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Economics in One Lesson Review   Leave a comment

Henry HazlittEconomics in One Lesson was recommended reading in my Econ 101 class in college and because it was short, I actually did skim it. I’m not sure how much I learned from that cursory glance with 20-year-old eyes, but when I reread it a few years ago, I kept feeling as though the book could have been written yesterday. You could insert today’s headlines into Hazlitt’s pages. I think everyone should read it. Fortunately, thanks to the Foundation of Economic Education, you don’t even need to spend money to read it.

I’ve given you a sampling of what Hazlitt wrote, but you can read the entire book in an afternoon or a couple of nights. It’s only 200 pages. The clear writing provides simple examples that refute many of the myths perpetrated by politicians and self-interest groups. Hazlitt’s clear insights are relentlessly applied until he erodes the myths promoted by pundits, politicians and economists alike.

One chapter is devoted to public works. Keep in mind that the following was written more than 60 years ago:

There is no more persistent and influential faith in the world today than the faith in government spending. Everywhere government spending is presented as a panacea for all our economic ills. Is private industry partially stagnant? We can fix it all by government spending. Is there unemployment? That is obviously due to ‘insufficient private purchase power.’ The remedy is obvious. All that is necessary is for the government to spend enough to make up the ‘deficiency.’

Vast amounts of economic literature is based on this fallacy. As so often happens with doctrines of this sort, it has become part of an intricate network of fallacies that mutually support each other.

Hazlitt goes on to clearly show the fallacies underpinning the thinking. We tend to look at things in isolation instead of as a whole, and, as Hazlitt concludes his book, seeing them in the whole is the goal of economic science.

I can’t recommend this book highly enough. No one who reads it will ever think about economic policy analysis in the same way again.

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The Lesson Restated   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

Image result for image of interest ratesThis is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

We’re coming to the end of Hazlitt’s book and I hope we’ve learned something. Although I shouldn’t be surprised, I was very surprised by Hazlitt’s spot-on analysis of our 2017 economy. It’s been 50 years since he wrote his book and it appears we have learned nothing in the intervening years. Lela

 

Economics … is a science of recognizing secondary consequences. It is also a science of seeing general consequences. It is the science of tracing the effects of some proposed or existing policy not only on some special interest in the short run, but on the general interest in the long run.

Economics is the science of tracing inevitable implications. The answer already lies in the statement of the problem. We may think we’re learning something new when we arrive at the result, but in reality, the inevitable result of a failed policy was just not recognized when it was proposed.

Few people recognize the necessary implications of the economic statements they are constantly making. When they say that the way to economic salvation is to:

  • increase “credit,” they fail to see that credit is debt, so they’re advocating for increased debt.
  • increase farm prices, they fail to see that city workers will now be poorer.
  • pay out government subsidies, they fail to see that means increased taxes on everyone eventually.
  • increase exports, they fail to see that will eventually increase imports.
  • increase wages, they fail to see that will increase to costs of production.

We must pay closer attention to the two-sided nature of these proposals. We also must stop looking at the effect of economic policies only on specific groups for the short run.

It would not occur to anyone unacquainted with the prevailing economic half literacy that it is good to have windows broken and cities destroyed; that it is anything but waste of men return to work; that machines which increase the production of wealth and economize human effort are to be dreaded; that obstructions to free production and free consumption increase wealth; that a nation grows richer by forcing other nations to take its goods for less than they cost to produce; that saving is stupid or wicked and that dissipation brings prosperity.

“What is prudence in the conduct of every private family,” said Adam Smith’s strong common sense in reply to the sophists of his time, “can scarce be folly in that of a great kingdom.”

But lesser men get lost in complications. They do not re-examine their reasoning even
when they emerge with conclusions that are palpably absurd.

The reader, depending upon his own beliefs, may or may not accept the aphorism of Bacon that “A little philosophy inclineth man’s mind to atheism, but depth in philosophy bringeth men’s minds about to religion.” 

A little economics can easily lead to the paradoxical and preposterous conclusions we have just rehearsed, but that depth in economics brings men back to common sense. For depth in economics consists in looking for all the consequences of a policy instead of merely resting one’s gaze on those immediately visible.

Hazlitt hoped we have rediscovered the “forgotten man” (from William Graham Sumner’s 1883 essay):

As soon as A observes something which seems to him to be wrong, from which X is suffering, A talks it over with B, and A and B then propose to get a law passed to remedy the evil and help X. Their law always proposes to determine what C shall do for X or, in the better case, what A, B and C shall do for X. . . . What I want to do is to look up C. . . . I call him the Forgotten Man. . . . He is the man who never is thought of. He is the victim of the reformer, social speculator, and philanthropist, and I hope to show you before I get through that he deserves your notice both for his character and for the many burdens
which are laid upon him.

Ironically, that phrase was revived in the 1930s, but it wasn’t applied to C, but to X. C was expected to support still more Xs and became more completely forgotten than ever.

It is C, the Forgotten Man, who is always called upon to stanch the politician’s bleeding heart by paying for his vicarious generosity.

The middle-class is C. You and I, dear readers, are C.

The fundamental fallacy that Hazlitt had examined in detail was, he felt, an almost. inevitable result of the division of labor.

In a primitive community, or among pioneers, before the division of labor has arisen, a man works solely for himself or his immediate family. What he consumes is identical with what he produces. There is always a direct and immediate connection between his output and his satisfactions. But when an elaborate and minute division of labor has set in, this direct and immediate connection ceases to exist. I do not make all the things I consume but, perhaps, only one of them. With the income I derive from making this one commodity, or rendering this one service, I buy all the rest. I wish the price of everything I buy to be low, but it is in my interest for the price of the commodity or services that I have to sell to be high. Therefore, though I wish to see abundance in everything else, it is in my interest for scarcity to exist in the very thing that it is my business to supply. The greater the scarcity, compared to everything else, in this one thing that I supply, the higher will be the reward that I can get for my efforts.

We each look to our own interests, but we don’t often realize the consequences of our actions. We rarely restrict our own efforts or output in order to create a scarcity in whatever it is we produce. It might make sense to do this if our aim is the drive up the price, but if there are others in our field, that doesn’t work, so we are concerned only with out own material welfare. We have no humanitarian scruples.

I want the output of all other wheat growers to be as low as possible; for I want scarcity in wheat (and in any foodstuff that can be substituted for it) so that my particular crop may command the highest possible price.

These selfish feelings wouldn’t affect only one else in ordinary circumstances, because wherever competition exists, each producer is compelled to put forth his utmost efforts to raise the highest possible crop on his own land. In this way the forces of self-interest are harnessed to maximum output. But if it is possible for wheat growers, for example, to cooperate to eliminate competition, and if the government permits or encourages this monopolization, the situation changes. The wheat growers may be able to persuade the national government or even the UN to force all of them to reduce the acreage planted to wheat, thus creating a shortage and raising the price per bushel of wheat. This might make the wheat growers better off. Everyone else is worse off because they must produce more to get less of what the wheat grower produces.

So the nation as a whole will be just that much poorer. It will be poorer by the amount of wheat that has not been grown, but it will be poorer also in everything else.

{W]hat applies to changes in supply applies to changes in demand, whether brought about by new inventions and discoveries or by changes in taste. A new cotton-picking machine, though it may reduce the cost of cotton underwear and shirts to everyone, and increase the general wealth, will throw thousands of cotton pickers out of work. A new textile machine, weaving a better cloth at a faster rate, will make thousands of old machines obsolete, and wipe out part of the capital value invested in them, so making poorer the owners of
those machines. The development of atomic power, though it could confer unimaginable blessings on mankind, is something that is dreaded by the owners of coal mines and oil wells.

There is no technical improvement that would not hurt someone, but there’s also no change in public taste or morals, that would not hurt someone. An increase in sobriety would put thousands of bartenders out of business. A decline in gambling would force croupiers and racing touts to seek more productive occupations. A growth of male chastity would ruin the oldest profession in the world.
But it is not merely those who deliberately pander to men’s vices who would be hurt by a sudden improvement in public morals. Among those who would be hurt most are precisely those whose business it is to improve those morals. Preachers would have less to complain about; reformers would lose their causes; the demand for their services and contributions for their support would decline. If there were no criminals we should need fewer lawyers, judges, and firemen, and no jailers, no locksmiths, and (except for such services as untangling traffic snarls) even no policemen.
Under a system of division of labor, in short, it is difficult to think of a greater fulfillment of any human need which would not, at least temporarily, hurt some of the people who have made investments or painfully acquired skill to meet that precise need.

This highlights the folly of the planend economy. It is impossible to create completely even economic progress. But the acolytes of economic planning repeatedly turn to protective tariffs, the destruction of machinery, the burning of crops … to a thousand restrictive schemes..

This is the insane doctrine of wealth through scarcity. It is a doctrine that may always be privately true, unfortunately, for any particular group of producers considered in isolation—if they can make scarce the one thing they have to sell while keeping abundant all the things they have to buy. But it is a doctrine that is always publicly false. It can never be applied all around the circle. For its application would mean economic suicide.

This was Hazlitt’s lesson in generalized form. Many of the things we think are true when we concentrate on a single economic group are really illusions when we apply them to everyone.

To see the problem as a whole, and not in fragments: that is the goal of economic science.

I got my copy of Hazlitt’s Economics In One Lesson from the Foundation for Economic Education. It was free. If you want to read the whole book, go find it.

Posted February 11, 2017 by aurorawatcherak in economics, Uncategorized

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The Assault on Savings   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

From time immemorial proverbial wisdom has taught the virtues of saving, and warned against the consequences of prodigality and waste. This proverbial wisdom has reflected the common ethical as well as the merely prudential judgments of mankind. But there have always been squanderers, and there have apparently always been theorists
to rationalize their squandering.

The classical economists, refuting the fallacies of their own day, showed that the saving policy that was in the best interests of the individual was also in the best interests of the nation. They understood that economics does not change from micro to macro scale. They offered evidence that the rational saver, in making provision for his own future, was not hurting, but helping, the whole community.

Image result for image of savingsIn 1946 and in 2017, you won’t find a lot of “mainstream” economists who embrace the ancient virtue of thrift. The Keyesenians claim they have new reasons for opposing savings and encouraging government spending, but Hazlitt recognized that there was nothing particularly new in their foolishness.

He asked his readers to return to the classical example offered by Bastiat nearly 100 years before. Imagine two brothers – one a spendthrift and
the other a prudent man. Both inherit an income of $50,000 a year. Disregard the income tax and don’t ask if either brother works for a living because such questions are irrelevant in this thought experiment.

Alvin is a lavish spender. He spends not only by temperament, but on principle. He is a disciple of Rodbertus, who declared in the middle of the 19th century that capitalists “must expend their income to the last penny in comforts and luxuries,” for if they “determine to save . . . goods accumulate, and part of the workmen will have no work.”

Alvin lives the high life and doesn’t stint himself on luxuries or staff to take care of those baubles and his wife and friends glitter with his presents. This means his savings account is dwindling, but savings is a sin, so not saving must be a virtue. Plus, he’s balancing out the economic harm being done by his miserly brother, Ben. It’s obvious to anyone with eyes that Alvin is stimulating employment wherever he spreads his money.

Ben is much less popular with tradesmen, restaurants and nightclub owners because he lives much more modestly and spends only about $25,000 of his annual income. For those people who only see the obvious, he is providing less than half as much employment as Alvin, and the other $25,000 is as useless as if it did not exist.

But with Bastiat as with Hazlitt, there was the unseen effect as well to be considered. What does Ben do with the other $25,000? He gives about $5,000 a year to charitable causes and to friends in need. These families then spend these funds on groceries, clothing or rent. So Ben’s funds create as much employment as if Ben had spent them directly on himself, but he has actually made more people happy as consumers, and that production is going more into essential goods and less into luxuries and superfluities.

So, what happens to the $20,000 Ben neither spends nor gives away? He doesn’t hide it under a matteress. He deposits it in a bank or he invests it. If deposited in a bank, the bank either lends it to businesses on short term for working capital, or uses it to buy securities. Ben is, therefore, investing his money either directly or indirectly and that money is invested to buy capital goods—houses, office buildings, factories, ships, trucks or machines. Any one of these projects puts as much money into circulation and gives
as much employment as the same amount of money spent directly on consumption.

“Saving,” in short, in the modern world, is only another form of spending. The usual difference is that the money is turned over to someone else to spend on means to increase production. So far as giving employment is concerned, Ben’s “saving” and spending combined give as much as Alvin’s spending alone, and put as much money in circulation.

Image result for image of interest ratesThe chief difference is that the employment provided by Alvin’s spending can be seen by anyone with one eye; but it is necessary to look a little more carefully, to recognize that every dollar of Ben’s saving gives as much employment as every dollar that Alvin throws around.

So time flies and a decade later, Alvin is broke and is no longer spending lavishly. He’s begging Ben for money. Ben continues with about the same ratio of spending to saving, provides more jobs than ever, because his income, through investment, has grown. His
capital wealth is greater. Moreover, because of his investments, the national wealth and income are greater; there are more factories and more production.

Of course, by 1946 and certainly in 2017, there are far more fallacies in play than in Bastiat’s time. Some stem from logical leaps that make no sense, especially coming from men who claim to be educated.

The word “saving” … is used sometimes to mean mere hoarding of money, and
sometimes to mean investment, with no clear distinction, consistently maintained, between the two uses.

Hoarding without purpose, especially on a large scale, would probably harm the economy, but the money-in-the-strongbox-in-the-basement sort of hoarding is extremely rare. There is a distinct form of this that occurs after a recession has commenced. We saw this (and are still seeing it) in 2009. Consumptive spending and investment contract as consumers reduce their buying, partly because they fear job loss, so they want to conserve their resources. They are planning for the future — spending less on luxuries now so they can continue to consume necessities if they lose their jobs.

Consumers also sometimes hedge their bets, assuming prices will fall and continue falling, so they hold money for a later time when they expect their money to have more value. This pattern does not spring from the same motives as normal saving, but it is still ridiculous to say that this sort of “saving” is the cause of depressions. It’s actually a CONSEQUENCE of depressions.

Hazlitt noted that sometimes “capricious government intervention in business” creates uncertainty, so profits are not reinvested and firms and individuals allow cash balances to accumulate in their banks. They keep larger reserves against contingencies. This cash hoarding may appear at casual glance to the cause of a subsequent slowdown in business activity, but the real cause is uncertainty created by government policies.

The larger cash balances of firms and individuals are merely one link in the chain of consequences from that uncertainty. To blame “excessive saving” for the business decline would be like blaming a fall in the price of apples not on a bumper crop but on the people who refuse to pay more for apples.

When people embrace a fallacy, sometimes they refuse to listen to any good argument against it. They will argue that consumers’ goods industries are built on the expectation of a certain demand, and that if people take to saving they will disappoint this expectation and start a depression. This neglects the reality that what is saved on consumers’ goods is spent on capital goods, and that “saving” does not necessarily mean even a dollar’s contraction in total spending. Yes, sudden changes can upset the economy, but the same unsettling without occur if consumers suddenly switched their demand from one consumers’ good to another.

Another objection against savings is to deride the 19th century with its supposed doctrine that mankind can grow a larger economy through saving and thrift. Hazlitt felt it necessary to address this objection with a more realistic picture of what actually happened.

There is a difference between savings and investment, but the enemies of savings tries to make these two independent variables. They create a picture where you have savers automatically, pointlessly, stupidly continuing to save while on the other hand, there are limited “investment opportunities” that cannot absorb this saving. The result, they claim, is stagnation. The only solution, they declare, is for the government to expropriate these stupid and harmful savings and to invent its own projects to use up the money and provide employment.

There is so much that is false in this picture and “solution” that we can here point only to some of the main fallacies. “Savings” can exceed “investment” only by the amounts that are actually hoarded in cash. Few people nowadays, in a modern industrial community like the United States, hoard coins and bills in stockings or under mattresses. To the small extent that this may occur, it has already been reflected in the production plans of business and in the price level. It is not ordinarily even cumulative: dishoarding, as eccentric recluses die and their hoards are discovered and dissipated, probably offsets new
hoarding. In fact, the whole amount involved is probably insignificant in its effect on business activity.

Most of us keep our money, if we have any savings, in the bank, and banks are eager to lend and invest it. They cannot afford to have idle funds. The only thing that will cause people generally to increase their holdings of cash, or that will cause banks to hold funds idle and lose the interest on them, is either fear that prices of goods are going to fall or the fear of banks that they will be taking too great a risk with their principal. That only happens AFTER signs of a depression, when it is prudent to hold some cash reserves.

“Savings” and “investment” are brought into equilibrium in the same way that the supply of and demand for any commodity are brought into equilibrium. In fact, they are analogolous. Just as the supply of and demand for any other commodity are equalized by price, so the supply of and demand for capital are equalized by interest rates.

The interest rate is merely the special name for the price of loaned capital. It is a price like any other.

Hazlitt might have been writing to people in 2017 instead of 1946 as he laughed into explaining interest rates.

This whole subject has been so appallingly confused in recent years by complicated sophistries and disastrous governmental policies based upon them that one almost despairs of getting back to common sense and sanity about it.

There’s an almost pathological fear of “excessive” interest rates. The argument goes that if interest rates are too high it will not be profitable for industry to borrow and invest in new plants and machines. This argument has caused governments everywhere to pursue artificial “cheap money” policies that overlook the effect of these policies on the supply of capital.

Yes, once again, government is looking at the effects of a policy only one one group and forgetting to look at the rest of the economy. If interest rates are artificially kept too low in relation to risks, funds will neither be saved nor lent. The cheap-money proponents
believe that saving goes on automatically regardless of interest rate. Rich people can only spend so much money, right? But what about the middle class? Savings has been virtually useless for 30 years and the savings rate in the United States is abysmal. Most of us live paycheck to paycheck and think Dave Ramsey is crazy. The argument overlooks the marginal saver, who is representative of the great majority of savers.

The effect of keeping interest rates artificially low … is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It brings
about a scarcity. It creates economic distortions.

The artificial reduction in the interest rate encourages increased borrowing, which encourages highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift and saving, brings about a comparative shortage of real capital.

Constant new injections of currency or bank credit is necessary to take the place of real savings.

This can create the illusion of more capital just as the addition of water can create the illusion of more milk.

This creates continuous inflation, leading to cumulative danger. The money rate will rise and a crisis will develop if the inflation. Cheap money policies eventually lead to more violent oscillations in business than those they are designed to remedy. If government doesn’t tamper with money rates through inflationary policies, increased savings create their own demand by lowering interest rates in a natural manner. The greater supply of savings seeking investment forces savers to accept lower rates. Equilibrium is achieved without government intervention.

Hazlitt also dealt with the fallacy that there is a limited amount of new capital that can be absorbed. He seems to shake his head sadly in his writing because this was believed not just by the uneducated, but by those claiming to be trained economists.

Almost the whole wealth of the modern world, nearly everything that distinguishes it from the pre-industrial world of the 17th century, consists of its accumulated
capital.

This capital consists of “durable goods” like automobiles, refrigerators, furniture,
schools, colleges, churches, libraries, hospitals, and private homes.

Never in the history of the world has there been enough of these. There is still, with the postponed building and outright destruction of World War II, a desperate shortage of them. But even if there were enough homes from a purely numerical point of view,
qualitative improvements are possible and desirable without definite limit in all but the very best houses.

The second part of capital consists of the tools of production, from crudest axe to amazing electronics. Similarly, there is no limit to the expansion that is possible and desirable in this area.

There will not be a “surplus” of capital until the most backward country is as well-equipped technologically as the most advanced, until the most inefficient factory in America is brought abreast of the factory with the latest and most elaborate equipment, and until the most modern tools of production have reached a point where human ingenuity is at a dead end, and can improve them no further. As long as any of these conditions remain unfulfilled, there will be indefinite room for more capital.

But how can the additional capital be “absorbed”? If it is set aside and saved, it will absorb itself and pay for itself. Producers invest in new capital goods by buying new and more ingenious tools because these tools reduce cost of production, by creating goods completely unaided by hand labor or they increase the quantities in which these can be produced or by reducing unit costs of production.

It should not be difficult to decide, after our analysis, with whom the real folly lies.

Posted February 10, 2017 by aurorawatcherak in economics, Uncategorized

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The Mirage of Inflation   3 comments

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.
The most obvious and yet the oldest and most stubborn error on which the appeal of inflation rests is that of confusing “money” with wealth.

That wealth consists in money, or in gold and silver,” wrote Adam Smith more than two centuries ago, is a popular notion which naturally arises from the double function of money, as the instrument of commerce, and as the measure of value. . . .

To grow rich is to get money; and wealth and money are considered synonymous. Real wealth consists in what is produced and consumed: the food we eat, the clothes we wear, the houses we live in. It is railways, roads, and cars; ships, planes, factories; schools, churches and theaters; pianos, paintings, and books.

Yet so powerful is the verbal ambiguity that confuses money with wealth, that even those who at times recognize the confusion will slide back into it in the course of their reasoning. Each man sees that if he personally had more money he could buy more
things from others. If he had twice as much money he could buy twice as many things; if he had three times as much money he would be “worth” three times as much. And to many the conclusion seems obvious that if the government merely issued more money and distributed it to everybody, we should all be that much richer.

Image result for image of inflationThese are the most naive inflationists, but there is a second group that is less naive, that senses there is a catch somewhere. They would limit in some way the amount of additional money they would have the government issue. They would have it print just enough to make up some alleged “deficiency” or “gap.” We call that “quantative easing” in the 21st century.

This second group reasons that purchasing power is chronically deficient because industry somehow does not distribute enough money to producers to enable them to buy back, as consumers, the product that is made. There mysterious leakage somewhere. There’s evena  group of economists who “prove” this by equations. On one side of their equations they count an item only once; on the other side they unknowingly count the same item several
times over. This produces an alarming gap between what they call “A payments” and what they call “A+B payments.”

So they found a movement, put on green uniforms, and insist that the government
issue money or “credits” to make good the missing B payments. The cruder apostles of “social credit” may seem ridiculous; but there are an indefinite number of schools of only slightly more sophisticated inflationists who have “scientific” plans to issue just enough additional money or credit to fill some alleged chronic or periodic “deficiency” or “gap” which they calculate in some other way.

There’s a third group — more knowing inflationists — who recognize that any substantial
increase in the quantity of money will reduce the purchasing power of each individual monetary unit, causing an increase in commodity prices. They aren’t disturbed by this. They actually want this sort of inflation because they believe it improves the position of debtors compared to reditors. Others believe will stimulate exports and discourage imports. Still others think it is an essential measure to cure a depression, to “start industry going again,” and to achieve “full employment.”

Image result for image of inflationThere are innumerable theories concerning the way in which increased quantities of money (including bank credit) affect prices. Some imagine that the quantity of money could be increased by almost any amount without affecting prices. They merely see this increased money as a means of increasing everyone’s “purchasing power,” in the sense of
enabling everybody to buy more goods than before. Maybe they never paused to consider that people cannot buy twice as much goods as before unless twice as much goods are produced. Maybe they fail to recognize the shortages of manpower, working hours, productive capacity or raw materials as a limitation on production and believe that is merely a shortage of monetary demand that prevents people from purchasing goods that don’t exist yet.

There are some eminent economists who hold a rigid mechanical theory of the effect of the supply of money on commodity prices. They believe the value of the total quantity of money multiplied by its “velocity of circulation” must always be equal to the value of the total quantity of goods bought. Multiply the quantity of money n times, in short, and you must multiply the prices of goods n times.

There is not space here to explain all the fallacies in this plausible picture. Instead we shall try to see just why and how an increase in the quantity of money raises prices.

 

Let’s say the government makes larger expenditures than it can or wishes to meet out of the proceeds of taxes or the sale of bonds paid for by the people out of actual savings. For example, the government prints money to pay war contractors.

Image result for image of inflationThe first effect of these expenditures is to raise the prices of supplies used in war and to put additional money into the hands of war contractors and their employees. The war contractors and their employees now have higher money incomes, which they can spend for goods and services they want. The sellers of these goods and services will be able
to raise their prices because of this increased demand. Those who have the increased money income will be willing to pay these higher prices rather than do without the goods; for they will have more money, and a dollar will have a smaller subjective value in the eyes of each of them.

So Group A (the war contractors and their employees) buys goods and services from Group B (those who produce those goods and services). Group B, as a result of higher sales and prices, will now buy more goods and services from Group C. Group C in turn will be able to raise its prices and will have more income to spend on group D. Okay, point taken. Circle of life. When the process has been completed, nearly everybody will have a higher income measured in terms of money. But (assuming that production of goods and services has not increased) prices of goods and services will have increased correspondingly; and the nation will be no richer than before.
This does not mean that everyone’s relative or absolute wealth and income will remain the same as before. The process of inflation will affect different groups to a greater or lesser extent. The first groups to receive the additional money will benefit most. The money incomes of Group A will have increased before prices have increased, so that they
will be able to buy almost a proportionate increase in goods. The money incomes of Group B will advance later, when prices have already increased somewhat; but Group B will also be better off in terms of goods. In the meantime, the groups that have still had no advance in their money incomes will find themselves forced to pay higher prices for the things they buy.

Let’s say we divide the community arbitrarily into four main groups of producers, A, B, C, and D, who get the money-income benefit of the inflation in that order. When the money incomes of Group A have already increased 30 percent, the prices of the things they [urchase have not yet increased at all. By the time money incomes of Group B have increased 20 percent, prices have still increased an average of only 10 percent. When money incomes of Group C have increased only 10 percent, however, prices have already gone up 15 percent. It gets worse. Although they money incomes of Group D have not yet increased, the average prices they have to pay for the things they buy have gone
up 20 percent.

In other words, the gains of the first groups of producers to benefit by higher prices or wages from the inflation are necessarily at the expense of the losses suffered (as consumers) by the last groups of producers that are able to raise their prices or wages.

It may be that, if the inflation is brought to a halt after a few years, the final result will be an average increase of 25 percent in money incomes, and an average increase in prices of an equal amount, both of which are fairly distributed among all groups. This does not cancel out the gains and losses of the transition period. Group D even though its own incomes and prices have at last advanced 25 percent, will be able to buy only as much goods and services as before the inflation started. It will never compensate for its losses during the period when its income and prices were lagging.
Inflation turns out to be merely one more example of our central lesson. “The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.”

It may indeed bring benefits for a short time to favored groups, but only at the expense of others. In the long run it brings disastrous consequences to the whole community. Even a relatively mild inflation distorts the structure of production, leading to the over-expansion of some industries at the expense of others in a misapplication and waste of capital. When the inflation collapses, or is brought to a halt, the misdirected capital investment—whether in the form of machines, factories, or office buildings—cannot
yield an adequate return and loses the greater part of its value.

Nor is it possible to bring inflation to a smooth and gentle stop in order to avert a subsequent depression. It is not even possible to halt an inflation, once embarked upon, at some preconceived point, or when prices have achieved a previously-agreed-upon level; for both political and economic forces will have got out of hand.

You cannot make an argument for a 25 percent advance in prices by inflation without
someone’s contending that the argument is twice as good for an advance of 50 percent, and someone else’s adding that it is four times as good for an advance of 100 percent. The political pressure groups that have benefited from the inflation will insist upon its continuance.

It is also impossible to control the value of money under inflation because the causation if not a merely mechanical one. You cannot say in advance that a 100 percent increase in the quantity of money will mean a 50 percent fall in the value of the monetary unit. The value of money depends on the subjective valuations of the people who hold it.

All this explains why, when super-inflation has once set in, the value of the monetary unit drops at a far faster rate than the quantity of money either is or can be increased. When this stage is reached, the disaster is nearly complete; and the scheme is bankrupt. Yet the ardor for inflation never dies. It would almost seem as if no country is capable of profiting from the experience of another and no generation of learning from the sufferings of its forbears. Each generation and country follows the same mirage. Each grasps for the same Dead Sea fruit that turns to dust and ashes in its mouth. For it is the nature of inflation to give birth to a thousand illusions.

In Hazlitt’s day as in our own, the most persistent argument put forward for inflation (uh, quantative easing) is that it will “get the wheels of industry turning” and save us from the irretrievable losses of stagnation and idleness, bringing “full employment.”

This argument in its cruder form rests on the immemorial confusion between money and real wealth.

It assumes new “purchasing power” is being created, and that the
effects of this new purchasing power multiply themselves in ever-widening
circles. Just look at the ripples!

The real purchasing power for goods consists of other goods. It cannot be wondrously increased merely by printing more pieces of paper called dollars. Fundamentally what happens in an exchange economy is that the things that A produces are exchanged for the things that B produces.

What inflation really does is to change the relationships of prices and costs. It is designed to raise the price of commodities in relation to wage rates and so restore business profits, by encouraging a resumption of output where idle resources exist, by restoring a workable relationship between prices and costs of production.

Historically this was done by a reduction in wage rates, but proponents of inflation believe that this is now politically impossible. Some go so far as to say reductions in wages are “anti-labor” or against the poor. Yet what they propose deceives labor by reducing real wage rates through an increase in prices. They disingenuously talk about paper money is if it were a form of wealth that can be created by will at the printing press.  They even solemnly discuss a “multiplier,” by which every dollar printed and spent by the
government becomes magically the equivalent of several dollars added to the wealth of the country. Like magicians, they divert attention from the real causes of any existing depression.

The real causes, Hazlitt said, are usually mal-adjustments within the wage-cost-price structure — maladjustments between wages and prices, between prices of raw materials and prices of finished goods, or between one price and another, or one wage and another. At some point these maladjustments have removed the incentive to produce, or have made it actually impossible for production to continue; and through the organic
interdependence of our exchange economy, depression spreads. Not
until these mal-adjustments are corrected can full production and
employment be resumed.

True, inflation may sometimes correct them; but it is a heady and dangerous method. It makes its corrections not openly and honestly, but by the use of illusion.

Hazlitt actually touched on the daylight savings time manipulation.

For inflation throws a veil of illusion over every economic process. It confuses and deceives almost everyone, including even those who suffer by it. We are all accustomed to measuring our income and wealth in terms of money. The mental habit is so strong that even professional economists and statisticians cannot consistently break it.

Economic reality is sometimes hard to understand. Who among us does not feel richer and prouder when we hear that our national income has doubled compared with some pre-inflationary period?

Inflation is the autosuggestion, the hypnotism, the anesthetic, that has dulled the pain of the operation for him. Inflation is the opium of the people.

Because inflation confuses everything is the reason “planned economy” governments resort to it. We saw in chapter 14, to take but one example, that the belief that public works necessarily create new jobs is false. If the money was raised by taxation, we saw, then for every dollar that the government spent on public works one less dollar
was spent by the taxpayers to meet their own wants, and for every public job created one private job was destroyed.
Suppose the public works were not paid for from the proceeds of  taxation? Suppose they are paid for by deficit financing—that is, from the proceeds of government borrowing or from resorting to the printing press? Then the result just described does not seem to take place. The public works seem to be created out of “new” purchasing power. You cannot say that the purchasing power has been taken away from the taxpayers. In the short-term, the nation seems to have got something for nothing.
Then we look at the long-term reality. The borrowing must someday be repaid. The government cannot keep piling up debt indefinitely. That leads to bankruptcy. As Adam Smith observed in 1776:

When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and completely paid. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.

Of course, for government to repay the debt it has accumulated for public works or war or whatever, it must necessarily tax more heavily than it spends. When it is time to pay the piper, it must necessarily destroy more jobs than it creates. The extra heavy taxation then required does not merely take away purchasing power; it also lowers incentives to production, and so reduces the total wealth and income of the country.
The only escape from this conclusion is to assume in true Keysenian form, that the politicians in power will spend money only in what would otherwise have been depressed or “deflationary” periods, and will promptly pay the debt off in what
would otherwise have been boom or “inflationary” periods.

This is a beguiling fiction, but unfortunately the politicians in power have never acted that way. Economic forecasting, moreover, is so precarious, and the political pressures at work are of such a nature, that governments are unlikely ever to act that way. Deficit spending, once embarked upon, creates powerful vested interests which demand its continuance under all conditions.

The country as a whole cannot get anything without paying for it. If no honest attempt is made to pay off the accumulated debt, and outright inflation is resorted to instead, then inflation becomes a form of taxation, which bears hardest on those least able to pay. Inflation is tantamount to a flat sales tax of the same percentage on all commodities,
with the rate as high on bread and milk as on diamonds and furs.
It can also be thought of as equivalent to a flat tax of the same percentage, without exemptions, on everyone’s income. It is a tax not only on every individual’s expenditures, but on his savings account, life insurance and retirement.

It is a flat capital levy, without exemptions, in which the poor man pays as high a percentage as the rich man.

Of course, that is assuming inflation affects everyone equally, which it rarely does. Some suffer more than others. The poor may be more heavily taxed by inflation, in percentage
terms, than the rich.

For inflation is a kind of tax that is out of control of the tax authorities. It strikes wantonly in all directions. The rate of tax imposed by inflation is not a fixed one: it cannot be determined in advance. We know what it is today; we do not know what it will be tomorrow; and tomorrow we shall not know what it will be on the day after.

Of course, like every other tax, inflation determines the individual and business policies we are all forced to follow. It discourages all prudence and thrift, encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce.

It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.

Posted February 9, 2017 by aurorawatcherak in economics, Uncategorized

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A Universal Basic Income Would Mean Massive Tax Hikes | Robert Colvile   Leave a comment

Here’s another companion piece to my series on Economics in One Lesson. UBI is often enthusiastically promoted by those who only see how it affects one group for a short period of time, rather than everybody for a long view. Lela

What connects Martin Luther King and Milton Friedman? George McGovern and Friedrich Hayek? The Adam Smith Institute and John McDonnell?

The answer is that all are fans of the universal basic income – a policy that is suddenly the hottest thing in town. Finland is trying it. Scotland may follow suit. Silicon Valley bigwigs, including Marc Andreesen, are keen. Long explorations of the idea have been published in the Financial Times and New Yorker. And this weekend, Benoît Hamon romped to victory in the French socialist primaries by making it the centrepiece of his manifesto.

UBI simplifies work incentives, but it also undermines them.

Image result for image of why universal basic income won't workUniversal basic income – or “UBI”, as the cognoscenti call it – is, in theory, wonderfully appealing. The idea is that rather than doling out benefits, the state guarantees every citizen a certain lump sum per year, handed out regardless of age or need.

You can tweak the model in a host of different ways – by giving higher amounts to the disabled, or the elderly, or smaller amounts to children, or by withdrawing the payment as earnings increase (which is how UBI’s sibling, the negative income tax, works). But the essence is that everyone gets the bare minimum needed to get by.

This has numerous theoretical advantages.

For those who are at the bottom of the heap, it ends the uncertainty surrounding welfare and benefits – they know they will always have just about enough to live on, helping them escape from the poverty trap. (This is similar to the use of direct cash transfers in aid, which have been proven to be far more effective than traditional donations.)

It is also more rational. According to this chart produced by the Royal Society of Arts (which has been one of the biggest boosters of the idea), a British version would drastically simplify the existing switchback ride of tax incentives, while providing a helping hand to the poorest in society.

It is far, far cheaper to administer than the existing system, in which people earn money, then hand it to the government, which hands it back to them. At a stroke, it therefore abolishes much of the bureaucracy associated with the welfare state.

It is also more efficient, and to libertarians, more moral. Giving people money to spend as they wish means that they are more likely to spend it on things they actually need or want, rather than on what government thinks they do. This is one reason why free-market thinkers such as Hayek and Friedman have been attracted to the idea, or variants upon it.

For family-values conservatives, it’s also a good thing because it pays money to individuals rather than households – meaning that couples are no longer penalised for getting together. In fact, most UBI designs in the UK see couples benefiting hugely and single people losing out.

The other main advantages of the UBI are more philosophical – or theoretical. For Anthony Painter of the RSA, and other romantics, it provides people with space to create, to be their best selves, free from the pressures of wage slavery. And the fact that it gives to the rich as well as the poor is, to some, a feature rather than a bug, as it gives them an investment in the welfare state.

The biggest problem of all? This thing costs money. Enormous amounts of it.

Most recently, its benefits have been couched in technological terms, as a hedge against the imminent robot revolution – a way to ensure that those who are thrown out of work by automation and algorithms do not rot on the dole. Some even combine these two Utopian visions, to paint a picture in which the robots do all the boring stuff while we live a life of leisure, using our stipend from the state to support ourselves while we dabble in poetry or pottery-making.

The Best Welfare Policy

But let’s ignore the robots for now, and deal with the reality. Because it’s one in which the idea of a universal basic income makes a great deal less sense.

For starters, UBI simplifies work incentives, but it also undermines them.

It may sound harsh, but the most successful form of welfare policy over the last few decades has been to stop handing it out. The principle behind the Wisconsin welfare reforms of the Clinton era, and the more recent reforms under the Coalition in Britain, was that there should be no excuse not to work if you could. And the result was an employment bonanza – what Fraser Nelson called, in the British context, a “jobs miracle”.

What these reforms showed was that the best form of welfare was work – that getting people on to the employment ladder, no matter how low the rung, was better for them (and for the state) than funding dependency. A guaranteed income is also a guarantee that it’s OK to be idle. Which is why, as David Frum and Jodie T Allen point out, everyone in the US lost interest in the idea in the first place.

Ah, say the advocates of the basic income, but in that case we’d set it low enough as to incentivise work.

But that brings us on to the biggest problem of all. Which is that this thing costs money. Enormous amounts of it.

An Expensive Proposition

The RSA’s version of the basic income looks like it just about makes the sums add up. But that’s because it sets it at a level of £3,692 (in 2012-13 prices, excluding housing and disability support). That’s not very much at all – in fact, it’s about a quarter of the national living wage. And even then, there’s a lot of devil in the detail.

Last year, I went to an event on this topic at the Resolution Foundation. Its experts crunched the numbers and found that, under a UBI scheme that pays people the same as they would get under Universal Credit (ie about the RSA level), and throws in universal child tax credit (rather than means-tested, as under the current system), taxes would have to rise. By a lot.

It would represent a transfer of £120 billion of extra taxation into the welfare state.

In fact, you would have to abolish the Personal Allowance – the £11,000 tax-free that everyone gets on their earnings. Instead, from the first pound you earned to the £43,001st, you’d pay a combined rate of income tax and National Insurance of around 35-40 per cent, after which the higher rate of tax would kick in as normal.

In other words, to get that £3,692 from the Government, you’d pay thousands of pounds more.

This would mean (and stop me if you don’t follow the logic) that large numbers of people would be paying a much larger amount of tax. In fact, it would represent a transfer of £120 billion of extra taxation into the welfare state – the equivalent of the entire budget of the NHS in England.

Now, you may not want to take that extra money from the rich. You might want to take it from companies, or introduce the idea more gradually. But if you want to move to a guaranteed income, you have to take it from somewhere.

And if you want to move to the level where it can actually support people to lead those kind of leisure-filled, pottery-making lives, you would need a truly gargantuan amount of money – even if you decided that rich people shouldn’t get it after all (which would obviously be politically appealing).

The best argument against UBI was put by Karen Buck, a Labour MP, at that Resolution Foundation meeting.

It’s old wine in new bottles – redistributive, Seventies-style taxation under a trendy new branding.

She was, she said, in favour of more generous welfare spending. But even she had to admit that introducing conditionality into the welfare system – pushing people off welfare into work – had been both effective and politically popular, and that UBI would throw it into reverse. And if you were going to decide to pump tens of billions of pounds into the welfare system, there were much better and more targeted ways of doing it.

A universal basic income, in other words, is a powerful idea because it seems so clear and so simple – a way to reward work, give security and simplify the welfare state, all at the same time.

But there’s a reason that, by and large, it’s those on the Left who are pushing the idea. Because it’s old wine in new bottles – redistributive, Seventies-style taxation under a trendy new branding.

There is nothing so powerful as a bad idea whose time has come. And reluctant as I am to quarrel with Hayek or Friedman, the sad truth is that universal basic income – at least in anything like the forms that are currently being proposed – is a very bad idea indeed.

Source: A Universal Basic Income Would Mean Massive Tax Hikes | Robert Colvile

Fetish of Full Employment   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

The economic goal of any nation or individual is to get the greatest result with the least effort. All economic progress of mankind consists of getting more production with the same labor. We domesticated animals, invented the wheel and the cart, the wagon, the railroad and the semi-truck to achieve this goal.

Image result for image of productivityThat seems pretty elementary, which is probably why people tend to forget about it and start shouting slogans about “full employment”.

We could define “full employment” as the absence of involuntary idleness. In economics, production is the end goal. Employment is merely the means. It is impossible to continuously have full production with full employment, but we can create the adverse conditions where we have full employment without full production.

Primitive tribes are naked, wretchedly fed and houses, but they do not suffer from unemployment.

Third world countries are comparably poorer than the United States, but the main trouble they suffer is primitive production methods, not unemployment. Divorce employment from the goal of full production and full employment is easily achievable. War provides full employment for every nation involved. Slave labor in Germany created full employment. Prisons and chain gangs can create full employment.

Coercion can always provide full employment.

Whenever we discuss full employment, wages and employment are discussed as if they had no relation to productivity and output. Hazlitt actually said it would be better to have full production with a portion of the population on welfare than to provide “full employment” by creating make-work that damages productivity.

In 1946, children and the elderly no longer worked and many women were stay-at-home mothers, because productivity improvements had increased wealth. In another words, there was a lot of unemployment in the country, but it was by choice, made possible by increases in productivity.

Disbanding Troops and Bureaucrats   1 comment

The art of economics consists in looking not merely at the immediate, but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group, but for all groups.

This is an ongoing series of posts on Henry Hazlitt’s Economics in One Lesson. You can access the Table of Contents here. Although written in 1946, it still touches on many of the issues we face in 2017, particularly the fallacies government economic programs are built upon.

 

I will admit, this fallacy is one I’ve always kind of believed, so let’s work through it together and let Hazlitt straighten out our thinking.

Image result for image of the dmvAfter every great war, it is proposed to demobilize the armed forces and there is always great fear that there will not be enough jobs for these forces, resulting in widespread unemployment. And this does occur in the short term, because it takes a while for private industry to reabsorb these folks. Hazlitt had just lived through the coming home of the World War 2 vets.

Hazlitt points out that when the military is released from service, it should result in the public budget being reduced, which will allow taxpayers to retain the funds that were previously taken from them in order to support the troops. Taxpayers will spend their reclaimed income to buy additional goods, which will provide employment to the workforce.

The problem with this is when soldiers were supported by an unbalanced budget funded by government borrowing or other deficit financing, but Hazlitt deferred that discussion to a later chapter.

The soldiers previously supported by civilians will not become merely civilians supported by other civilians. They will become self-supporting civilians.

Image result for image of the dmvIf we assume that the men who would otherwise have been retained in the armed forces are no longer needed for defense, then their retention would have been sheer waste. They would have been unproductive. The taxpayers, in return for supporting them, would have got nothing. But now the taxpayers turn over this part of their funds to them as fellow civilians in return for equivalent goods or services. Total national production, the wealth
of everybody, is higher.

The same reasoning applies to civilian government officials whenever they are retained in excessive numbers. Every time there is an attempt to reduce the number of unnecessary officeholders, there is a cry that this action will be deflationary. You will remove the purchasing power from these officials. You’ll cause an economic depression.

[T]he fallacy comes from looking at the effects of this action only on the dismissed officeholders themselves and on the particular tradesmen who depend on them. … [I]t is forgotten that … the taxpayers will be permitted to keep the money that was formerly taken from them for the support of the bureaucrats.

With more of their income to utilize, taxpayers will spend more and that provides jobs for the dismissed bureaucrats. Washington DC might be less prosperous, but the rest of the country can afford more stores.

The bureaucrats seek private jobs or create private businesses, becoming truly productive men and women. Hazlitt explained that he was not talking about laying off bureaucrats who provide ESSENTIAL services that make it possible for private industry to function in an atmosphere of law, order, freedom and peace. Bureaucrats value as employees should consist in the utility of their services, not in the “purchasing power” they posses by virtue of being on the public payroll.

This “purchasing power” argument could just as easily apply to a thief who robs you. After he takes your money, he has more purchasing power that he uses to support bars, restaurants, tailors, automobile workers, etc. But for every job his spending provides, your own spending must provide one less, because you have that much less money to spend.

When your money is taken by a thief, you get nothing in return. When your money is taken through taxes to support needless bureaucrats, precisely the same situation exists.

 

Posted January 21, 2017 by aurorawatcherak in economics

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