Mark Skousen's Contributions To Economics

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Following my review of Mark Skousen‘s paper on GDE, I was pleased to discover this piece by Ken Schoolland, Professor of Economics, Hawaii Pacific University, chronicling Mark’s contributions to economics.

“If I have been able to see farther than others, it was because I stood on the shoulders of giants.”  — Sir Isaac Newton

Carl Menger, Eugen Böhm-Bawerk, Ludwig von Mises, Friedrich Hayek, Murray N. Rothbard, Roger W. Garrison, and many others have laid the foundation for Austrian economics. One more deserves acknowledgement. Mark Skousen’s scholarship has been highly innovative and ambitious in dethroning and supplanting three principal forces in modern economics:  (1) the Keynesian macro model of big government; (2) Paul Samuelson’s popular Economics textbook, which promoted the welfare state, progressive taxation, and an anti-saving mentality; and (3) Robert Heilbroner’s Worldly Philosophers, whose favorite economists are Marx, Veblen, and Keynes.  Market-oriented economists have published numerous critiques of Keynesian economics, but the best way to fight a bad idea is by developing a better idea.  I see Skousen’s efforts as successful in accomplishing this and as a positive contribution to economics.

Summary

Here is a basic summary of his efforts over the past thirty years, followed by a more detailed explanation: 1.  Keynes mutiny:  The Structure of Production (1990, 2007) develops a universal four-stage macro model that challenges the Keynesian/monetarist monolith. Better than GDP:  As part of this 4-stage model, he introduces a new national income statistic, known as Gross Domestic Expenditures (GDE), that establishes the proper balance between consumption (the “use” economy) and production (the “make” economy), and demonstrates that business investment, not consumer spending, drives the economy (thus, confirming Say’s law over Keynes’s law). 2.  Exit Samuelson:  Economic Logic (2000, 2010) is an innovative new textbook that integrates powerful Austrian concepts into standard economics textbooks and re-establishes classical economic policy. 3.  Move over, Heilbroner:  The Making of Modern Economics (2001, 2009), a new history of economics, offers a bold running plot with Adam Smith and his “system of natural liberty” as the heroic figure. In short, Skousen attempted to supplant Keynes, Samuelson and Heilbroner – a triathlon feat in economics.  Here are the details.

The Structure of Production (1990, 2007)

Skousen’s first important work is The Structure of Production, published in hardback by New York University Press in 1990, and in paperback with a new introduction in 2007. Structure is a treatise in macroeconomics and a positive alternative to John Maynard Keynes’sGeneral Theory of Employment, Interest and Money (1936).   In the early 1980s Skousen addressed the need for an updated macro model of the economy that challenged the Keynesian/monetarist monolith and did a better job of analyzing economic activity and the business cycle. He was attracted to the Austrian idea, originating with Carl Menger and his intellectual descendants, of a time structure of production involving capital- and labor-using stages of production through time. With The Structure of Production, Skousen created a generalized four-stage macro model based on the ingenious stages-of-production model Hayek developed in his small book, Prices and Production (1931), known as Hayekian triangles.  However, if the Austrian macro model would ever challenge and replace the Keynesian neo-classical model, it required a theoretical approach that needed to be updated, one that would fit historical data and modern macroeconomic statistics.  Given that Hayek’s model never went beyond the purely theoretical level, Skousen created a 4-stage model that fit government statistics, such as price indices, inventories, employment, and national input-output data.  The generalized four-stage model of the economy is illustrated below: Figure 1. GDE measures spending at all stages of production. GDP measure final output only. This model fits well into price indices compiled by U. S. Commerce Department’s Bureau of Economic Analysis (BEA). For example, for the “resources” stage there is the raw commodity price index.  For the production and distribution stages one could use the producer price index (PPI).  And for the retail stage, there is the Consumer Price Index (CPI).

Aggregate Supply and Demand Vectors

Structure advances the Hayekian stages-of-production model with the introduction of the Aggregate Supply Vector (ASV) and the Aggregate Demand Vector (ADV) as a way of measuring macroeconomic equilibrium, disequilibrium, and the business cycle.  Here Skousen notes that the supply chain of production is a downward-sloping schedule that reflects distance and direction over time (thus a “vector”).  ASV is determined by productivity, the profit margins at each stage of production, and interest rates.  (See Structure, pp. 201-203, and Economic Logic, pp. 583-587.) The payment schedule for goods and services produced at each stage moves in an upward direction, which he calls the Aggregate Demand Vector (ADV).  ADV is influenced by time preference, the “natural” rate of interest based on the decision of individuals to consume or save their income. Macroeconomic equilibrium is achieved where ADS = ADV at each stage of production (similar to what Mises called the evenly-rotating economy).  When the market rate is artificially reduced to below the natural rate of interest, ADS and ADV move in different directions, and thus create a business cycle. The influence of The Structure of Production can be measured in several ways: as the underground bible for supply-side economics; a revival of Say’s law; an Austrian advance over the Keynesian macroeconomic model and the monetarist disequilibrium model of the business cycle; and a new tool for financial analysis. Its most important function is to serve as a theoretical counterpoint to the standard KeynesianWeltanschauung.  What drives the economy?  According to Keynesians and Keynes’s law, “demand creates supply.”  Consumption drives the production process; consumer spending is paramount, since it represents most economic activity (over 70% of GDP in the US).  On the other hand, according to supply-siders and Say’s law, “supply creates demand.”  Production drives consumption; saving and investment, technology and productivity, are paramount.  Which force is more important?

Gross Domestic Expenditures (GDE)

To answer this question, The Structure of Production introduces a new national income statistic, known as Gross Domestic Expenditures (GDE), which measures spending at all stages of production in the economy.  GDE is defined as follows:

GDE = Intermediate Production + GDP

Or in other words,

GDE = “Make” economy + “Use” economy

The creation of GDE is necessary because Gross Domestic Product (GDP), the most common denominator of economic activity, focuses solely on final output, the end product, or what is known as the “use” side of the economy.  It ignores to a large degree the “make” side of the production process, the goods-in-process at the intermediate stages of production.  As a result, GDP over-emphasizes consumption at the expense of saving and business investment.  By adding the intermediate stages, GDE establishes the proper balance between consumption and saving/investment, between the “use” economy and the “make” economy. Drawing from the annual input-output data compiled by the Bureau of Economic Analysis, gross business receipts from the IRS, and other sources, GDE estimates gross spending patterns in intermediate production (goods-in-process) and final output.  GDE should be the starting point for measuring aggregate spending in the economy.  It complements GDP and can easily be incorporated in standard national income accounting and macroeconomic analysis.  In the United States, Skousen’s research shows that GDE appears to be more than twice the size of GDP and he discovered that GDE is historically three times more volatile than GDP.  Thus, GDE serves as a better indicator of business cycle activity.  (See Skousen’s working paper, “Gross Domestic Expenditures (GDE): The Need for New National Aggregate Statistic,” 2010.) In developing GDE, Skousen behaved in a manner similar to Milton Friedman when Friedman added up components of the money supply to create M1 and M2 in The Monetary History of the United States (Princeton University Press, 1963).  Nobody had created the monetary aggregates M1 and M2 until Friedman came along.  In Skousen’s case, the IRS provided the raw data — the gross business receipts produced each year from tax returns of corporations, partnerships, sole proprietorships, and farms. By adding them all together, Skousen came up with GDE. GDE is useful in debunking the popular Keynesian myth that consumer spending drives the economy.  Granted, consumer spending represents 70% of GDP in the United States, but GDP accounts for “final output” only, and is therefore not fully representative of total spending in the economy.  Using GDE, Skousen found that consumption accounts for only approximately 30% of total economic activity, and that business investment (intermediate spending plus final capital investment) is, in fact, the largest sector of the economy.   This conclusion is more consistent with the leading economic indicators published by the Conference Board.   Again, Say’s law is validated.

Economic Logic (2000, 2010)

Second, Skousen challenged Paul Samuelson and provided an alternative principles textbook to Samuelson’s popular Economics (1948), which forms the Keynesian basis of most modern-day courses in college economics.  Establishment textbooks, borrowing from Samuelson, use the perfect competition model in micro and the Aggregate Supply and Demand (AS-AD) model in macro, both of which are defective.  Using these models, economists and government officials often support anti-trust legislation, debt financing, excessive consumption, and progressive taxation (all Keynesian mainstays).  Skousen wanted to create a principles textbook that removed bad economic theories and replaced them with sound economic principles on a consistent basis.  He also wanted to write a textbook was based on his experience as a businessman and investor.  Too many economics textbooks are written by ivory-tower academics and are, therefore, too theoretical. Economic Logic (2000, 2010) establishes a logical step-by-step approach to teaching college economics—thus the title. Skousen’s background in business suggested a new pedagogy, beginning the micro chapters with the profit-and-loss income statement, followed by supply and demand.  His approach is distinctly Austrian, using Carl Menger’s “theory of the good,” which focuses on the quantity, quality, and variety of goods and services rather than earning income as the best measure of standard of living.  Economic Logic begins with the P&L statement (a Austrian-style two-stage micro model), followed by supply and demand analysis.  Classroom experience demonstrated that students preferred this innovative approach over the traditional pedagogy of introducing supply and demand first, followed by profit and loss.  It is also a good way to introduce economics students to business, finance, and accounting, which are often minimized in economics courses. The macro chapters incorporate Skousen’s 4-stage model of the economy (the first to appear in an economics textbook), and integrate GDE with GDP and standard aggregate statistics, and business-cycle theory.  GDE does not replace GDP, it complements it. He also introduced the Aggregate Supply Vector (ASV) and Aggregate Demand Vector (ADV) as a more accurate approach to the business cycle.  By integrating “Austrian” elements, his macro model more accurately reflects the dynamics of the global economy, including supply-side technological changes, asset bubbles and commodity inflation, and the boom-bust business cycle.  It also reestablishes the virtues of balanced budgets, thrift, and limited government that are absent in Samuelson-style textbooks. Economic Logic also has chapters missing in other textbooks:  the origin of money, and the pros and cons of an international gold standard, central banking, and inflation targeting; the Mises/Hayek theory of the business cycle; a full critique of the Keynesian Aggregate Supply and Demand (AS-AD) model; entrepreneurship, financial markets, and government regulation; a review of major schools of economics, including Austrian, Keynesians, Marxist, Chicago, and Public Choice. In sum, Economic Logic does something not previously achieved:  It integrates Austrian concepts into the standard economics textbook and has been adopted by a number of schools, such as the University of Detroit-Mercy and Universidad Francisco Marroquin in Guatemala.

The Making of Modern Economics (2001, 2009)

Third, and especially popular with students in my classes on the History of Economic Thought, isThe Making of Modern Economics (2001, 2009). This book reveals a new way to study the lives and ideas of the great economic thinkers.  In my estimation, it’s the most fascinating, entertaining and readable history I have seen, and I have encouraged translations abroad.  So far it has been translated into Chinese, Turkish, and Spanish. It is a bold history told for the first time as a running plot with a singular heroic figure, Adam Smith and his “system of natural liberty,” at the center of the discipline. Almost all histories of thought have previously been written by socialists, Marxists and Keynesians, with Robert Heilbroner’s classic title, The Worldly Philosophers, being a combination of all three.  His three favorite economists are Marx, Veblen, and Keynes. Heilbroner devotes a chapter to Joseph Schumpeter, but only because he is an enfant terrible of the Austrian school.  Sadly the sins of omission are too great to salvage Heilbroner.  He has virtually nothing to say about J. B. Say, Frederic Bastiat, Ludwig von Mises, Milton Friedman, and, like all other histories of thought, he has no running plot or single heroic figure. On a broader scale, Skousen’s history of economics breaks new ground by rejecting the standard political spectrum, what he calls the “pendulum” approach to identifying economists.  In the world of competing ideologies, the standard political spectrum has Adam Smith, advocate of laissez faire, on the extreme right; Karl Marx, the radical socialist on the extreme left; and John Maynard Keynes, supporter of big government, in the middle.  This pendulum approach is unsatisfactory since it equates Adam Smith with the extremism of Karl Marx and represents Keynes as the golden mean. In The Making of Modern Economics (and The Big Three in Economics, a shortened version), Skousen presents a unique alternative by creating a “Totem Pole of Economics,” where economists and their theories are measured  by their impact on economic freedom and growth.  In his ranking, Adam Smith is on top, followed by Keynes, and Marx is “low man” on the Totem Pole of Economics. Thus, the story of modern economics begins with Adam Smith, the heroic figure, and thereafter economists are ranked to the extent that they advanced or retarded Smith’s “system of natural liberty.”  Skousen showed how Karl Marx, Thorstein Veblen, John Maynard Keynes, and even some disciples such as Robert Malthus and David Ricardo detracted from the Smithian model of democratic capitalism during periods of economic failure and upheaval, while Carl Menger, Alfred Marshall, Irving Fisher, Ludwig von Mises, and Milton Friedman, among others, remodeled and improved upon Smithian economics as the world economy recovered and prospered. Especially novel, I think, is the contribution of chapter 10, in the middle of the book.  It follows the success of the marginalist revolution that advanced the Adam Smith model and established “neo-classical” economics as a formal science.  Heilbroner and other historians highlighted the sociology of Thorstein Veblen, a major American critic of “neo-classical” economics without providing a counterweight.  Skousen’s middle chapter juxtaposes the ingenious work of Max Weber, the German sociologist who offered a spirited defense of “rational” capitalism.  The two sociologists served as a perfect counterbalance. The Making of Modern Economics also breaks new ground by publishing a hundred illustrations, portraits, and photographs, and offering details and little-known anecdotes about the lives and ideas of the economists, including creative chapter titles and musical selections reflecting the spirit of each major thinker.  Skousen makes the lives and ideas of the great economists come alive like no other textbook, and my students find it especially refreshing. In sum, I salute Mark Skousen for advancing the theory and history of economics and encourage students and colleagues to study his textbooks and insights.

Books by Mark Skousen

  • Economics of a Pure Gold Standard (Foundation for Economic Education, 1988, 1996, 2010).
  • The Structure of Production (New York University Press, 1990).
  • Economics on Trial (Irwin McGraw Hill, 1991; 2nd edition, 1993). Translated into Japanese.
  • Dissent on Keynes, editor (Praeger Publishing, 1992).
  • Puzzles and Paradoxes in Economics, co-authored with Kenna C. Taylor (Edward Elgar, 1997). Translated into Korean and Chinese.
  • Economic Logic (Capitol Publishers, 2000, 2010).  Translated into Chinese and Turkish.
  • The Making of Modern Economics (M. E. Sharpe Publishers, 2001, 2009).  Now in its 2ndedition; translated into Chinese, Turkish, Mongolian, and Spanish.
  • The Power of Economic Thinking (Foundation for Economic Education, 2002). Translated into Chinese.
  • Vienna and Chicago: A Tale of Two Schools of Free-Market Economics (Capital Press, 2005).  Translated into Chinese.
  • The Power of Economic Thinking (Foundation for Economic Education, 2002). Translated into Chinese.
  • The Big Three in Economics: Adam Smith, Marx, and Keynes (M. E. Sharpe, 2007).
  • EconoPower:  How a New Generation of Economists is Transforming the World (Wiley & Sons, 2008).  Translated into Chinese, Korean and Portuguese.

About Ken Schoolland

Ken Schoolland is Associate Professor of Economics and Political Science at Hawaii Pacific University, and author of the acclaimed work “The Adventures of Jonathan Gullible.” See http://www.jonathangullible.com/

The War On The Poor

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The gigantic sums of credit created out of nothing, causing a doubling and in some cases tripling of the money supplies of Western Governments, over the two-decade boom that we have just experienced, have consequences. Unless you were living at the bottom of the ocean, or on planet Zog for the last three years, the most obvious consequence is that this boom was unsustainable, as they all are. The bust has wreaked havoc across the developed world. The poorest members of society will be forced to pay for the errors of their political masters, and the richest members of society will benefit. During the boom, our nominal prices were pretty stable, i.e. general price inflation was viewed by mainstream economists and the press to be under control. The reality was quite different. Great productivity gains in all sectors of the economy during this period should have been delivering up much more purchasing power for a given amount of money, i.e. lower prices. We saw this in the Industrial Revolution, and the Technological Revolution we are living through should be no different. Entrepreneurs have been mixing up the factors of production in better combinations to deliver up more goods and services with those same factors of production. These productivity gains have been squandered by an inflating money supply. What some of us have known to be happening in the last two decades is now evident even to those with room temperature IQ. The productivity gains have slowed as the bust bites, and money inflation is now picking up a big head of steam. We are told by our political masters that “a dose of rapid inflation will clear out the system in the least painful way.” How many times have you heard that said? Even members of the Fed question this reasoning (albeit a minority). Take a look at this speechby Richard Fisher, the following section in particular:

As to the proposition that higher prices of financial assets will liberate those most in need, I wondered aloud if that were indeed true. We are already seeing the beginnings of speculative activity in stocks, bonds, buyouts and commodity markets. The rich and the quick are certainly able to exploit these circumstances to get richer. I have no problem with market operators making money; I did so myself in my previous life as a funds manager (before I took the vow of financial chastity and joined the Fed!). But I take no comfort, and see considerable risk, in conducting monetary policy that has the consequence of transferring income from the poor and the worker and the saver to the rich. Senior citizens and others who saved and played by the rules are earning nothing on their savings, while big debtors and too-big-to-fail oligopoly banks benefit from their subsidy. I know of no presidential administration or Congress, Republican or Democrat, that will tolerate, let alone advocate for, that dynamic for long, and I expressed my worry that this could come back to bite us and possibly threaten our independence.

I concur fully with these sentiments. Make no mistake here, policies of inflationism allow the governments of the world to unleash a vile pestilence on the poorest members of society, and the rich and nimble will profit from this. Like the man from the Fed, I blame no one for seeking to take opportunities to protect his or her savings and deploy them to take advantage of this situation, and I will do my best to make sure as little of my purchasing power is robbed from me as possible. We must remember that this policy destroys the purchasing power of people who need to live off their savings and who are on fixed or low incomes, largely pensioners and the poor. The War on the Poor was not unleashed by the current crop of governments around the world, but by their predecessors. I suspect there are no politicians who will point out that what they are actually doing is a soft default. We must remember that the levels of inflation we are experiencing, and will continue to experience, constitute a sovereign default in all but name. It is an acknowledgement that we will never pay back the debt owed in the public and the private sector at real purchasing power terms, but we will do it in nominal terms by letting inflation extract wealth from the population at large. A hard default would cause turmoil, no doubt, as it has in Iceland, but the War on the Poor would stop and a reallocation of resources from the profligate and imprudent to the more prudent and wiser users of capital would take place. Iceland is well down this road, and they will prosper quicker as a result. Our experiment with inflation could be two decades long, just as long as the boom! We may well rue the day we did not opt to let our banks go bust. Our politicians will tell us that there is no policy of inflation. They will say inflation results from the rise in foreign prices of commodities, the massive costs of imports, and trade unions pushing up wages. Inflation is always a monetary phenomenon, and the root of all control of the money supply goes right back to the government. They have a monopoly on the issue of currency, and power over the issue of credit via their control of the reserve ratio, and control of interest rates (the price of loanable funds). A simple example will show why the government’s role is essential. If a Russian or Arab puts up the price of oil, as there is more demand and or they have constrained supply, the Englishman buying will pay more to the Russian and the Arab. Thus a wealth transfer is achieved from the Englishman, who now has less to spend on other things. His reduced demand for other goods means that no overall price inflation can occur. Inflation can only happen with regard to commodity price rises if the person buying the commodity is determined to continue spending on other goods at his previous rate, and is able to get more credit from his bank (i.e. more money). Governments committed to inflationism are dishonest in what they do. I accept that a level of economic ignorance may well dominate the upper echelons of the governments of the world, and most politicians seem to be blissfully ignorant that what they are promoting is the mass extraction of wealth from the largest part of the voting population, to give to a minority. Even more baffling is that left wingers seem as happy with this as right wingers. Our job on this site is to try to make all aware that their policies will impoverish the weakest and most vulnerable, and weaken a recovery. If the War on the Poor is waged unwittingly, that will be small comfort to those affected.

Some Virginia Legislators Worry about Hyperinflation!

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A good article from Robert Jackson Smith:

Some legislators in the Commonwealth of Virginia are worried about hyperinflation!  See House Joint Resolution No. 557.  Should the Commonwealth adopt a currency to serve as an alternative to the currency distributed by the Federal Reserve System?  Could an alternative currency avoid or mitigate many of the economic, social, and political shocks to be expected to arise from hyperinflation, depression, or other economic calamity related to the breakdown of the Federal Reserve System?  These are the questions some Virginia legislators are asking.  They’re even proposing to appoint a joint subcommittee to study whether the Commonwealth should adopt a currency to serve as an alternative to the currency distributed by the Federal Reserve! In my opinion yes, an alternative currency would help to avoid and/or mitigate many of the economic, social, and political shocks arising from a breakdown of the Federal Reserve System.  The thing is, however, that an alternative currency already exists.  It’s called gold/silver, and it’s available in several forms.  Gold and silver have been used as money for thousands of years.  They have proven themselves to be reliable as media of exchange, stores of value, and units of measure for as long as man has recorded history.

Read the whole article.

Gross Domestic Expenditures

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If you want to read a very genuine and new contribution to the body of knowledge set out in academic terms, I recommend this paper by Mark Skousen:

Here’s the introduction:

In national income and product accounts, Gross Domestic Product (GDP) is widely recognized as the most common denominator of economic performance. However, because it measures final output only, GDP overemphasizes the role of consumer spending as a driver of economic growth rather than saving, business investment, and technological advances. In an effort to create a more balanced picture of the production/consumption process, I create Gross Domestic Expenditures (GDE), a new national aggregate statistic that measures sales at all stages of production. Drawing from the annual input-output data compiled by the Bureau of Economic Analysis, gross business receipts from the IRS, and other sources, GDE estimates gross spending patterns in intermediate production (goods-in-process) and final output. GDE should be the starting point for measuring aggregate spending in the economy, as it measures both the “make” economy (intermediate production), and the “use” economy (final use or GDP). It complements GDP and can easily be incorporated in standard national income accounting and macroeconomic analysis. In the United States, GDE appears to be more than twice the size of GDP, and has historically been three times more volatile than GDP, and serves as a better indicator of business cycle activity. I conclude that consumer spending represents approximately 30 percent of total economic activity (GDE), not 70 percent as often reported. This conclusion is more consistent with the leading economic indicators published by the Conference Board.

Sean Corrigan has published something similar on our site, and he comes to the same conclusions: the unmeasured part of the economy, the producing part, is 3 to 1 to the final goods part. This erroneous GDP measure leads economists to be able to claim that consumer spending is some 70% of all economic activity as it is mainly the final goods, i.e. the consumption goods, that are measured in standard GDP statistics . In simple terms, when I used to sell fish in this country I bought fresh landed fish at auction. I would then take it back to my factory and cut to the bespoke requirements of our chef customers. Only the value-adding part of this process would be included, so as to avoid double counting of the final goods sold that make up the GDP stats. The restaurateur would only have the value adding he does measured. In short, if you eat some fish and chips in a restaurant, GDP measures the initial price of the raw material plus the value added in each sector of the economy it passes through until you eat it. As far as the GDP numbers are concerned, you have eaten the raw material and the difference between the raw material and the battered fish and chips. My prior company, Seafood Holdings, was the largest fresh fish seller to the food service sector and as far as the GDP measure was concerned, we did not exist! Skousen’s GDE measure shows how the larger producer sector in the economy is much more sensitive to things like interest rate movements that, according to the Austrian Theory of the Business Cycle, will cause greater investment in the productive sector as it seeks to make more things. Empirical support is offered by this paper for the ATBC, if it were required! Prof Skousen provides a very simple pedagogical approach to measure the entire production process to create a full picture of what goes on in the economy where all sectors activities are measured. This shows us how important prior production is before you even get to the consumption sector. This shows us that the consumption sector is not 70% of the economy but closer to 30%. This shows us that the desire to stimulate consumption over and above anything else is misguided. This means that our political masters and their court economists are looking at the economy with a partial eye patch on one eye and a cataract on the other. Surprised? I thought not. Legislators who read this site, please take note! You need to produce something to be able to consume something. You can’t consume something unless you have done, or someone else has done, some prior production of a good or service of some use to your fellow man. To be able to produce more things, we need to save, not spend on consumption. It was an axiom of Keynes, that final demand determined the level of prosperity in the economy. It is the exact opposite: production precedes consumption. Also, that whole productive sector of the economy dwarfs the size of the consumption sector 3:1. Policy makers should be putting all their efforts to removing barriers for wealth creation in that sector and encouraging savings. The German people seem to get this. The mercantilist policy of Keynes and his follows needs periodic refutation.  Like a Zombie waking up from the dead, it perpetually haunts our policy makers. Prof Skousen provides a rigorous statistical paper and methodology to help slay the Keynesian beast once more.

Reactions to Robert Peston's Documentary

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I’ve been really encouraged by the response to Robert Peston’s documentary, Britain’s Banks: Too Big to Save?. Lots of people are waking up to the problems at the core of our banking system, and like-minded campaigners are using the documentary to help spread the word. For the Adam Smith Institute, Sam Bowman wrote

There’s a big debate on the right at the moment about the banks: naturally, most of us are sympathetic with private businesses, but people like Toby are making the argument that British banks are so closely interwound with the state that they can be better understood as semi-state bodies than private firms. If banks cannot make significant losses without being bailed out by the taxpayer, is it appropriate to think of them as creatures of capitalism or of the state? I honestly don’t know, but it’s a debate we need to have if we’re to make the necessary structural changes to the regulatory system to avoid another Great Recession like the one we are (hopefully) crawling out of now.

Meanwhile, Josh Ryan-Collins at the New Economics Foundation expounded the benefits of a 100% reserve system:

An economy running on this kind of foundation should be less prone to pro-cyclical tendencies (boom and bust) and less inflationary (house price inflation in particular) than an economy based on fractional-reserve banking. And the enormous, tax-payer underwritten banks that currently monopolise credit creation would be bought back down to size, enabling greater competition and diversity in our banking sector.

Monetary reform is an idea that should appeal to people from all across the political spectrum. It is an idea whose time has come.

Gerzensee

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Somebody I know is doing a doctorate degree in economics. In Switzerland, all such candidates have to spend several months at Gerzensee, a luxurious manor house owned by SNB, where they are trained in monetary economics. It was at this training, where this picture was taken: image[1]

More Trouble Coming

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On Financial Sense Newshour this week Bill Laggner and Kevin Duffy, Co-Founders of Bearing Asset Management, join Jim Puplava for discussions about more trouble coming to the markets and economy.

http://www.netcastdaily.com/broadcast/fsn2010-1120-1.mp3

What can Business Learn from Academia: Fish, Hayek, Keynes and Oakeshott

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Having recently sold my food business, life is moving at a much slower pace, which gives time for thought and reflection before I undertake my next venture or ventures. One thought was: what did I learn from academia that I applied to my business dealings? I concluded that my behaviour was moved by my instinct and alertness to opportunity, and my ability to provide strategic leadership to people and give them vision. With my actions over the years I was always Hayekian in outlook. I could not say for sure if my reading of Hayek made me behave and structure my business as I did, or if I just did it because common sense always told me that local management, with profit and loss responsibility handed down to the smallest units possible, and as little reliance on the central head office function as possible, was the only way forward. In fact, to the day I sold, I never did have a head office. This perplexed bankers, accounts etc, but no one else. I also used to say to my people, “if the man from Mars (read: management consultant, banker, accountant, anyone who’s good at spreadsheets and sits at a desk) came down and looked at our business, he would say we are mad”. We would sometimes send three vehicles to deliver fish down the same road to different people at different times of the day — we should surely consolidate these deliveries, and send one vehicle only. Also, we would buy some of the same species of fish from all the ports of the land, indeed from all over the world, and but not consolidate our buying power. “You are mad”, the Martian would say, “you are running an inefficient business”. To this I’d respond that the proof is in the bottom line of the P&L. We made more money than any of our competitors, by far. So do not worry, I told my people, with reason and conviction I knew our approach was right. The Keynesian approach would be the opposite of the Hayekian, and would be just what my hypothetical man from Mars would advocate. The aggregation for efficiencies by central agents would have destroyed my business, as I saw happen with my major competitors once the spreadsheet whallas got involved. Dispersed knowledge, collected locally and applied intelligently, told us that our customers were prepared to pay more for very convenient just-in-time deliveries. Some of our customers opened up their business for a lunch service that required delivery early in the morning; others were evening service only. Some were open 24 hours; others were night only. So we catered to all, as opposed to saying “we are only in this area from time X to time Y, on such and such a day”. This meant vans going out 1/4 full and “inefficient”, but up to three times a day with a higher margin payload delivering up more profit. Dispersed knowledge, collected locally and dealt with intelligently, told us that buying wild-hunted local fish from various ports and harbours, and selling it locally having bought at different cost prices (rather than using our buying power to leverage the best deal with the cheapest central seller) actually meant we could sell fish to the local restaurant and hotel marketplace for more margin and hence more profit was delivered to the P&L. The aggregating and centralising “Keynesian” approach would have been the end for us. One influence that I must also add to this little reflective piece is Michael Oakeshott. His On Human Conduct has probably had more influence on me than Human Action by Mises. This being an economics-orientated web site, I think this is the first time I’ve mentioned the great political philosopher. Tradition, intimation, and latent knowledge and talent are often hard to observe. Cooking a recipe is following a simple set of instructions, just like cutting fish. Some of us can perform only moderately well (even with lots of training), and others, like Gordon Ramsey, outstandingly. This talent is latent and cannot be written down and copied. It can’t be rationalised. It is the aim of most of the world’s all-encompassing philosophies to be rationalistic in outlook. Applied to business, there were many skills I could not objectify that key members of my staff displayed. If they produced a profit, I left alone. This is not to say you should not always attempt to fully understand what is going on, and why people do things in certain ways; you always should. My Oakeshottian contribution was to exhaust this process of understanding, only gently change if it was deemed wrong by me, and love and cherish it if it was a little bit off piste and entrepreneurial. This is why my bottom line was always bigger than my competitors. Oakeshott famously criticised his LSE contemporary Hayek by saying that his political philosophy, as expounded in The Road to Serfdom, of less planning was just as much a rationalist ideology as the central planners he cautioned against, even if it may be a better approach. Irrationality, “quirkiness”, hidden skill, and entrepreneurial talent are all things that do not fit in the box. These I always sought to preserve and encourage in the business. So my rational leadership and vision was always tempered by respect for this insight of Oakeshott. This is also why I am a liberal philosophically, tempered with good doses of conservative wisdom and leanings.

Those Dishonest Goldsmiths

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My second beach reading has been the above named article. Like the last one I reviewed, this is written by one of the giants of the Austrian School, Prof George Selgin. You can download this paper in draft here. For anyone interested in the origins of modern banking, this paper should definitely be consulted. Prof Selgin challenges the conventional wisdom that the acts of some goldsmiths as they took in gold for safe keeping and issued out more claims, or promises, to redeem gold than there was gold in their vaults, was fraudulent. In a good bit of historical detective work, the Professor has dug up new references that would seem to show some of the following points, which may surprise some readers:

  1. Goldsmiths paid interest, so this implied that people knew that they were not engaging in an act of safekeeping, but were indeed entering into lending (client / depositor) and borrowing (the goldsmith / banker).
  2. The use of the word deposit was used to describe a deposit for safekeeping and a deposit for lending.
  3. There was case law well before Carr v Carr in 1811 that clearly established that if you deposited in a sealed bag, your money would be yours and stored for safekeeping only. If it was deposited loose, it would indeed be a act of lending, by the depositor, to the goldsmith.
  4. When I last read the case notes of Carr v Carr I do seem to remember that the bag was indeed sealed and earmarked, but the judge found that it was still a bank debt obligation as opposed to a safekeeping arrangement. Not being able to check sources from the beach, I would not say for certain that his was the case, however, I believe it was contra Selgin.
  5. The goldsmiths rejected the establishment of a state sponsored Bank of England. There was a smear campaign against goldsmiths to discredit them.
  6. The real angst against the Goldsmiths was that (i) they exported heavier and finer coin for export where it would fetch a better price and leaving the less valuable coin for the local population and (ii) they were usurious in the way they charged interest.
  7. After King Charles I’s theft of money deposited form safe keeping in the Mint, merchants placed money in the hands of corrupt servants who them embezzled funds with the knowing and or unknowing collaboration of some goldsmiths.

Other economists such as Jesus Heurta De Soto in his book, Money, Bank Credit and Economic Cycles, may well dispute this history as he has documented many counterexamples to support the usual notion that goldsmiths over-issued promissory notes to specie deposited. Anyway, does it matter to us today what happened in our history concerning this disputed issue? I say yes it does. Selgin’s work clearly shows us that there was confusion between the use of the term deposit. Some used it clearly to mean safekeeping and some lending. To me this begs the question, should banking be about a fiduciary arrangement of trust between parties, an enduring obligation of safekeeping and careful investment, or should it be about a straight forward commercial investment with risk to get reward? This today is still not clear for most depositors. Take the example of the Cobden Centre’s commission of a survey of 2,000 people. Here the majority think they own the money deposited and want to have safe and easy access. Most are confused that to have interest this means they have to lend it to bankers to invest, implying risk and reward. Confusion still reigns supreme in matters of banking. For my part, as Carswell and Baker have said in Parliament, we can help clear up this multi century confusion by defining a deposit for custody and deposit for lending. One is a enduring relationship of trust, the other a commercial relationship of profit and loss. I hold also, that with regards to bankers offering fractional reserve accounts, this is possible if the following is adhered to:

  1. Both parties know this is happening (i.e. the contract explicitly explains this),
  2. The bank receives the deposited money and makes you a timed depositor from an accounting perspective, for an agreed time period, thus making sure there is no maturity mismatch and no grant of legal privilege required to keep the bank solvent (i.e. it is forced to account like any other commercial entity).
  3. The depositor is offered “instant access” by exception only via the bank making available for redemption only the cash it has on hand and in its own equity funds. If a panic / run occurs, it can enforce a no redemption policy until the time deposit expires.

This way, you can begin to see a way of squaring the circle: having banks with full reserves, that a run could not be made against, that could not over issue bank credit, but only lend real timed savings, but would also allow a solvent “fractional reserve” type of account. Fiduciary and trust would be the bywords for the safekeeping and investment for the lending and paying of interest. Selgin’s work is a very interesting revisionist historical account of the foundation of modern banking and should be read by all interested in the subject area. The questions that arise from it are touched upon here by me. I urge you all to read if you have time as it may stimulate more and other thought processes.

Did Hayek and Robbins Deepen the Great Depression?

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I always love sitting on the beach in the Caribbean post Christmas, catching up with my neglected reading and getting lots of strange stares from fellow holiday makers looking at my book titles. “Oh, how interesting”, they politely comment, when what I know they want to say is “you weirdo!” Anyway, some of you readers may well appreciate … Caribbean Reading 1: Did Hayek and Robbins Deepen the Great Depression? This is written by Professor Lawrence (Larry) White, one of the leading Austrian School economists of his generation. His speciality is monetary theory and economic history. Little has been said of White on this site as I and a number of my fellow writers have many problems with his views on free banking, but as we have no corporate line at the Cobden Centre, we do have writers who have great sympathy with his views who are free to “big him up,” not to mention enthusiastic commentators who blog on our site with vigour! The article does what it says on the tin. It shows that Hayek and Robbins at the LSE in the 30′s did not have any policy application to the workings of the liquidationists in the Hoover administration. Indeed it becomes clear that the American administrations of the 30′s came under the direct influence of the Real Bills Doctrine before the Keynesian tidal wave swept all other forms of economics to the backwaters of remote and inhospitable places. The article is a great service to economic history. It the allows us to ask the question of ourselves as Austrian School sympathisers: in this Great Depression 2, what should we be advocating? White shows us that Hayek and Robbins in the 20′s would have supported a real deflation due to the great productivity increases in the key world economies at the time. Instead, more fiduciary media was created that caused the roaring 20′s boom that led to the bust of the late 20′s and 30′s. He goes on to show how Hayek, faced with the significant money deflation, advocated in his writings a policy of holding the money supply at it’s old level: the pre-bust level . The inflating of prices caused malinvestments and the deflating of it would cause unnecessary bankruptcies. In and ideal world, if wages and other key factors of production were flexible, a mild deflation would take place, prices would readjust, and we would soon get back to a productive economy. If they were not, we would spiral into a “secondary deflation.” This was akin to mass money hoarding and a Central bank could step in and provide cash for investment projects so that large parts of the productive structure would not be blown away. This would offset the irrational panic. Both Robbins and Hayek thought a mild deflation with a fully functioning free market would clear out the past excesses in a targeted way. They both thought that post Depression 1, the deflation was too severe and advocated a money creating process by the Central Bank to prop up industry. This has given a branch of modern day Austrian School, the Monetary Equilibrium School led by Selgin and White himself, the intellectual antecedents to develop out this theory further . Are we at the stage today when we need a Central Bank accommodative policy to avoid a secondary deflation ? As we have had real money supply contraction (when you look at cash notes, coins, and demand deposits and not timed deposits see Baxendale and Evans on money supply definitions here) would it be time to do this now? With what great wisdom does the Monetary Equilibrium School / Demand School come to be able to gauge when a good deflation turns into a bad ? Are we in a bad deflation yet? I can’t personally see how creating more money units to offset a demand to hold cash will achieve anything other than sowing of the seeds for the next credit induced boom. However, lets give money creation in these circumstances the benefit of the doubt and say “yes, it will make people feel more comfortable to know their bank will be more accommodating to their needs in personal and business life.” They then start to respond again and the old patterns of spending reboot themselves and the new additional money stays in circulation and bingo, we have a mini credit boom on our hands again with the massive distortion of the structure of production this implies. I would counsel anyone interested in this interpretation of Hayek’s work to look more closely at this line of thinking, as it is not far from being as dangerous as Bernanke’s own thoughts. I would encourage people to think about what gets in the way of prices resetting themselves, allowing employers to set flexible wage and working time policies in these circumstances, for example, may well be a far better policy for Austrians to pursue. Labour is invariably the most expensive part of the cost base of most firms and this does seem to sure-fire way of avoiding a secondary wipe out deflation. I would also look at advocating a money base fix so there could never be a deflation. Huerta De Soto advocates this in Chapter 9 of Money, Bank Credit and Economic Cycles, which you can download here. I have also advocated a similar approach, in layman’s terms, here. We can never know what Hayek and Robbins would be advocating today. Thanks to White’s essay, we do know what they did and did not advocate, and who was and was not listening to them in the first Great Depression. We do also know there are wide views across the modern Austrian School . I favour a “play it safe” approach, and do not think you can predict what the right or wrong level of demand for money is to offset with newly minted “counterfeit” money. There are ways to avoid deflation; a money base fix is described above . A freer market would of course prevent much of this happening anyway!