Paul Krugman suggests that cutting the minimum wage won’t help employment. My hope here is to uncover his errors.

First, Krugman makes the argument for cutting the minimum wage. He states:

Here’s how the fallacy [of composition] works: if some subset of the work force accepts lower wages, it can gain jobs. If workers in the widget industry take a pay cut, this will lead to lower prices of widgets relative to other things, so people will buy more widgets, hence more employment.

Of course, that’s not the argument that is typically made at all.Most students of Principles of Microeconomics should have heard the argument against the minimum wage. The real story goes like this:

Demand for labor is downward sloping. The supply of labor is upward sloping. This establishes an equilibrium wage where the quantity demanded and supplied are equal. A minimum wage, if it does anything at all, pushes the wage above this level, so that there is a greater quantity supplied than demanded. We call this surplus supply “unemployment”.

The argument doesn’t rely whatsoever on changes in the relative prices of products. Rather, it relies on the fact that the demand for labor is downward sloping – which comes from marginal productivity, and that the supply of labor is upward sloping – which comes from, for example, “reservation wages” being met for more workers.

Back in the day, Keynes suggested that this story is inadequate at the macro level. The problem is that the marginal revenue product of labor depends on demand for the product – but that demand depends on income, and income depends on wages. So, if wages fall, then incomes fall, which drives down the demand for the product – which, in turn, drives down the demand for labor – in the same proportion that wages fell. So, in the end, there’s no impact on employment. The decrease in wages caused a corresponding decrease in employment.

However, within the Keynesian framework there is a way for cutting wages to still “fix unemployment”. The fall in prices means that the real value of money has increased – so people have excess real money, and try to divest themselves of this extra money by buying bonds. Buying bonds pushes down the interest rate, which, in turn, stimulates investment, which, in turn, stimulates employment.

Krugman says that this story doesn’t work once we’re in a liquidity trap. Interest rates are already at their lower bound, so buying more bonds won’t decrease them – and therefore, investment doesn’t get stimulated, and therefore employment doesn’t increase.

So, where, specifically, does Krugman go wrong?

(1) The demand for labor depends on the expected discounted marginal revenue product. So, what matters is not the present demand for the product, but the expected future demand. For Keynes’s original argument to work, we need a feedback from present prices to expected future prices, so that as one falls the other does so – and does so proportionally. This is not necessarily true – in fact, it’s probably not true.

Suppose that right now the price of oil is $50 a barrel, and I expect it to go up to $100 a barrel next year. Then, tomorrow, the price of oil shoots up to $75 a barrel. Do I revise my expected future price up to $150, to keep the proportions the same? Maybe, maybe not. But, I will say that “not” certainly feels more likely.

So, what happens if demand doesn’t fall in proportion with the current price of the product? Employment increases as wages fall. Even if a decreased current price arising from the fall in income does decrease the expected price to some degree, as long as it is less than the fall in present wages, the level of employment will increase.

(2) The entire apparatus fails to realize that there is significant variation in wages across workers – even within the same industry or even the same firm.

Why does this matter? Because it breaks the argument down entirely. For example, suppose that workers are divided into groups based on seniority. In that case, the fact that new workers are hired at lower wages than before doesn’t mean that ALL workers are paid lower wages. So, wages don’t fall in proportion with the minimum wage – which means that incomes don’t fall by that proportion, so demand for the product doesn’t fall in proportion, so product prices don’t fall in proportion, so demand for labor doesn’t fall in proportion. In the end, what does this mean? In short, that the Principles of Microeconomics story is basically right. When marginal wages fall, employment goes up – and the fact that not all wages move together prevents the Keynesian feedback.

(3) The framework ignores that excess real balances can be drawn down by buying things.

To be fair, Krugman acknowledges this, but writes it off as insignificant. Here’s what he says:

Somebody is going to ask, what about the real balance effect? Doesn’t a falling price level make people wealthy, by raising the real value of the money they hold. The answer is, consider the magnitudes. Before the crisis, the monetary base — the system’s “outside money” — was around $800 billion. (It’s a much more confusing situation now, so I won’t try to parse the current numbers here). This means that even a 10 percent fall in the price level, which is very hard to achieve, would raise real wealth by only $80 billion. Compare this with the effects of the decline in housing and stock prices, which reduced household wealth by $13 trillion in 2008. The real balance effect is totally trivial.

The problem? Krugman looks at the wrong number. It’s not the monetary base (reserves + currency) that matters. It’s the quantity of money balances, something more like M1, MZM, M2, or the Austrian Money Supply. Let’s just look at MZM (which includes checking accounts, savings accounts, and money market accounts). Right now, MZM sits at about $9.5 trillion. So, a decrease in prices of 10% would lead to an increase in wealth of about $950 billion. True, this is less than 10% of the $13 trillion decline, but it’s not “totally trivial”.

Why does this matter? Because it’s one more reason that a decrease in wages won’t lead to a proportional decrease in prices – which means that a decrease in wages will increase employment.

A significant part of the Keynesian argument against free markets (and for minimum wages) rests on the argument that Krugman presents. The assumptions that this argument rests on are simply not true. Meanwhile, the assumptions underlying the argument for lower wages increasing employment are far more reasonable.

Just a taste of the presentations that you can find at ASSC:

Uncertainty and the Role of Bureaucratic Management within the Firm by

David Gernhard (Grove City College)

A Combinatorial and Praxeological Exploration of the Economic Calculation Problem by

Abhinandan Mallick (University of Birmingham)

Stateless Law in the Highlands of Guatemala by

Michelle Carrera (Universidad Francisco Marroquin)

This weekend, I had the pleasure of traveling to Grove City College in Grove City, PA to attend the Austrian Student Scholars Conference.

I was a mere observer at this event – but what I observed was good scholarship and great fun.The Conference kicked off on Friday night with dinner (Beef Stroganoff) and mingling with the fellow scholars. That night, Benjamin Powell presented about statelessness in Somalia. The punchline: Somalia is generally better off without a state than it was with one. Also, Somalia is better off than many of its neighbors that have states.

On Saturday, there were eight sessions (running two at a time – I overheard Walter Block mourning the fact that he couldn’t attend all of them) for student presentations. Being a “Macro” guy, I attended sessions on Revisiting the Great Depression, For and Against Private Law, Austrian Views of Cycles and Investing, and Money.

Papers ran the gamut from a deconstruction of the Eichengreen-Temin argument for why the gold standard caused the Great Depression, to Stateless Law in Guatemala, to discussion of how exchange rates can impact the international production structure – and those were just papers that I heard presented.

Between sessions and during meals there was plenty of time to meet up with old friends and make new ones.

The conference concluded on Saturday night with Dr. Walter Block talking about his 41 years as an Austrian economist. From his humble beginnings as a pinko commie in Brooklyn to his years studying under Becker, the story of Dr. Block’s life unfolded. The talk ended with discussion of various Austrian distinctives and how they impact the way we look at economics. As always, Dr. Block proved entertaining and informative.

If you’re an Austrian student (in undergrad or grad schoool), I highly recommend presenting at ASSC – or, at the very least, attending to observe. You’ll come away from the weekend with new knowledge and new friends.

Last night, my wife and I went to see the new computer-animated film “9″. After watching it, I had some somewhat spoiler-y thoughts… (Don’t read more unless you don’t mind spoilers!)For those who don’t mind spoilers…

The basic premise behind “9″ is that there was a war between machines and humans. “9″ picks up after the war when only a few little animate dolls and a mechanical cat “survived”.

Throughout the movie, the backstory gets revealed in more detail. What we find out:

“The Machine” was built by a scientist, and was designed to make more of itself.
“The Chancellor” (and obviously dictatorial figure) declared that “The Machine” would “usher in a new era of prosperity for the State”.
“The Machine” then turned against the people, and the war began.

One doesn’t have to think too hard to draw parallels between “The Machine” and “The State” as we know it.
Many interventions are designed by (social) scientists – often well-meaning ones.
As Mises notes, interventions do result in more interventions being created. (We need new interventions to fix the problems caused by old ones.)
Massive interventions are often hailed as beginning a new era by those in power (New Deal, Great Society, etc.).
As Hayek notes, the State often turns on its people as the “Worst Get on Top”.

Naturally, there are other possible interpretations – that’s the nature of literature – but it’s nice when there’s an Austro-libertarian one so close to the surface.

Paul Krugman has a recent post, giving two reasons why the free market cannot cure health care. As should be no surprise to a Mises.org reader, Krugman is quite wrong.Drawing from a classic article by Kenneth Arrow, Krugman gives two main reasons that health care is something that cannot be left to a free market.

First, health care expenses are characterized by risk. That is: there is a relatively low probability of having a very large expense. Typically, these large expenses are such that an individual could not afford to pay them out of pocket, should the need arise.

The conclusion: health insurance is necessary.

As far as this goes, Krugman is largely correct. Health care is largely characterized by having a low probability of getting hit with some very expensive medical conditions, so some sort of insurance is a sensible solution.

However, there is no reason to claim that insurance of this type is not a “free market” phenomenon. Now, it is definitely true that our current health “insurance” scheme is not really very “insurance” like, for the most part. (Auto insurance doesn’t pay for oil changes – nor should health insurance pay for predictable annual physicals, if it exists to protect against unforeseen events.) However, this does not rule out the possibility of actual insurance in health care.

So far, we’ve seen that Krugman’s first point – though correct on the surface – does not show that the free market can’t cure health care. All he has done is predict HOW the free market would sensibly do it. This leaves a question: How does Krugman come to his conclusion from this point? Well, he makes a few claims about insurance that simply aren’t true.

“It [health care] must be largely paid for by some kind of insurance. And this in turn means that someone other than the patient ends up making decisions about what to buy.”

This does not follow at all. Now, it is true that someone other than the patient MIGHT end up making decisions about what to buy. But, there is no reason at all that this is the way things must be. For example, one could easily imagine a health insurance setup in which insurance companies paid a flat amount of money for a particular diagnosis, and leaves it up to the patient to decide how to spend that money. (For example, a cancer patient may decide to take a trip around the world rather than seeking treatment.) If we assume that the free market insurance scheme MUST work like the one we have, then what Krugman says is true – but that assumption is far too strong. Whenever markets are freed, they tend to breed variety – so it is very likely that at least some insurance companies would have a payment scheme like the one I suggest here.

“This problem is made worse by the fact that actually paying for your health care is a loss from an insurers’ point of view — they actually refer to it as ‘medical costs.’ This means both that insurers try to deny as many claims as possible, and that they try to avoid covering people who are actually likely to need care.”

The first part is, in fact, always the case with insurance – or gambling, for that matter. Yet, when it comes down to it, most insurers (and casinos) do pay in the event that they are supposed to according to their contract. Apart from any legal ramifications from a contract breach, insurance companies also have to deal with negative consequences arising from customers being dissatisfied. If my mechanic cuts corners and puts only water in my radiator rather than coolant, then I will stop going to that mechanic – and you can bet that I’ll bad-mouth him on my personal blog, and give him a negative review with AAA. (Note: I’m actually quite satisfied with my mechanic – so no worries.) Insurance companies – in a free market – would be under precisely the same pressure. If they refuse to pay when they obviously should, then they will lose customers and develop a bad reputation. This encourages insurance companies to actually pay when they are contractually obligated to.

As far as avoiding covering people that are likely to need care – this is not so. In a free market, people who are in poor health will likely still be able to get health insurance – it will just be quite expensive for them. This is, of course, natural. Teenager drivers (or drivers with accidents on their record) are bigger risks – therefore, the fair thing to do is charge them more for insurance. The same goes for those that are under signficant health risks.

Now, it is true that, on some level, this strikes people as “unfair”. There is something in most people that makes them feel quite uncomfortable with charging the sick more than the healthy. We have a sense that “they’ve already been through enough”. Here, there’s a simple solution: private, voluntary charity. As Mises pointed out, action can be thought of as an attempt to remove a “felt uneasiness”. Certainly, seeing the chronically ill have to pay a lot for their medical expenses creates a felt uneasiness in many, and therefore it is quite likely that private charities will be set up to help alleviate the cost for sufferers of various chronic conditions. The marvelous thing about this system is that it is precisely those conditions that society actually feels compassionate toward that will receive the compassion, as it is quite likely that at least some of these charities will be disease-specific (after all, we already have numerous disease-specific foundations that fund research – so why not ones that fund actual treatment?).

So, what is clear: Professor Krugman’s first point is not anywhere close to sufficient to showing that a free market cannot solve the health care problem. Even if we grant that insurance will exist (and it probably will), it does not follow that health insurance companies in a free market will perform poorly.

“The second thing about health care is that it’s complicated, and you can’t rely on experience or comparison shopping.”

I could grant Krugman his first claim. But, I cannot grant him this one. From what is written here, it is immediately obvious that Prof. Krugman has not faced any serious illnesses. If he had, he would be aware of something called a “second opinion”. It is not the least bit uncommon for people to seek a second opinion, or, when one procedure has failed to prove effective, to try another – often from a different doctor with different ideas. Effectively, what all of this is is “comparison shopping that relies on experience”. So, based on a purely empirical level, Krugman’s claim is false. Now, it is true that because of our current insurance scheme that we don’t compare along the lines of price most of the time. But, we certainly would if prices were paid more directly by the consumer. (Note: I know that, for me, there is a significant exception to this rule. When I seek treatment, I choose a visit with my primary care physician if possible. The reason? Because the copay on my other options – urgent care and the emergency room – are significantly higher than for my doctor. Put simply: people do respond to prices!)

As an additional point, Krugman’s argument is sneaky. For a moment I was going to suggest that Krugman’s connection between “complicated” and “can’t comparison shop” was false. Then I noticed: he actually doesn’t connect the two. He doesn’t say “it’s complicated, therefore we can’t comparison shop.” He says “it’s complicated, and we can’t comparison shop.” These are two different points. I’ve already dealt with comparison shopping, so let’s go back to complication.

Let’s face it – lots of things are complicated. A car is a sophisticated piece of machinery. The laptop I’m typing on is sophisticated. Lots of things are sophisticated. True, the human body is several times more sophisticated. But, I don’t have to be a mechanic to know that my car isn’t running “right”. I don’t have to be a computer expert to know when my internet connection is “laggy”. And I don’t have to be a doctor to know that I “don’t feel good”. The fact is that what matters in my experience as a consumer of various services is my experience as a consumer of various services. The only reason complication matters is because it causes me to seek out an expert rather than try to solve the problem directly myself. But, once I follow the expert’s advice, I am capable of evaluating whether it worked – in as far as I care as a consumer.

In fact, as Austrians know, complication is a point for the free market. As Hayek noted, one significant problem with central planning is the information problem. There is simply too much information in the economy for a central authority to be able to process it effectively (or even gather it, as a very large portion of the information is actually not directly observable). So, given this complication, it makes far more sense to have consumers decide what matters and what doesn’t – as only consumers have the most important information: does their experience match what they want from their health care system? If we want to get a “yes” answer from that question, we should adopt a system in which consumers have choices. And, as we all know, the free market provides far more choices than any centrally planned system could.

Charles Davi over at The Atlantic recently wrote an article detailing a particular example of “market failure” – the so-called “coordination failure”. Here, I hope to offer a largely Austrian view of this “failure”. In the end, we’ll see that a proper understanding of the problem will eliminate any valid role for government.
Davi presents us with a simple example to demonstrate what he means by a market failure. Imagine a case where I would like to have my house painted, and would be willing to pay you a certain sum to do it. Also, you would happily exert the effort to paint my house for that sum. So, it’s obvious that the best thing that can happen is for me to pay you to paint my house.

However, there’s a small difficulty. Neither of us trust each other, which creates a problem for the timing of payment. For example, if I pay you first, I fully expect you to “take the money and run”. So, I end up losing the money and not having my house painted. Meanwhile, if you work first, then you fully expect me to refuse to pay. So, you end up working and not getting paid. Since each of us distrust the other, the deal doesn’t end up happening. A “suboptimal outcome”.

There are several levels on which the problem breaks down. First, Misesians should be quick to point out that preferences can only ever be objectively known from action. So, a person can say “I would prefer that you pay a certain sum of money and that I paint your house than not”, but if that same person is offered the deal, and doesn’t take it, we reach a very obvious conclusion. They were lying. Or, to be a bit more charitable, they were imprecise. What they actually meant was “I would prefer to paint your house under conditions of 100% certainty that you would pay me a certain sum if I did.” Since 100% certainty is not the condition under which the choice is made, there is no contradiction in declaring this preference and then not actually choosing to paint the house when given the opportunity.

Taking this view, a Misesian can quickly point out the first problem in Davi’s logic: he’s comparing apples and oranges. He defines “optimality” based on an imaginary construct where there is 100% certainty. Then, he mourns the fact that reality is not like his imaginary construct. However, if we take the conditions of reality as given (that is, we take as given the lack of trust), then the decision that is reached is actually optimal. Given the amount of uncertainty involved, both you and I would rather not engage in the trade than engage in it. So, there is nothing “suboptimal” in the outcome at all. Now, we can’t completely blame Davi for this approach. After all, comparing the real world to imaginary constructs and using these constructs to condemn reality is a long-accepted practice in the mainstream of economics. Austrians are often alone in declaring that this is not a valid way of measuring the optimality of market outcomes.

Davi declares that the way that “free market zealots” solve the problem is by appealing to reputation. So, we can achieve some degree of certainty by looking at each other’s past. Davi declares that “That would probably work in a tiny village where everyone knows everyone else, travel is infrequent, and therefore reputations are easy to track. But in the developed world, it’s impractical and creates a fantastic opportunity for those willing to move around a lot pretending to be a painter.” However, it’s obvious that the free market zealot Davi talked to was terribly uncreative. There are, in fact, a number of ways that the mistrust problem can be ameliorated. For example, I can agree to pay you at the end of each hour of work. So, at worst, you will waste 1 hour of your time. Once I refuse to pay you for an hour’s work, you can simply stop working for me. Or, alternatively, I can pay you in advance for each hour of work. Then, if there’s an hour where you take my money and laze about, I can refuse to hire you for the next hour. This diminishes the risk significantly, and allows for reputations to be formed “on the spot”. Now, in reality, the way this kind of thing tends to work is through a multiple payment system. So, I would pay you half of the money in “advance” and half upon completion. This sort of setup can be used to establish reputations very quickly, even in a big world where laborers move frequently.

Davi’s complaints about the reputation system, though, are not limited to its unworkability. He also declares that “if it were practical, any system based on reputation alone would favor incumbents and make it very difficult for new entrants to compete”. However, this is very far from reality. It seems that Davi doesn’t recognize that the level of pay is not a given. So, as a new entrant, I can offer my services at a discount to make up for my lack of reputation. So, employers would have two types of employees to choose from: those that have good reputations, but high wages, and those that have no reputation (or bad reputations!) and low wages. A proper “reputation premium” would allow for both types of workers to find jobs.

Davi’s suggested solution to the problem is one that we find in the real world quite a bit. We write an enforceable contract. This is certainly a sensible solution. Then, the needed trust is transferred from being our trust in each other to being our trust in the government. Since there are relatively few governments in the world, they will have reputations that are easy to track. In offering it Davi makes a very strong assumption. He assumes that only government is capable of enforcing contracts. However, in theory and in reality, more than just governments are capable of enforcing contracts. Ed Stringham is one who documents this quite nicely. So, even if we accept that Davi’s solution of enforceable contracts is the only or best one, he still has to show that government is the only or best way to enforce contracts. I strongly suspect that private arbitration is likely to be significantly better – if only because the costs of enforcement will be paid by the parties that benefit (which guarantees that the benefit from enforcement is greater than the cost) rather than being socialized.

After discussing coordination failures and suggesting that the problem requires a government solution, Davi moves on to suggest another vague case in which regulation is called for: when “sophisticated” parties are dealing with “unsophisticated” parties. Davi suggests that there are “obvious” examples in which regulation is called for so that unsophisticated parties don’t get “screwed or even physically injured … even if [they] are not technically mislead[sic]“. This is an odd statement that obviously cannot mean what I think it means – that is, that the unsophisticated are signing up willingly and knowingly so that the sophisticated can cause them physical injury. Since that obviously cannot be the intended meaning, I’m left wondering exactly what the intended meaning is. But, let us suppose for the moment that the sophisticated are in a position to take advantage of the unsophisticated. The question then arises: will regulation actually help? Here, we have to ask how regulation is likely to be formed. One can easily make the argument for regulatory capture in this case. After all, regulation can only help because one party is significantly more powerful or knowledgeable than the other. So, who is likely to have a greater voice in forming regulation? I’d suggest that the sophisticated party will – and see very little reason to expect the opposite. So, from a purely practical standpoint, the question is: is it better to hand the abusive “sophisticated” parties the weapon of government, or is it better to make them operate without that weapon? I think the answer is obvious.

Davi himself notes that poor regulation is often worse than no regulation at all. As Bob Murphy has noted, it’s likely that the SEC actually encouraged fraud. It’s almost certain that Madoff’s scam would have come to an end had the SEC not given its tacit approval. One can come up with numerous examples of similar situations for other regulatory agencies. (The FDA regularly blocks effective treatments, yet we still end up with drug recalls. What gives? Maybe it’s that the FDA is actually working for the drug companies – who also exploit government protections to create intellectual monopoly – rather than working for the public good. You know, just maybe.)

In sum, Davi’s critique of the free market condemns it based on imaginary constructs, implicitly assumes that moderately creative solutions (solutions that are found all the time in reality) are impossible, acts as if government is the only possible enforcer of contracts (despite numerous real examples to the contrary), and acts as if bureaucracies can avoid regulatory capture (once again, despite experience that suggests that regulatory capture is a powerful force in reality).

Once we properly understand the problem we will reach a conclusion that should be quite familiar to mises.org readers: the market provides better solutions than government does, and getting government involved is likely to make things worse.

Apparently, Secretary Geithner is going to China this weekend. In part, he’s going to be there to tell China to stop exporting so much.

Which, of course, raises a serious question. If China stops exporting (as much) to the US, where will they get the dollars to lend our government so that we can repair our crumbling roads and bridges?
The rather obvious effect: we’re going to have to get the money some other way.

For example, the Fed could just print the money and buy the Treasuries.

Some other interesting points:

(1) Peter Schiff predicted “decoupling”. I confess that I doubted this idea. Then, it started happening… and now the US’s Sec. of the Treasury is explicitly asking for it.

(2) As someone who is irrationally optimistic, I have held the belief that Bernanke wouldn’t allow a hyperinflation. That is, he would actually reverse course when inflation looked like it would be a problem. Given this new evidence, it’s obvious that Mark Thornton and Jeff Tucker (and others) are dead right. Bernanke’s choice isn’t just between hyperinflation and “somewhat higher” interest rates. It’s going to be between hyperinflation and soaring interest rates. It’s hard to believe that he’ll tolerate soaring interest rates – even if he would have tolerated “somewhat higher” rates.

Which really leaves the Fed with one halfway decent option. Increase reserve requirements.

But I’m finding it more difficult to be irrationally optimistic about that actually occurring…

I was thinking about the Keynesian liquidity trap today, and I came to an interesting conclusion.

If Keynesian theory were true, and Krugman were right that we are in the liquidity trap, then the Fed has a rather obvious solution in its hands: print a bunch of money and pay off everyone’s debts. (It can do this by buying every loan, and then forgiving all of them.)

Immediately, the banks wouldn’t have to worry about toxic assets, as there would be none. Every debt instrument would be purchased at face value. Families wouldn’t have to worry about making loan payments, as the loans would be gone. Every single balance sheet in the US would show a large, positive net worth (well, except for those of silly renters – like my wife and me – who refuse to go deep into debt).

Now, the typical problem would be that such an action would lead to enormous price inflation.

But, not so right now! We’re in the liquidity trap! When we print all this money and hand it to creditors, they’ll sit on it so that it never gets spent, and never causes inflation. Keynesian theory is very clear on one point: you can’t print yourself out of the liquidity trap.

Just one more case where the logical conclusions of Keynesian theory demonstrate its absurdity.

Apparently, Secretary Geithner has discovered that it is “hard” for the government to “set” the “value” of toxic assets. (Pardon my quotation marks.)

I’m sure he’s right, given that he’s simultaneously trying to:

1. Set the value so that the banks look solvent.
2. Set the value so that the assets can be sold without bank balance sheets deteriorating.

The problem, of course, is that establishing (2) requires that we value the toxic legacy assets according to what they can actually be sold for. Something economists like to call the market price. But, (1) requires that we value the toxic legacy assets above the fair market prices. No force of will or “clever” policy can change that fact.

So, it seems that Geithner has realized that a task that is logically impossible is “difficult”. At least his understanding is moving in the right direction.

So, Brad DeLong discovered that he’s often in a tag with “ludwig von mises” and “lew rockwell”, and as the person who “owns” the tag, has forbidden anyone from posting his name with those.

My reply on his blog: “If you promise to stop taking Mises out of context, so that I have to put him back IN context, then I’ll consider your proposal.”

On the other hand, maybe we should stop giving him publicity…

Continuing in the fight for a 100% reserve banking system (or at least a system closer to that than the one we have), I just sent the following message to the Board of Governors.

Naturally, feel free to copy-paste, or send them your own comments here.

To the Board of Governors: As you know, recent PPI data shows a marked increase in Final Goods prices – and generally CPI follows PPI somewhat closely. With this increase in prices it is imperative that we prevent further increases in the broader money supply while at the same time maintaining the integrity of the financial system.

To that end, I recommend that the Board consider a substantial increase in the reserve requirement ratio. Such a move will prevent the historically enormous monetary base from leading to increases in the broader monetary aggregates. Also, it will encourage banks to continue to hold a large quantity of excess reserves which will keep their balance sheets relatively strong in this unsteady time.

As a final point, I would like to remind the Board that focusing on interest rates in a time when very high inflation threatens, and the government has adopted a policy of large deficits is a bad idea. A focus on keeping interest rates low in this fiscal environment is essentially equivalent to handing monetary authority to the federal government, which has historically been the recipe for starting high inflation and/or hyperinflation. Though allowing interest rates to rise may be temporarily painful, the early 1980s shows that the sacrifice necessary to stop or prevent inflation is generally far smaller than many estimate. When given the choice between stagflation with a risk of hyperinflation or an inflation-fighting recession, the latter is most certainly better for the economy in the long run, and the short run costs are just that – short.

No response necessary.

Sincerely,
Lucas M. Engelhardt, ABD
PhD Candidate and GTA
Department of Economics
The Ohio State University

So, Newsweek finally realized that the past 8 years looks far more like “socialism” than “small government”.

http://www.newsweek.com/id/183663

If only they had been labeling it “socialism” when it was happening, then we could actually talk about real solutions now – like diminishing government’s role in the economy. Instead, they were declaring that we had “deregulation”, so the answer is obvious – “reregulation”.

So, I’ve recently started following Nobel Laureate Paul Krugman’s blog. Naturally, he’s normally wrong – in particular about declaring that government should spend a lot of our money. So, I was shocked this morning. He had an entry condemning bailing out the banks.

Some highlights:
He called writing down troubled assets “recognizing reality”.
He even condemned “socialized losses, privatized profits”.

If only he didn’t follow this entry with one about the dangers of deflation…

So, Joe Stiglitz is weighing in on the crisis with an article with Vanity Fair. His claims? Five major mistakes were made.

#1: Firing the regulator inflation-fighter Paul Volcker in favor of free-marketeer Alan Greenspan
#2: Gramm-Leach-Bliley AKA the “Financial Services Modernization” Act
#3: “Applying the Leeches” – by which he means poorly planned, “ineffective” tax cuts/”stimulus”, that “made” the Fed pump money into the economy to stimulate it.
#4: “Faking the Numbers” – misleading accounting + dishonest ratings
#5: “Letting it Bleed” – bailouts instead of fixing the real problem

Simple responses?

#1: Doesn’t matter who is in charge, the nature of the fractional reserve banking system paired with fiat currency would have pushed us this direction.
#2: I’m pretty sure that Robert Ekelund and Mark Thornton have said the same sort of thing, but with an actual reason: our banking system is filled with moral hazards (fiat money, FDIC, fractional reserves, the Fed), so this “deregulation” amounted to corporate welfare.
#3: “Yes, but…” if the Fed did not exist, then we would have avoided the current crisis anyway.
#4: Agreed. Fraud is bad. Even anarchocapitalists don’t approve of fraud.
#5: Also agreed. Bailouts will make the problem worse, and don’t fix the real problem. The real, root problem isn’t a lack of regulation; it’s the government-sponsored system of moral hazards that eliminates every natural check on irresponsible lending and makes regulation the only way to manage lending risk. Eliminate the moral hazards, and the regulations stop being “necessary”.

So close, and yet, so, so far.

Banks are holding nearly 100% reserves for transactions deposits. (As of November 19, they had about $652 billion in reserves for about $700 billion in transactions deposits.) We could implement the 100% reserve rule now for transactions deposits. These reserves would not be lent out in the future, which would keep the banks solvent going forward. FULL ARTICLE