Wednesday, July 31, 2013

Runaway Relief and Social Insecurity

IN THE UNITED STATES, FEDERAL PROGRAMS TO RElieve poverty and unemployment first went into effect on a large scale in the Great Depression. The argument was that they were needed only during the emergency. Since then the nation has enjoyed a return of prosperity, an enormous growth in national income, a fall of unemployment to record low levels, and a sharp decline (by any consistent definition) in the number and proportion of the poor. Yet relief, unemployment insurance, Social Security, and scores of other welfare programs have expanded at an accelerative rate.
In a 1935 message to Congress, President Franklin D. Roosevelt declared: “The Federal Government must and shall quit this business of relief. . . . Continued dependence upon relief induces a spiritual and moral disintegration, fundamentally destructive to the national fiber.”
The contention then made was that, if unemployment and old-age insurance programs were put into effect, poverty and distress would be relieved by contributory programs that did not destroy the incentives and self-respect of the recipients, and that relief could gradually be tapered off to negligible levels.
Let us look first at what has happened to Social Security itself. Since the original act of 1935 there have been constant additions and expansions of benefits. As early as 1939, both the benefit and tax provisions of the basic act were overhauled. The 1939 package added survivors’ benefits.
In 1950, coverage was broadened substantially to include about 90 per cent of the employed labor force. (Initially it had been only about 60 per cent.) The length of working time required to qualify for coverage was sharply reduced.
In 1954 and 1956 there were further liberalizations of coverage. Disability benefits were added. The 1956 amendment dropped the minimum retirement age required for women from 65 to 62.
In 1958, benefits for dependents of disabled workers were added. In 1961 the retirement age for men was also reduced to 62, though with a lower level of benefits than was payable at 65.
The 1965 legislation added Medicare for some 20 million Americans over 65. It made a host of other expensive changes. To the traditional Social Security program it added a 7 per cent across-the-board increase in cash benefits to retired workers.
In addition to other changes, the scale of benefits was increased in 1952, 1954, 1958, and 1965.
The 1967 Social Security amendments increased payments to the 24 million beneficiaries by an average of 13 per cent, raised minimum benefits 25 per cent, increased benefits to non-insured persons over 72, and also increased survivor and disability insurance benefits.
The original Social Security payroll tax was 1 per cent of wages up to $3,000, to be paid both by workers and employers. The combined rate of tax is now 9.6 per cent of wages up to $7,800.
But nobody can seriously expect even these greatly increased payroll taxes to pay for the liabilities that the government has already undertaken. W. Rulon Williamson, the actuary for the Social Security Board from 1936 to 1947, estimated even before the latest increases that it would take $150 billion more just to take care of those who were already on the benefit rolls, and that it would probably take at least $1 trillion to take care of the families of those who are already paying Social Security taxes, but have not yet retired. That estimate doesn’t cover Medicare.
What, meanwhile, has happened to the relief programs that unemployment insurance and Social Security were designed to make unnecessary?
In 1937, the first full year in which the initial Federal public assistance programs were in operation, $316 million was paid out to relief clients under the federally aided programs. In i960 the comparable total had increased more than tenfold, to $3.3 billion.
Though the Federal contribution has been mounting steadily during the years, the burden borne by the States and localities has been mounting at an almost equal rate. The amount of public aid alone paid out by the States and localities increased from $624 million in 1935 to $3 billion in 1966. The total of all social welfare expenditures borne by the States and localities alone has grown from $3.3 billion in 1935 to $40.8 billion in 1966, and for 1968 was probably about $46 billion.
The Federal budget lists the total cost of “Federal Aid to the Poor” in i960 at $9.5 billion. For 1969 the cost is listed at $27.7 billion, nearly three times as much.
These figures include the cost of aid to education, work and training, health, cash benefit payments, and other social welfare services. In the 1969 fiscal year, the Federal Government placed the number of persons on direct relief at 8.8 million. This was an increase of 60 per cent compared with the number twelve years before, though the rate of unemployment is lower than it was then.
The Federal Government estimated that there are still about 29 million “poor” by official definition (a family of four with an annual income under $3,335). Not only do the individual programs to “assist” them become more costly year by year, but new programs are constantly being added, though they overlap and duplicate each other. Upward of 70 agencies have been counted operating some 300 programs for uplifting people.
A detailed account of the waste and scandals that have accompanied these proliferating programs can be found in Shirley Scheibla’s recent book, Poverty Is Where the Money Is.*
In addition to specific antipoverty programs, the Federal Government’s total welfare outlays—including agricultural subsidies, housing and community development, health, labor and welfare, education, and veterans’ benefits—come to a staggering total for the single 1969 fiscal year of more than $68 billion.
Even so we have not finished yet. We must add the $46 billion annual welfare cost that falls on the States and localities, making a grand total of more than $114 billion.
Yet nearly all the “reforms” that are being proposed, even under the new Republican Administration, are changes that would still further increase the Social Security and direct relief burden, not reduce it.
One of these proposals, which may even be enacted into law before this book appears, is that all welfare be placed in the hands of the Federal Government, with a uniform level of relief payments throughout the nation. The practical effect of this would be to reduce the present high relief payments in the big cities hardly at all, but to increase enormously the relief paid in the poorer States and in the country districts.
The relief recipients in the poorer States and country districts would not only, because of their comparatively much lower living costs, be much better off than the relief recipients in the big cities, but their relief payments would be so much higher in comparison with the local wage rates in their districts that hundreds of thousands more would prefer going on relief to staying at work.
As the relief system would probably be administered by the city and county governments, while the Federal taxpayers were footing the bill, all incentives to economy and the elimination of malingerers and chiselers from the relief rolls would fall to the vanishing point. The country would slide easily toward guaranteed-income plans, and the waste and corruption in relief payments would make present waste and corruption seem trivial in comparison.
Man vs. The Welfare State

Tuesday, July 30, 2013

Famines Are Government-Made

FOR THE LAST FEW YEARS AN INFLUENTIAL GROUP OF social reformers has been energetically propagating a dangerous myth. This is that the accelerating pace of population growth is overtaking the rate at which the world can produce food, and that disastrous famines are almost inevitable unless the growth of population can be throttled.

In October, 1966, a study by Prof. Karl Brandt, one of the world’s great agricultural authorities, retired director of Stanford University’s Food Research Institute and a former member of the President’s Council of Economic Advisers, exploded this myth. But his analysis did not receive anything like the attention it deserved.

Governments’ first priorities, Brandt declared, should not be to effect “planned parenthood crash programs,” but to adopt policies that give farmers the freedom and incentive to expand food production.
Brandt has no quarrel with “planned parenthood by voluntary individual decision.” But it would necessarily take years before even successful government birth control propaganda could appreciably affect the total size of the population. Moreover, the emphasis on birth control to counteract famine diverts attention from the enormous potential increase in food production that has now been made technically possible.

Science and technology have now developed overabundant sources of energy, which have opened the gates to replace human and animal power by mechanical power in food production.

The most crucial of all fertilizers, nitrogen, has now been made potentially abundant everywhere in the world at declining costs. One ton of pure nitrogen can yield from 15 to 20 tons of grain equivalent. Technology has developed new methods of irrigation, highly effective weed killers and pesticides, better means of storing and preserving perishables.

Why, then, has the world still been having famines? Brandt replies that in the last generation most of these famines have been primarily government-made. He cites the collectivist policies in Soviet Russia that initially resulted in the starvation of five million people and have continued to prevent any proper expansion of food output there for nearly forty years. Similar and worse policies have cost uncounted millions of lives in Red China.

Famine has been produced by similar policies in India. In its socialist mania for “industrialization,” the Indian government has squeezed the major part of the capital for that industrialization out of farm income. It has arbitrarily set high prices for all manufactured goods and low prices for food and other farm products.

On top of this crushing discouragement to food production, mismanagement and neglect have led to a situation in which mice, rats, birds, and locusts are permitted to devour India’s homegrown food faster than American Food for Peace can be shipped in at very high expense.

On top of all this, some 200 million government-protected sacred cows are allowed to roam around eating food while people are dying of hunger.

Our government has not insisted on any adequate conditions in return for our enormous gifts of food to India. So, Brandt concluded, our generosity has been contributing unwittingly to the prospect of real famine there, while weakening the United States dollar:

Such gifts allow the Indian government further leeway to continue ill-advised policies which suffocate the initiative of their farmers. The magnitude of food deficits these policies continue to create is so enormous that with all charity and foreign aid, we and the other industrial nations cannot possibly compensate for them.
Man vs. The Welfare State

Monday, July 29, 2013

Who Protects the Consumer?

CONSUMERS ARE SOMETIMES ASKED TO PAY TOO much for goods. This has been true since the beginning of time. Their great protection against overcharging has been competition. The intelligent shopper can compare price and quality, and go to the merchant who offers the best goods at the cheapest price.

Consumers are sometimes cheated. This also has been true since the beginning of time. They have sometimes been the victims of deceptive practices; they have been sold shoddy goods, or defective goods, or goods that have been misrepresented. Again, their greatest protection has always been competition. They can cease to buy from the dishonest merchant. In addition, when the amount involved is large enough, they have been able under general laws against dishonest practices to resort to the law or to take a case to court.

But in recent years, particularly in the Kennedy and Johnson Administrations, an ominous network of legislation has grown up which attempts to regulate quality and quantity in the minutest detail in one industry or trade after another.

An idea of the scope of this can be gathered from a single message to Congress by President Johnson on February 17, 1967. Here are some of his requests:
I recommend the Truth-in-Lending Act of 1967. . . .
I recommend the Interstate Land Sales Full Disclosure Act of 1967. . . .
I recommend the Welfare and Pension Protection Act of 1967. . . .
I recommend the Medical Device Safety Act of 1967. . . .
I recommend the Clinical Laboratories Improvement Act of 1967. . . .
I recommend the Wholesome Meat Act of 1967. . . .
I recommend the Fire Safety Act of 1967. . . .
I recommend the Natural Gas Pipeline Safety Act of 1967. . . .
He also recommended that Congress give “careful consideration to the [346-page] report and recommendations of the Securities and Exchange Commission” on the detailed control of mutual funds, and that it enact new controls of the electric power industry as soon as a report by the Federal Power Commission was completed.

All this in one message. All this to be rushed through in 1967.

Furthermore, this message came when the most detailed regulation of special industries had already been enacted. On March 15, 1962, President Kennedy had sent a similar special message to Congress with similar recommendations. One result was that Congress that year passed a far more stringent drug-control law. Previously the government had power only to prevent the marketing of unsafe drugs. A new drug could be marketed if the government took no action within 60 days after an application was filed. The new law reversed this, and gave a bureaucrat power to hold up approval of a drug indefinitely until the manufacturer could prove to the bureaucrat’s satisfaction that the drug was not only safe but “effective.” This could give the bureaucrat life-or-death power over a company or its products. It is a very dubious legal principle that allows any bureaucrat to keep off the market something that, even though harmless, is in his opinion “ineffective,” and that in addition puts the burden of proof of effectiveness on the producer. The new drug law has discouraged research and slowed down the introduction of new life-extending drugs.

Before President Johnson’s 1967 message on consumer protection, an automobile safety law had been passed, as well as a food labelling and packaging law. Presumably the designs of future cars will not be specified by engineers, but by lawyers and congressmen, who will also take increasing control over labelling.

There is one very nasty by-product of this itch for more and more Federal control of business. The congressmen and bureaucrats who favor it begin by an enormous propaganda campaign against the industry or trade that they want to control. Thus, in order to get through the Wholesome Meat Act, government officials charged that unsafe and filthy meat was being sold almost everywhere. Then in order to get through a poultry-control bill, Miss Betty Furness, President Johnson’s consumer adviser, stated: “There’s not a place in the U. S. . . . where you can order a chicken sandwich with the confidence you are not endangering your health.” Earlier in 1968, in a sweeping indictment, she had charged that every merchant was “after your back teeth.”

A Senate committee recently held hearings to decide whether the automobile repair industry, with its tens of thousands of local garages and repairmen, ought not to be brought under direct Federal control. The committee credulously listened to witnesses who told it that the chances are 99 to 1 that work ordered will not be done properly, if it is done at all. The implication was left that the industry is made up mainly of incompetents and crooks.

Just how detailed were some of the new regulations that President Johnson was urging in his 1967 message can be judged from its passages on the control of medical devices. Government bureaucrats were to prescribe “standards” for “bone pins, catheters, X-ray equipment and diathermy machines.” Bureaucrats were to say what kinds of nails and screws were to be used for bone repair, and what kinds of artificial eyes were to be permitted.

All this is an ominous reminder of medieval despotism. One thinks of the law of Henry VIII, which made it a penal offense to sell any pins but such as were “double-headed, and their head soldered fast to the shank, and well smoothed; and the shank well shaven; and the point well and round-filed and sharpened.”

The pervading assumption of the Kennedy and Johnson Administrations was that any and all problems could be solved if only we piled up enough new laws and restrictions. Yet it may be doubted that consumers are going to be helped much by defaming and harassing producers.

The consumer has one great protection against incompetent producers or dishonest sellers. This is his own intelligence and his own decisions. His views are heard every day in his purchases and refusals to purchase. With every penny that he spends, the individual consumer is casting his vote for this product and against that. He does not need to sign petitions or march in picket lines. If he patronizes a product, the firm that makes it prospers and grows; if he stops buying a product, the firm that makes it goes out of business. The consumer is the boss. The producers must please him or die.

But this is another way of saying that the great protection of the consumer is the competition among producers for his patronage. This is another way of saying, as even President Johnson admitted in his consumer protection message, that: “Most of these problems are resolved in the free competitive market through the energies of private enterprise. It is remarkable how well the free enterprise system does its job.” This was excellent lip service, but Mr. Johnson’s detailed recommendations were based on the opposite assumption.

A thousand examples could be cited of the miraculous effect of free market competition in serving the consumer. I will content myself with one—the food industry.

The original packaging bill before the 89th Congress not only sought to protect the consumer against fraudulent or deceptive labelling and packaging, but it sought to standardize sizes, shapes and proportions of packages and net weights and quantities. Industry witnesses showed by numerous examples, however, how this would have discouraged innovation and restricted consumer choice. “If there are 8,000 different items in the average supermarket today as compared with 2,000 some years ago,” testified Arthur E. Larkin, Jr., president of the General Foods Corporation, “it’s because the consumer wants it that way. . . . No one of those 8,000 items will continue to be produced and occupy shelf space if the customers don’t take it off the shelf and put it in their shopping bags. . . . Each product must win its right to survival. Each must be sold in sufficient quantity to be profitable.”
In other words, once more, the way to protect the consumer is not to impede and harass, but to encourage the producer.
Man vs. The Welfare State

Sunday, July 28, 2013

More on Price Controls

THE WELFARE STATE CAN ARISE AND PERSIST ONLY by cultivating and living on a set of economic delusions in the minds of the voters.
As we saw at the beginning of the last chapter, the policies of the welfare state follow a typical time sequence. First the welfare state promises special subsidies or other benefits to this or that pressure group. This increases its expenditures. But it cannot or dare not boost taxes enough to meet these increased expenditures fully. So it runs a deficit, and pays for it by printing more irredeemable paper money. This lowers the value of the currency unit by causing more money to be offered for the same supply of goods. The result is a price rise. The next step of the inflating government is to blame the price rise on sellers, on Big Business, on “profiteers.” The step after that is to put legal ceilings on prices, or to order them to be rolled back, to “protect the consumer.”
If the public is convinced, on the other hand, that it is the government’s fiscal and monetary policies, and not the greed of producers and sellers, that are forcing up prices, and if the public realizes further that government price control only compounds the evils brought about by monetary inflation, and if the public recognizes that price control in the long run cannot help but must hurt the great body of consumers, then the chief political prop of the welfare state will collapse.
It is of the first importance, therefore, even if this necessitates some repetition, to consider the case against price controls in more detail and at much greater length than we did in the brief survey in the last chapter.
Prices in a free market are determined by supply and demand. If the relative demand for a product increases, consumers will be willing to pay more for it. Their competitive bids will both oblige them individually to pay more for it and enable producers to get more for it. This will raise the profit margins of the producers of that product. This, in turn, will tend to attract more firms into the manufacture of that product, and induce existing firms to invest more capital into making it. The increased production will tend to reduce the price of the product again, and to reduce the profit margin in making it. The increased investment in new manufacturing equipment may lower the cost of production. Or—particularly if we are concerned with some extractive industry such as petroleum, gold, silver, or copper—the increased demand and output may raise the cost of production. In any case, the price will have a definite effect on demand, output, and cost of production, just as these in turn will affect price. All four—demand, supply, cost, and price—are interrelated. A change in one will bring changes in the others.
Connexity of Prices
Just as the demand, supply, cost, and price of any single commodity are all interrelated, so are the prices of all commodities related to each other. These relationships are both direct and indirect. Copper mines may yield silver as a by-product. This is connectedness, or connexity, of production. If the price of copper goes too high, consumers may substitute aluminum for many uses. This is a connexity of substitution. Dacron and cotton are both used in drip-dry shirts; this is a connexity of consumption.
In addition to these relatively direct connections among prices, there is an inescapable interconnectedness, or interconnexity, of all prices. One general factor of production—labor—can be diverted, in the short run or in the long run, directly or indirectly, from one line into any other line. If one commodity goes up in price, and consumers are unwilling or unable to substitute another, they will be forced to consume a little less of something else. All products are in competition for the consumer’s dollar; and a change in any one price will affect an indefinite number of other prices.
No single price, therefore, can be considered an isolated object in itself. It is interrelated with all other prices. It is precisely through these interrelationships that society is able to solve the immensely difficult and always changing problem of how to allocate production among thousands of different commodities and services so that each may be supplied as nearly as possible in relation to the comparative urgency of the need or desire for it.
As the eminent economist Ludwig von Mises has demonstrated, only the capitalist system, with private property, a sound currency, free markets, and freedom from price controls, can solve this great problem of “economic calculation.”
Because the desire and need for, and the supply and cost of, every individual commodity or service are constantly changing, prices and price relationships are constantly changing. They are changing yearly, monthly, weekly, daily, hourly. People who think that prices normally rest at some fixed point, or can be easily held to some “right” level, could profitably spend an hour watching the ticker tape of the stock market, or reading the daily report in the newspapers of what happened yesterday in the foreign exchange market, and in the markets for coffee, cocoa, sugar, wheat, corn, rice, and eggs; cotton, hides, wool, and rubber; copper, silver, lead, and zinc. They will find that none of these prices ever stands still. This is why the constant attempts of governments to lower, raise, or freeze a particular price, or to freeze the interrelationship of wages and prices just where it was on a given date (“holding the line”) are bound to be disruptive wherever they are not futile.
Efforts to Boost Prices
Let us begin by considering governmental efforts to keep prices up, or to raise them. Governments most frequently try to do this for commodities that constitute a principal item of export from their countries. Thus Japan once did it for silk and the British Empire for natural rubber; Brazil has done it and still periodically does it for coffee; and the United States has done it and still does it for cotton and wheat. The theory is that raising the price of these export commodities can only do good and no harm domestically because it will raise the incomes of domestic producers and do it almost wholly at the expense of the foreign consumers.
All of these schemes follow a typical course. It is soon discovered that the price of the commodity cannot be raised unless the supply is first reduced. This may lead in the beginning to the imposition of acreage restrictions. But the higher price gives an incentive to producers to increase their average yield per acre by planting the supported product only on their most productive acres, and by more intensive employment of fertilizers, irrigation, and labor. When the government discovers that this is happening, it turns to imposing absolute quantitative controls on each producer. This is usually based on each producer’s previous production over a series of years. The result of this quota system is to keep out all new competition; to lock all existing producers into their previous relative position, and therefore to keep production costs high by removing the chief mechanisms and incentives for reducing such costs. The necessary readjustments are prevented from taking place.
Meanwhile, however, market forces are still functioning in foreign countries. Foreigners object to paying the higher price. They cut down their purchases of the valorized commodity from the valorizing country, and search for other sources of supply. The higher price gives an incentive to other countries to start producing the valorized commodity. Thus, the British rubber scheme led Dutch producers to increase rubber production in Dutch dependencies. This not only lowered rubber prices, but caused the British to lose permanently their previous monopolistic position. In addition, the British scheme aroused resentment in the United States, the chief consumer, and stimulated the eventually successful development of synthetic rubber. In the same way, without going into detail, Brazil’s coffee schemes and America’s cotton schemes gave both a political and a price incentive to other countries to initiate or increase production of coffee and cotton, and both Brazil and the United States lost their previous monopolistic positions.
Meanwhile, at home, all these schemes require the setting up of an elaborate system of controls and an elaborate bureaucracy to formulate and enforce them. These have to be elaborate, because each individual producer must be controlled. An illustration of what happens may be found in the United States Department of Agriculture. In 1929, before most of the crop control schemes came into being, there were 24,000 persons employed in the Department of Agriculture. Today there are 120,000. These enormous bureaucracies, of course, always have a vested interest in finding reasons why the controls they were hired to enforce should be continued and expanded. And of course these controls restrict the individual’s liberty and set precedents for still further restrictions.
None of these consequences seems to discourage government efforts to boost prices of certain products above what would otherwise be their competitive market level. We still have international coffee agreements and international wheat agreements. A particular irony is that the United States was among the sponsors in organizing the international coffee agreement, though its people are the chief consumers of coffee and therefore the most immediate victims of the agreement. Another irony is that the United States imposes import quotas on sugar, which necessarily discriminate in favor of some sugar-exporting nations and therefore against others. These quotas force all American consumers to pay higher prices for sugar in order that a tiny minority of American sugar cane producers can get higher prices.
I need not point out that these attempts to “stabilize” or raise prices of primary agricultural products politicalize every price and production decision and create friction among nations.
Holding Prices Down
Now let us turn to governmental efforts to lower prices or at least to keep them from rising. These efforts occur repeatedly in most nations, not only in wartime, but in any time of inflation. The typical process is something like this: The government, for whatever reason, follows policies that increase the quantity of money and credit. This inevitably starts pushing up prices. But higher prices are not popular with consumers. Therefore the government promises that it will “hold the line” against further price increases.
Let us say it begins with bread and milk and other necessities. The first thing that happens, assuming that the government can enforce its decrees, is that the profit margin in producing necessities falls, or is eliminated, for marginal producers, while the profit margin in producing luxuries is unchanged or goes higher. As we saw in the previous chapter, this reduces and discourages the production of the controlled necessities and relatively encourages the increased production of luxuries. But this is exactly the opposite result from what the price controllers had in mind. If the government then tries to prevent this discouragement to the production of the controlled commodities by keeping down the cost of the raw materials, labor and other factors of production that go into those commodities, it must start controlling prices and wages in ever-widening circles until it is finally trying to control the price of everything.
But if it tries to do this thoroughly and consistently, it will find itself trying to control literally millions of prices and trillions of price cross-relationships. It will be fixing rigid allocations and quotas for each producer and for each consumer. Of course these controls will have to extend in detail to both importers and exporters.
Price Control Distorts Production
If a government continues to create more currency with one hand while rigidly holding down prices with the other, it will do immense harm. And let us note also that even if the government is not inflating the currency, but tries to hold either absolute or relative prices just where they were, or has instituted an “income policy” or “wage policy” drafted in accordance with some mechanical formula, it will do increasingly serious harm. For in a free market, even when the so-called price “level” is not changing, all prices are constantly changing in relation to each other. They are responding to changes in costs of production, of supply, and of demand for each commodity or service.
And these price changes, both absolute and relative, are in the overwhelming main both necessary and desirable. For they are drawing capital, labor, and other resources out of the production of goods and services that are less wanted and into the production of goods and services that are more wanted. They are adjusting the balance of production to the unceasing changes in demand. They are producing thousands of goods and services in the relative amounts in which they are socially wanted. These relative amounts are changing every day. Therefore the market adjustments and price and wage incentives that lead to these adjustments must be changing every day.
Price control always reduces, unbalances, distorts, and discoordinates production. Price control becomes progressively harmful with the passage of time. Even a fixed price or price relationship that may be “right” or “reasonable” on the day it is set can become increasingly unreasonable or unworkable.
What governments never realize is that, so far as any individual commodity is concerned, the cure for high prices is high prices. High prices lead to economy in consumption and stimulate and increase production. Both of these results increase supply and tend to bring prices down again.
Excessive Fears of Monopoly
Very well, someone may say; so government price control in many cases is harmful. But so far you have been talking as if the market were governed by perfect competition. But what of monopolistic markets? What of markets in which prices are controlled or fixed by huge corporations? Must not the government intervene here, if only to enforce competition or to bring about the price that real competition would bring if it existed?
The fears of most economists concerning the evils of “monopoly” have been unwarranted and certainly excessive. In the first place, it is very difficult to frame a satisfactory definition of economic monopoly. If there is only a single drug store, barber shop, or grocery in a small isolated town (and this is a typical situation), this store may be said to be enjoying a monopoly in that town. Again, everybody may be said to enjoy a monopoly of his own particular qualities or talents. Yehudi Menuhin has a monopoly of Menuhin’s violin playing; Picasso of producing Picasso paintings; Elizabeth Taylor of her particular beauty and sex appeal; and so for lesser qualities and talents in every line.
On the other hand, nearly all economic monopolies are limited by the possibility of substitution. If copper piping is priced too high, consumers can substitute iron or plastics; if beef is too high, consumers can substitute lamb; if the original girl of your dreams rejects you, you can always marry somebody else. Thus, nearly every person, producer, or seller may enjoy a quasi monopoly within certain inner limits, but very few sellers are able to exploit that monopoly beyond certain outer limits. There has been a growing literature within recent years deploring the absence of perfect competition; there could have been equal emphasis on the absence of perfect monopoly. In real life competition is never perfect, but neither is monopoly.
Unable to find many examples of perfect monopoly, some economists have frightened themselves in recent years by conjuring up the specter of “oligopoly,” the competition of the few. But they have come to their alarming conclusions only by inserting in their own hypotheses all sorts of imaginary secret agreements or tacit understandings between large producing units, and deducing what the results could be.
Now the mere number of competitors in a particular industry may have very little to do with the existence of effective competition. If General Electric and Westinghouse effectively compete, if General Motors and Ford and Chrysler effectively compete, if the Chase Manhattan and the First National City Bank of New York effectively compete, and so on (and no person who has had direct experience with these great companies can doubt that they dominantly do), then the result for consumers, not only in price but in quality of product or service, is not only as good as that which would be brought about by atomistic competition but much better, because consumers have the advantage of large-scale economies, and of large-scale research and development that small companies could not afford.
A Strange Numbers Game
The oligopoly theorists have had a baneful influence on the American antitrust division and on court decisions. The prosecutors and the courts have recently been playing a strange numbers game. In 1965, for example, a Federal district court held that a merger that had taken place between two New York City banks four years previously had been illegal, and must now be dissolved. The combined bank was not the largest in the city, but only the third largest; the merger had in fact enabled the bank to compete more effectively with its two larger competitors; its combined assets were still only one-eighth of those represented by all the banks of the city; and the merger itself had reduced the number of separate banks in New York from 71 to 70. (I should add that in the four years since the merger the number of branch bank offices in New York City has increased from 645 to 698.) The court agreed with the bank’s lawyers that “the general public and small business have benefited” from bank mergers in the city. Nevertheless, the court continued, “practices harmless in themselves, or even those conferring benefits upon the community, cannot be tolerated when they tend to create a monopoly; those which restrict competition are unlawful no matter how beneficent they may be.”
It is a strange thing, incidentally, that though politicians and the courts think it necessary to forbid an existing merger in order to increase the number of banks in a city from 70 to 71, they have no such insistence on big numbers in competition when it comes to political parties. The dominant American theory is that just two political parties are enough to give the American voter a real choice; that when there are more than these it merely causes confusion, and the people are not really served. There is much truth in this political theory as applied in the economic realm. If they are really competing, only two firms in an industry are enough to create effective competition.
Monopolistic Pricing
The real problem is not whether or not there is “monopoly” in a market, but whether there is monopolistic pricing. A monopoly price can arise when the responsiveness of demand is such that the monopolist can obtain a higher net income by selling a smaller quantity of his product at a higher price than by selling a larger quantity at a lower price. It is assumed that in this way the monopolist can realize a higher price than would have prevailed under “pure competition.”
The theory that there can be such a thing as a monopoly price, higher than a competitive price would have been, is certainly valid. The real question is, how useful is this theory either to the supposed monopolist in deciding his price policies or to the legislator, prosecutor, or court in framing antimonopoly policies? The monopolist, to be able to exploit his position, must know what the “demand curve” is for his product. He does not know; he can only guess; he must try to find out by trial and error. And it is not merely the unemotional price response of the consumers that the monopolist must keep in mind; it is what the effect of his pricing policies will probably be in gaining the good will or arousing the resentment of the consumer. More importantly, the monopolist must consider the effect of his pricing policies in either encouraging or discouraging the entrance of competitors into the field. He may actually decide that his wisest policy in the long run would be to fix a price no higher than he thinks pure competition would set.
In any case, in the absence of competition, no one knows what the “competitive” price would be if it existed. Therefore, no one knows exactly how much higher an existing “monopoly” price is than a “competitive” price would be, and no one can be sure whether it is higher at all!
Yet antitrust policy, in the United States, at least, assumes that the courts can know how much an alleged monopoly or “conspiracy” price is above the competitive price that might have been. For when there is an alleged conspiracy to fix prices, purchasers are encouraged to sue to recover three times the amount they were allegedly forced to “overpay.”
Refrain from Price Fixing
Our analysis leads us to the conclusion that governments should refrain, wherever possible, from trying to fix either maximum or minimum prices for anything. Where they have nationalized any service—the post office or the railroads, the telephone or electric power—they will of course have to establish pricing policies. And where they have granted monopolistic franchises—for subways, railroads, telephone or power companies—they will of course have to consider what price restrictions they will impose.
As to antimonopoly policy, whatever the present condition may be in other countries, in the United States this policy shows hardly a trace of consistency. It is uncertain, discriminatory, retroactive, capricious, and shot through with contradictions. No company today, even a moderate-sized company, can know when it will be held to have violated the antitrust laws, or why. It all depends on the economic bias of a particular public prosecutor, court, or judge.
There is immense hypocrisy about the subject. Politicians make eloquent speeches against “monopoly.” Then they will impose tariffs and import quotas intended to protect monopoly and keep out competition; they will grant monopolistic franchises to bus companies or telephone companies; they will  approve monopolistic patents and copyrights; they will try to control agricultural production to permit monopolistic farm prices. Above all, they will not only permit but impose labor monopolies on employers, and legally compel employers to “bargain” with these monopolies; and they will even allow these monopolies to impose their conditions by physical intimidation and coercion.
I suspect that the intellectual situation and the political climate in this respect are not much different in other countries. To work our way out of the existing legal chaos is, of course, a task for jurists as well as for economists. I have one modest suggestion: We can get a great deal of help from the old common law, which forbids fraud, misrepresentation, and all physical intimidation and coercion. “The end of the law,” as John Locke reminded us in the seventeenth century, “is not to abolish or restrain, but to preserve and enlarge freedom.” And so we can say today that in the economic realm the aim of the law should be not to constrict, but to maximize price freedom and market freedom.

Man vs. The Welfare State

Saturday, July 27, 2013

Price Controls

WHEN THE WELFARE STATE SPENDS RECKLESSLY, runs chronic deficits, expands credit, and prints more money, prices begin to soar. Invariably the government blames business, especially Big Business, and hints darkly at price controls.

But being a self-styled “liberal” government, it begins by suggesting only “voluntary” controls. It draws up “guidelines.” Prices of course continue to rise, because the government is printing more money, thereby reducing the value of the currency unit.

The government’s next step is to select as its special target some big corporation (or industry consisting mainly of big corporations) and demand that it roll back some price increase it has just announced. The big corporation is selected for attack, of course, because it is easy to arouse popular prejudice against it. It can either be denounced as a monopoly or accused of “administering” prices.

The favorite scapegoat in the United States for the last twenty years or more has been the steel industry. Though the total value of the steel produced yearly in this country amounts to only 2 per cent of the gross national product, the government, whenever it attacks steel prices, contends that steel enters into a multitude of products, that a steel price increase is “pyramided” throughout industry, and so sets off a chain reaction of inflation. This argument will not bear serious analysis, but that has never prevented its repeated use.

One minor irony is that though the government publishes a monthly index of consumer prices, and a monthly index of wholesale prices, and that though the former is a weighted average of some 400 selected prices and the latter a weighted average of some 2,000 prices, the monthly government report never tells the reader just how many of these prices rose and how many fell in the month reported. It is true that it sometimes gives partial enumerations. Thus, in its report on wholesale prices for March, 1968, it tells us: “Prices were higher for 110 of the 225 industrial product classes; there was no change for 85 and declines occurred for 30.” But if it told us that of the 2,000 individual prices it records of all items, about 1,000, say, went up in a given month, 740 were unchanged and 260 declined, the public would instantly see the absurdity as well as the injustice of the government’s selecting one price rise among 1,000 price rises, or even a price rise in one industry out of price rises in 110 industries, for special denunciation and attack.

A rise of nearly all prices, or of most prices out of tens of thousands, indicates the operation of a common cause. That cause is the monetary policies of the government itself. Prices do not rise today because businessmen have suddenly become greedier than they were yesterday. We may assume that sellers operating either under competition or monopoly were already charging as much as they could successfully get. The problem is to explain why they can charge more today than they did yesterday, or more this year than last year. If nearly all can charge more, this means that some general condition has changed.

Government price control attempts to ignore this change. That is why government price control always works harm. Attempts to hold down or roll back prices, when they do not merely lead to black markets and quality deterioration, must reduce and disrupt production and distort the balance and structure of production. (Artificially depressed prices, of course, also stimulate demand for the items subject to them.)

When the price of one item, say some necessity such as bread or milk, is held below the price that supply and demand would set in a free market, it reduces the comparative profit margin in making that product and soon creates a shortage of that product. This is exactly the opposite result from the one the government price-fixers had in mind. If, in the effort to cure this, the government tries to hold down the prices of the labor, raw materials, and other factors that go into producing the price-controlled product, the price control must be extended in ever-widening circles, until the government finds itself trying to fix the price of everything.

As there are probably at least 10 million separate prices in the American economy, and as this implies something on the order of 50 trillion cross-relationships among prices, the government sets itself a fantastically impossible task. But this does not mean it cannot do immense harm to the economy when it nevertheless undertakes this task.

It is ironic that even a “labor” government, once it undertakes price controls to try to prevent the consequences of its own monetary inflation, is finally forced to face the fact that it cannot do this unless it is also prepared to control and hold down wages. This is what happened in England. But a government’s wage-control orders are enormously harder to enforce than its price-control orders. If the wage control is real and rigid, the unions simply defy it; so it finally becomes riddled with loopholes and exceptions, which cause the price control either to do increasing damage to production or to break down.

A special case of price control is the attempt to hold down interest rates, either on loans to business or on home mortgages. At the beginning this looks easier than other forms of price control. It merely seems necessary to issue more money to increase the supply of loanable funds. But when interest rates are reduced in this way, two consequences follow. The lower interest encourages more borrowing, which tends to raise the rate again. And the increased amount of money and credit starts pushing up prices and wages. This forces businessmen to borrow still more, if they want to continue to buy even the same volume of inventories and employ even the same number of workers as before, to do the same volume of business.

And if, as a result of the increased volume of money and credit, prices have risen, say, 5 per cent in the last twelve months and are expected to rise 6 per cent in the next twelve months, lenders begin to realize that when they get 6 per cent nominal interest on their money they are in reality getting no interest at all.

This is one reason why interest rates in the United States in 1968 and 1969 soared to record high levels. It is precisely the government effort to hold them down that forced them up. This is just one more illustration of how government controls eventually bring about precisely the opposite effects of those intended.

Arthur M. Okun, the last chairman of President Johnson’s Council of Economic Advisers, ignoring the fact that unions cannot successfully raise wages or businessmen prices unless monetary inflation permits it, called on business and labor to practice “voluntary restraint” and stop raising prices and wages. But if employers and workers did exercise “voluntary restraint,” and deliberately charged less or asked less than they could get in a free competitive market, they would in fact be doing the community a disservice.

The demand and supply of each of thousands of different commodities and services are changing every day. When an increase in the money supply does not falsify the result, the goods and services in most demand rise in price while those in least demand fall. So the profit margin in supplying the goods in greater demand increases while that in supplying the goods in less demand falls. This causes more to be produced of the goods in more demand and relatively less to be produced of the goods in less demand. Thus the tens of thousands of different goods and services produced in the nation tend constantly to be produced in the changing proportions in which they are most wanted.

Prices are indispensable signals to producers and consumers. They must tell the truth about supply and demand. “Voluntary restraints”—and still more, government “guidelines”—falsify the signals and disorganize and unbalance production.

Monetary inflation is a dreadful thing. But what does immensely more harm than the inflation itself is the attempt to conceal or suppress its consequences through price and wage controls.

Man vs. The Welfare State

Friday, July 26, 2013

The High Cost of Wage Hikes

IT OUGHT TO BE OBVIOUS THAT MINIMUM WAGE laws hurt most the very people they are designed to “protect.” When a law exists that no one is to be paid less than $64 for a 40-hour week, then no one whose services are not worth $64 a week to an employer will be employed at all. We cannot make a man worth a given amount by making it illegal for anyone to offer him less. We merely deprive him of the right to earn the amount that his abilities and opportunities would permit him to earn, while we deprive the community of the moderate services he is capable of rendering. In brief, for a low wage we substitute unemployment.

Yet we initiated the folly of a Federal minimum wage law 30 years ago, and we have been compounding that folly ever since. The first Labor Standards Act of 1938 fixed a minimum wage of 25 cents an hour. This was raised to 30 cents in 1939, 40 cents in 1945, 75 cents in January, 1950, $1.00 in March, 1956, $1.15 in September, 1961, $1.25 in September, 1963, $1.40 in February, 1967, and $1.60 in February, 1968.

In 1938 the average hourly wage in manufacturing industries was 62 cents an hour. In January, 1968, it was $2.64 an hour. But our legislators, not content with this general rise in wages due to more and better tools and natural economic forces, have decided to keep raising the legal minimum wage even faster than the fast-rising market average. Thus the statutory minimum was only 29 per cent of average hourly earnings in manufacturing just before the increase in 1950, but 40 per cent before the increase of the minimum in 1956,43 per cent before the increase in 1961, 47 per cent before the increase in 1963, and 54 per cent before the increase in 1968. The consequence of this is that the legal minimum wage was pushed up 114 per cent between early 1956 and 1968, though average hourly earnings in manufacturing rose only 55 per cent. Meanwhile, the Federal minimum wage has become effective over a far greater range.

The net result of all this has been to force up the wage rates of unskilled labor much more than those of skilled labor. A result of this, in turn, has been that though an increasing shortage has developed in skilled labor, the proportion of unemployed among the unskilled, among teen-agers, females and non-whites has been growing.

The outstanding victim has been the Negro, and particularly the Negro teen-ager. In 1952, the unemployment rate among white teen-agers and non-white teen-agers was the same—9 per cent. But year by year, as the minimum wage has been jacked higher and higher, a disparity has grown and increased. In February of 1968, the unemployment rate among white teenagers was 11.6 per cent, but among non-white teenagers it had soared to 26.6 per cent.

In addition to the direct harm done by the minimum wage in creating unemployment among the unskilled, it must bear at least part of the blame for the recent riots in the cities—where the unemployed are concentrated.

The statistical evidence showing that the minimum wage has caused unemployment among Negroes and the unskilled is extensive. It is gratifying to report that some of the country’s outstanding academic economists—Professors Yale Brozen, Arthur Burns, Milton Friedman, Gottfried Haberler, James Tobin, to mention a few—have gathered this evidence and presented a conclusive case against a statutory minimum wage. Yet successive Administrations and Congresses have persistently refused to accept their logic or to face the glaring facts.

There are other labor laws, antedating the minimum wage, that have had even worse consequences. In the early Nineteen Thirties the theory grew up that wages were too low and workers were exploited because there were not enough unions and those that existed had too little bargaining power. The proposed remedy for this was to create more and stronger unions, and the way to do that was to forbid employers to discriminate against union workers in hiring, in promoting, or in granting wage increases. Therefore, in 1935 Congress passed the Wagner Act, which gave unions the right to “bargain collectively through representatives of their own choosing” and prohibited employers from engaging in a whole list of “unfair labor practices.”

The Wagner Act was completely one-sided, hypocritical, and self-contradictory. On the one hand, it pretended to be two-sided by making it an unfair labor practice “by discrimination in regard to hire or tenure of employment or any term or condition of employment to encourage or discourage membership in any labor organization.” But immediately following this was a provision declaring that “nothing in this act  . . . shall preclude an employer from making an agreement with a labor organization . . . to require as a condition of employment membership therein.” In brief, the law prohibited an employer from discriminating against union members, but permitted and encouraged (and often in fact compelled) him to discriminate against non-union members.

The Wagner Act proved so viciously one-sided in practice that in 1947 Congress amended it in the Taft-Hartley Act. But the Taft-Hartley Act, contrary to popular impression, changed little of substance. And the National Labor Relations Board has successfully ignored or circumvented the provisions that did.

The factual situation today is that the compulsory union shop can be forced on employers and workers in the majority of the states. If a union makes an exorbitant demand, the employer cannot simply refuse to meet it. He is compelled by the Taft-Hartley Act to keep “bargaining” with that union and no one else. If he announces that he will regard strikers as having quit their jobs, and will carry on his business by hiring workers to replace them, his plant will be surrounded by pickets to intimidate anyone who thinks of passing through. And because of the legal roadblocks set up by the Norris-LaGuardia Act of 1932, he will probably be unable to get injunctive relief in the courts, even from crippling vandalism and violence.

The “right to strike” is interpreted today not merely as the right to quit work, but the “right” forcibly to prevent others from taking the jobs that the strikers have voluntarily vacated. The Taft-Hartley Act, amending the Wagner Act, specifically provided that “to bargain collectively  . . . does not compel either party to agree to a proposal or require the making of a concession.” But the employer is in fact compelled to make concessions. He is compelled to make them because unions today enjoy a special license to keep a plant closed by intimidatory mass picketing until their demands are met. If an employer does somehow succeed in keeping his plant open, and peaceably replacing strikers to carry on his business, the Labor Board is likely to come along years later, as it has done time and time again, and rule that by finally ceasing to “bargain” with the original union that struck he violated the Taft-Hartley Act and must therefore re-employ the original strikers, with retroactive pay to cover the period of their unemployment.

Yet this factual situation is ignored by practically everybody as if it did not exist. When a particularly outrageous or disruptive strike halts vital services, and a few congressmen begin to demand compulsory arbitration, they are told that the government should not intervene but allow the processes of “free collective bargaining” to continue.

It is true that compulsory arbitration is not the solution. But it is not true that the “collective bargaining” taking place is “free.” The government is in fact intervening every day through its one-sided laws. It is already a participant on the side of the striking union. It is granting special immunities to the union to use intimidation and violence. It is putting special compulsions on the employer to yield to the demands of the union, or to grant costly concessions, for fear of the even more costly or perhaps mortal penalties if he breaks off negotiations with the union members on strike and decides to employ replacements.
By the Norris-LaGuardia Act of 1932, by the Wagner Act of 1935 and the Taft-Hartley amendments of 1947, by loaded decisions pouring out daily from the National Labor Relations Board, and by the failure of local authorities to provide adequate police protection to employers and workers trying peaceably to carry on a struck business, we are daily forcing up wage rates to points that threaten to bring the economy to a halt, unless more money is printed so that demand, prices, and profit-margins can keep pace.

For thirty years we have been in an unending race between the printing press and the demands of the labor unions. Instead of showing any signs of slowing to a halt, the race is becoming more determined and more desperate on both sides.

Man vs. The Welfare State

Thursday, July 25, 2013

Consequences of Dollar Debasement

LET US BEGIN BY RECALLING TWO COMPARISONS already mentioned. From the end of 1939 to the end of 1968 the United States’ stock of money (hand-to-hand currency plus demand bank deposits) has been increased more than fivefold—from $36 billion to $193 billion. In the same thirty-year period (in spite of a huge increase in industrial production), prices of goods and services increased by an average of 164 per cent.

This debasement of the dollar resulted in a succession of problems, including a chronic “deficit” in the American balance of payments.

The “balance-of-payments problem” has arisen not merely because of our domestic inflation but because of the combination of this with the so-called “gold exchange” standard and the world monetary system set up at Bretton Woods in 1944. Under that system each government undertook to keep its own currency unit within 1 per cent of parity in either direction by buying or selling that currency against other currencies in the foreign exchange market. In addition, the United States Government undertook to make the dollar the world’s “reserve currency” and anchor currency by guaranteeing to keep it convertible at all times (for foreign central banks, but not for its own citizens) into gold at the fixed price of $35 an ounce.

Though only central banks, and neither American nor foreign private citizens, have the right to ask for this conversion, keeping the dollar convertible into gold at this fixed price has proved increasingly embarrassing to our monetary authorities, especially since 1957. During the last decade we have been sending or spending abroad for various purposes—to pay for imports, for foreign aid, and for the support of our armed forces in Europe and in Vietnam—billions of more dollars each year than we have been getting back in payment for our exports and earnings on our capital invested abroad.
This excess of outgoing dollars is called the “deficit” in our balance of payments. From the end of 1957 to the end of 1967 this deficit ran at an average of $2.8 billion a year. At the end of 1968 the cumulative total was in the neighborhood of $30 billion. In early 1969 the deficit on a “liquidity” basis was running at an annual rate of $6.8 billion.

As a result, our monetary gold stock had fallen from $22.8 billion at the end of 1957 to only $10.4 billion in July, 1969. Against these reduced gold reserves the United States had liquid liabilities to foreign official institutions of $10.8 billion, plus short-term liabilities to private foreigners of $22.6 billion—a total of nearly $34 billion.

In much discussion our dollar liabilities to private foreigners are not counted as a potential demand on our gold reserves because private banks, firms, and individuals cannot directly demand gold for their dollars. But under the International Monetary Fund agreements they can always indirectly sell their dollars at par to their respective central banks.

In sum, against United States gold reserves of only about $10 billion there are more than three times as many potential foreign dollar claims for gold.

As our gold has drained out, and as foreign dollar claims against it have mounted, the blame has been put on this “deficit” in our balance of payments. But instead of dealing with the main cause of this deficit—domestic inflation—our governmental authorities have allowed the inflation to go on, and have even increased it, while trying to stop the symptom. They have treated the deficit in the balance of payments as itself the problem, and have adopted desperate measures to try to halt it by direct controls.
Their first major control, imposed in 1964, was a penalty tax on purchases by Americans of foreign securities. To make such foreign investments the culprit responsible for a balance-of-payments deficit was not only arbitrary but implausible on its face. In the five years 1958 to 1962 the aggregate net outflow of $16.6 billion for new foreign investment was offset by $15.4 billion of income from previous investment. Even the Secretary of the Treasury, who had asked for the penalty tax, conceded: “In the long run the outflow of American capital to foreign countries is more than balanced by the inflow of income earned on that capital.”

He urged the tax, in fact, “only as a temporary measure to meet our problem pending more fundamental solutions.” Of course the more fundamental solutions were never adopted, so not only was the “temporary” security tax renewed, but on January 1, 1968, the President added mandatory controls on direct investments by American corporations abroad.

The implication of these measures is that our private foreign investment has been one of the chief causes of the deficit in our balance of payments. This is clearly untrue. It is Federal spending, through foreign aid and military outlays, that has been in deficit. In recent years the private sector as a whole, as a result of export surpluses and income on private investments abroad, has continued to generate a payments surplus.

In 1967 our total new foreign investments—including bank loans, purchases of foreign securities, and direct investments in factories and sales facilities—amounted to $5.6 billion. But the income from these and earlier private investments came to $6.2 billion.

At best, then, all these foreign investment restrictions and prohibitions are shortsighted. Any reduction we make in new foreign investment today means a corresponding reduction in investment income tomorrow.

If the Federal Government, instead of picking foreign investment as the culprit chiefly responsible for our balance-of-payments deficit, had put punitive tariffs on the further import of foreign luxuries—liquors, wines, perfumes, jewelry, furs, and automobiles—its action would still have been a mistake, but much less damaging to our future economic strength. These tight curbs on direct foreign investments by American corporations must severely hamper their ability to compete successfully with other international corporations in Europe and the rest of the world.

The President’s own Economic Report of 1967 pointed out that: “U.S. investment abroad generates not only a flow of investment income but also additional U.S. exports. From a balance-of-payments point of view this is an additional dividend.” The U.S. Department of Commerce found, in fact, that in 1964 $6.3 billion, or 25 per cent of our total exports in that year, went to affiliates of American companies overseas.

It is hardly too much to say that direct foreign investments, with the exports and income to which they give rise, are the greatest single source of long-range strength in our balance-of-payments position.
Still worse, from the standpoint of their direct restriction on personal liberty, were the Johnson Administration’s proposals (fortunately not enacted) to have Congress impose practically prohibitive penalty taxes on Americans travelling abroad.

The whole effort to eliminate our balance-of-payments deficit by direct controls over arbitrarily selected individual items is doomed to failure. Such controls may succeed in changing the relative amounts of different items, but cannot change the end result. At best we can make our immediate balance of payments look better at the expense of our future balance. We cannot unilaterally cut down our purchases or travel or investments abroad without also cutting down our sales abroad and our investment income from abroad. In his Economic Report of 1968, President Johnson himself conceded that “by provoking retaliation” we may “reduce our receipts by as much as or more than our payments.”
The whole so-called “balance-of-payments problem” would never have arisen except under the arbitrarily contrived International Monetary Fund gold-exchange system set up at Bretton Woods in 1944. It could not exist if the United States and other countries were on a pure “floating” paper standard with rates fluctuating daily in a free market, because under such a system the fluctuations would themselves set in motion the self-correcting forces to prevent unwanted deficits or surpluses from arising. Nor could the balance-of-payments problem exist if the United States and other leading countries were on a full gold standard. A “deficit” in the balance of payments would then lead to an immediate outflow of gold. This in turn would lead to immediately higher interest rates and a contraction of currency and credit in the “deficit” country, and the opposite results in the “surplus” countries, and so bring the so-called deficit to a halt.

Under the Bretton Woods system and the “gold exchange” standard, however, no self-correction of this sort is allowed to take place. When we “lose” paper dollars abroad we simply print more at home to take their place. And when Europe gains these dollars they find their way into the central banks, where they become additional “reserves” against which the European governments issue still more of their own currency. Thus further inflation, in both the “deficit” and the “surplus” country, seems to take place automatically.

In the IMF system there are no freely fluctuating market rates for individual currencies to reveal and correct international imbalances. Market rates are not allowed to fluctuate by more than 1 per cent above or below parity. At that point each government is obligated to buy or sell its own or foreign currencies to prevent any further departure from parity.

These currency-pegging operations are supplemented by the so-called gold-exchange standard. This arrangement, which goes back to international agreements in 1921 and 1922, permits central banks to count not only their gold but their holdings of dollars (and of British pounds) as part of their reserves. The arrangement was adopted in the belief that there was a “shortage of gold” and a “shortage of international liquidity.” As a result the world’s monetary “reserves” today consist of about $42 billion in gold plus about $28 billion of “reserve currencies,” of which more than $15 billion are American dollars. As credit and other currencies are issued against these reserve currencies, the reserves themselves are inflated.

The real reason the American monetary authorities fear a continued “deficit” in the balance of payments is that they have given the central banks of other countries the right to demand gold for their dollars at $35 an ounce. They have seen more than half our gold reserves flow out in the last twelve years, and they are fearful of losing any more.

They long ago persuaded the Federal Government to prohibit American citizens from holding or asking for gold. In the last few years they have resorted to increasingly desperate expedients. Where possible, they have brought political pressure on foreign central banks to keep them from asking for gold for their dollars. Early in 1968 they stopped feeding out gold to hold down the price in private markets in London, Paris, and Zurich. They now try to maintain an inherently unstable two-price system, with official monetary gold at $35 an ounce and non-monetary gold free to sell at whatever price supply and demand fix.

Early in 1968 the Administration also got Congress to abolish the remaining gold-reserve requirement of 25 per cent against Federal Reserve notes, on the plea that this was necessary to reassure foreign central banks by making all remaining United States gold holdings available to them. But what this action really did was to remove the last legal limitation on the amount of paper money that the Federal Reserve system may issue.

Finally, the American government has pressed for the creation by the International Monetary Fund of “special drawing rights” (SDR’s), or “paper gold,” to “supplement” dollars as international reserves. The only thing this purposely complicated scheme can do is to adulterate reserves still further and make it possible for nations to issue still more paper money against these paper SDR’s, which are declared with a straight face to be just as good as gold if not better.

All these schemes are unsound, and in the end all of them will prove futile. The truth is that no solution of the monetary problem, national or international, will be possible until inflation is stopped, and that it will not be stopped as long as we have the welfare state.

Man vs. The Welfare State

Friday, July 19, 2013

We Owe It To Ourselves

Man vs. The Welfare State

AT THE OUTBREAK OF WORLD WAR I, THE NATIONAL debt amounted to only $1.2 billion. At the end of 1919 it had swelled because of that war to $25.5 billion. But there was a national sense of responsibility about it. Prudent policies were followed. Successive Republican administrations reduced it at a rate of nearly $1 billion a year, so that at the end of 1930 it was down to $16.2 billion.

But then, well before we got into World War II, welfare spending started to soar. There was no effort to balance the budget; the cult of deficits prevailed. At the end of fiscal year 1941, five months before Pearl Harbor, the public debt was at the then record level of $55.5 billion. We ended the war with a public debt of $260 billion, but this time there was no important reduction, except almost by accident in 1948 and 1951. Chronic deficits have now brought it up to $363 billion.

It is amusing to recall the rationalizations that accompanied each succeeding deficit. At first each presidential message would solemnly estimate a surplus for the next fiscal year, which always turned out to be a deficit before the year was over. Next, the budget was always to be balanced sometime in the next couple of years—but, of course, not now.

Then a new doctrine began to be put forward. It set up a straw-man: the conservative who allegedly insisted that the budget must be balanced every year, come hell or high water. Ah no, this new doctrine replied; the budget need be balanced only over a period. But the high priests of the new doctrine never got around to specifying just how long the period should be, or just when it would be safe to begin to show a surplus again. They showed no ardor for sticking to the arithmetic even of their own proposals. If, as in the eight years 1961 through 1968, there was an uninterrupted average administrative deficit of $8 billion a year, shouldn’t there be an average surplus of $8 billion a year for the next eight years?
The argument for a budget balanced “over a period” has, in fact, been quietly dropped. In its place is the argument that the budget should never be balanced when there is less than full employment, or even when there threatens to be less than full employment. And this again has become in fact an argument for a perpetual deficit. For though President Johnson’s economic advisers called for and got a tax increase (but never called for a spending cut), no one dreamed of suggesting a surplus, or even a balanced budget. In presenting his budget for the fiscal year 1968, for example, President Johnson planned a deficit of $4.3 billion in the cash budget and of $8.1 billion in the orthodox administrative budget. (The actual administrative deficit turned out to be $25.4 billion.) “To seek a lower deficit or a surplus” for 1968, he warned, “would be unwarranted and self-defeating” because it would “depress economic activity.”

The implication of this whole philosophy is that it is dangerous even to balance the budget, and that so far from trying to pay off or even reduce the national debt, we should permit a perpetual increase.
Let us look at what this has already meant for annual interest payments alone. They have doubled in the last ten years—from $8.3 billion in 1960 to $16 billion in 1970. Thus interest payments alone are every year greater than the entire amount it took to run the government in 1941, and more than five times as much as was required to run the government in 1929.

In 1932 Candidate Franklin Roosevelt was alarmed because the national debt had increased by $3 billion in the preceding two years. But for a generation the size and growth of the national debt have been lightly dismissed with the argument that “we owe it to ourselves.” This was presented in the Nineteen Thirties as a brilliant discovery of the “new” economics; but the argument is so old that it was familiar to the great British philosopher David Hume, who answered it in a brilliant essay in 1740: “The practice of contracting debt will almost infallibly be abused in every government . . . We have indeed been told that the public is no weaker upon account of its debts, since they are mostly due among ourselves.” But Hume then went on to point out that the creditors who received the interest on the debt were by no means the same people as the taxpayers who had to pay it, and that practically no one paid and received exactly the same amount. The tax burden fell mainly upon the active workers and producers, and hampered production. “If all our present taxes be mortgaged,” he asked, “must we not invent new ones? And may not this matter be carried to a length that is ruinous and destructive?”
“I must confess,” he also wrote in the course of his essay, “that there is a strange supineness, from long custom, creeped into all ranks of men, with regard to public debts,” so that hardly anyone dared to hope that substantial progress would ever be made in paying them off. We find plenty of evidence of this complacency today. Academic economists even vie with each other in trying to prove that the situation is after all very good.

A favorite argument of the last few years is that “the nation is growing faster than its debt.” This is “proved” statistically. In the table below, for example, I merely bring up to mid-1969 some comparisons presented (in billions of dollars) by one academician in 1964:


National debt

Gross National Product

Debt as burden on GNP

So we might advance triumphantly to the conclusion that the national debt, when viewed as a burden on a year’s production, has been cut by two-thirds since 1945!

The conclusion would be technically correct, but complacency would be unjustified. The reason the national debt is less of a burden is that, through inflation, the purchasing power of the dollar has been steadily reduced. It has been reduced 65 per cent since 1933 and more than 50 per cent since 1945. Let us state this another way. By failing to balance its budget, by borrowing, by monetizing the debt, by printing more dollars, by steadily diluting the dollar’s purchasing power, the government has in effect repudiated 65 cents of every dollar it borrowed in 1933 and 50 cents of every dollar it borrowed in 1945.

To put it bluntly, the government’s creditors have been swindled.

Adam Smith, writing in 1776, was perfectly familiar with this method of disguised repudiation. “When national debts have once been accumulated to a certain degree,” he wrote, “there is scarce, I believe, a single instance of their having been fairly and completely paid.” But governments usually covered “the disgrace of a real bankruptcy” by the “juggling trick” of “a pretended payment” in depreciated money.
So the relationship that seems to give some present-day writers so much satisfaction—that the national debt, in dollar terms, has been falling in relation to the gross national product in dollar terms—is simply the outcome of the steady depreciation of the dollar. The more inflation we have, and the more the purchasing power of the dollar is depreciated, the more the national debt will “fall” in relation to the GNP, because the GNP, measured in soaring prices, will rise in relation to the dollar debt.

Do we have any serious intention of ever paying off our national debt in dollars of at least present purchasing power? If so, isn’t it about time we begin to balance the budget and make an honest start?