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Friday, January 30, 2009

Pragmatistism Primed: We Can't Know What Works

The goal of the pragmatist is to dispense with abstract principles in favor of brute action in an effort to do “what works”. I submit that there is another level of pragmatism that I will dub pragmatism “primed.”

Pragmatism primed consists of being so disintegrated intellectually that in addition to dispensing with principles in favor of that “which works” you dismiss the possibility of being able to determine if the action does indeed “work”. This is apparently what is happening to the auditors at the GAO who have been tasked with determining whether or not the “bailout” programs are working.

WASHINGTONWe may never know whether the government's $700 billion bailout of the financial industry worked, according to a new report from congressional auditors.

That's because it will be impossible to sort out which of the recent rule changes and spending programs have made a difference, according to the report released Friday by the Government Accountability Office.

…."Even with more time and better data, it will remain difficult to separate the impact of TARP activities from the effect of other economic forces," the report said.

Notwithstanding the fact that it can be proved that government intervention in the economy has caused the crisis and further intervention is exacerbating the crisis, you might think that the fact that the pragmatist auditors admit they can not know whether the “action” is working might give some pause to taking further action. Of course, not – it is reason to take more actions. In fact, their recommendation is to take action about determining whether the action is working. Let’s dub this type of action "meta-action" or “action about actions.”

"We continue to believe that additional action is needed to better ensure that all participating institutions are accountable for their use of program funds," the GAO said.

The report also said Treasury had "taken important steps" to address nine recommendations from the earlier report, which included calls to improve communication about the bailout and hire staff to oversee it.

But Treasury "has yet to fully address eight" of the recommendations, the report said.

"The lack of a clearly articulated vision has complicated Treasury's ability to effectively communicate to Congress, the financial markets, and the public on the benefits of TARP," the report said.

Should we wait for the meta-action to give us some data about the performance of these actions or at least wait for a "clearly articulated vision" before we take any more action?

Officials have been considering several programs, including a government-run "bad bank" that would buy up trouble assets clogging banks' balance sheets, and additional guarantees against losses like those granted to Bank of America and Citigroup. Additional capital injections also are possible.

Since these plans could cost more than the $350 billion remaining from the $700 billion bailout, Treasury may have to ask Congress for more money to help stabilize the financial system.

The administration also has said it plans to spend $50 billion to $100 billion of the remaining money to help homeowners facing foreclosure.

Administration officials said they expect an announcement on these plans sometime next week.

Well, they are going to wait a week. That is a lifetime for a pragmatist primed.

Wednesday, January 28, 2009

Just Do It

Quoting Yahoo News:

WASHINGTON – President Barack Obama met face-to-face Tuesday with congressional Republicans who have been chafing over parts of a $825 billion plan to pull the country out of recession, and he urged lawmakers to "keep politics to a minimum" and quickly approve the measure.

"The statistics every day underscore the urgency of the economic situation. The American people expect action," the new Democratic president said in brief remarks between private meetings with House and Senate Republicans at the Capitol. "I don't expect 100 percent agreement from my Republican colleagues, but I do hope that we can all put politics aside and do the American people's business right now."

Notice that in the current debate over the “stimulus” bill there is an underlying premise that “bi-partisanship” is good. In other words, if the two parties agree to something or anything then it is seen as “good”, but if the two sides argue and do not agree it is cast as “politics” or “partisanship” or “standing in the way of getting something ‘done’”. The presumption is that the actual action being debated is not actually relevant. It is just important that “something” get done. Under this theory, the real problem is that one side or the other is “ideological” and is standing in the way of getting this something done. Since the action being taken undoubtedly involves state expropriation of taxpayer wealth for the unearned benefit of others, a corollary of this theory is that state sanctioned theft is a natural and unquestionably necessary function of the state. Only an “ideologue” could stand in the way of this unquestionable “good”.

What philosophy could give rise to a situation in which the exasperation and frustration over a proposed government program relates not to the nature or virtues of the program but to the motives of anyone who question it? The answer is exactly what I have been posting about for months[1, 2]: the philosophy of Pragmatism.

Recall that to the pragmatist, ideology is not relevant. Obama has explicitly stated that he is "concerned with facts not ideology." In other words, he does not want to debate what is good or evil. He does not want to debate over individual rights, justice, or the role of government. He is not concerned with “why” this economic catastrophe has occurred or how this catastrophe is a logical consequence of the very actions he is proposing to take. He is not concerned with the long run consequences of these actions in terms of what effect it will have on the economy or what precedent it will set in terms of the role of government. This would require ideology or a set of principles derived logically from observation. The “facts” or "statistics" show that people are suffering NOW as the economy contracts. Businesses and individuals are losing money NOW. Equity prices are going down NOW. The pragmatist must act. If there is no money, create the money. If people are losing jobs, create jobs. Sure, there might be some disagreement but "the American people expect action."

An ideologue might argue that those who earn money have a right to it. They might tell you that it is immoral for the government to initiate force against businesses and individuals in order to take their earnings and redistribute them to those who have not earned them. Ideologues might demonstrate that the function of government is to protect the rights of those who earn wealth by punishing those who initiate force and that any initiation of force by the government against the productive is a fundamental inversion of its role and profoundly evil. Ideologues might prove to you that, in practice, the government is not productive so it can not create wealth – it can only spend it. Any dollar spent by the government is a dollar not spent or saved by someone else. Therefore they might prove how government is responsible for the current economic disaster and demonstrate that freedom not government is the solution.

To the pragmatist, this is all irrelevant. He must act. And how should he act if he has no ideology? He accepts the default philosophy of the culture: altruism and self-sacrifice are morally good and selfishness is evil. Therefore, to “act” means to act in a way that maximizes sacrifice and that reduces selfishness. For example, if some people are richer than others, they must be forced to give away some of their wealth to those who are poorer. If a corporation is seeking to profit, they must be throttled with taxes and regulations. But isn’t this an ideology? It is, but to the pragmatist minds of Obama, the academics, and the liberal media it is metaphysically given that altruism is the standard of morality. Anyone who would argue that wealth belongs to the person who earns it would be cast as a lunatic or worse – an “extremist”… gasp.

Even Republicans will not make this argument. Republicans make a “practical” argument that Obama’s plan is destined to failure which it is, however, they do not question the ethical premise underlying the proposal nor can they uphold a proper morality based on reason, self-interest, and individual rights. Thus, the Republicans "compromise" with the Left which means, instead of opposing the program on principle, they fight for say 10% less than otherwise while "me too-ing" the pragmatist-altruistic sentiment that they are acting bi-partisan, helping the poor, sticking it to the rich, etc. This pisses off the principled voters who backed Republicans because they bought their "less government" rhetoric and pisses off the Left who rightly see them as hypocrites who publicly proclaim sympthathy for the Left's ethical philosophy while trying to obstruct it politically. This is why the Republican's keep losing and the country keeps drifting Leftward.

Defenders of freedom and capitalism need to argue that partisanship is good. Ideology and principles do matter. We need to argue that Obama's ideology of non-ideololgy is profoundly wrong and is a smoke screen that obscures his underlying philosophy of altruism, collectivism and statism. Before we can argue for the right principles, we need to argue for principles!

Tuesday, January 27, 2009

Pssst, Over Here....I Got a Taxpayer Injection...

In the latest surreal development surrounding the so-called “bailout”, the First Pragmatist is aiming to curb lobbying for the loot:

The Obama administration on Tuesday will announce tough new restrictions on bailout funds aimed at curbing lobbying by companies that receive taxpayer injections.

In fact, the government has a plan that I have dubbed the “Government Plan Name So Ridiculous that Even Ayn Rand Could Not Have Dreamed of Satirizing It in Atlas Shrugged”:

The Treasury Department is announcing a new plan to “Keep Lobbying and Special Interest Influence Out of Emergency Economic Stabilization Act (EESA) Investment Decisions.”

Here are the first two mandates:

1. “Combat lobbyist influence in EESA process: We will implement safeguards to crack down on lobbyist influence over the program, including restricting contacts with lobbyists in connection with applications for, or disbursements of, EESA Funds.”

2. “Keeping politics out of funding decisions: We will ensure that political influence does not interfere with EESA decision making, using as a model for these protections the limits on political influence over tax matters.”

They want to keep “politics out of the funding decision”?!! In what sense is any aspect of this entire program not political?!! The premise of this program is delusional. I think Obama truly believes he is a deity of some sort sent to save us poor saps from ourselves. More likely, Obama sees himself as a Platonic Philosopher King able to know the true Form of Bailout and therefore determine what is good for the Republic. How else could you believe that you have the right to spend $850 Billion of money that is not yours?

With this in mind, He is going to “restrict contacts with lobbyists”. What form will that take exactly? Will they sequester the Congress and the Treasury Department, tap phones, or perhaps, set up a “contact free” perimeter around DC? Furthermore, who should decide who gets the loot? Shouldn't companies be allowed to make their case for why they should receive their share of the theft? Do we want a handful of Philosopher Kings deciding this behind closed doors?

I wonder if I should be restricted from writing about this? I will go to the Cave to ask.

Monday, January 26, 2009

Christ Would Not Have Run Up the Score

In a story that demonstrates the essence of religion and the ethical conflict that is destroying America:

The coach of a Texas high school basketball team that beat another team 100-0 was fired Sunday, the same day he sent an e-mail to a newspaper saying he will not apologize "for a wide-margin victory when my girls played with honor and integrity."

Kyle Queal, the headmaster for Covenant School, said in The Dallas Morning News online edition that he could not answer if the firing was a direct result of coach Micah Grimes' e-mail disagreeing with administrators who called the blowout "shameful."

...On its Web site last week, Covenant, a private Christian school, posted a statement regretting the outcome of its Jan. 13 shutout win over Dallas Academy. "It is shameful and an embarrassment that this happened. This clearly does not reflect a Christlike and honorable approach to competition," said the statement, signed by Queal and board chair Todd Doshier.

Grimes, who has been criticized for letting the game get so far out of hand, made it clear in the e-mail Sunday to the newspaper that he does not agree with his school's assessment. "In response to the statement posted on The Covenant School Web site, I do not agree with the apology or the notion that the Covenant School girls basketball team should feel embarrassed or ashamed," Grimes wrote in the e-mail, according to the newspaper. "We played the game as it was meant to be played. My values and my beliefs would not allow me to run up the score on any opponent, and it will not allow me to apologize for a wide-margin victory when my girls played with honor and integrity."

I agree with the administration that this win was not "Christlike". In fact, I would argue the whole notion of competition is not Christlike. The purpose of religion is not to be great at something "earthly" - it is to live a life of asceticism in glorious sacrifice to the almighty God. Would Jesus have played basketball with his disciples much less run up the score on them? The fundamental problem is not that the coach ran up the score - it is the attempt by the school to act out a contradiction. The contradiction lies in reconciling the Christian moral code of altruism with an activity that requires selfishness.

Every sport demands individual effort in pursuit of a goal: winning the competition. Each player seeks to improve his individual skills and ability to function effectively on the team. This is a highly selfish activity in that the individual seeks the pride of having achieved a goal in pursuit of individual and team excellence. The Christian moral code demands not selfish pride and individual happiness but self-abnegation and self-denial. Earthly pleasures are regarded by Christianity as sins of the flesh, and true glory is to be found by worshipping and sacrificing oneself to God.

Note that this inherent contradiction between the morality of sacrifice and the rational egoistic pursuit of happiness is at the root of a conflict that has torn America apart. On the surface, Americans have always admired success, and the cultural obsession with sports and competition reflects this. Yet, at the same time, the culture remains steeped in the morality of sacrifice. For example, what do the anti-trust statutes imply? They imply that if one is too successful at business he must be punished and must be forced to surrender his business to his inferiors. What do marginal tax rates imply? They imply that the more one earns, the more he must surrender to those who have not earned it. Altruism is the basis for the popular socialist principle: "From each according to ability, to each according to need."

Under the morality of altruism, this coach got exactly what he deserved for being excellent at his job and playing with "honor and integrity." He got fired.

Saturday, January 24, 2009

Congratulations, Mr. Pragmatist

In previous posts [1], I have claimed that Obama is a prototype of the philosophical pragmatist and at the dawn of his self-declared "new era of responsibility" I would like to follow up to illustrate how this philosophy is playing out in practice. Again, the essence of pragmatism is the rejection of principles in principle. Quoting Ayn Rand:

A principle is “a fundamental, primary, or general truth, on which other truths depend.” Thus a principle is an abstraction which subsumes a great number of concretes. It is only by means of principles that one can set one’s long-range goals and evaluate the concrete alternatives of any given moment. It is only principles that enable a man to plan his future and to achieve it.
To disagree with a principle or an ideology for a specific reason or fact is one thing, but to reject principles or "ideology" as such is to reject the human method of cognition and reduce man to the state of an animal. Such a mind rejects the possibility of truth and mindlessly clamors for "practicality" and "compromise". Quoting Ayn Rand again:

...To make it more grotesque, that haggling is accompanied by an aura of hysterical self-righteousness, in the form of belligerent assertions that one must compromise with anybody on anything (except on the tenet that one must compromise) and by panicky appeals to “practicality.”
The desire to "compromise with anybody on anything" is the hallmark of the pragmatist and such a desire necessitates contradiction. Consider the following foreign policy statement from Obama quoted in this article:

“Let me be clear: America is committed to Israel’s security and we will always support Israel’s right to defend itself against legitimate threats,” Mr Obama said.

First note that he offers a bold "Let me be clear" as if he is going to clarify his position. He then states that we are "committed to Israel's security" and "support Israel's right to defend itself." Now to implement such a policy in principle would entail a certain logical progression. In other words, such a policy would entail defining "legitimate threat" and then supporting Israel if it were to defend itself from such a threat. In the present case, Israel means to defend itself from Hamas which is a brutally repressive military regime which barbarically slaughters it's own people, states in its charter its intention to destroy the state of Israel, and routinely launches rockets at Israel from Gaza. Wouldn't that constitute a "legitimate threat" and therefore justify Israel's invasion of the territory? Quoting the same article:

But in comments referring to the Gaza conflict he added: “I was deeply concernedby the loss of Palestinian and Israeli life in recent days and by the substantial suffering and humanitarian needs in Gaza. Our hearts go out to Palestinian civilians who are in need of immediate food, clean water, and basic medical care, and who’ve faced suffocating poverty for far too long.”

He called on Arab governments to “act on” the promise of a Saudi-led 2002 Arab peace initiative by supporting the Palestinian Authority headed by President Mahmoud Abbas “taking steps towards normalising relations with Israel, and by standing up to extremism that threatens us all.”

Supporting Israel would mean decrying the loss of Israeli life and blaming Hamas for all the deaths that have resulted since Hamas' actions necessitated the invasion. In fact, the Palestinian "civilians" are the one's who elected Hamas as their leaders! Were American's concerned about German or Japanese "civilians" in World War II? This statement is a blatant contradiction. He attempts to sanction Israel's defensive actions while at the same time he undermines them by referencing his own emotional reaction to the logical consequences of the action. But, of course, to the pragmatist there is no contradiction. The concept of contradiction implies the concept of objective truth. If nothing can be really true, then how can any one claim contradict any other claim?

Israel upholds the rule of law and recognizes basic individual rights and therefore represents a bastion of western civilization amidst the barbarism which pervades most of the middle east. Israel can not "compromise" with regimes that do not recognize its right to exist and brazenly call for its annihilation. A regime that does not respect the rights of its own people can not be trusted to respect the rights of other nations.

However, as a pragmatist, Obama must act. What should he do? Should he recognize the objective distinction between Israel and her enemies and relate the interests of Israel to the objective interests of the United States which you think might include freedom and individual rights? Of course not. There is no objective truth. No "culture" is better than any other. He is "not concerned with ideology but with facts." He seeks "peace" - without ever understanding what peace actually means.

Objectively, "peace" is a state or condition that exists in the absence of war but it can not mean simply the momentary cessation of hostilities. If this were the case, every time soldiers stopped shooting it would be considered a state of "peace". "Peace" also implies "harmonious relations" or "freedom from dispute" which implies a long term political resolution based on two governments recognizing the right of the other to exist and respecting each others territorial boundaries. This does not mean you necessarily agree with everything the other country does, but it does imply a certain fundamental relationship between the two parties.

Based on this fact, how can there be "peace" between Israel and Hamas if Hamas is dedicated to the destruction of the Israeli state and the imposition of Islamic law? The pragmatist can not think in such terms. "Peace" to the pragmatist means absence of fighting right now. Therefore, the goal must be to get the parties to stop fighting - at any cost. Logically, since Israel is stronger militarily, Obama must ask Israel to sacrifice itself to its enemies in order to achieve "peace". After all, if Israel were to continue to destroy its enemies it will result in death and that must stop right now. Won't stopping the fight now allow Hamas to regain its strength and lead to further attacks on Israel in the future leading to even more death in the long run not only of Palestinians but of our Israeli allies? Of course, but Obama must be pragmatic.

I think there is another element to Obama's pragmatism which explains his contradictory policy. An important aspect of pragmatism is that it is a philosophy of nothing. It rejects principles per se. Therefore, a practitioner of pragmatism accepts ethical premises from the prevailing culture amounting to a default philosophy which underlies the direction in which the "action" takes place. Obama's default position is liberation theology or Christian Marxism and this implies that he must side with the Palestinians. Why? Note the reference in his statement to the Palestinian civilians "who’ve faced suffocating poverty for far too long." Notice he states this as if it is simply a natural fact without cause and without any attribution of responsibility to the Palestinians themselves. Israel is strong and capitalistic (relatively speaking of course) and the Palestinians are weak. Poverty anywhere is a form of social injustice which can only be explained by Marxist exploitation theory, i.e., the "rich" abusing the poor. Quoting wikipedia:
Liberation theology is a school of theology within Christianity, particularly in the Roman Catholic Church. It emphasises the Christian mission to bring justice to the poor and oppressed, particularly through political activism. Its theologians consider sin the root source of poverty, recognizing sin as capitalism, and capitalism as class war by the rich against the poor.
Notice the reoccurring pattern of Muslim attacks on Israel followed by a military response followed by calls for "peace" and "compromise" followed by attacks, etc. The whole basis of Obama's approach to foreign policy is based on the idea that there is no objective distinction between good and evil. This is why he claims he will negotiate with Iran and why his first call to a foreign leader as President was to Palestinian President Abbas allegedly "to make good on his promise of 'ushering in a new era of peace'".

I'm sure this will lead to an "era of peace" in the same sense that 1938 and 1939 were an era of peace for Britain after Chamberlain ceded the Sudetenland to the Nazis.

Friday, January 23, 2009

Costanza Theory

In an episode of Seinfeld, Jerry’s hapless friend, George Costanza, decides that to change his life around, he will simply do the opposite of whatever he normally would have done. So, for example, in an encounter with an attractive woman in a restaurant, rather than lie, he tells her that he is unemployed and lives with his parents to which the surprised woman responds with immediate arousal. George discovers that, for him, the secret to success is doing “the opposite.”

Based on the pattern identified in my previous post Bizzaro World, I now suggest that the government immediately adopt Costanza Theory in dealing with the nation’s economy and foreign policy.

For example, if the government ordinarily would be inclined to stimulate the economy by spending money, it should instead attempt to save money. If the government is inclined to increase taxes, it should lower them. If the government is inclined to increase regulation in any sphere of the economy, it should reduce regulations and so on. With respect to foreign policy, if the government ordinarily would “negotiate” with our enemy it should refuse to speak to them. If it is inclined to retreat in a war, it should immediately attack. Even at the risk of the American government attacking Canada or the United Kingdom, I think the benefit that we annihilate a country like Iran and secure Western civilization far outweighs the risks.

I really believe that if the current government simply did “the opposite” of everything it normally does – we could have a utopia on earth.


Quoting this article:

"I don't think we will live the same way for 10 years," says Howard Davidowitz, chairman of New York-based retail consultant and investment bank Davidowitz & Associates. "People are so scared they're starting to save."

Oh my god no! Saving!!!! Ahhhh!!!

Thursday, January 22, 2009

Houses Are Not Investments

As Dr. Reisman has pointed out in Capitalism and in his recent post, houses should not be regarded as investments. Houses are depreciating consumer goods although the rate of depreciation is slower than many consumer goods. So why do people regard houses as investments and often see equity in their home as a primary savings vehicle? Quoting Dr. Reisman:

Only decades of inflation and credit expansion could make it possible for people to think of the houses they occupy as an investment. In reality, a house is a consumers’ good, just like an automobile or a refrigerator. The only difference is that it depreciates more slowly than they do. Only a long string of years in which inflation took place more rapidly than houses depreciated enabled their prices to rise every year and people to come to regard them as a source of financial gain. If not for inflation and the rise in prices that it produces, it would be very clear that housing is a wasting asset, a slowly wasting asset to be sure, but a wasting asset nonetheless.

As this chart shows, when you express the price of a house in terms of another real asset like gold (as opposed to government dollars), you can see that the price of houses is currently the same price as it was in 1900. The house itself depreciates and the land should stay about even with gold so this chart is about what you would expect.

Another way in which the government fuels the illusion that housing is an investment is by effectively subsidizing the real estate market. It does this in two primary ways.

One way it does this is through FNMA, FHLMA, and GNMA (Fannie Mae, Freddie Mac and Ginnie Mae as they are popularly called) which underwrite pools of mortgage loans. In other words, mortgage banks can sell pools of mortgages to these companies who are tacitly supported by the federal government. This means that mortgage banks are more likely to lend than they otherwise would be if they were on the hook.

The second way is through the mortgage tax deduction. This deduction allows one to deduct mortgage interest against their taxable income. This creates the illusion that the home owner is getting a discount on their mortgage. However, I would argue that all it does is raise home prices so that you are no better off. For example, imagine that the government gave everyone a pizza subsidy. At first, you might pay $2 for pizza that originally cost $3. However, this subsidy would increase aggregate demand for pizza and ultimately the cost of pizza would rise to say $4. Then with your $1 subsidy, pizza would again cost $3 so that you are no better off. In housing, this tax deduction enables people to buy more house than otherwise so it increases aggregate demand for housing. I believe this generally has increased the price level of houses more than otherwise so that the mortgage deduction is actually a facade in terms of real savings.

In all, the government policy of inflation and housing subsidies has created a situation in which a large portion of our nations' savings has been poured into the equivalent of refrigerators. The world is now beginning to realize the consequences of this mistake.

Tuesday, January 20, 2009

Inaugurating the Principle of Unprincipled

"There is no doubt that any policies I implement will be based on the economic situation I inherit from George Bush - ...as a manager of the economy you should base your decisions on facts not ideology - so even if I am predisposed to a certain set of policies I will want to see what's going on at the moment and ask a wide range of viewpoints from business leaders...some of these [tax increases] you could possibly defer..." - Barack Obama
The quotes in these links capture the essence of modern philosophy and therefore represent everything that is wrong with American politics...

The above is an excerpt from my June 2008 post, The Pragmatist Fascist vs. the Principled Fascist, in which I attempted to philosophically distinguish the two presidential candidates. On the day of Obama's inauguration, I am linking back to that post because I think it is relevant in helping to understand the current president's ideology of non-ideology and therefore in forecasting what he is likely to do. I hold that Obama's default position from the nothingness of pragmatism is liberation theology or Christian Marxism which I previously discussed here.

Friday, January 16, 2009

Bizarro World

In the DC comic universe, there exists a place called Bizarro world.

In the Bizarro world of "Htrae" ("Earth" spelled backwards), society is ruled by the Bizarro Code which states "Us do opposite of all Earthly things! Us hate beauty! Us love ugliness! Is big crime to make anything perfect on Bizarro World!".

I believe that without knowing it, we have somehow all moved to Bizarro world.

The United States government is trillions of dollars in debt so it is proposing to spend $850 Billion.

The government wants to pass a “stimulus” package but it is threatening to repeal tax breaks for banks and reinstate the estate tax .

And amidst bone chilling temperatures and scientific evidence pointing to a new ice age (also, see my previous post), the Congress wants to pass a bill to prevent global warming.

Fortunately, the incoming president whose policies are based on Keynesian economics, Marxism, and religion has adopted the motto "Change" to describe his presidency.

I am going to continue writing now.

Thursday, January 15, 2009

Tales From The History of Money and Banking Part 1

There are many books on the history of money and banking, philosophy and economics but very few if any that integrate these concepts together to show how essential the concept of money is to civilization. The lack of integration directly follows from the disastrous state of the economics profession and of modern philosophy. The result is that most people are left without any understanding of the fundamental economic or philosophical ideas needed to combat the government's assault on money.

As we are yet again experiencing first hand, the current socialized system of fiat money and fractional reserve banking is immoral in principle and a complete and utter disaster in practice in the same way and for the same reasons that any form of socialism is immoral and disastrous. Despite the destruction wrought by socialized money, fiat money and fractional reserve banking is taken as the metaphysically given and hardly questioned even by professional economists. What I would like to begin doing in this blog is to integrate the history, economics and philosophy of money and banking but in a way that makes the basic concepts intelligible to the non-economist and non-philosopher. I am not going to do this in an organized way but will post periodically and at some point maybe try and tie the ideas together in a more organized fashion with a view towards formally publishing. So please comment away and help lead me in the right direction.

In this post, I am going to focus on the history and meaning of fractional-reserve banking and distinguish the concept of storing money somewhere with the concept of lending money to someone. These are two distinct concepts legally and practically, however, today's banks package these practices together in a way that I claim is inherently fraudulent and based on some terrible common law legal precedents from the 19th century.

The reason I am starting with this is that it sets the stage for understanding the various economic crises that occurred, particularly in the 19th century, when the U.S. was actually on some form of a gold standard. As we will see in future articles, these economic crises would not have occurred under a gold standard if the government had served its proper role in enforcing banks' contractual obligations to redeem in specie (gold or silver) and to properly safeguard assets entrusted per the deposit contract. In turn, these panics, recessions, and depressions that were caused by the government led to more government intervention ultimately resulting in the complete nationalization of the money supply and banking system in 1913 in the form of the Federal Reserve system which haunts us to the present day.

To start, let me define "fractional-reserve banking". Fractional-reserve banking is the banking practice of only holding a fraction of your customers deposits and lending out the balance while simultaneously maintaining an obligation to redeem all deposits on demand (if that sounds contradictory it is). Fractional reserve banking has been around in essence for centuries. Even when notes were redeemable in gold, many banks practiced fractional reserve banking by lending out their customers gold and keeping a little bit around in case someone came asking for it (and they hoped that a lot of customers didn't come asking for it...). Today, banks are required by law to keep about 10% of their deposits on "reserve" at a Federal Reserve bank. In other words, they claim that you can withdrawal all of your money at any time but they don't really have it all because they loan it out. So, if all the customers showed up at the same time and asked for their money, the bank would collapse. To understand fractional reserve banking better, it's important to discuss the history of the fundamental legal issues underlying deposit contracts and loan contracts and to trace how fractional reserve banking involves a bastardization of the two entirely distinct legal and business concepts.

If you wanted to store a bike for the winter but didn't have storage space you might consider renting a garage somewhere. You would find a place that rents space and pay them a fee to store and safeguard your bike there. The contract is rather straightforward in the sense that you are placing your property in someone's safekeeping but at no point would you consider transferring direct title to the bike to the garage owner, i.e., you still own the bike even though you are storing it on someone else's property. More importantly, the act of placing your bike in safekeeping does not imply that the garage owner takes title to your bike. At any time, you would expect to be able to show up at the garage and get your bike, right? This type of transaction is known as a "bailment" in the sense that you are hiring someone to safeguard your stuff. The contract is known as a "regular deposit" contract.

The situation gets a little more complicated when you have "fungible" goods. Fungible goods are things like grain, gold, or jelly beans that all look alike when you put them in a big pile. If a bunch of people want to store their grain in one place, often they will just pool the like grain together in a big pile and when you want your "share" of the grain you deposited earlier you show up and they just give you that amount of grain. There is no practical way the storage place could figure out exactly what pebbles of grain were yours and you really wouldn't care as long as you got the same amount you deposited of the same quality. The quantity that you are owed has the fancy legal name "tantundem" and this type of contract is known as an "irregular deposit" contract.

Notice that the principle is exactly the same in the case of a regular deposit contract and an irregular deposit contract. You are storing a good whether it be something specific like a bike or something fungible like gold (money) and you expect the safe keeper to maintain possession of your property at all times

These two types of contracts should be distinguished from the "loan" contract. In a loan contract, you transfer legal ownership of something like money to someone else and allow them to use it in any way they wish (or in a way specified in the contract). In this case, you are transferring title to someone else in exchange for future goods specified in the contract such as the amount of money plus interest

You can see that these transactions are based on two very distinct concepts. In one case, you actually pay someone a fee to perform the service of safekeeping. In the other case, you transfer ownership of property in the present in exchange for future goods, i.e., for payment in the future.

Now, let's say that a garage owner from our example above has a bunch of people store their
bikes with him for safe keeping, and he gives each of the bike owners a piece of paper that entitles them to come and pick up their bike. He notices that these bike receipts can be used by the bike owners to buy other things. For example, he observes that a bike owner who wanted to buy a sofa simply traded his bike receipt to the sofa owner. He knows that the sofa owner could take the bike receipt to his garage and demand the bike, but since he doesn't expect all the bike owners to show up for their bikes at the same time he gets an idea. He prints up more bike tickets than he has bikes and trades them for things or loans the tickets to others. People happily accept the bike tickets in a trade because they expect that they can get the bike anytime they want. And since people trust that the bikes are at the garage, very few people actually show up to get the bike. So the garage owner prints even more tickets and buys even more things and lends to even more people. This is great. The local economy booms as the garage owner purchases more and more things resulting in large bike ticket revenue for other local merchants and the persons which borrowed tickets purchase things. At some point, one or two of the merchants go to get the bikes. At first, the garage owner is fine. But as more nervous people show up, the bikes begin to disappear until they are all gone. At some point, since there are more tickets than bikes, the garage owner will not be able to make good on his obligation to redeem the tickets in bikes and he goes bankrupt along with his customers.

Should the garage owner's actions be considered fraudulent in that he misappropriated assets that were entrusted to him by virtue of a deposit contract and issued tickets for assets that did not actually exist? Furthermore, what if the government not only refused to prosecute the garage owner but allowed him to "suspend" bike redemption? Wouldn't the government's action encourage more and more garage owners to misappropriate their clients assets if they believed that the government would not enforce the redeemability of the receipt tickets?

It's important to point out that historically (and logically), the activity of deposit and loan were conducted as two separate businesses. The business of warehousing goods dates back at least to Ancient Greece and Egypt. De Soto[1] analyzes the writing of a Greek named Isocrates from 393 B.C. in which he discusses a case of misappropriation by a banker of a customer's deposit. De Soto discusses the implications of the case:

It is therefore clear that in Greek banking, as Isocrates indicates in his speech, bankers who received money for safekeeping and custody were obliged to safeguard it by keeping it available to their clients. For this reason, it was considered fraud to employ that money for their own uses.
The history of misappropriation of deposits made under the principle of irregular deposit contracts has a sordid history from Ancient Greece through the 20th century. In other words, since customers rarely needed all of their gold (or whatever fungible good was being stored), the safe keeper was tempted to loan it out to make "extra" money. As long as the customers didn't all show up at the same time he was safe. But as soon as rumor started and customers began demanding their property (a classic run on the bank), it was soon discovered that the goods were not all there and disaster ensued.

A notable exception was the Bank of Amsterdam for about 150 years from 1609 to the 1790's. The Bank of Amsterdam literally maintained almost a 100% reserve ratio (kept 100% of all the customer deposits) for 150 years. Quoting De Soto[1]:

It was founded after a period of great monetary chaos and fraudulent (fractional-reserve) private banking. Intended to put an end to this state of affairs and restore order to the financial relations, the Bank of Amsterdam began operating on January 31, 1609 and was called the Bank of Exchange. The hallmark of the Bank of Amsterdam was its commitment, from the time of its creation, to the universal legal principles governing the monetary irregular-deposit. More specifically, it was founded upon the principle that the obligation of the depository bank in the monetary irregular-deposit contract consists of maintaining the constant availability of the tantundem in favor of the depositor; that is, maintaining at all times a 100-percent reserve ratio with respect do "demand" deposits. This measure was intended to ensure legitimate banking and prevent the abuses and bank failures which had historically occurred in all countries where the state had not only not bothered to prohibit and declare illegal the misappropriation of money on demand deposit in banks, but on the contrary, had usually ended up granting bankers all sorts of privilege's and licenses to allow their fraudulent operation, in exchange for the opportunity to take fiscal advantage of them.
The committment by the Bank of Amsterdam to a 100% reserve ratio allowed it to satisfy every request for withdrawal in any manner of crisis that arose. Quoting De Soto[1]: "Increasing and lasting confidence in its soundess resulted, and the Bank of Amsterdam became an oject of admiration for the civilized economic world of the time" [1].

The Bank of Amsterdam led to the creation of the Bank of Stockholm in 1656 which divided itself into two separate departments: one for safekeeping assets and one for loans. Again, these practices are and were considered to be two separate activities. However, although they were supposed to function independently of one another, the Bank of Stockholm violated the separation and it was nationalized in 1668 by the Swedish government. Quoting De Soto[1]:

Not only did it violate the traditional principles which guided the Bank of Amsterdam, but it also initiated a new fraudulent and systematic practices: the issuance of banknotes or deposit receipts for a sum higher than actual deposits received in cash. This is how banknotes were born, along with the lucrative practice of issuing them for a higher amount than the total of deposits. Over time, this activity would become the banking practice par excellence, especially in the centuries that followed, during which it deceived scholars, who failed to realize that the issuance of banknotes had the same repercussions as artificial credit expansion and deposit creation.
The disatrous Bank of England was created in 1694 to help finance public expenditures In the wake of a half century of expensive wars that left England desperate for funds but unable to suck any more tax revenue out of its subjects. Rothbard discusses the details of the creation of The Bank of England [2]:

The Bank of England promptly issued the enormous sum of L760,000, most of which ws used to buy government debt. This had an immediate and considerably inflationary effect, and in the short span of two years, the Bank of England was insolvent after a bank run, an insolvency gleefully abetted by its competitors, the private goldsmiths, who were happy to return to it the swollen Bank of England notes for redemption in specie.

It was at this point that a fateful decison was made, one which set a grave and mischievious precedent for both British and American banking. In May 1696, the English government simply allowed the Bank of England to suspend specie payment -that is, to refuse to pay its contractual obligation of redeeming its notes in gold- yet to continue in operation, issuing notes and enforcing payments upon its own debtors. The Bank of England suspended specie payment, and its notes prompty fell to a 20 percent discount against specie, since no one knew if the Bank would ever resume payment in gold.

The straits of the Bank of England were shown in an account submitted a the end of 1696, when its notes outstanding were L765,000 backed by only L36,000 in cash. In those days, few noteholders were willing to sit still and hold notes when there was such a low fraction of cash.

Specie payments resumed two years later, but the rest of the early history of the Bank of England was a shameful record of periodic suspensions of specie payment, despite an ever-increasing set of special privileges conferred upon it by the British government.

The reason this is significant is as De Soto[1] explains "This was the dawn of the modern banking system, based on a fractional-reserve ratio and a central bank as lender of last resort."

In the next part, I will discuss various 19th century crises that occured in the United States as a result of fractional reserve banking compounded by the government's suspension of specie redemption, and I will discuss several seminal court cases in the 19th century which ultimately established the "legality" of fractional reserve banking by removing the distinction between the deposit and loan contract.

[1] Money, Bank Credit, and Economic Cycles, Jesus Huerta De Soto

[2] The Mystery of Money and Banking, Murray N. Rothbard

Sunday, January 11, 2009

Keeping Iran Nukes in "View"

While the Bush administration is aggressively destroying the nation's economy on the home front, it is ignominiously retreating on a second front: the so-called war in the middle east. The New York Times reports that the administration denied aid for an Israeli raid on an Iranian nuclear site.

Given that Iran is to Islamic fundamentalism what Germany was to Nazism, you might think that Bush would have some interest in neutralizing its nuclear program before it can produce a bomb. Apparently not. You might think Bush would have an interest in neutralizing its direct finance and support of terrorism against Israel, America and our Western allies and its support of the insurgency in Iraq. No. You might think that if Bush is not willing to fight Iran then at least it might be willing to aid the Israeli's by giving in to its requests for bunker busting bombs. Sorry. Well, if we are not going to fight Iran, and we are not going to directly assist the Israeli's with weapons, at the very least you would expect Bush to allow the Israeli's to fly through Iraqi airspace to prevent the greatest terrorist nation in the world from obtaining nuclear weapons - airspace that has cost the lives of thousands of U.S. military personnel and hundreds of billions of taxpayer dollars in our so-called war on terrorism? Nope.

Why? According to the article, the reasons were as follows:
The interviews also indicate that Bush was convinced by top administration officials, led by Defense Secretary Robert M. Gates, that any overt attack on Iran would probably prove ineffective, lead to the expulsion of international inspectors and drive Iran's nuclear effort further out of view. Bush and his aides also discussed the possibility that an airstrike could ignite a broad Middle East war in which America's 140,000 troops in Iraq would inevitably become involved.
First, why would we need "international inspectors" if we wiped out their nuclear program and annihilated the regime which oversees it? Isn't the goal to drive Iran's nuclear effort "out of view" by destroying it? Wouldn't keeping it in "view" imply that they would continue to build nuclear plants? Is our goal to have inspectors watch the Iranians build a nuclear power plant or is it to prevent them from building the bomb? If we thought that the Iranians had the means to hide their nuclear program, then doesn't that imply that we should focus on annihilating the source of the problem and breaking their will to fight us? In other words, wouldn't that be an argument for even more aggressive action than the Israelis are even proposing? Didn't we attack Iraq because we suspected they might some day build a nuclear weapon yet we will not even aid our ally's attempt to eradicate one of the most direct and real threats that is happening in "view"?

Second, doesn't the entire history of appeasement glaringly demonstrate that ignoring an enemy to avoid becoming "inevitably involved" in the short run will inevitably lead to greater losses in the long run?

Well, Bush has a plan. I should say a "covert" plan. You see, as the New York Times reports (shhhhhh), this "covert" plan is designed to "subtly sabotage" the Iranian nuclear program. OK -- deep breath -- first, I don't think the plan is real covert anymore. Second, if you have the greatest military in world history sitting on the doorstep of the enemy, how about OVERTLY sabotaging the nuclear program with some bunker busting bombs?

I guess Bush just wants to focus on the economy.

Friday, January 9, 2009

Cargo Cult Economics

In a chapter of Nobel prize winning physicist Richard Feynman's book Surely You're Joking Mr. Feynman! he discusses junk science and relates it to a tribal phenomena known as the cargo cult.
In the South Seas there is a cargo cult of people. During the war they saw airplanes land with lots of good materials, and they want the same thing to happen now. So they've arranged to imitate things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head like headphones and bars of bamboo sticking out like antennas--he's the controller--and they wait for the airplanes to land. They're doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn't work. No airplanes land. So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they're missing something essential, because the planes don't land.
In other words, rather than understanding and initiating the fundamental cause of some effect the cargo cult imitates the form of the causal process in the hope that it will bring them the actual effect. In this case, the islanders created an imitation airport in the hopes that it would result in actual goods being brought by airplanes. In the same way, Keynesian economists can be thought of as cargo cult economists.

Everywhere we hear the Keynesian doctrine that in order to restore economic prosperity, we must encourage spending. If only people would spend we would be OK. The Fed is lowering interest rates to zero in order to encourage lending. Obama is proposing to spend hundreds of billions of dollars to "restore" economic growth. Naturally, the money for these programs will be created out of thin air by the Federal Reserve when it purchases Treasury securities with fake money.

In a simple barter economy, you would not think to offer nothing for a good that you desire. You would offer something that you own or have created. In reality, nothing changes when you introduce a medium of exchange (money) in order to simplify transactions. In order to actually spend money, you must produce something and offer it as a value for a value. In other words, spending or "demand" is a consequence of production. Your demand is your supply which is in essence
Say's Law.

Notice that the cargo cult economists try and imitate the form of a valid economic transaction by advocating the creation and expansion of paper money. When the government prints paper money and offers the paper dollars for goods and services, it appears that someone has produced wealth and is exchanging it for an equal value. After all, in the past, when the paper was backed by real wealth (gold), it was observed that there was a lot of paper money around. So, just as the cargo cults fabricated control towers and runways in the hope that it would bring real goods, the cargo cult economists believe that by creating paper money with fancy ink and stamping a large number on it, wealth will result. But just as the "planes don't land" for the islanders, creating paper money does not create goods.

I must go now. I created a cardboard gas pump, and I'm going to check to see if gas appeared yet.

Tuesday, January 6, 2009

In the Long Run, Keynes is Not Dead

To counter the argument that inflationary policies are destructive in the long run, John Maynard Keynes famously quipped that “in the long run, we will all be dead.” Unfortunately, the only person who will not die is Keynes and his disastrous economic theories. An article recently appeared on the front page of the Wall Street Journal entitled Hard-Hit Families Finally Start Saving, Aggravating Nation's Economic Woes immediately implying the utterly absurd notion that "savings" somehow hurts the economy. Quoting the article:

Usually, frugality is good for individuals and for the economy. Savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation's standard of living. But in a recession, increased saving -- or its flip side, decreased spending -- can exacerbate the economy's woes. It's what economists call the "paradox of thrift."

Of course, this is hardly a "paradox." When someone goes to the bank for a loan to buy a house, a car, etc. where does the money come from for this loan? So spending on anything other than inexpensive consumer items like soap and shampoo depends largely on the savings of others. Second, savings provides the capital necessary to fund productive expenditures which of course lead to greater productivity, increased real wages, and consequently higher living standards.

The catastrophic boom bust cycle which creates the phenomena discussed in the article is caused by government led credit expansion. In the "boom" phase, the government does everything in its power to decrease saving primarily by inducing illiquidity, i.e., as prices rise and credit is widely and easily available, firms and consumers tend to hold smaller cash balances. This induces individuals to consume as opposed to save (see the chart in the WSJ article of changes in personal consumption) and creates malinvestment throughout the economy as capital flows to businesses that momentarily appear to be profitable. When the supply of new money is subsequently reduced by the government (mostly to avoid hyperinflation) many businesses will fail as consumers stop spending money and retrench, i.e., are forced to rebuild their liquidity. In the short run, as the economy contracts in the wake of a bust it is true that many businesses will fail. But this effect is not caused by savings. It is caused by government credit expansion which led to over consumption and malinvestment in the first place. Ironically, it is savings that will come to the rescue. During a recession, as firms and individuals rebuild their liquidity (by saving more and spending less) prices and wages decline, profitability is restored and real wages can begin to increase.

We have been down the road of consumption vs. savings before (see my previous post Production and the Primacy of Existence.) Note that Dr. Reisman specifically addresses Keynes and the "paradox of thrift" in his treatise Capitalism in Chapter 18 Keynesianism: A Critique” specifically in Section 3 Critique of the “Paradox of Thrift” Doctrine p. 884. In this section, he discusses the more general argument but also refutes some more technical arguments that would appeal more to advanced students of economics.

Finally, for entertainment and educational value read the following research report published in November of 1934 by the American Institute for Economic Research. It could have been written yesterday. See especially the authors sarcastic reference to America's "unofficial English advisor, Dr. John Maynard Keynes." All of their reports are archived here. It's amazing how little has changed or been learned in the economics profession in 80 years.

Monday, January 5, 2009

Government Roads and State Pizza

After my last post, Monica commented:

It doesn't seem that obvious to me that our road conditions are a manifestation of socialism. I think most government interference is very evident, though, for rational people who know about any given industry.

I think she meant that it is hard for people with bad or no philosophy to see obvious flaws in government programs or state run monopolies which is absolutely true. I find that the sentiment that a nationalized business is fine or not obviously bad is very common, and it leads to a crucial principle. This essential principle was explained by Henry Hazlitt in his famous book Economics In One Lesson (which is an absolute must read and which echoes the same point made much earlier by the 19th century economist Frederic Bastiat) which is that people often only consider the direct result of an action and do not consider the action that did NOT occur. Hazlitt uses this principle to examine dozens of common economic fallacies.

For example, he starts with an example of someone who throws a brick through a store window which causes the store owner to replace the window with glass. Observers witnessing this conclude that throwing bricks through windows is "good" for the economy since it added revenue to the glass maker's business. Of course, if the store owner had NOT had to spend the money on new glass he would have spent the money somewhere else. So the glass makers benefit was the store owner's (and other businessman's) loss. There is no "net gain" to the economy from throwing bricks through windows. If you think this example is ridiculous, how many people claim that World War II was "good" for the American economy? In fact, isn't Obama telling us right now that "public works" will be good for the economy and that environmental regulations will improve the economy because it will create "green" jobs? This fallacy is everywhere.

The same principle can be applied to roads, airports, public transportation, utilities, education, mail, and any other activity that the government has taken over which should be performed by the free market. Let's take the roads for example.

Since we literally see the government roads, often in decent condition, one might conclude that the government is doing a pretty good job. After all, you drive on the road and your car usually doesn't fall through, etc. What is not seen is what would exist had the government NOT monopolized road construction. Some of what is not there we can imagine, but most often it can not be imagined since we have no idea what the profit motive would have led private individuals to build.

In the case of roads, I believe that government failure is absolutely obvious. Government roads are a literal disaster.

In particular, consider a traffic “jam”. Such an instance is a daily routine for millions of people and has become accepted practice. When you wait in traffic, you are waiting in a government line to use a government road just as you might wait in line at a government subsidized hospital, the post office or the motor vehicle department. The fact that people have become conditioned to accept the traffic jam is a frightening development and conjures the image of mindless hordes waiting for their ration of bread at a Soviet distribution center.

There is no need for a shortage of roads. The traffic jam represents an economic "shortage" in the sense that the supply of roads is artificially restricted relative to the demand. First, the government does not charge a fee to use its service nor does it charge a higher price when demand is at its peak (like a hotel raising rates when a convention is in town). Furthermore, the government is not motivated by profit to supply more roads so the supply constantly is overwhelmed by demand. On top of that, state and federal environmental regulations restrict the construction of new roads even if a local government was inclined to build more. Instead of building more roads, the government's response to increasing demand has been to mandate "carpool" lanes and put up billboards urging its customers (drivers) not to use its product by carpooling or by driving less. Could you imagine any private business faced with overwhelming demand urging its customers to buy less of its product? If lines form around the block for a particular product, how long would it take private business to supply enough of the product to satisfy demand?

The rampant occurrence of road shortages in virtually every city is certainly a manifestation of socialism as is the general quality of many highways especially in large cities that in some cases are barely passable and outright dangerous. The issue of road "supply" is the same problem that any business faces when it needs to expand its supply. If land is not available adjacent to a road then why not build underground and have multiple layers of roads (one for express traffic and one for local traffic)? It is possible that road suppliers could partner with car makers and build a car that drives automatically based on new technology. Why are semi-trucks allowed to drive on the same highway that motorcycles and cars use? Shouldn't larger vehicles have their own lanes? Wouldn't that be safer? This is just a start. We can not imagine the innovations that would take place if roads were privately owned.

The problem of not focusing on what is NOT happening is especially acute in cases where the government has monopolized a business for so long that no one can imagine an alternative. It would be like if the government had nationalized the pizza business 100 years ago and everyone was used to State Pizza. If someone proposed privatizing pizza you could just imagine the objections: State Pizza is pretty good already - if we privatize, then only the rich will be able to afford pizza, what about the employees of the state pizza unions, they will be unemployed, what about people in rural communities, they won't get pizza unless the state provides it, etc.

The most important take away from this is: in order to understand the consequences of government action, do not just look at what it does directly. Imagine what could have happened and what did not happen as a result of government action.

Friday, January 2, 2009

Bad Economics as Disturbing Performance Art

The power of art lies in its reduction of complex abstractions to the perceptual level. For example, a sculpture of a strong, intelligent man represents the metaphysical value judgment of the artist that man is efficacious in an intelligible universe. Holding a wide abstraction in his immediate perceptual awareness is powerfully necessary to a conceptual consciousness. Just as fine art reduces complex abstractions to percepts, there are everyday perceptual level experiences that can concretize economic and political abstractions although it does not really constitute art since it is not a selective re-creation of reality - it is reality. However, such processes can still serve a similiar function in terms of giving us a simpler form with which to hold a more complex idea.

For example, if one were to drive on I-95 in southern Florida, one would witness hundreds of miles of decrepit, potholed concrete, suddenly shifting curves awkwardly designed to avoid construction, lack of lane delineations, idled equipment, traffic jams, and frequent breakdowns and deadly car accidents. Such an experience enables one to hold in his perceptual field the following abstraction: government intervention in the economy. In other words, in a cursory glance one can perceive the destruction, inefficiency, and suffering that results from state intervention in the marketplace . The same abstraction can be concretized by observing a public housing project, a public school, public transportation, etc. In fact, I submit that all of I-95 in southern Florida be regarded as a work of naturalistic performance art dedicated to the theme of capitalism vs. socialism or life vs. death.