Do Nothing: A Positive Proposal For Recovery

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It was recently pointed out to me that certain free market orientated friends dislike policies that fail to restore immediate growth:

Basic economic theory posits that as households and businesses become more uncertain about the future, the more they save from their after-tax incomes — and a rising savings rate in the private sector at a time of belt-tightening in the public sector is not the prescription for growth, unless somehow exports emerge as a critical safety valve. For sure, if there is one development that does seem encouraging, it is that there is something of a manufacturing renaissance taking hold, but the effects on the overall economy are going to pale next to the round of consumer retrenchment we are likely to see in coming quarters and years.

On the face of it, who would not want growth when we are on our knees awaiting the next blood letting that will inevitably unfold as the second phase of the Great Recession comes upon us? A large credit boom such as the one we saw from the mid 90’s to the late 00’s causes many more goods to be produced, with the newly created credit, than there are savings to buy these goods. With only a limited amount of factors of production and productivity gains not creating more goods and services fast enough, we have businesses biding up resources and thus prices against each other. This causes local asset price booms. Think Dot.com. Think housing. This causes the general price level to rise, rather than fall. Productivity and technology gains should allow price falls (think of the costs of your computer over the last two decades), but economy-wide, they never do. People eventually reduce their consumption of goods, having depleted their savings. As consumers disappear, and turn their attention once more to saving, the boom goes to bust. So what needs to happen is that prices be allowed to fall. We should embrace this process. When prices fall, the consumers become more and more confident that what they are being offered is fair value or even undervalued, and they start to increase their buying volume again. This is when the seeds of recovery start to show fruit. We should also remember that the only way to create wealth is for entrepreneurs to find better ways to combine the existing factors of production in better ways to make goods and services that people want. They do this by using their savings to invest in better capital formation. This is done brick by brick, over time. It is done by entrepreneurs, not governments. The only thing the latter can do is provide the legal framework, the rules of the game, so that entrepreneurs can get on with producing the goods and services of the economy that satisfy the needs of their fellow man. However the government tries to intervene — through bailouts, deficit spending, quantitative easing, credit easing, enterprise zones, ‘green’ subsidies, or tax gimmicks — they cannot help but produce uncertainty, which is the real killer of the recovery. When people aren’t sure how the rules are about to change, they put more money into precautionary savings. All private enterprises do the same: it is the only rational response. In this paper (PDF), which won the 2010 Frisch Medal of the Econometric Society for its author, Nicholas Bloom shows how uncertainty can be one of the most disruptive factors for an unbalanced economy attempting recovery. He does not show how the economy comes to be so unbalanced in times of recessions, but his analysis of the impact of “uncertainty shocks” is compelling. Bloom concludes:

The uncertainty shock also induces a strong insensitivity to other economic stimuli. At high levels of uncertainty the real-option value of inaction is very large, which makes firms extremely cautious. As a result, the effects of empirically realistic general equilibrium type interest rate, wage, and price falls have a very limited short-run effect on reducing the drop and rebound in activity. This raises a second policy implication, that in the immediate aftermath of an uncertainty shock, monetary or fiscal policy is likely to be particularly ineffective

So the only way to cure this recession is for the policy makers to get out of the way, let prices fall, let debt get written off, and let people start buying again those good and services they want, at prices they can afford to pay. Prior to 1929, this of course was the usual public policy response. After World War I, in the belligerent countries, we had a large build-up of capital to produce weapons of destruction. This distortion away from what consumers would normally need had to unwind. In the USA, for example, this was painfully deflationary, from Jan 1920 – July 1921, but within 18 months the whole recession was over. Since that recession we have been faced with a mix of policy activism by our elected representatives and interventions of various shapes and sizes leading for example to the prolonged Great Depression. I contend that with all the frantic policy activism we see over in Europe, especially now, we can expect the Great Recession go on for many years to come. I know that advocating a “do nothing” policy is for a politician like advocating that all new born babies should be eaten, but sometime what seems the least palatable — letting prices fall and debts be written off — is in fact the quickest and least painful option. As an Ironman athlete, my coach prescribes one rest day per week when I do no physical activity at all, and one calendar month per year when I remain largely inactive. This is a very important part of my training program, and it needs to be given as much attention as the swim, bike and the running aspects. Inactivity can be good! As an investor, instead of looking at the stock market going up, down, sideways, backwards, and every which way as the herd charges around, being busy and active on a whisper here, a phrase said there, by a politician or policy maker, I suggest a different course: choose your companies based on their true fundamentals. Do they have great management? Do they have original owner participation? Do they make great products that are needed all the time? Do they have good barriers to entry? Do they have a strong balance sheets and little or no debt? Then you can make your choices, sit back and do NOTHING as a positive investment strategy. If our bust is allowed to unfold, there will be momentary panic as the voices of the political class fall silent, but people will soon realize that as they still need to eat, drink, and keep warm. The world goes on, the sun rises and sets, and as long as people need things, there will be people who will supply those things. Entrepreneurship will never be snuffed out. I advocate a POSITIVE policy of doing nothing.

Addendum

Since I wrote this, Sean Corrigan has sent me an article (PDF) by our friend Prof Steve Horwitz about the Hoover administration. It covers the 29 – 31 crash period, and is very pertinent to today. This administration, we are always told, was a “do nothing” free market administration, and it was Hoover’s non-policies that actually deepened the Great Depression.  Horowitz concludes:

Despite overwhelming evidence to the contrary, from Hoover’s own beliefs to his actions as president to the observations of his contemporaries and modern historians, the myth of Herbert Hoover’s presidency as an example of laissez faire persists. Why that is so is beyond the scope of this study, but it surely remains a source of comfort to those among the intelligentsia who deeply believe that the Great Depression demonstrates the problems with free-market capitalism and the importance of government intervention in stabilizing a market economy. The truth, of course, is nearly the opposite. This misinterpretation of the Great Depression lies at the bottom of much of their more general belief in the deep flaws of market economies, as we have seen in the way the media and many intellectuals have cheered on the activism of Bush and Obama since 2008. Accepting Hoover’s role as the father of the New Deal would challenge the fundamental argument at the core of their preferred narrative that laissez faire made matters worse during the Depression and that government intervention was the solution. Everyone agrees that Hoover’s presidency made things worse, but for the critics of capitalism to accept the truth of Hoover’s activist policies would require that they question the effectiveness of such activism and drop the claim that laissez faire failed. In the past three years the failure of massive government intervention to deal with our own economic crisis has become clearer each day. Facing a failed ideology, it should not come as a surprise that defenders of the interventionist faith would cling to the Hoover myth like a plank in the ocean. Un- fortunately for them, the historical facts are not on their side and, unfortunately for the American economy, the persistence of the Hoover myth continues to justify the counterproductive policies of the Obama administration and thereby prevents markets from generating the economic recovery of which they are fully capable.

How Deposit Insurance Reduces Financial Stability

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Andrew Lilico has written a great article for The Telegraph on the dangers of deposit insurance:

In a classic 2005 paper from the highly authoritative Journal of Monetary Economics, Asli Demirgüç-Kunt and Enrica Detragiache investigated the question “Does Deposit Insurance Increase Banking System Stability?“  Their answer, based on an empirical study of a large panel of countries from 1980 to 1997, was that it does not; in fact, as they put it: “explicit deposit insurance tends to be detrimental to bank stability”.

I recommend the whole article.

We Love Terry Smith!

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A great letter to the editor of the FT from Terry Smith:

Sir, I refer to the debate being conducted in the pages of the Financial Times between those who propose further Keynesian measures, such as Martin Wolf (“Struggling with a great contraction”, August 31), and those who do not accept that they will work, such as Wolfgang Schäuble (“Austerity is the only cure for the eurozone”, September 6). Such so-called Keynesian measures as advocated by, among others, Ed Balls, Samuel Brittan, Paul Krugman, George Magnus and Barack Obama as well as Mr Wolf have not worked to date, and they will not work. Their advocates seem to assume that their repeated failure to solve our economic problems just means that the medicine must be repeated, which reminds me of Richard Nixon’s motto that “if two wrongs don’t make a right, try three”. I say “so-called” Keynesians because these advocates seem not to realise that Keynes’ theories did not rescue us from the Great Depression. They are also asymmetric in their application of his theories – calling for ever larger deficit spending, having overlooked the bit about running a surplus in a boom. But above all, they do not seem to realise that they cannot work in a period of debt deflation in which a recession is preceded by the collapse of the banking system, as their current failure is demonstrating. To the ordinary person in the street, the idea that we can rescue ourselves from a crisis caused by excessive borrowing by borrowing even more must seem mad. In this respect they are possessed of far more common sense than those who are currently advocating just such a course of action and purport to be our leaders. The first step in rectifying this situation should be to make a clear and unambiguous statement about the actual debt the UK is carrying. To give a lead to this, today we have circulated to every member of parliament a tin can emblazoned with the UK debt figure – £3,589bn including commitments for public sector pension commitments, private finance initiative and banking sector guarantees, so that they can see what it is they are metaphorically “kicking down the road” with their present policies. This, ahead of the party conference season, I hope might spur some considered and honest debate on this issue. It is time for those who wish to lead us out of this crisis to tell people how bad the current situation really is and the painful remedies which will be needed to remedy it. Terry Smith, Chief Executive, Tullett Prebon, London EC2, UK

Phases Of The Crisis – Are We Approaching The Endgame?

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Phase 1: Greenspan, the arch money crank

The Greenspan “put”, and the collective adoption by most central bankers of low interest rates after the dot-com bust and 9/11, caused one of the largest injections of bank credit in history. Since bank credit circulates as money, we can say public policy has created the largest amount of new money in history. This should never be confused with creating new wealth. That is what entrepreneurs do when they use the existing factors of production — land, labour and capital — in better ways, to make new and better products. The money unit facilitates this exchange. Now to a money crank.  He will assume that new money will raise prices simultaneously and proportionately, so the net effect of the economy is that all the ships rise with the tide at the same rate. He’ll say that money is neutral and does not have any effect on the workings of the economy. One of the great insights of the older classical economists, and in particular the Austrian School, is that new money has to enter the economy somewhere.  Injected money causes a rise in the price levels associated with the industry, businesses, or people who are fortunate enough to be in receipt of the new money. Prices change and move relative to other prices. It is often quite easy to see where the new money enters into the economy by observing where the booms are. Suppose a banker sells government bonds to another part of the government (as has been the case with UK QE policy).  For selling, say, £30bn of government debt to the Bank of England, he gets a staggering, eye-popping bonus. With his newly minted money, he buys a new £10m house in Chelsea, a £5m yacht in Southampton, some diamonds for the wife to keep her happy, and lives a happy and rich life. The estate agent spends his commission on a luxury car, and some more humdrum items that mere mortals buy.  At each point in time, the prices of the goods favoured by the recipients of new money are being bid up relative to what they are not spending on.  Eventually these distortions ripple through the economy, and the people furthest from the injection of new money — those on fixed income, pensioners, welfare recipients — end up paying inflated prices on the basic goods and services they buy. A real transfer of wealth takes place, from the poorest members of society to the richest. You could not make this up. I am no fan of the “progressive” income tax, but I certainly can’t support a regressive wealth transfer from the poor to the rich! Even when the government was not creating new money itself, it was setting the interest rate, or the costs of loanable funds, well underneath what would naturally be agreed between savers and borrowers.  Bankers are exclusively endowed with the ability to loan money into existence, so they welcome the low rates and happily lend, charging massive fees to enrich themselves in the process. After the dot-com bubble, it was property prices that went up and up.  Not only do we have the richer first recipients of new money benefiting at the expense of the poor, we have a massive mis-allocation of capital to “boom” industries that can only be sustained so long as we keep the new money creation growing. Our present monetary system is both unethical and wasteful of scarce resources. We do not let counterfeiters lower our purchasing power, and we should not let governments and bankers do it.

Phase 2: Bush & Brown – private debt nationalised by the Sovereign

This flood of new money brought more marginal lending possibilities onto the horizon of the bankers. They devised a range of exotic products whose names are now familiar: CDO, MBS, CDO-squared, Synthetic CDO, and many more — all created to get lower quality risk off the issuing bank’s balance sheet, and onto anyone’s but theirs! In 2007/2008, bankers started to wake up to the fact that everyone’s balance sheets were stuffed with candyfloss money, at which point they suddenly got the jitters and refused to lend to each other.  As we know, bankers are the only people on the planet who do not have to provide for their current creditors; they can lend long and borrow short. Thus, the credit crunch happened when the demand for overnight money to pay short-term creditor obligations ran dry. Our political masters then decided that we could not let our noble bankers go bust; we had instead to make them the largest welfare state recipients this world has ever known! Not the £60 per week and housing benefit kind for these characters, but billions of full-on state support to bail out their banks. They failed at their jobs and bankrupted many, but they kept their jobs with 6, 7, or 8 figure salaries! Bush told us that massive state intervention was needed to save the free market. Brown said the same. We were told that there would be no cash in the ATMs and society would most certainly come to an end if heroic action was not taken to “save the world”, as Brown so memorably put it (though he seemed to think he had accomplished this feat singlehandedly). Thank God for Gordon! Now in Iceland, a country I was trading with at the time, their banks did go bust; no one could bail them out. But within days the Krona had re-floated itself and payments continued; within weeks they had a functioning economy. Within days the good assets of Lehman Bros had been re-allocated, sold to better capitalists than they. But with these notable exceptions, socialism was the order of the day. Bank’s inflated balance sheets were assumed by sovereign states. Like lager louts on a late night binge, after a Vindaloo as hot as hell itself, heads of government seemed to care little for the inevitable pain that would follow, as states tried to digest what they had so hastily ingested. Indeed, the failed organs of the nationalised banks survive only on life support, enjoying continuous subsidy through the overnight discount window. But the sovereign governments, under various political colours, had a history of binging. In our case the Labour Party spent more than it could possibly ever raise off the people in open taxes, and the Tories offer “cuts” which in reality mean that the budgets of some departments will not increase as quickly as they were planned to.

Phase 3: King Canute, sovereign default

Default is the word that can’t be mentioned. In reality, we should embrace default. This debt is never going to be repaid. Never, that is, in purchasing power terms. S&P ratings agency have hinted at this with the recent US rating downgrade. They know the American government can always mint up what it needs so long as it has a reserve currency. They also know that this is a soft default. In real terms, people seem likely to get back less than they put in. Hard default should be embraced by the smaller nations like Greece and Ireland, so they can rid themselves of obligations they cant afford to pay. This will be good for taxpayers in the richer countries of Europe, as they will no longer be bailing out those who foolishly lent to these countries. It will be good, too, for the debtor nations, as they can remove themselves from the Euro and devalue until they are competitive again. They will, however, need to learn to live within their means. Honest politicians need to come to the fore to effect this. Yes, this will be painful and the people who lent these profligate and feckless politicians the money will get burnt. However, the FT has recently seen prominent advocates for a steady 4%-6% inflation target. This is the debtors’ choice and the creditors’ nightmare, with collateral damage for those on fixed or low incomes, for the reasons mentioned above. Should we let the Philosopher Kings have their way?

“Let all men know how empty and worthless is the power of kings. For there is none worthy of the name but God, whom heaven, earth and sea obey”.

So spoke King Canute the Great, the legend says, as waves lapped round his feet. Canute had learned that his flattering courtiers claimed he was “so great, he could command the tides of the sea to go back”. Now Canute was not only a religious man, but also a clever politician. He knew his limitations – even if his courtiers did not – so he had his throne carried to the seashore and sat on it as the tide came in, commanding the waves to advance no further. When they didn’t, he had made his point: though kings may appear ‘great’ in the minds of men, they are powerless against the fundamental laws of Nature. King Canute, where are you today? We need honest politicians and brave men to step forward and point out the folly of trying paper over the cracks. Unless banks write off under-performing (or never-to-perform) securities from both the private sector and the public sector, we will progressively impoverish more and more people. Let better business people buy the good assets of the bust banks, and let them provide essential banking services. Let the sovereigns that can’t pay their way go bust and not impoverish us any further with on-going bailouts. In all my years in business, your first loss is always your best loss. Yes, this will be painful. Politicians, fess up to the people: you do not have a magic bullet and you can’t offer sunshine today, tomorrow and forever. I fear that if we do not do this, we approach the end game: the total destruction of paper money. Since August the 15th 1971, paper money has not been rooted in gold. It is the most extreme derivative product, entirely detatched from its underlying asset. Should the failure of this derivative come to pass, we will have to wait for the market to create something else. Will we be reduced to barter, as the German people were in the 20s? A process of wipe out for all will be a hell of a lot harder than sensible action now.  It is still not too late.

The Demise Of Central Planning

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As a young man, Prof Ebeling witnessed first hand the demise of the Soviet system. The article below is a truly remarkable eye witness account of the 72 hours that changed the world. Pause on that: just 72 hours to move from seemingly unassailable Communist Party rule to the new beginnings of the Russian nation we have today. As we know, Mises had shown in the early ’20s how it was impossible for a pure socialist system to centrally plan; in the absence of a price system, they could not properly allocate scare resources. In the late ’30s, Hayek showed us how it was impossible that any one group of planners match the interpersonal transactions of hundreds of millions of people, each with their own particular subjective values on each of the specific things they were doing. It took 70 years for the total collapse of the Soviet system. Then 72 hours changed the world. We see that Soviet-style planing of money still lingers on in the world today. We are not accustomed to thinking that the Bank of England, the Federal Reserve and the European Central Bank are money planning bureaus, but that is what they do: try to plan our money supply . We have 9 wise men in the MPC who do this. In our case, they do this by inflation targeting via interest rate adjustments and their own bond purchases. The money supply needs no more planning than the price of apples does, yet we still cling to this notion. To all policy makers, those 72 hours Ebeling writes about are a stark reminder that when confidence blows in something, and people lose faith in the status quo, things can change very quickly indeed! The credit-induced boom of the central banks, with their private sector mints, the private banks, lending recklessly during the noughties, led to catastrophe by 2007/08. The policy response of our dear leader Gordon Brown involved the socialisation of banking losses. Having assumed the liabilities of the banks, national governments across the Western world are now crisis. Like the cartoon character who runs off the edge of the cliff with his legs still spinning, suspended in mid air, it may be the sudden awareness of an untenable position that brings the paper money system crashing back down to earth. Are we due for our own 72 hours of reckoning?

When Soviet Power Crumbled: The Failed Hard-Line Coup Attempt of August 1991 by Richard M. Ebeling

Twenty years ago, on August 22, 1991, I stood amid a vast cheering crowd of tens of thousands of people outside the Russian parliament building in Moscow, the capital of the Soviet Union. They were celebrating the failure by diehard Soviet leaders to undertake a political and military coup d’état meant to maintain dictatorial communist rule in the Union of Soviet Socialist Republics. Four days earlier, on August 19th, a band of hard-line Soviet political and military leaders had initiated the coup attempt against the leadership of Mikhail Gorbachev, the General Secretary of the Communist Party of the U.S.S.R, and Boris Yeltsin, president of the Russian Soviet Federated Socialist Republic, the largest of the constituent republics of the Soviet Union. Fearful that the political and economic reforms that had been introduced by Gorbachev shortly after his ascendency to the top leadership position in the Soviet Communist Party in 1986 were now threatening to bring about the disintegration of the Soviet Union, the hard-line conspirators were determined to preserve intact what remained of Soviet power in their own country.

Gorbachev’s Attempt to Save Socialism

Gorbachev believed that the Soviet Union had taken several serious wrong turns in the past. But he was not an opponent of socialism or its Marxist-Leninist foundations. He wanted a new “socialism-with-a-human-face.” His goal was a “kinder and gentler” communist ideology, so to speak. He truly believed that the Soviet Union could be saved, and with it a more humane collectivist alternative to Western capitalism. To achieve this end, Gorbachev had introduced to two reform agendas: First, perestroika, a series of economic changes meant to admit the mistakes of heavy handed central planning. State enterprise managers were to be more accountable, small private businesses would be permitted and fostered, and Soviet companies would be allowed to form joint ventures with selected Western corporations. Flexibility and adaptability would create a new and better socialist economy. Second, glasnost, political “openness” under which the follies of the past would be admitted and the formerly “blank pages” of Soviet history – especially about the “crimes of Stalin” – would be filled in. Greater historical and political honesty, it was said, would revive the moribund Soviet ideology and renew the Soviet people’s enthusiastic support for the redesigned bright socialist future. The more hard-line and “conservative” members of the Soviet leadership considered all such reforms as opening a Pandora’s Box of uncontrollable forces that would undermine the Soviet system. They had already seen this happen in the outer ring of the Soviet Empire in Eastern Europe.

The Beginning of the End in Eastern Europe

In 1989 Gorbachev had stood by as the Berlin Wall, the symbol of Soviet imperial power in the heart of Europe, had come tumbling down, and the Soviet “captive nations” of Eastern Europe – East Germany, Poland, Czechoslovakia, Hungary, Romania and Bulgaria – that Stalin had claimed as conquered booty at the end of the Second World War, began to free themselves from communist control and Soviet domination. The Soviet hard-liners were now convinced that a new political treaty that Gorbachev was planning to sign with Russian president Yeltsin and Nursultan Nazarbayev, president of the Soviet republic of Kazakhstan, would mean the end of the Soviet Union, itself. Already, the small Baltic republics of Estonia, Latvia, and Lithuania were reasserting the national independence they had lost in 1939-1940, as a result of Stalin and Hitler’s division of Eastern Europe. Violent and murderous Soviet military crackdowns in Lithuania and in Latvia in January 1991 had failed to crush the budding democratic movements in those countries. Military methods had also been employed, to no avail, to keep in line the Soviet republics of Georgia and Azerbaijan.

Communist Conspirators for Soviet Power

On August 18th, the hard-line conspirators tried to persuade Gorbachev to reverse his planned political arrangements with the Russian Federation and Soviet Kazakhstan. When he refused he was held by force in a summer home he was vacationing at in the Crimea on the Black Sea. Early on the morning of August 19th, the conspirators issued a declaration announcing their takeover of the Soviet government. A plan to capture and possibly kill Boris Yeltsin failed. Yeltsin eluded the kidnappers and made his way to the Russian parliament building from his home outside Moscow. Military units loyal to the conspirators ringed the city with tanks on every bridge leading into the city and along every main thoroughfare in the center of Moscow. Tank units had surrounded the Russian parliament, as well. But Yeltsin soon was rallying the people of Moscow and the Russian population in general to defend Russia’s own emerging democracy. People all around the world saw Yeltsin stand atop an army tank outside the parliament building asking Muscovites to resist this attempt to return to the dark days of communist rule. The Western media made much at the time of the apparent poor planning during the seventy-two hour coup attempt during August 19th to the 21st. The world press focused on and mocked the nervousness and confusion shown by some of the coup leaders during a press conference. The conspirators were ridiculed for their Keystone cop-like behavior in missing their chance to kidnap Yeltsin or delaying their seizure of the Russian parliament building; or leaving international telephone lines open and not even jamming foreign news broadcasts that were reporting the events as they happened to the entire Soviet Union.

The Dangers If the Hard-liners had Won

Regardless of the poor planning on the part of the coup leaders, however, the fact remains that if they had succeeded the consequences might have been catastrophic. I have a photocopy of the arrest warrant form that had been prepared for the Moscow region and signed by the Moscow military commander, Marshal Kalinin. It gave the military and the KGB, the Soviet secret police, the authority to arrest anyone. It had a “fill-in-the-blank,” where the victim’s name would be written in. Almost 500,000 of these arrest warrant forms had been prepared. In other words, upwards of a half-million people might have been imprisoned in Moscow, alone. The day before the coup began, the KGB had received a consignment of 250,000 pairs of handcuffs. And the Russian press later reported that some of the prison camps in Siberia had been clandestinely reopened. If the coup had succeeded, possibly as many as three to four million people in the Soviet Union would have been sent to the GULAG, the notorious Soviet labor camp system. Another document published in the Russian press after the coup failed had the instructions for the military authorities in various regions around the country. They were to begin tighter surveillance of the people in the areas under their jurisdiction. They were to keep watch on the words and actions of everyone. Foreigners were to be even more carefully followed and watched. And their reports to the coup leaders in Moscow were to be filed every four hours. Indeed, when the coup was in progress, the KGB began to close down commercial joint ventures with Western companies in Moscow, accusing them of being “nests of spies,” and arrested some of the Russian participants in these enterprises.

Fear Underneath the Surrealism of Calm

During the coup attempt Moscow had a surrealistic quality. On the streets around the city it seemed as if nothing were happening – except for the clusters of Soviet tank units strategically positioned at central intersections and at the bridges crossing the Moscow River. Taxi cabs patrolled the avenues looking for passengers; the population seemed to go about its business walking to and from work, or waiting in long lines for the meager supplies of everyday essentials at the government retail stores; and motorists were as usual also lined up at the government owned gasoline stations. Even with the clearly marked foreign license plates on my rented car, I was never stopped as I drove around the center of Moscow. The only signs that these were extraordinary days were the grimmer than usual looks on the faces of many; and that in the food stores many people would silently huddle around radios after completing their purchases. However, the appearance of near normality could not hide the fact that the future of the country was hanging in the balance.

Russians Run the Risk for Freedom

During the three days of that fateful week, Russians of various walks of life had to ask themselves what price they put on freedom. And thousands concluded that risking their lives to prevent a return to communist despotism was price they were willing to pay. Those thousands appeared at the Russian parliament in response to Boris Yeltsin’s appeal to the people. They built makeshift barricades, and prepared to offer themselves as unarmed human shields against Soviet tanks and troops, if they had attacked. My future wife, Anna, and I were among those friends of freedom who stood vigil during most of those three days facing the barrels of Soviet tanks. Among those thousands, three groups were most noticeable in having chosen to fight for freedom: First, young people in their teens and twenties who had been living in a freer environment during the previous six years since Gorbachev had come to power, and who did not want to live under the terror and tyranny their parents had known in the past. Second, new Russian businessmen, who realized that without a free political order their emerging economic liberties would be crushed. And, third, veterans of the Soviet war in Afghanistan, who had been conscripted into the service of Soviet imperialism and were now determined to prevent its return. The bankruptcy of the Soviet system was demonstrated not only by the courage of those thousands defending the Russian parliament, but also by the unwillingness of the Soviet military to obey the orders of the coup leaders. It is true that only a handful of military units actually went over immediately to Yeltsin’s side in Moscow. But hundreds of Russian babushkas – grandmothers – went up to the young soldiers and officers manning the Soviet tanks, and asked them, “Are you going to shoot their mother, your father, your grandmother? We are your own people.” The final act of the coup came when these military units refused to obey orders and seize the Russian parliament building, at the possible cost of hundreds or thousands of lives.

Freedom! Freedom! Freedom!

On that clear, warm Thursday of August 22th, that huge mass of humanity that had assembled in a large plaza behind the Russian parliament stood and listened as Boris Yeltsin told them that that area would now be known as the Square of Russian Freedom. The multitude replied in unison:Svaboda! Svaboda! Svaboda! – “Freedom! Freedom, Freedom!” A huge flag of pre-communist Russia, with its colors of white, blue and red, draped the entire length of the parliament building. The crowd looked up and watched as the Soviet red flag, with its yellow hammer and sickle in the upper left corner, was lowered from the flagpole atop the parliament, and the Russian colors were raised for the first time in its place. And again the people chanted: “Freedom! Freedom! Freedom!” Not too far away from the parliament building in Moscow, that same day, a large crowd had formed at Lubyanka Square at the headquarters of the KGB. With the help of a crane, these Muscovites pulled down a large statue of Felix Dzerzhinsky, the founder of the Soviet secret police that stood near the entrance to the KGB building. In a small park across from the KGB headquarters, in a corner of which rests a small monument to the victims of the Soviet prison and labor camps, an anti-communist rally was held. A young man in an old Czarist Russian military uniform burned a Soviet flag, while the crowd cheered him on. The seventy-five-year nightmare of communist tyranny and terror was coming to an end. The people of Russia were hoping for freedom, and they were basking in the imagined joy of it.

Freedom’s Hope and Post-Communist Reality

The demise of the Communist Party and the Soviet system was one of the momentous events in modern history. That it came about with a relatively small amount of bloodshed during those seventy-two hours of the hard-line coup attempt was nothing short of miraculous – only a handful of people lost their lives. The last twenty years have not turned out how many of the friends of freedom in Russia had hoped. Indeed, post-communist Russia saw a contradictory, poorly organized, and corrupted privatization of Soviet industry, plus a high and damaging inflation in 1992-1994; a severe financial crisis in 1998; a return to authoritarian political rule following Vladimir Putin’s rise to power in 1999; two bloody and destructive wars in the attempted breakaway region of Chechnya; wide spread and pervasive corruption at all levels of government; state controlled and manipulated markets, investment, and commerce; assassinations and imprisonments of political opponents of the regime; and significant nostalgia among too many in the country for “great power” status and the “firm hand” of the infamous Stalinist era. Nonetheless, for those of us who were fortunate enough to be in Moscow in August 1991, it remains in our minds as an unforgettable historical moment when the first and longest-lived of the 20th century’s totalitarian states was brought to the doorstep of its end. Dr. Richard M. Ebeling is Professor of Economics at Northwood University. This article was first published at the NU blog, In Defense of Capitalism & Human Progress on the 18th of August

Hayek vs Keynes Debate Rebroadcast

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Back in the ’30s, at the time of the original Keynes-Hayek debate, Hayek had a solid methodological system that could explain the causes of the recession of the late ’20s and early ’30s, and it’s subsequent gyrations, up and down. The root cause was excessive credit creation by the world’s main central banks, and their fractional reserve private sector mints, the banks. This bank credit was loaned out to businesses who bought extra kit to produce goods and services more efficiently. The boom in producer sectors bid up relative prices for their resources. Higher wages for labour meant more consumption, boosting consumer sectors. This in turn pushed up relative prices in those sectors. Competition for resources bid up prices until no one believed the prices were sustainable — pop goes the mega bubble, and boom turns to bust. This is called the Austrian Theory of the Business Cycle. At the BBC LSE Hayek v Keynes debate, Lord Skidelsky told us that everyone knew it was excess credit that caused this boom, and that this was called the “Treasury View.” This of course is not true; the noble Lord is misinformed. The Treasury View was advanced by members of the Chancellor’s department saying, in short, that for every increase in public expenditure advocated by Keynesian types to alleviate the Great Depression effects, there would be an equivalent reduction in private sector expenditure that would mean that the net effect in the economy is zero. Whilst I hold that this is a valid view, it is not one that gives us the theoretical tools to understand why boom and bust happen in the first place. Mises and Hayek gave us these tools with the Austrian Theory of the Business Cycle. Neither the Treasury View, as expounded by the likes of Ralph Hawtrey, nor the Keynesian view were based on a series of logical deductions from root causes. The best Keynes could offer as an explanation for boom and bust was “animal spirits”.  He is Theory Lite in this respect. Unfazed by his shaky foundation, Keynes confidently prescribed how to correct an animal-spirit-induced bust.  We are told to spend when the private sector is not spending. Who does this? The government on our behalf.  The Treasury View makes clear that it’s futile to tax the private sector in order to spend, so we have the cries from modern day Keynesians to carry on borrowing and spending in order to force a correction . If you haven’t got the correction you desire, you have not borrowed enough! So say the likes of Krugman and Skidelsky, drunk on the intoxicating work of Keynes. The faulty logic than runs underneath this way of thinking is called the “Circular Flow of Income.” This is now bread and butter in any economics text book. One person’s income, when spent on goods and services, becomes another person’s income. Cut one and you cut all. Therefore, a series of cuts or austerity measures is exactly what you should not be doing at a time of bust; you need to keep everyone’s income up. Hayek held that relative prices and income where what mattered, not gross aggregates . If a man has an income of £100 and costs of £90, we can say he has a profit of £10. Then recession hits and he has an income of £85 and still costs of £90, so he is sunk by £5. Thus the aim of the man in question, with income of £85 is to get his costs down to under £75 and restore his profitability. As this is done, the foundations for recovery are laid. Even better, if he can get costs to £74, on lower income and a lower costs base, he is in fact more profitable than in the glorious boom times! In the 5 mins each speaker had in this debate to present their case, some of this came across and some of it did not. Jamie Whyte and George Selgin did a fantastic job at putting forward the case for Hayek. Skidelsky sadly did not represent Keynes very truthfully, for the reasons I have outlined above. Selgin picked him up on various other errors and misrepresentations. This debate is very relevant for today as no doubt we will be told the current market corrections are “Animal Spirits”, and that the answer is further government intervention. The BBC tell us the debate had over 1 million listeners and was in their top 5 podcasts. In all my years studying at the LSE and as a donor to it, I have never seen three lecture theatres full of public and students alike. Not even for visiting Heads of State! This is the debate of our times. I am delighted to say that the program will be re-run, and they expect another 1.5 millions viewers.  Our friend at the Mises Institute, Stephan Kinsella, has blogged all the details here. If you want to educate yourself a little more on these matters, or even if you think you are very familiar with all of the issues, the debate is definitely worth a listen.  If you can’t wait for the next BBC broadcast, you can find it online as an MP3. Since the original broadcast, the debate has continued online.  On the 3rd of August,PrimeEconomics published a list of eight alleged fallacies in the Keynes/Hayek debate, drawing a number of responses, including some from George Selgin.  On the same day, Selgin posted his own account of the debate at FreeBanking.org.  More recently, on the 18th of August, Selgin took up Skidelsky’s suggestion that “no government has ever achieved a speedy recovery from a recession by clamping down on its spending or reducing its indebtedness”, citing the US recovery from a deep recession in 1920.  The following day, Skidelsky published his account of the Keynes-Hayek rematch at Project Syndicate, declaring

Except to Hayekian fanatics, it seems obvious that the coordinated global stimulus of 2009 stopped the slide into another Great Depression.

You can read Selgin’s response at FreeBanking.org. Personally, I look forward to the day when Paul Krugman will come and stand on that same stage where Hayek delivered his famous Prices and Production lectures, and engage in serious debate with Austrian economists. How many lecture theatres would that fill? What global TV audience would it draw? For those at the BBC and for those at the LSE, I think my next Distinguished Hayek Fellowship Teaching Programme event the LSE should be just this debate, and I would be happy to support and fund whatever I can. I repeat, this is the debate of our times.  Only someone of the stature of Krugman can represent Keynes, we need to move this debate up and along now.

Related articles
  • Hayek vs Keynes at the LSE – John Phelan, 27 July 2011

Jack Farchy In The FT On $5000 Gold

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FT – Bullion bulls talk of $5000 gold Historically, gold and silver were the money of choice, freely chosen by the people as the most marketable commodities. The value of your labour was measured in these precious metals. Wicked Kings through the ages debased the people’s money for their own profit. The last English king to do this was Henry VIII. Our money was free from debasement for many years thereafter; the value of our work undebauched. Today, governments around the world assume the powers of kings of old as they embark on the “monetisation” of their debt, minting new money from nowhere. They call it QE. Since 1971, when Nixon severed the last link to gold (struggling to pay for the latest war), paper currencies have been the most extreme derivatives, resting on a mere memory of underlying value. CDO squared has nothing on paper fiat. So the people are voting with their feet, and returning to ancient currency — to gold and silver. How much does an ounce of gold buy you today? $1800 worth of goods and services. And a year ago? $1200 worth of goods and services. How much purchasing power been taken away from you? How long will governments around the world, with no political will to tackle their dangerous debts and zombie banks, be able to maintain confidence in their paper systems? I do not know, but I feel that we’re fast approaching a day when the whole western monetary system will fundamentally change. I hope the new paper will be redeemable in gold or silver. Governments can’t mint this stuff up like magic. They will be forced to raise money through taxation alone, according to what the public will bear. No longer will they be able to kick the can down the road, while stealthily confiscating the fruits of our labour. I am delighted that even the FT, that stalwart of conventional economics, is now asking ‘how high could gold go?‘. Let us hope they consider the fundamentals, and recall our long, sorry history of debasement.

Charles Moore reviews Keynes vs Hayek

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I was pleased to see the LSE’s recent Hayek vs Keynes debate picked up by Charles Moore atThe Telegraph:

The Hayekians, led by Professor George Selgin, argued that Keynes failed to see the way busts are the natural result of booms – the “malinvestment hangover” from the party that went on too late the night before. In the rap, by the way, Keynes is depicted as the life and soul of the party, getting all the girls (not quite what happened in his real private life), but then throwing up after too much whisky. Prof Selgin pointed out that, since the current crisis began in 2007/8, absolutely tons of public money has been poured into all the banks that went wrong, and they have only gone wronger.

Moore sums things up nicely:

Hayek’s ideas … appeal to anyone who inclines to believe that people are more likely than governments to act in their best interests. Reality is the best counsellor: “There is no painless recovery from an unsustainable boom”, and if something is unsustainable, it makes no sense to try to sustain it. Keynes appeals to our longing for a clever piece of magic which can rescue us from our follies. Hayek appeals to our more common-sense understanding that only our own best efforts can save us. Being highly suspicious of prestidigitation by governments, I lean to the side of Hayek.

Very encouraging times to be an Austrian!

What Type Of Free Banking Do We Want?

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The article below represents the intellectual endeavours of two of the young stars of the Austrian School to address some of what they describe as “quibbles” with one of the more senior members of the School, Professor George Selgin and to some extent Prof Horwitz and our own Founding Fellow, Prof Anthony Evans. I have taken great inspiration from all of the people mentioned above, some more than others, but I fall on the side of the 100%FB for some of the reasons advocated by the two writers. Debates get heated and we get hot under the collar, but one thing is for sure: with an eye on practical politics, we must remember that the true enemy is the monetary socialism that we have today. We may have currency failure in Europe soon. In the USA we may have a final realisation that, as in the UK at the dawn of the First World War, the baton of economic leadership has moved on. These are the most uncertain of times. If we in the free market movement are to have any hope of getting anywhere, we must be able provide positive policy solutions. I would urge all mentioned here to turn attention to just that going forward, if no further understandings can be made between FRFB and 100%FB. I know for sure, I would bite your hand off today if any one of those systems was offered in exchange for an end to state supported FR banking! There is even a small chance that as this Great Recession rolls out, that is all the powers that be may be left with as policy solutions. We must be ready to provide solutions to our political masters.

Unanswered Quibbles with Fractional Reserve Free Banking

Abstract: In this article we reply to George Selgin’s counterarguments to our article “Fractional Reserve Free Banking: Some Quibbles”. Selgin regards holding cash as saving while we focus on the real savings necessary to maintain investment projects. Real savings are unconsumed real income. Variations in real savings are not necessarily equal to variations in cash holdings. We show that a coordinated credit expansion in a fractional reserve free banking (FRFB) system is possible and that precautionary reserves consequently do not pose a necessary limit. We discuss various instances in which a FRFB system may expand credit without a prior increase in real savings. These facets all demonstrate why a fractional reserve banking system – even a free banking one – is inherently unstable, and incentivized to impose a stabilizing central bank. We find that at the root of our disagreements with Selgin lies a different approach to monetary theory. Selgin subscribes to the aggregative equation of exchange, which impedes him from seeing the microeconomic problems that the stabilization of “MV” by a FRFB system causes.

Read the whole article (PDF).

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The Privileged Few Have Eaten Everybody Else’s Lunch

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Another great interview with Sean Corrigan on CNBC

Airtime: Mon. Jul. 18 2011 | 7:00 AM ET Big US banks should have been allowed to fail, Sean Corrigan, chief investment strategist at Diapason Commodities Management, told CNBC Monday. “The privileged few clustering around the Treasury Secretary and the Fed have eaten everybody else’s lunch,” he said.