution, he states:

“In his best-known work, No Treason, Lysander Spooner argued that the Constitution of the United States was illegitimate because it was not and could never have been consented to by the people on whom it was imposed. Although as an undergraduate, I found Spooner’s argument unanswerable (and I must admit so it remained until I was in my forties), the problem was largely theoretical…

My answer to Spooner’s challenge in found in part I of this book.”

In part I he writes,“For a law is just, and therefore binding in conscience, if its restrictions are 1) necessary to protect the rights of others and 2) proper insofar as they do not violate the preexisting rights of the persons on whom they are imposed.

“The second of these requirements dispense with the need to obtain the consent of the person on whom the law is imposed. After all, if the law has not violated a person’s rights, then that person need not consent to it. The first requirement supplies the element of obligation. If the law is necessary to protect the rights of others, then it is as obligatory for the person on whom it is imposed as protecting that person’s rights is obligatory on the legal system itself. Persons have an obligation to obey such a law just as they have an obligation to respect the rights of others. While the protection of rights is not the only function performed by a government, it is the only function that -on this account of legitimacy- justifies restricting personal freedom in the absence of the actual consent of the individual…

“Therefore, when we move outside a community constituted by unanimous consent, every freedom-restricting law must be scrutinized to see if it is necessary to protect the rights of others without improperly violating the rights of those whose freedom is being restricted. In the absence of actual consent, a legitimate lawmaking process is one that provides adequate assurances that the laws it validates are just in this respect. If a lawmaking process provides these assurances, then it is ‘legitimate’ and the command it issues are entitled to the benefit of the doubt. They are binding in conscience unless shown to be unjust…

“On this account, there are not one but two sources of binding law: laws that are produced by unanimous consent regimes, and laws that are produced by regimes whose legitimacy rests solely on their procedural assurances that the rights of the nonconsenting persons on whom they are imposed have been protected.”

This passage seems to suggest a dramatic change in political philosophy compared to Barnett’s old writings where he equates nonconsensual government jurisdiction with aggression (Rothbard quotes Barnett in The Ethics of Liberty on this point).

Does anyone find his new position compelling?

From Edward Cox:

I don’t know if it’s been previously mentioned, but Mises, in his book
Liberalism, directly addresses the issues of free trade and international
capital mobility that have been debated by Paul Craig Roberts and several
Austrian economists during the past weeks. The relevant passage can be
found here.

From Gael J. Campan

The Jerusalem Post published a response, entitled Austrian School Flunks, to an earlier article of mine on the subject of deflation.

Here is my response, before it was edited:Jonathan Lipow did not appreciate my editorial “Save us from the deflation doctors” published in the 12th of November issue of the Post, where I stated my opinion regarding the present state of deflation in Israel, which I consider to be an expectable and healthy phenomena as opposed to the ill-fated outcomes of inflationpolicies.

He expressed his discomfort in a very defensive piece “Austrian theory flunks” where he lead several charges and granted me the privilege of personal attack as if, in the realm of economic thinking and debate, authors could be more relevant than the rigor and logic of their positions.

To start with, he correctly identified my economic background as Austrian School of Economics. After acknowledging its originality, he lead a charge arguing that first, it is not a new theory and second, its macroeconomics has been “utterly rejected” by mainstream economics.

This is an argument from intimidation: “do not reader dare considering Austrian School of Economics since it is already discarded by mainstream economists”. I personally prefer to give credit to the readers ability to make their own mind on the basis of explicite arguments.

Regarding this specific matter, the mainstream of the 20th century happened to be successively Classic, Marxist, Keynesian, Monetarist, Neo-classic, Post-Keynesian, to name a few; i.e. one thing and its opposite. So even if Austrian free-market economics was not considered mainstream, with regard to the historical volatility of paradigms within the academy, it might as well underline its robustness and its impermeability to intellectual fashions.

Now, it is true that Austrian economists, such as Ludwig Von Mises and Murray Rothbard, provide an alternative approach to what Mr. Lipow calls mainstream macroeconomics.

Specially as far as the business cycle issue is concerned, they provide a complete explanation of how government-controlled central banks do trigger booms and busts by inflating the money supply.

At the center of this explanation lies the axiom of time preference or preference for the present (that Mr. Lipow mistakenly calls time discount rate). It is the simple fact that individuals always prefer to enjoy economic goods earlier instead of later. Applied to savings, this preference determines the amount of money available for investment : I am willing to lend NIS 100 now (that is, to sacrifice current consumption) against the promise of NIS 100 + X in one year from now.

This supply of savings from customers confronts with a demand for financing from entrepreneurs. From this confrontation results the natural interest rate which is the price entrepreneurs pay on a given market for borrowing money.

Then, if suddenly the authorities pump money into the economy, more credit become available for investment and the interest rate drops. Note that this is an artificial process, since there was no increase in real savings, no change of time preference.

With the new interest rate, ventures that were not profitable at the previous interest rate become profitable, at least apparently : sales projections are great and stock-market ramps up. Meanwhile these new projects look for capital and labor, thereby putting pressure on prices of non-specific production factors, ultimately spreading prices increase through the economy. At this stage, all the elements of what is commonly described as a boom are set.

It is brought to a halt when, the new products and services coming to fruition, demand does not materialize. Hence inventories skyrocket, stock-market plummets, companies go bankrupt and massive unemployment follows.

If the government renounce to its inflating power, the economy can recover from its hangover and refocus on profitable ventures backed by sound savings.

This is why I keep thinking that transitory deflation – which is the present state of Israel economy – is healthy : it is a sign of recovery in process, of cleaning up of the economy.

This is why I keep denouncing calls for easing credit or cutting interest rate : they are precisely the cause of business cycles and of the current recession. Incidentally, it does not make any sense to target a normal or “expectable” interest rate as Mr. Lipow wishes he had (he said between 2 and 4%) since interest rate is a price and as such should be subjected to supply and demand.

Consider now Mr. Lipow’s charge that, according to the Austrian theory, investors are ­ I quote him ­ “a bunch of idiots” who make wrong expectations regarding the market and are repeatedly mislead by wrong monetary policies, never learning from past mistakes. He even diagnoses ­ I quote him again ­ “split of personality” and “mass psychotic episodes” for investors who, as customers, should know very well that their time preference did not really change.

Beyond the tentative humor, I am stunned by the oversimplification and falsehood of such arguments. In real life, as in Austrian theory, investors and entrepreneurs are not one thinking abstract category but a group of different individuals with specific situations and different time preferences. If as a car manufacturer you decide to give up driving and take a bicycle, will you infer that since you are a representative customer your business is over ?

As far as the “learning from mistakes” charge is concerned, there is no evidence that correct expectations regarding the outcome of loose monetary policy would prevent the boom and bust cycle. Even if they know business cycle theory and anticipate a bust, entrepreneurs in place before money pumping have no choice but to endure the pressure from new entrants who funded their projects with cheaper money. They must fight to keep their resources from being hired and therefore are powerless against the increase of their costs of production and the shrinking of their margins.

Bottom line, the only beneficiaries of inflation are the early receivers who see their relative purchasing power increase, out of thin air and at the expense of later or no receivers since they enjoy it before prices increase spreads through the economy.

In a desperate attempt to prove his point favoring inflation Mr. Lipow introduced a comparison between the deflationary 19th century and the inflationary 20th century based on some unquoted empirical study covering US, Canada and Europe.

He bluntly affirmed that GDP per capita grew 1% in the former and 2% in the later century.

You don’t have to be an economist ­ – mainstream or not – ­ to see that this affirmation, which Mr. Lipow presents as an evidence, is ridiculous. How can he expect us to believe the GDP per capita has grown 3 % in the last two centuries that taken together, saw the realization of the agricultural, industrial and financial revolutions, just to name some key historical events !?

If this is being mainstream, although I know few economists that would recognize themselves in such a clumsy intellectual endeavor, then I definitely keep the challenger position.

Still, if of any consolation for Mr. Lipow, the one good thing about being mainstream is that when you are wrong, you are not alone.

From Toby Baxendale:

As a businessman with a degree in economics, and trying in my spare time to keep up with contemporary developments, I read in my LSE Alumni magazine, that the 2003 Nobel Prize winner, Professor Engle from NYU Stern School of Business, a fellow old Alumni recently spoke at the School. The blurb on Professor Engle says the following: “Professor Engle was cited for his methods of analyzing economic time series with time-varying volatility, a discovery which was a major breakthrough. He found that the concept of autoregressive conditional hetroskedasticity (ARCH) accurately captures the properties of many time series, and then developed methods for statistical modeling of time-varying volatility.”

Well, I can hardly pronounce “autoregressive conditional hetroskedasticity,” can anyone tell me what it is? What value does the understanding of it have for humanity? Any hints or explanations would be gratefully received.

Posted from Paul Craig Roberts:

Many libertarians have misinterpreted what Senator Charles Schumer and I are saying about free trade, and they are misinterpreting or misapplying trade theory. I do not know why this is the case. Perhaps libertarians perceive a threat to one of their vital commitments and rush to its defense before they get their minds around the problem. Please accept my assurances that it is not I who threatens free trade. Free trade is threatened by new developments delivering results different from the promise of shared gains. Libertarians need to understand these new developments in order to have input into the resolution of the difficulty. Toward this end, I will again attempt to explain the new problem.
Begin with the realization that free trade is a policy, not a theory. The case for the policy is that it brings shared gains to the populations of the free trading countries. There will be winners and losers within each country, but on average the wins within each country outweigh the losses.

For there to be shared gains from free trade, countries must specialize and trade in goods in which they have comparative advantage. Comparative advantage comes from countries having different opportunity costs of producing traded goods. Those opportunity costs depend on factor endowments. Internationally mobile factors of production alter or obliterate the internal cost ratios that determine comparative advantage. Indeed, comparative advantage is irrelevant to the capitalists’ investment decision once capital is mobile between nations, because profit would be maximized by following absolute advantage.

Consider, for example, a trading country specializing according to comparative advantage. Now introduce new developments that create opportunity for capitalists to reallocate productive factors from comparative advantage at home to absolute advantage abroad. The result is a collapse in the conditions under which free trade produces mutual gains to trading countries.

It is possible to have a free trade policy based on absolute advantage. This free trade policy rests on the argument that world welfare is maximized at the expense of some countries. This is the free trade model that changed conditions have brought into operation. Changes in political and technological conditions have made it possible for first world capitalists producing for first world markets to substitute cheap foreign labor for expensive first world labor in their production functions. As daily announcements from US multinational corporations make clear, this dumping of first world labor is occurring across the entire range of tradable goods and services.

Offshoring platforms, both for manufacturing and for knowledge jobs, are now well developed in China and India. Because of the huge excess supplies of labor overhanging those labor markets, equally productive Asian labor can be hired for much less than first world labor. The high wage of first world labor is no longer protected by the confinement of first world capital and technology to the first world.

The displacements of first world labor are not occurring because of traditional import competition under conditions of comparative advantage. They are occurring because first world capital and technology are flowing abroad to the absolute advantage of equally productive but much cheaper labor.

We cannot dismiss this new development by arguing that factor-price equalization will restore equilibrium. Factor-price equalization is a result of a static model with many assumptions. Its point is to illustrate the insight that trade in goods is ultimately trade in the factors that produce the goods. Given the excess supply of Asian labor, it will be many years, decades, perhaps a half century, before the excess supply of labor is drawn down. In the meantime, US wages will rapidly fall to Asian levels. Business Week has already reported a case of top flight American software engineers being hired in the US at only a slight premium over Indian wages.

Another mechanism for bringing about adjustment is exchange rates. However, China pegs its currency to the dollar and resists pressures to appreciate its currency or allow a float. With the exchange rate unable to bring about an adjustment in the cost of Asian labor and in the prices in US currency of goods produced by US multinationals offshore for US markets, the US can lose in the meantime many millions of high value-added jobs as well as entire industries and occupations.

The economic and social dislocations and political instability can be severe. For example, the software engineers’ mortgages and debts will not be cut in half just because their salaries were. American voters will not be content that their sufferings are offset by gains in India and China.

One of my professors, Ronald Coase, advised that economists should occasionally emerge from their abstract models and look out the window. They might be surprised at what they see. This was Coase’s way of admonishing us to remember that theories and theorems are tools for understanding reality. We should always regard them as tools and not let them do our thinking for us. I have always tried to follow Coase’s advice.

When economists reply to me that offshore production in China makes Chinese more wealthy with the result that they buy more of our goods and cause more employment in our export industries, they overlook that Chinese wages are too low to replace via imports the domestic purchasing power lost in the US due to offshoring. These economists are not looking out the window. The US economy is 25 months into a recovery. By previous experience the economy would have created millions of new jobs by now. Charles McMillion, president of MBG Information Services in Washington, DC, says that his analyses show that 25 months after the trough in the average business cycle, the economy normally adds about 6% to its jobs total. Since November 2001, 7.85 million new jobs should have been created. Instead, the economy has lost almost another million private sector jobs during two years of recovery.

This is unprecedented, doubly so considering the extraordinary ease of monetary and fiscal policy. We are pumping $500 billion annually into other country’s markets for goods and services, and there is no sign of it coming back to us in employment growth in tradable goods and services. The only jobs that the economy has been able to create during two years of recovery are in low pay non-tradable services.

Economists have offered a running apology, but no explanation. I offered an explanation. The US economy is creating jobs for foreigners. The US is creating jobs for foreigners by running up debt, which foreigners are converting into ownership of our assets and the future income streams that they produce. This is not a picture of shared gains from trade based on comparative advantage.

Stephen Roach at Morgan Stanley and others, who pay closer attention to the matter than I do, have reported that upwards of 65% of our “imports” from China represent offshore production. The dislocations caused by these “imports” are a product of US labor being substituted out of US production functions. They are not a product of competitive trade. Economists need to address precisely what is being traded when a US multinational discharges its US employees and hires foreign ones.

Many have informed me that there is nothing new about capital mobility, that foreign investment has been taking place for a long time. They overlook the fundamental difference between traditional foreign investment and offshoring. Historically, the world has experienced protection, not free trade. Foreign investment was motivated by desire to enter foreign markets in the face of prohibitive tariffs. It was not, as in the case of offshoring, motivated by seeking absolute advantage in low cost labor abroad. Moreover, foreign investment was confined to the first world, except for some investments in extractive industries. Many of these investments, such as Chilean copper, were confiscated, reminding capitalists of Adam Smith’s and David Ricardo’s admonitions to keep their capital at home.

When factors of production flow from comparative advantage at home to absolute advantage abroad, the shared gains case for free trade breaks down. That is what Senator Schumer and I pointed out The challenge is to restore conditions under which free trade produces shared gains.

Some libertarians believe that globalism is a new force that is smashing states and establishing a stateless world of free markets. This is a nice dream, but nevertheless a dream. The more likely effect of US decline, absolute or relative, and rising success and confidence in Asia will be challenges and conflicts. Libertarian nirvana will never be. Libertarians should understand that they can affect things only on the margin. The issue is a little more freedom or a little less. Libertarians deprive themselves of policy input when they refuse to settle for anything but the perfection of abstract models. They deprive themselves of an audience when they declare themselves for free trade regardless of what it may do to their country.

Two final points. Yes, my mother told me that you are judged by the company that you keep. No doubt, Charles Schumer’s mother told him the same thing. My company looks as damning to his side as his looks to mine. We both ignored our mothers’ strictures in order to focus thought on an issue prior to the time that panic sets in. What will be the response if the economy continues to lose jobs after three years of recovery? At what point will job loss from offshoring cause GDP growth to stop? To decline? What happens to people with stagnant or falling wages when China is forced off the dollar peg and Wal-Mart’s prices rise?

Critics may say that this will never happen. But two years ago the same people would have denied that two years of economic recovery would produce a net loss of almost one million jobs.

In conclusion, people who resort to ad hominen attacks have weak arguments. Unable to deal intellectually with an argument, they fall back on name-calling. They try to discredit an argument they cannot answer by discrediting the person.

Although I had a graduate education with the finest economists extant at the University of Virginia, University of California at Berkeley, and at Oxford University, I can make mistakes just like the next man. If I turn out to be mistaken in my diagnosis of the job-loss recovery and the rise of free trade based on absolute instead of comparative advantage, so be it. I did my duty and offered an explanation in place of excuses. I am a person of good will. I will listen to a better explanation.

From Gary North

Read this article by W. Lind with Mises’s distinction between profit management and bureaucratic management in mind. An army, unlike most other bureaucracies, faces a kind of market: a war. There are success indicators imposed by outside forces independent of the army. Thus, entrepreneurship must function in an army in order for it to survive. This is not true of other bureaucracies.

Lind is saying that the modern army must move from bureaucratic management (centralized) to profit management (decentralized). Of course, we don’t want a war. So, in the absence of war, armies move toward bureaucratic management. Until the shooting starts, armies want Eisenhowers, not Pattons.

The Swiss have it right: arm the population, train the men, have Alps, and stay home.

The New York Times runs an interesting piece on New England Patriots coach Bill Belichick, who is among the top geniuses in the NFL today. First, some backround info on Belichick. Prior to his head coach positions, he was a masterful defensive coordinator, a man so naturally inclined toward details, planning, and memorization that his father, a long-time coach at Navy, had him memorizing plays and analyzing Navy game films before he was 10 years old. Everywhere he has coached, he has turned his defense into a powerhouse unit. He has done this not because he automatically attracts the best player personnal everywhere he goes, but because he is an incredibly astute theorist. For Belichick, everything from Xs and Os to cutting players is an exercise in grand theory. He has been known to build defensive game plans that have shut down some of the most explosive offenses in recent history. So, what makes him so unique?

Economics. Or so says Belichick. He graduated from Wesleyan with an economics degree. Okay, a not-quite-Austrian program, but nonetheless, his mathematical and economics background have fed his penchant for strategy, deep analysis, and cost-benefit decisions. Where other coaches only see an individual’s outward performance, Belichick lays out his plans based on deeper analysis. He measures the player’s direct cost to the team and the various opportunity costs of keeping the player. The benefits of that player’s performance are weighed against the assorted costs to determine whether ot not that player will advance the performance of the team, as a whole, while at his position. Apparently, he finds that using simple, incremental analysis adds to his problem-solving ability, which he relies on for both personnel and gameplan decisions. Belichick, in my opinion, though not necessarily the finest coach in the NFL, is the game’s greatest master in terms of the particulars of planning and gameday management, and he accomplishes this as an economist and field academic.

Posted by Karen De Coster

Some nuances to  Robert’s last reply

a) Free movement of capital to third world countries to produce for its home markets should not necessarily benefit them at the expense of first world countries. On the contrary it is beneficial for first world countries.  Reisman  makes clear that “loss of capital” to third world countries is compensated by: (a) Lower import prices which make up for the loss of nominal wages; (b) Capital allocated where it is more productive cumulates at a higher rate in third world countries, which results in most of this capital being ploughed back into USA. This new capital invested in USA (be it “financial” or “real” assets) bids up productivity of USA labor. I refer to Reismans’ “Capitalism” for a full account of this fact.

b) Even if USA workers were not better off, USA considered as a whole (capitalists and workers) would be much better off. The gains to be derived by capitalists resulting from free movement of capital are enormous.

c) What really happens (and this is what bothers “welfarists”) is that migration of capital results in the erosion of the tax base. Such erosion jeopardises the welfare state. It might even happen that the less competent USA workers might actually see their purchasing power being reduced, since it may well occur that the losses of welfare benefits exceed the gains brought about by free movement of capitals. Therefore, irrespective of the gains or losses for workers arising out of globalisation, what really worries the “establishment” is the loss of a tight grip over the most productive citizens (the owners of capital). If Mr. Roberts contends that free movement of capitals jeopardises the whims of the State, he is right.

d) Mr. Robert’s ideas are based on the premise that the “State” has the right to control the use of private property, that the individual should sacrifice himself to the State’s interests. HERE IS THE CRUX of this debate: Whether the State has the right to have a group of enslaved milk cows and whether the cows’ milk is for the benefit of the collective. Libertarians deny this right. Mainstream thinks otherwise. However, it seems quite “un-American” to maintain such views. USA was founded on the premises of individualism, the pursuit of one’s own happiness and self reliance. Such three principles clearly contradict the view that the individual should sacrifice for the State (that is for others, be it fellow nationals or foreigners). If America falls prey to the collective ideas to be found in the rest of the world, the days of America as the leading power of the world are counted.

Posted by Jose Ferre

Responding to Steele, by Robert Murphy

When it comes to taking potshots at Ludwig von Mises, there is no easier target than his “dogmatic” insistence that economic theories are true a priori, and that testing them is not only unnecessary but nonsensical.  Mises believed economic science was a subset of praxeology—the science of human action—and that the methods of the natural scientist were inappropriate for the social scientist.  I have tried in previous articles to explain and defend Mises’ unorthodox position.  In the present article, I will respond to a few objections leveled by David Ramsay Steele in his book, From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation (Open Court, 1992).

Posted by Mises.org Working Papers

John Snow  repeats the refrain again, apparently with a straight face.  No howls of laughter from the crowd are mentioned, but even the reporter seems to be suspicious of the claim.

Posted by Jim Waddell

So says Former Malaysian Prime Minister Mahathir Muhammad to Saudi Arabia.  Who knows, if Bush’s “strong dollar policy” continues, the Saudis just might listen.

Posted by Jim Waddell

Posted by Don Lloyd

What happens when capital is moved from USA country to Malaysia? Less productivity in USA and more productivity in Malaysia. But given the new conditions, it is still better to trade than not to trade! The problem is actually capital mobility, not free trade. It seems that forbidding capitalists to move capital out of the country would solve the problem. But…wait…aren’t there other countries willing to invest into the same factory? If they do it, USA will face absolutely the same situation! There will be only one difference – the profit from the new factories will not flow into the USA.

Fears of capital mobility are really funny anyway. Here in Czech Republic I hear frequent complaints about foreign companies – that they suck their profit from our country and use us as poor servants, and that we are going to serve the rich. And now I hear complaints from the other side of ocean that they fear the mobility of capital!

Posted by Ondrej Palkovsky

New models of “urban planning” are all the rage: the young, hip, creative workforce is attracted by art lofts, local music, entertainment districts, urban recreation…and we see it all in “downtown revitalization” programs aimed not at cutting taxes or providing safe neighborhoods but at providing the various amusements and shiny objects that the modern high-tech workforce supposedly demands.

There’s one problem: these plans don’t work. The bursting tech bubble showed us that there is no “new economics” in general; the  Wall Street Journal points out that evidence in employment trends don’t exactly confirm the hypothesis that “hip” cities outperform “unhip” cities. Much to the chagrin of those who have a stake in this new urbanism, it may just be that “old economy” stalwarts like low taxes and secure property rights may be the true path to urban revitalization.

Posted by Art Carden