Trade and the Rise of Freedom

by Thomas DiLorenzo

Thomas DiLorenzo is professor of economics at Loyola College in Maryland. This is adapted from a paper presented at the Ludwig von Mises Institute’s conference on “’The History of Liberty” at Auburn University, January 29, 2000.

It is no exaggeration to say that trade is the keystone of modern civilization. As Murray Rothbard wrote, “The market economy is one vast latticework throughout the world, in which each individual, each region, each country, produces what he or it is best at, most relatively efficient in, and exchanges that product for the goods and services of others. Without the division of labor and the trade based upon that division, the entire world would starve. Coerced restraints on trade—such as protectionism—cripple, hobble, and destroy trade, the source of life and prosperity.”[1]

Human beings cannot truly be free unless there is a high degree of economic freedom—the freedom to collaborate and coordinate plans with other people from literally all around the world. That is the point of Leonard Read’s most famous article, “I, Pencil,” which describes how producing an item as mundane as an ordinary pencil requires the cooperation and collaboration of thousands of people from all around the world, all of whom possess very specific knowledge that allows them to assist in the manufacture and marketing of pencils. The same is true, of course, for virtually everything else that is produced.

Without economic freedom—the freedom to earn a living for oneself and one’s family—people are destined to become mere wards of the state. Thus, every attempt by the state to interfere with trade is an attempt to deny us our freedom, to impoverish us, and to turn us into modern-day serfs.

Ludwig von Mises believed that exchange is “the fundamental social relation” which “weaves the bond which unites men into society.”[2] Man “serves in order to be served” in any trade relationship in the free market.[3] Mises also distinguished between two types of social cooperation: cooperation by virtue of private contract and coordination, and cooperation by virtue of command and subordination or “hegemony.”[4] The former type of coordination is symmetrical and mutually advantageous, while the latter is asymmetrical—there is a commander and a commandee, and the commandees are mere pawns in the actions of the commanders. When people become the mere pawns of their rulers they cannot be said to be free. This, of course, is the kind of “cooperation” that exists at the hands of the state.

Western civilization is the result of “achievements of men who have cooperated according to the pattern of contractual coordination” Mises wrote.[5] The contractual state is guided by such concepts as natural rights to life, liberty, and property, and government under the rule of law. In contrast, the “hegemonic society” is one that does not respect natural rights or the rule of law. All that matters are the rules, directives, and regulations issued by dictators, whether they are called kings or congressmen. These directives may change daily, and the wards of the state must obey. As Mises wrote, “The wards have one freedom only: to obey without asking questions.”[6]

Trade involves the exchange of property titles. Restrictions on free trade are therefore an attack on private property itself and not “merely” a matter of “trade policy.” This is why such great classical liberals as Frederic Bastiat spent many years of their lives defending free trade. Bastiat, as much as anyone, understood that once one acquiesced in protectionism, no one’s property was safe from myriad other governmental acts of theft. To Bastiat, protectionism and communism were essentially the same philosophy.

It has long been recognized by classical liberals that free trade is the most important means of diminishing the likelihood of war. Nothing is more destructive of human freedom than war. It always leads to a permanent enlargement of the state—and a reduction in human freedom—regardless of who wins. On the eve of the French Revolution many philosophers believed that democracy would put an end to war, for wars were thought to be fought merely to aggrandize and enrich the rulers of Europe. The French quickly proved this theory wrong, however, for under the leadership of Napoleon they, in Mises’s words, “adopted the most ruthless methods of boundless expansion and annexation.”[7]

Thus it is not democracy that is a safeguard against war but, as the British (classical) Liberals were to recognize, free trade. To Richard Cobden and John Bright, the leaders of the British Manchester School, free trade—both domestically and internationally—was a necessary prerequisite for the preservation of peace; for in a world of trade and social cooperation, there are no incentives for war and conquest. It is government interference with free trade that is the source of international conflict. Indeed, naval blockades that restrict trade are the ultimate act of war. Throughout history restrictions on trade have proven to be impoverishing and have instigated acts of war motivated by territorial acquisition and plunder.

It is no mere coincidence that the 1999 meeting of the World Trade Organization—a cabal of bureaucrats, politicians, and lobbyists that favors government-controlled trade—was marked by a week of riots, protests, and violence. Whenever trade is politicized the result is inevitably conflict that quite often leads, eventually, to military aggression.

Mises summarized the relationship between free trade and peace most eloquently when he noted:

What distinguishes man from animals is the insight into the advantages that can be derived from cooperation under the division of labor. Man curbs his innate instinct of aggression in order to cooperate with other human beings. The more he wants to improve his material well-being, the more he must expand the system of the division of labor. Concomitantly he must more and more restrict the sphere in which he resorts to military action . . . . Such is the laissez-faire philosophy of Manchester.[8]

As Bastiat often said, if goods can’t cross borders, armies will. This is a quintessentially American philosophy; it was the position of George Washington, Thomas Jefferson, and Thomas Paine, among others. “A foreign policy based on commerce” wrote Paine in Common Sense, would secure for America “the peace and friendship” of the Continent and allow her to “shake hands with the world—and trade in any market.”[9] Paine—the philosopher of the American Revolution—believed that free trade would “temper the human mind,” help people to “know and understand each other,” and have a “civilizing effect” on everyone involved in it.[10] Trade was seen as “a pacific system, operating to unite mankind by rendering nations, as well as individuals, useful to each other . . . . War can never be in the interest of a trading nation.”[11]

George Washington agreed. “Harmony, liberal intercourse with all nations, are recommended by policy, humanity, and interest,” he stated in his September 17, 1796, Farewell Address.[12] Our commercial policy “should hold an equal and impartial hand; neither seeking nor granting exclusive favors or preferences; consulting the natural course of things; diffusing and diversifying by gentle means the streams of commerce, but forcing nothing.”[13]

The Eternal Struggle Between Freedom and Mercantilism

The period of world history from the middle of the fifteenth to the middle of the eighteenth centuries was an era of growth in world trade, technology, and institutions suited to trade. Technological innovations in shipping, such as the three-masted sail, brought the merchants of Europe to the far reaches of America and Asia. This vast expansion of trade greatly facilitated the worldwide division of labor, greater specialization, and the benefits of comparative advantage.[14]

But whenever human freedom advances, as it did with the growth of trade, state power is threatened. So states did all they could then, as now, to restrict trade. It is the system of trade restrictions and other governmental interference with the free market, known as mercantilism, that Adam Smith railed against in The Wealth of Nations.As Rothbard has written:

Mercantilism, which reached its height in the Europe of the seventeenth and eighteenth centuries, was a system of statism which employed economic fallacy to build up a structure of imperial state power, as well as special subsidy and monopolistic privilege to individuals or groups favored by the state. Thus, mercantilism held that exports should be encouraged by the government and imports discouraged.[15]

Classical liberals waged an ideological war against mercantilism during the eighteenth and nineteenth centuries, and scored some major victories for freedom. The French physiocrats, led by the physician and economist François Quesnay, were influential from the 1750s to the 1770s. They were among the first laissez- faire thinkers who denigrated mercantilist propaganda and called for complete freedom of domestic and international trade. Their position was based on sound economics as well as Lockean notions of natural rights. Quesnay wrote, “Every man has a naturalright to the free exercize of his faculties provided he does not employ them to the injury of himself or others.”[16]

When Anne Robert Jacques Turgot, a precursor of the Austrian school, became finance minister of France in 1774, his first official act was to free the import and export of grain. At around the same time, Adam Smith was defending trade on moral as well as economic grounds by identifying it is as part of the system of”natural justice” One of the ways he did this was to defend smuggling as a means of evading mercantilist restrictions on trade. The smuggler, explained Smith, was engaged in “productive labor” that served his fellow man (consumers), whereas if he were caught by the government and prosecuted, his capital would be “absorbed either in the revenue of the state or in that of the revenue-officer” which is an “unproductive” use “to the diminution of the general capital of the society.”[17]

The Manchester School

Despite powerful arguments in favor of free trade offered by Quesnay, Smith, David Ricardo, and others, England (and other countries of Europe) suffered from protectionist trade policies in the first half of the nineteenth century. The British public was plundered by the mercantilist Corn Laws, which placed strict quotas on the importation of grain. By raising food prices, the laws benefited landowning political supporters of the government at the expense of consumers, especially the poor. But this changed thanks to the heroic and brilliant efforts of what came to be known as the Manchester School, led by two British businessmen (and later, statesmen), John Bright and Richard Cobden. Bright and Cobden formed the Anti-Corn Law League in 1839 and turned it into a well-oiled political machine with mass support, distributing literally millions of leaflets, holding conferences and gatherings all around the country, delivering hundreds of speeches, and publishing their own newspaper, The League.[18]

The Irish potato famine of 1845 created great pressures for repeal of the Corn Laws, which was finally achieved on June 25, 1846. The elimination of all other import duties followed, and a 70-year period of British free trade began. Cobden was also influential in pushing through the Anglo-French treaty of 1860, which lowered French tariffs and helped put that country on the road to freer trade.

The Great Bastiat

From his home in Mugron, France, Frederic Bastiat single-handedly created a free-trade movement in his own country that eventually spread throughout Europe. Bastiat was a gentleman farmer who had inherited the family estate. He was a voracious reader, and spent many years educating himself in classical liberalism and in almost any other field that he could attain information about. After some 20 years of intense intellectual preparation, articles and books began to pour out of Bastiat (in the 1840s). His book Economic Sophisms is to this day arguably the best defense of free trade ever published. Economic Harmonies quickly followed, while Bastiat published in magazines and newspapers all over France. His work was so popular and influential that it was immediately translated into English, Spanish, Italian, and German.

Because of Bastiat’s enormous influence, free-trade associations, modeled after one he had created in France and similar to the one created by his friend Richard Cobden in England, began to sprout in Belgium, Italy, Sweden, Prussia, and Germany.

To Bastiat, collectivism in all its forms was immoral as well as economically destructive. Collectivism constituted “legal plunder,” and to argue against the (natural) right to private property would be similar to arguing that theft and slavery were moral. The protection of private property is the only legitimate function of government, Bastiat wrote, which is why trade restrictions—and all other mercantilist schemes—should be condemned. Free trade “is a question of right, of justice, of public order, of property. Because privilege, under whatever form it is manifested, implies the denial or the scorn of property rights.” And “the right to property, once weakened in one form, would soon be attacked in a thousand different forms.”[19]

The Struggle Against Mercantilism in America

There is no clearer example of how trade restrictions are the enemy of freedom than the American Revolution. In the seventeenth century all European states practiced mercantilism. England imposed a series of Trade and Navigation Acts on its colonies in America and elsewhere; they embodied three principles: (1) all trade between England and her colonies must be conducted by English (or English-built) vessels owned and manned by English subjects; (2) all European imports into the colonies must “first be laid on the shores of England” before being sent to the colonies so that extra tariffs could be placed on them; and (3) certain products from the colonies must be exported to England and England only.

In addition, the colonists were prohibited from trading with Asia because of the East India Company’s state- chartered monopoly. There were duties placed on all colonial imports into England.

After the Seven Years War (known in America as the French and Indian War), England’s massive landholdings (Canada, India, North America to the Mississippi, most of the West Indies) became expensive to administer and police. Consequently, the Trade and Navigation Acts were made even more oppressive, which imposed severe hardships on the American colonists and helped lead to revolution.[20]

After the American Revolution trade restrictions nearly caused the New England states—which suffered disproportionately from them—to secede from the Union. In 1807 Thomas Jefferson was president and England was once again at war with France. England declared that it would “secure her seamen wherever found,” which included U.S. ships. After a British warship captured the U.S.S. Chesapeake off Hampton Roads, Virginia, Jefferson imposed a trade embargo that made all international commerce illegal. After Jefferson left office his successor, James Madison, imposed an Enforcement Act, which allowed war-on-drugs-style seizure of goods suspected to be destined for export.

This radicalized the New England secessionists, who had been plotting to secede ever since Jefferson was elected, and who issued a public declaration reminding the nation that “the U.S. Constitution was a Treaty of Alliance and Confederation” and that the central government was no more than an association of the states. Consequently, “whenever its [the Constitution’s] provisions were violated, or its original principles departed from by a majority of the states or their people, it is no longer an effective instrument, but that any state is at liberty by the spirit of that contract to withdraw itself from the union.”[21]

The Massachusetts legislature formally condemned the embargo, demanded its repeal by Congress, and declared that it was “not legally binding.” In other words, the Massachusetts legislature “nullified” the law, just as South Carolina would nullify the 1828 Tariff of Abominations some 20 years later. Madison was forced to end the embargo in March 1809.

There has always been a collection of men in America who wanted to bring the British mercantilist system here precisely because it was so destructive of freedom. They figured to be the commanders of the system and its chief beneficiaries. As John Taylor of Caroline observed, these men “included Hamilton and the Federalists and later, the politicians of the Era of Good Feelings in the 1820s who eventually became Whigs.”[22] These men “sought to bring the British system to America, along with its national debt, political corruption, and Court party.”[23]

Taylor, a noted Anti-Federalist, was a lifelong critic of mercantilism, who laid out his criticisms in his 1822 book,Tyranny Unmasked. Like Bastiat, Taylor saw protectionism as an assault on private property that was diametrically opposed to the freedom the American revolutionaries had fought and died for. Taylor sought to “unmask” the tyranny of the fables and lies that the mercantilists had devised to promote their system of plunder. If one looked at England’s mercantilist policies, Taylor wrote, “No equal mode of enriching the party of government, and impoverishing the party of people, has ever been discovered.”[24] He wrote of the “indissoluble conexions” between both “the freedom of industry and national prosperity” and also “between national distress and protecting duties, bounties, exclusive privileges, and heavy taxation.”[25] The former produces national happiness, whereas the latter produces national misery, according to Taylor. In pointing out the folly of economic autarky (self-sufficiency) he asked:

Will Alabama want nothing but cotton, should that State select this species of labour for its staple? Can she eat, drink, and ride her cotton? Can she manufacture it into tools, cheese, fish, rum, wine, sugar, and tea? . . . . Is not Georgia a market for manufacturers, and Rhode-Island a market for cotton, in consequence of the division of labor?[26]

Many of Taylor’s arguments were adopted and expanded on by the South Carolinian statesman John C. Calhoun during the struggle over the 1828 Tariff of Abominations, which a South Carolina political convention voted to nullify. The confrontation between that state, which was very heavily dependent on imports, as was most of the South, and the federal government over the Tariff of Abominations almost led to the state’s secession some 30 years before the War Between the States. The federal government backed down and reduced the tariff rate in 1833.

The northern manufacturers who wanted to impose British-style mercantilism on the country did not give up, however; they formed the American Whig party, which advocated three mercantilist schemes: protectionism, corporate welfare, and a central bank to pay for it all. From 1832 until 1852 the Whigs, led by Henry Clay and later by Abraham Lincoln, fought mightily in the political arena to bring seventeenth-century mercantilism to America.[27]

The party died in 1852, but the Whigs simply began calling themselves Republicans. The tariff was the centerpiece of the Republican party platform of 1860, as it had been when the same collection of northern economic interests called itself “Whigs” during the previous 30 years.

By 1857 the level of tariffs had been reduced to the lowest level since 1815, according to Frank Taussig in his classic Tariff History of the United States.[28] But when the Republicans controlled the White House and the southern Democrats left the Congress, the Republicans, as former Whigs, did what they had been itching to do for decades: go on a protectionist frenzy. In his first inaugural address Lincoln stated that he had no intention to disturb slavery in the southern states and even if he did, there would be no constitutional basis for doing so. But he promised a military invasion if tariff revenues were not collected. Unlike Andrew Jackson, he would not back down from the South Carolinian tariff nullifiers.

By 1862 the average tariff rate had crept up to 47.06 percent, the highest level ever to that point, even higher than the 1828 Tariff of Abominations. These high rates lasted for decades after the war.

Many of the newspapers that supported the Republican party openly called for a military invasion of southern ports to keep the South from adopting free trade, which was written into the Confederate Constitution of 1861. On March 12, 1861, for example, the New York Post advocated that the U.S. Navy “abolish all ports of entry” in the South.[29] On April 2, 1861, the Newark Daily Advertiser in New Jersey warned ominously that southerners had “apparently taken to their bosoms the liberal and popular doctrine of free trade” and that free trade “must operate to the serious disadvantage of the North” as “commerce will be largely diverted to Southern cities.” The “chief instigator” of “the present troubles,” South Carolina, has all along been “preparing the way for the adoption of free trade” and must be stopped by “the closing of the ports” by military force.[30]

As mentioned above, by 1860 England itself had moved to complete free trade; France sharply reduced her tariff rates in that very year; and the free-trade movement started by Bastiat was spreading throughout Europe. Only the northern United States was clinging steadfastly to seventeenth-century mercantilism.

After the war the northern manufacturing interests who financed and controlled the Republican party “ushered in a long period of high tariffs. With the tariff of 1897, protection reached an average level of 57 percent.”[31] This political plunder continued for about 50 years after the war, at which time international competition forced tariff rates down moderately. By 1913 the average tariff rate in the United States had declined to 29 percent.

Protectionists Triumph

But the same clique of northern manufacturers was begging for “protection” and persisted until President Herbert Hoover signed the Smoot-Hawley Tariff of 1929, which increased the average tariff rate on over 800 items back up to 59.1 percent.[32] Smoot-Hawley spawned an international trade war that resulted in a 50 percent reduction in total exports from the United States between 1929 and 1932.[33] Poverty and misery were the inevitable result. Even worse, the government responded to these problems of its own creation with a massive increase in government intervention, which only produced even more poverty and misery and deprived Americans of more and more of their freedoms.

Since the seventeenth century all the great classical liberals have defended free trade and opposed trade restrictions. Restrictions on trade are an attack on the institution of private property, interfere with the international division of labor that is the source of our prosperity, and are nothing less than an act of theft. As Murray Rothbard remarked:

[T]he impetus for protectionism comes not from preposterous theories, but from the quest for coerced special privilege and restraint of trade at the expense of efficient competitors and consumers. In the host of special interests using the political process to repress and loot the rest of us, the protectionists are among the most venerable. It is high time that we get them, once and for all, off our backs, and treat them with the righteous indignation they so richly deserve.[34] []


Notes

  1. Murray Rothbard, “Protectionism and the Destruction of Prosperity,” found on www.mises.org/fullarticle.asp?title=protectionism&month=1.
  2. Ludwig von Mises, Human Action: A Treatise on Economics, Scholar’s Edition (Auburn, Ala.: Mises Institute, 1998 [1949]), p. 195.
  3. Ibid.
  4. Ibid., p. 196.
  5. Ibid., p. 198.
  6. Ibid., p. 199.
  7. Ibid., p. 819.
  8. Ibid., p. 827.
  9. Thomas Paine, Common Sense, p. 20, in Philip S. Foner, ed., Complete Writings of Thomas Paine (New York: 1954).
  10. Ibid.
  11. Ibid.
  12. W.B. Allen, ed., George Washington: A Collection (Indianapolis: LibertyClassics, 1988), p. 525.
  13. Ibid.
  14. Nathan Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich (New York: Basic Books, 1986), pp. 71-112.
  15. Murray Rothbard, “Mercantilism: A Lesson for Our Times?” in his The Logic of Action II (Cheltenham, England: Edward Elgar, 1997), p. 43.
  16. Cited in Henry Higgs, The Physiocrats (New York: Langland Press, 1952), p. 45.
  17. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: Oxford University Press, 1976), p. 898.
  18. Nick Elliott, “John Bright: Voice of Victorian Liberalism,” in Burton W. Folsom, Jr., ed., The Industrial Revolution and Free Trade (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1996), p. 28.
  19. Frederic Bastiat, Selected Essays on Political Economy, George B. de Huszar, ed. (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995), p. 111.
  20. Samuel Eliot Morison, Henry Steele Commager, and William Leuchtenburg, The Growth of the American Republic (New York: Oxford University Press, 1980), pp. 112-25.
  21. James Banner, To the Hartford Convention: The Federalists and the Origins of Party Politics in Massachusetts, 1789-1815 (New York: Alfred A. Knopf, 1970), p. 301.
  22. John Taylor, Tyranny Unmasked (Indianapolis: Liberty Fund, 1992), p. xvi.
  23. Ibid.
  24. Ibid., p. 11.
  25. Ibid., p. 19.
  26. Ibid., p. 24.
  27. Michael F. Holt, The Rise and Fall of the American Whig Party (New York: Oxford University Press, 1999).
  28. Frank Taussig, A Tariff History of the United States (New York: Putnam, 1931), p. 157.
  29. Howard Perkins, Northern Editorials on Secession (Gloucester, Mass.: Peter Smith, 1964), p. 600.
  30. Ibid., p. 602.
  31. Wilson Brown and Jan Hogendom, International Economics (New York: Addison-Wesley, 1994), p. 188.
  32. Ibid., p. 192.
  33. Ibid., p. 193.
  34. Rothbard, “Protectionism.”

This article has been published with FEE’s permission.

Property and Liberty

By James Bovard

James Bovard is the author of “Freedom in Chains: The Rise of the State and the Demise of the Citizen” (St. Martin’s Press).


Property is “the guardian of all other rights,” as Arthur Lee of Virginia wrote in 1775.[1] The Supreme Court declared in 1897: “In a free government almost all other rights would become worthless if the government possessed power over the private fortune of every citizen.”[2] Unfortunately, legislators, judges, and political philosophers in the twentieth century have perennially disparaged property’s value to freedom.

Without private property, there is no escape from state power. Property rights are the border guards around an individual’s life that deter political invasions. Those who disparage property often oppose any meaningful limits on government power. John Dewey, for instance, derided “the sanctity of private property” for providing “freedom from social control.”[3] Socialist regimes despise property because it limits the power of the state to regiment the lives of the people. A 1975 study, The Soviet Image of Utopia, observed, “The closely knit communities of communism will be able to locate the anti-social individual without difficulty because he will not be able to ‘shut the door of his apartment’ and retreat to an area of his life that is ‘strictly private.’”[4] Hungarian economist Janos Kornai observed: “The further elimination of private ownership is taken, the more consistently can full subjection be imposed.”[5]

Yet Oxford professor John Gray asserted in 1990 that “very extensive State intervention in the economy has nowhere resulted in the extinction of basic personal and political liberties.”[6] One wonders which freedoms Bulgarian and Romanian citizens enjoyed under communism that Gray neglects to mention. Perpetual shortages of almost all goods characterized East Bloc economies; politicians and bureaucrats maximized their power and maximized people’s subjugation through discretionary doling out of goods. Shortages created new pretexts to demand further submission: the worse the economic system functioned, the more power government acquired—until the people rose up and destroyed the governments.[7]

The Economy Is Lives

Government cannot control the economy without controlling the lives of everyone who must rely on that economy to earn his sustenance. There is more to life than wealth. But the more wealth government seizes from people, the more likely that government will be able to control all the other good things in life. Once government domineers the economy, it becomes far more difficult to resist the extension of government power further and further into the recesses of each person’s life.

Property rights are not concerned merely with the sanctity of the estates of the rich. The property right that each citizen has in himself is the foundation of a free society. As James Madison observed, “Government is instituted to protect property of every sort; as well that which lies in the various rights of individuals, as that which the term particularly expresses.”[8] The property that each citizen has in his rights is the foundation of his ability to control his own life and strive to shape his own destiny.

Some contemporary liberals argue that government ownership is the ultimate safeguard of freedom. According to Alan Wolfe, “No one would be able to enjoy the negative liberty of walking alone in the wilderness if it were not for the regulatory capacity of government to protect the wilderness against development.”[9] Wolfe implies that if the government did not own much of the nation’s land, private citizens would ravage the landscape from coast to coast. However, private landowners have a better record of safeguarding the environmental quality of their land than does the federal government.[10] The Army Corps of Engineers has destroyed far more of the natural river beauty in this country than has any private malefactor, and the Federal Emergency Management Agency’s lavish subsidies for “flood insurance” have made possible vast numbers of buildings on ecologically fragile coastlines.[11] Wolfe also implies that no private forest owner would permit anyone else to walk on his land. However, the proliferation of contracts for hunting on private land show that, with a sound incentive system, access to private land can easily be negotiated. Citizens have different values, and many citizens prefer to keep their land in semi-pristine condition. Besides, even if all citizens wanted to sell their land to developers, only a small percentage of such land would be developed—simply because there is no economic rationale for developing much of rural America.

Bulwark of Privacy

The sanctity of private property is the most important bulwark of privacy. University of Chicago law professor Richard Epstein wrote that “private property gives the right to exclude others without the need for any justification. Indeed, it is the ability to act at will and without need for justification within some domain which is the essence of freedom, be it of speech or of property.”[12] Unfortunately, federal law enforcement agents and prosecutors are making private property much less private. In 1984 the Supreme Court ruled in Oliver v. United States—a case involving Kentucky law-enforcement agents who ignored several “No Trespassing” signs, climbed over a fence, tramped a mile and a half onto a person’s land and found marijuana plants—that “open fields do not provide the setting for those intimate activities that the [Fourth] Amendment is intended to shelter from government interference or surveillance.”[13] (The Founding Fathers apparently forgot to include a parenthesis in the original Fourth Amendment specifying that it applied only to “intimate activities.”) And the Court made it clear that it was not referring only to open fields: “A thickly wooded area nonetheless may be an open field as that term is used in construing the Fourth Amendment.”[14] Justice Thurgood Marshall dissented: “Many landowners like to take solitary walks on their property, confident that they will not be confronted in their rambles by strangers or policemen.”[15] Even prior to this ruling, it was easy for law-enforcement agents to secure warrants to search private land merely by concocting an imaginary confidential informant who told police about some malfeasance.[16]

The core of the “open fields” decision is that the government cannot wrongfully invade a person’s land, because government agents have a right to go wherever they damn well please. After this decision, any “field” not surrounded by a 20-foot-high concrete fence is considered “open” for inspection by government agents. (And for those areas that are sufficiently fenced in, the Supreme Court has blessed low-level helicopter flights to search for any illicit plants on the ground.[17])

The Supreme Court decision, which has been cited in over 600 subsequent federal and state court decisions, nullified hundreds of years of common-law precedents limiting the power of government agents. The ruling was a green light for warrantless raids by federal immigration agents; in late 1997 the New York Times reported cases of upstate New York farmers’ complaining that “immigration agents plowed into fields and barged into packing sheds like gang busters, handcuffing all workers who might be Hispanic and asking questions later . . . . [D]oors were knocked down, and workers were wrestled to the ground.”[18] In a raid outside of Elba, New York, at least one INS agent opened fire on fleeing farm workers.[19] Many harvests subsequently rotted in the fields because of the shortage of farm workers.

Conflicting Views of Freedom

The “open fields” doctrine provides an acid test of conflicting views on freedom. Are people more or less free when government agents can roam their land? Are they more or less free when they can be accosted by government agents any time they step past the shadow of their front door? Is freedom the result of government intrusions—or of restrictions on intruders? The scant controversy the 1984 decision evoked is itself a sign of how statist contemporary American thinking has become.

Few government policies better symbolize the contempt for property rights than the rising number of no-knock raids. “A man’s home is his castle” has been an accepted rule of English common law since the early 1600s and required law-enforcement officials to knock on the door and announce themselves before entering a private home. But this standard has increasingly been rejected in favor of another ancient rule—“the king’s keys unlock all doors.”[20]

A New York Times piece observed in 1998 that “interviews with police officials, prosecutors, judges and lawyers paint a picture of a system in which police officers feel pressured to conduct more raids, tips from confidential informers are increasingly difficult to verify and judges spend less time examining the increasing number of applications for search warrants before signing them.”[21] The Times noted that “the word of a single criminal, who is often paid for his information, can be enough to send armed police officers to break down doors and invade the homes of innocent people.”[22]

No-knock raids have become so common that thieves in some places routinely kick down doors and claim to be policemen.[23] The Clinton administration, in a 1997 brief to the Supreme Court urging blind trust in the discretion of police, declared that “it is ordinarily reasonable for police officers to dispense with a pre-entry knock and announcement.”[24] Law-enforcement agencies’ fear of losing small amounts of drug evidence has fueled attacks on the sanctity of homes. The Clinton administration, for instance, appears far more concerned about the flushing of drugs than about the flushing of privacy. In a 1995 brief to the Supreme Court, the Clinton administration stressed that “various indoor plumbing facilities . . . did not exist” at the time the common law “knock-and-announce” rule was adopted.[25] Making a grand concession to civil liberties, the administration admitted that “if the officers knew that . . . the premises contain no plumbing facilities . . . then invocation of a destruction-of-evidence justification for an unannounced entry would be unreasonable.”[26] The Supreme Court has failed to impose effective restraints on police’s prerogative to carry out no-knock raids. Professor Craig Hemmens observed that the Court’s “recent decisions involving the knock and announce rule, essentially gutted the rule, reducing it to little more than a ‘form of words.’”[27]

Police also possess the right to destroy property they search. Santa Clara, California, police served search and arrest warrants by firing smoke grenades, tear-gas canisters, and flash grenades into a rental home; not surprisingly, the house caught fire and burned down. When the homeowner sued for damages, a federal court rejected his plea, declaring that the police “only . . . carelessly conducted its routine and regular duty of pursuing criminals and obtaining evidence of criminal activity. The damage resulted from a single, isolated incident of alleged negligence.”[28]

It is as much a violation of property rights and liberty when government agents storm into the shabbiest of rental apartments as when they invade the richest mansion. The sanctity acquired by renters to a private domain illustrates how the exchange of private property can give someone vested rights—rights within which they can build and live their own lives. Local and state governments routinely treat renters as second-class citizens; many localities have mandatory inspection policies for all rental units that permit government officials to search private dwellings without a warrant or any pretext. Park Forest, Illinois, in 1994 enacted an ordinance that authorizes warrantless searches of every single-family rental home by a city inspector and police officer, who are authorized to invade rental units “at all reasonable times.” No limit was placed on the power of the inspectors to search through people’s homes, and tenants were prohibited from denying entry to government agents. Federal Judge Joan Gottschall struck down the searches as unconstitutional in February 1998, but her decision will have little or no effect on the numerous other localities that authorize similar invasions of privacy.[29]

Bane of Freedom?

Some socialists have argued that private property is a bane of freedom because inequality of wealth is equivalent to political tyranny. According to historian R. H. Tawney, “Oppression . . . is not less oppressive when its strength is derived from superior wealth, than when it relies on a preponderance of physical force.”[30] But regardless of how much wealth a person owns, he has no legal right to coerce other citizens. Offering someone the best wage he can find is unlike holding a gun to his head; offering someone the best price for a product he is selling is not like expropriation. A legitimate government must restrict the coercion of all citizens, including those with the largest bank accounts. But the fact that politicians are sometimes corrupted by bribes and deny equal protection of the law to the poor is not a good reason to give more power to politicians.

To understand the difference between economic wealth and political power, consider the difference between the power of a boss and that of a government agent. Any power that a boss or company has over a person is based on a contract, express or implied; that power is limited to the work and time contracted for. (Contracts for lifetime labor are illegal in the United States.) A boss’s power is conditional, dependent on an employee’s choosing to continue to receive a paycheck.

In contrast, the government agent’s power is often close to absolute: for example, a citizen who refuses to pull over for a traffic cop flashing his lights can face jail time, regardless of whether the cop had a legitimate reason to stop him. Markets allow people a choice of whom to deal with, while government dictates that citizens must submit to its orders. As Nobel laureate James Buchanan observed, “As individuals become increasingly dependent on ‘the market,’ they become correspondingly less dependent on any identifiable person or group. In political action, by contrast, increasing dependence necessarily becomes increasing subjection to the authority of others.”[31]Markets limit the power of people to dictate to other people because the parties can seek other bidders or sellers. Markets provide venues for people to voluntarily agree with other people. Markets are symbolic of voluntary activities in the same way that jails are symbolic of coercion.

Some friends of government legitimize vesting sweeping power in politicians by defining practically any private business decision as coercive. Economist Robert Kuttner declared on a 1997 PBS program that “when a company relocates overseas . . . that is a form of violence.”[32] To define practically any economic change as “violence” is to authorize an unlimited number of political first strikes against property owners. If moving a factory overseas is a form of violence, then moving a factory across state lines is also a form of violence—since the “violence” is presumably done by a factory leaving one location, regardless of where it relocates. When a person is given a “right” to a job, all other people are prohibited from competing for that job.

A viable concept of freedom must consist of more than psychological wish fulfillment—more than a fantasy world in which every citizen can buy low and sell high, in which every citizen gets the wages he demands and pays the prices he pleases. It is crucial to distinguish between frustrated economic aspirations and government coercion. Feeling a compulsive need to impress neighbors by buying a swimming pool is not the same as facing arrest for planting grass seed in your yard and allegedly disturbing a federally designated wetland. The compulsion to buy a suit of the latest fashion is not the same compulsion as experienced during an IRS audit, especially if the agent decides to employ a notorious “lifestyle audit,” which forces citizens to detail and justify how much cash they had on hand at any one time a year or two before, whether they have a safe deposit box and what it contains, how much they spend on groceries, where they eat out, what toys they buy for their children, and what books or jewelry they purchase.[33] The compulsion to buy a new car differs from the compulsion you feel when police pull you over, announce that your appearance matches that of a “drug courier profile,” and proceed to rummage through your trunk, glove compartment, tire hubs, and pockets, and to ask a bevy of incriminating questions about your personal life.[34] The fact that a person spends himself deeply into debt and thus feels obliged to keep working at a job he despises is not coercive because no one compelled the person to become a mindless consumer.

An inability to find a satisfactory job or satisfactory career path is not a violation of liberty—unless government or private action forcibly blocks or restrains people. A person is not “oppressed” by his own lack of marketable job skills: every art history major who did not find a good job after college is not a victim of some sinister force.

One of the clearest violations of freedom of contract is government licensing laws, which prohibit millions of Americans from practicing the occupation of their choice. Over 800 professions, from barbers to masseuses to interior designers to phrenologists to tattooists to talent agents, now require a government license to practice. Licensing laws are usually engineered by professional associations that want to “protect” the public from competitors who might charge lower prices.[35] Licensing laws kept many blacks out of the skilled professions until the civil rights era. The Federal Trade Commission perennially reports on the anticompetitive aspects of state government licensing boards.[36] For many professions, private accreditation systems—many of which have already been developed—would provide a much more reliable consumer guide than politically controlled certification systems.

Liberty in Action

Property is the basis of freedom of contract, which is simply liberty in action. Without freedom to exchange, government places all exchanges at the discretion of the political-bureaucratic ruling class. As new forms of property and wealth have developed in the last 200 years, it is now much clearer how vital property is to all citizens’ freedom, not merely that of landowners. By holding title to certain resources (including themselves and their own labor), people can make exchanges with others that allow them to raise themselves, to better provide for their families, to pursue their own values. Freedom is more than the right to own property or the right to buy and sell. But once the citizen loses the right to own—even if he previously owned nothing—he loses the ability to control his own life. If the citizen is denied the right to own or control his own computer disks or the clothes on his back, he has little chance of being able to shape his own future.

Property rights and market economies are vital steppingstones to political freedom. Private property gives people a place to stand if they must resist the government. Market economies and private property allow citizens to build up sufficient wealth to resist government pressure.

It is important to have freedom to buy and sell, to invest, to innovate, to choose one’s risks and reap one’s profits—but it is not enough. It is also vital that police not be able to break people’s heads, or entrap them on bogus charges, or intercept their e-mail at a whim, or target them because of their race, ethnicity, or political ideas. Unfortunately, some advocates of economic freedom seem nonchalant about practically any use of government power that does not directly interfere with profit-making.


Notes

  1. Quoted in James W. Ely, Jr., The Guardian of Every Other Right (New York: Oxford University, 1992), p. 26.
  2. Chicago, Burlington & Quincy R.R. v. Chicago, 166 U.S. 226 (1897).
  3. John Dewey, Liberalism and Social Action (New York: G. P. Putnam’s Sons, 1935), p. 34.
  4. Jerome Gilison, The Soviet Image of Utopia (Baltimore: Johns Hopkins University Press, 1975), p. 149.
  5. Quoted in Robert Skidelsky, The Road from Serfdom (New York: Penguin, 1997), p. 99.
  6. Ibid., p. 119.
  7. James Bovard, “Eastern Europe, The New Third World,” New York Times, December 20, 1987, and James Bovard, “The Hungarian Miracle,” Journal of Economic Growth, January 1987.
  8. The Writings of James Madison, vol. 6, ed. Gaillard Hunt (New York: G.P. Putnam’s Sons, 1906), p. 103. The quote is from an article Madison wrote for the National Gazette, March 29, 1792.
  9. Alan Wolfe, review of Stephen Holmes’s Passions & Constraint: On the Theory of Liberal Democracy, New Republic, May 1, 1995.
  10. Tom Bethell, The Noblest Triumph: Property and Prosperity Through the Ages (New York: St. Martin’s Press, 1998), pp. 272-89.
  11. James Bovard, “Assistance to Flood Victims Invites Further Disaster,” Los Angeles Times, June 18, 1997.
  12. Richard Epstein, Takings (Cambridge, Mass.: Harvard University Press, 1985), p. 66.
  13. Oliver v. United States, 466 U.S. 170, 179 (1984).
  14. Ibid., p. 180, fn. 11.
  15. Ibid., p. 192.
  16. The National Law Journal reported in 1995 that between 1980 and 1993 the number of federal search warrants relying exclusively on confidential informants nearly tripled, from 24 percent to 71 percent, and that “from Atlanta to Boston, from Houston to Miami to Los Angeles, dozens of criminal cases have been dismissed after judges determined that the informants cited in affidavits were fictional.” Mark Curriden, “Secret Threat to Justice,” National Law Journal, February 20, 1995.
  17. Florida v. Riley, 488 U.S. 445 (1989).
  18. Evelyn Nieves, “I.N.S. Raid Reaps Many, But Sows Pain,” New York Times, November 20, 1997.
  19. Associated Press, “Agent Fired During Raid on Migrants, Report Finds,” New York Times, December 12, 1997.
  20. Craig Hemmens, “I Hear You Knocking: The Supreme Court Revisits the Knock and Announce Rule,”University of Missouri at Kansas City Law Review, Spring 1998, p. 562.
  21. Michael Cooper, “As Number of Police Raids Increase, So Do Questions,” New York Times, May 26, 1998.
  22. Ibid.
  23. Barney Rock, “Kicking in Doors New Trend among Thieves,” Arkansas Democratic Gazette, January 21, 1995.
  24. Hemmens, p. 584.
  25. Brief for the United States as Amicus Curiae Supporting Respondent, Wilson v. Arkansas, no. 94-5707, February 23, 1995, p. 26.
  26. Ibid., p. 28.
  27. Hemmens, p. 601.
  28. Patel v. U.S., 823 F. Supp. 696, 698 (1993). For discussion of this case, see Gideon Kanner, “What Is a Taking of Property?” Just Compensation, December 1993.
  29. Kenneth Black et. al v. Village of Park Forest, 1998 U.S. Dist. LEXIS 2427, February 23, 1998.
  30. Quoted in Robert E. Goodin, Reasons for Welfare (Princeton, N.J.: Princeton University Press, 1988), p. 307.
  31. James Buchanan, “Divided We Stand,” review of Democracy’s Discontent: America in Search of a Public Philosophy” by Michael J. Sandel, Reason, February 1997, p. 59.
  32. “Debate on Free Trade,” Public Broadcasting Service, August 15, 1997.
  33. Arthur Fredheim, “IRS Audits Digging Deeper Beneath the Surface,” Practical Accountant, March 1996, p. 20.
  34. See, for instance, Tracey Maclin, “The Decline of the Right of Locomotion: The Fourth Amendment on the Streets,” Cornell Law Review, September 1990, p. 1258, and Mark Kadish, “The Drug Courier Profile: In Planes, Trains, and Automobiles; and Now in the Jury Box,” American University Law Review, February 1997, p. 747.
  35. See, for instance, Sue Blevins, “Medical Monopoly: Protecting Consumers or Limiting Competition?” USA Today (magazine), January 1998, p. 58.
  36. Interview with Federal Trade Commission spokesman Howard Shapiro, July 28, 1998.

This article has been published with FEE‘s permission.

Profit: Not Just a Motive – Profits Tell Producers What They Should and Should Not Do

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University and the author of Microfoundations and Macroeconomics: An Austrian Perspective, now in paperback.

One of the more common complaints of critics of the market is that “the profit motive” works at cross-purposes with people and firms doing “the right thing.” For example, Michael Moore’s film Sicko was motivated by his desire to take the profit motive out of health care because, in his view, the ways people seek profits do not lead them to provide the level and kind of care he thinks patients should have.

Leaving aside for a moment whether the health-care industry is really dominated by the profit motive (given that almost half of U.S. health-care expenditures are paid for by the federal government, it is not clear which motives dominate) and whether Moore knows better than millions of individuals what their health-care needs are, the claim that a “motive” is a root cause of social pathologies is worthy of some critical reflection. The critics seem to suggest that if people and firms were motivated by something besides profit, they would be better able to provide the things that patients really need.

The overarching problem with blaming a “motive” is that it ignores the distinction between intentions and results. That is, it ignores the possibility of unintended consequences, both beneficial and harmful. Since Adam Smith, economists have understood that the self-interest of producers (of which the profit motive is just one example) can lead to social benefits. As Smith famously put it, it is not the “benevolence” of the baker, butcher, and brewer that leads them to provide us with our dinner but their “self-love.” Smith’s insight, which was a core idea of the broader Scottish Enlightenment of which he was a part, puts the focus on the consequences of human action, not their motivation.

What we care about is whether the goods get delivered, not the motives of those who provide them. Smith led economists to think about why it is that, or under what circumstances, self-interest leads to beneficial unintended consequences. It is perhaps human nature to assume that intentions equal results, or that self-interest means an absence of social benefit, as was often the case in the small, simple societies in which humanity evolved. However, in the more complex, anonymous world of what Hayek called “the Great Society,” the simple equation of intentions and results does not hold.

As Smith recognized, what determines whether the profit motive leads to good results are the institutions through which human action is mediated. Institutions, laws, and policies affect which activities are profitable and which are not. A good economic system is one in which those institutions, laws, and policies are such that the self-interested behavior of producers leads to socially beneficial outcomes. In mixed economies like that of the United States, the institutional framework often rewards profit-seeking behavior that does not produce social benefit or, conversely, prevents profit-seeking behavior that could produce such benefits. For example, if agricultural policy pays farmers not to grow, then the profit motive will lead to lower food supplies. If environmental policy confiscates land with endangered species on it, owners of such land who are driven by the profit motive will “shoot, shovel, and shut up” (that is, kill off and bury any endangered species they find on their land).

The same issues can be raised in the health-care industry. Before blaming the profit motive for the problems in the industry, critics might want to look at the ways in which existing government programs like Medicare and Medicaid, the interpretation of tort laws, and regulations such as those that limit who can practice what sorts of medicine might lead firms and professionals to engage in behavior that is profitable but unbeneficial to consumers. Labeling the profit motive as the source of the problem enables the critics to ignore the really difficult questions about how institutions, policies, and laws affect the profit-seeking incentives of producers and how that profit-seeking behavior translates into outcomes. Placing the blame on the profit motive without qualification simply overlooks the Smithian question of whether better institutions would enable the profit motive to generate better results and whether current policies or regulations are the source of the problem because they guide the profit motive in ways that produce the very problems the critics identify.

For example, high medical costs may well be a result of profit-seeking providers’ recognizing that government programs are notoriously bad at pricing services accurately and keeping good track of their expenditures. Ignoring the way institutions might affect what is profitable is often due to a more general blind spot about the possibility of self-interested behavior generating unintended beneficial consequences. Before we attempt to banish the profit motive, shouldn’t we see whether we can make it work better?

Placing blame for social problems on the profit motive is also easy if critics offer no alternative. What should be the basis for determining how resources are allocated if not in terms of profit-seeking behavior under the right set of institutions? How should people be motivated if not by profit? Often this question is just ignored, as critics are merely interested in casting blame. When it is not ignored, the answers can vary, but they mostly invoke a significant role for government. The interesting aspect of such answers is that critics do not suggest that we somehow convince producers to act on the basis of something other than profit, but that instead we replace them with presumably other-motivated bureaucrats or have those bureaucrats severely limit the choices open to producers. The implicit assumption, of course, is that the government personnel will not be motivated by profits or self-interest in the same way as the private-sector producers are.

How realistic this assumption is remains highly questionable. Why should we assume that government officials are any less self-interested than private individuals, especially when the door between the two sectors is constantly revolving? And if government officials do act in their self-interest and are motivated by the political analogs of profits (for example, votes, power, budgets), will they produce results that are any better than the private sector’s? If blaming the profit motive entails giving government a bigger role in solving problems, what assurance can critics of the profit motive provide that political officials will be any less self-interested and that their self-interest will produce any better results?

One will look in vain in Sicko, for example, for any analysis of the failures of state-sponsored health care in Cuba, Canada, Great Britain, or anywhere else. To blame the profit motive without asking whether an alternative will better solve the problems supposedly caused by the profit motive is to bias the case against the private sector.

How Will They Know?

Even this argument, however, does not go far enough. We are still, after all, focused on intentions and motivation. What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

Suppose for a moment that we try to take the profit motive out of health care by going to a system in which government pays for and/or directly provides the services. Suppose further that we could, somehow, ensure that the political officials would not be self-interested. For many critics of the profit motive, the problem is solved because public-spirited politicians and bureaucrats have replaced profit-seeking firms.

Well, not so fast. By what method exactly will the officials know how to allocate resources? By what method will they know how much of what kind of health care people want? And more important, by what method will they know how to produce that health care without wasting resources? It’s one thing to say that every adult should, for example, have a checkup every year, but should it be provided by an MD, an LPN, or an RN? What kind of equipment should be used? How thorough should it be? And most crucially, how will political decision-makers know if they’ve answered these questions correctly?

In markets with good institutions, profit-seeking producers can get answers to these questions by observing prices and their own profits and losses in order to determine which uses of resources are more or less valuable to consumers. Rather than having one solution imposed on all producers, based on the best guesses of political officials, an industry populated by profit seekers can try out alternative solutions and learn which ones work most effectively. Competition for profit is a process of learning and discovery. For all the profit-critics’ concern—especially but not only in health care—that allocating resources by profits leads to waste, few if any understand how profits and prices signal the efficiency (or lack thereof) of resource use and allow producers to learn from those signals. The most profound waste of resources in the U.S. health-care industry stems from the incentives and market distortions created by government programs such as Medicare and Medicaid.

Thus the real problem with focusing on the profit motive is that it assumes that the primary role of profits is to motivate (or in contemporary language “incentivize”) producers. If one takes that view, it might seem relatively easy to find other ways to motivate them or to design a new system where production is taken over by the state. However, if the more important role of profits is to communicate knowledge about the efficiency of resource use and enable producers to learn what they are doing well or poorly, the argument becomes much more complicated. Now the critics must explain what in the absence of profits will tell producers what they should and should not do. Eliminating profit-seeking from an industry doesn’t just require that a new incentive be found but that a new way of learning be developed as well. Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market. Critics may consider eliminating the profit motive the equivalent of giving the Tin Man from Oz a heart; in fact it’s much more like Oedipus’ gouging out his own eyes.

This article has been published with FEE‘s permission.

The Search for an Ideal Money

Henry Hazlitt

Mr. Hazlitt, noted economist, journalist and author, here examines perhaps the most important question facing us today.


For more than a century economists have toyed with the idea of designing or inventing an ideal money. So far no two of them seem to have precisely agreed on the detailed nature of such a money. But they do seem at the moment to agree on at least one negative point. I doubt that there is any economist today who would defend the international or American monetary system just as it is. No one openly defends the violent daily and hourly fluctuations in exchange rates, the steadily increasing unpredictability of future import, export, or domestic prices. Every newspaper reader fears that commodity prices will be higher next year and still higher the year after that. Even the man in the street, in brief, senses that the world is drifting toward monetary chaos.

But concerning the remedy, we find little agreement. Inflation is bad, some agree. Yes; but it isn’t as bad as depression and unemployment; and at least it puts off those greater evils, so we must have just a little more inflation as long as these evils threaten us. Inflation is bad, others agree; but it has nothing to do with the monetary system. Rising prices are brought about by the greed and rapacity of sellers; they could promptly be stopped by price controls. Or, inflation is bad, still others concede; and yes, it is brought about by the increase in the quantity of money and credit.

But this is not the fault of the monetary system itself, but of the blunders and misdeeds of the politicians or the bureaucrats in charge of it.

Even those who admit that there is something wrong with the monetary system itself cannot agree on the reforms needed in that system. Scores of such reforms have been proposed.

The reformers, however, tend to fall into two main groups. One of these would have nothing to do with a gold, a silver, or any other commodity standard, but would leave the issuance and control of the currency entirely in the hands of the State. The other group would return to some form of the gold standard.

Each of these two groups may again be divided into two schools. In what I shall call the statist or paper-money group, one school would leave everything to the day-to-day discretion of government monetary authorities, and the other would subject these authorities to strict quantitative controls. And in the gold group, likewise, one school would allow discretion, within vague but wide limits, to private bankers and government authorities, while the second would impose severe and definite limits on that discretion.

So we have, then, four main schools of monetary theorists.

Nearly every currency proposal can be classified under one of them.

Paper Money — No Controls

Let us begin with School One, the paper-money statists, who would leave the power of controlling the nature, quantity and value of our money solely in the hands of the politicians in office or the bureaucrats they appoint. This is the worst imaginable monetary system, but it is the one that prevails nearly everywhere in the world today. It has brought about practically universal inflation, unprecedented uncertainty, and economic disruption.

None of this is accidental. It was built into the system deliberately adopted at a conference of 44 nations at Bretton Woods in 1944, under the guidance of Harry Dexter White of the U.S. and Lord Keynes of England. The ostensible purpose of that conference was to increase “international cooperation” and — believe it or not — to “stabilize” currencies and exchange rates.

The chief architects sincerely believed (though they did not as openly avow) that this end could best be achieved by phasing gold out of the monetary system. So they put the world, in effect, not on a gold but on a dollar standard. The value of every other currency was to be maintained by making it convertible into the American dollar at a fixed official exchange rate.

The system still had one tie to gold. The dollar itself was to be kept convertible into that metal at $35 an ounce. But this tie was weakened in two ways. Other countries could keep their currencies stabilized in terms of the dollar, not through the operations of a free foreign exchange market (as under the pre-World War I gold standard) but by government sales or purchases of dollars — in other words by government pegging operations. And dollars were no longer convertible into gold on demand by anybody who held them; they were convertible only by foreign central banks. The U.S. could even (off-the-record) use its great political and economic power — which in time it did — to indicate to any central bank with the effrontery to ask for gold that this was not considered a friendly act.

So the artificial stability that the Bretton Woods system was able to maintain for a few years was not the result of any real attempt by each country to keep its own currency sound — by refraining from excessive issuance of money and credit — but of government pegging operations and gentlemen’s agreements not to upset the apple cart.

This arrangement proved, in the end, unwise, unsound, and unstable. The system was able to maintain the appearance of stability only by the stronger currencies constantly rushing to the rescue of the weaker. The U.S., say, would rush in and lend Britain millions of dollars, or buy millions of pounds. It would do the like for other currencies in crisis. But using the stronger currencies to support the weaker only weakened the stronger currencies. When the U.S. Treasury bought millions of pounds with dollars, it in effect got these dollars by printing them.

And so when the dollar itself, as the result of our own recklessness, began to turn bad, and when we went off the gold standard openly in August, 1971, other nations were affected. Germany, for instance, under the terms of the Bretton Woods agreements, had to buy billions of dollars to keep the D-mark from going above its official parity. And where did Germany get the billions of marks necessary to buy the billions of dollars? Why, by printing them.

So the faster-inflating nations almost systematically exported their inflations to the slower-inflating nations. And this almost systematically brought the world toward its present inflationary chaos.

True, the nations with stronger currencies, even when they felt obliged by their Bretton Woods agreement to buy weaker currencies, did not have to increase their own money supply to buy them. Neither Germany nor any other nation that acquired dollars had to use the dollars as added central bank “reserves” against which they could issue still more of their own currency. They could have “sterilized” their reserves of dollars. Or they could have reduced their other government expenditures correspondingly when they felt obliged to buy dollars, or raised the amount by added taxation, instead of simply printing more D-marks or whatever. But these would have been very difficult decisions. They might have endangered the tenure of the governments that made them. What they chose seemed under the circumstances the path of least resistance.

What has to be made crystal clear, if we are to lay the foundations for any permanent sound monetary reform, is that the present worldwide inflationary chaos is not a mere accident. It is not something that has happened in spite of the wonderfully modern and enlightened International Monetary Fund system. It is something that has happened precisely because of that system. It is, in fact, its almost inevitable result.

Steady Breakdown

It was precisely the kind of “international cooperation” it set up that led to its final breakdown. The countries whose policies were chronically leading them into currency crises should have been obliged to pay the penalty. The faltering currencies should not have been rescued by the central banks of other countries. It was exactly because the soft-currency countries knew that an American or international safety net would be almost automatically spread out to save them that they chronically got themselves into more trouble. As it was, the system kept breaking down anyway, but there was a sort of open conspiracy to ignore its fundamental unsoundness. In September, 1949, the British pound was devalued by 30 per cent, from $4.03 to $2.80. When this happened some 25 other countries devalued within a single week. In November, 1967 the British pound was devalued once more, this time from $2.80 to $2.40. There have been in fact hundreds of devaluations of currencies in the International Monetary Fund since it opened for business in 1946. In its Monthly Bulletin the Fund has printed literally millions of statistics a year, but it has steadfastly refused, up to now, to publish one figure — the total number of these devaluations.

Enough of this. It should no longer be necessary to prove how bad the Bretton Woods system turned out to be. Few people, aside from the bureaucrats whose jobs are at stake, would seriously try to glue it together again. The system is dead. Unfortunately the corpse has not been buried.

The Monetarists

Let us turn to the next candidate — the proposals of the so-called monetarists. Two things may by said in favor of the monetarists. First, they do recognize the close connection between the quantity of money and the purchasing power of the monetary unit. And second, they do acknowledge the importance of imposing strict and explicit limits on the issuance of money. But there are serious weaknesses both in their factual assumptions and in their policy proposals.

It is true that there is a close relation between the outstanding supply of money and the buying power of the individual monetary unit. But it is not true that this relation is inversely proportional or in any other way fixed and dependable. Nor is it true that there is any fixed “lag” between an increase of a given percentage in the “growth” of the money supply and an increase of the same percentage in prices. The statistics on which this conclusion is based are at best inadequate. They do not cover enough currencies over long enough periods.

What happens during a typical inflation, for example, is that in its early stages commodity prices do not rise as fast as the supply of money is increased and in its later stages prices rise much faster than the supply of money is increased.

Monetarists will dismiss this whole comparison as unfair and irrelevant. They do not regard themselves as proposing inflation at all. To them inflation is defined not as an increase in the money supply, but only as a rise in prices. And their proposal, as they see it, is to increase the stock of money 3 to 5 per cent a year just to keep the price “level” from falling. They propose an annual increase in the money stock merely to compensate for an expected annual increase of 3 per cent or more in the “productivity” of the economy.

The monetarists’ proposal rests on a false factual assumption. There is no automatic and dependable annual increase in “productivity” of 3 per cent or any other fixed rate. The increase in productivity that has occurred in the U.S. in recent years is the result of saving, investment, and technical progress. None of these is automatic. In fact, in the last two years or so, the usual “productivity” measures have actually been declining.

Wholly apart from the formidable mathematical and statistical problems involved, which space does not permit me to go into, the maintenance of the price “level” is a dubious goal. It is based on the assumption that falling prices are somehow “deflationary,” and that in any case they tend to bring about recession. This assumption is questionable. When the stock of money is not increased, falling prices are a normal result of increased production and economic progress. They need not bring recession, because the falling prices are themselves the result of falling production costs. Real profit margins are not reduced. Money wage-rates may not increase, but real wages will increase because the same money will buy more. Falling prices with continued or rising prosperity have occurred again and again in our history.

Abuses of Union Power

In our present world of powerful and aggressive labor unions, with legally built-in coercive powers, the monetarists do have a legitimate fear that such unions will not be satisfied with increased purchasing power for the same money wages. In that case, when such unions ask and get excessive wage-rates, they may bring on unemployment and recession. But this danger will exist under any monetary system whatever, as long as we retain our present one-sided labor laws and union ideology.

The central and fatal flaw of the monetarist proposal is its extreme political naïveté. It puts the power of controlling the quantity, the quality, and the purchasing power of our money entirely in the hands of the State — that is, of the politicians and bureaucrats in office.

I am tempted to add that it leaves this power entirely to the discretion, the arbitrary caprice, of the temporary holders of office in the State. The monetarists would deny this. They would limit the discretion of the monetary managers, they contend, by a strict rule. The managers would be ordered to increase the stock of money by only 2, or 3, or 4, or 5 per cent per year; and this figure would be written into the law, or into the Constitution.

It is a sign of the monetarists’ own vacillation that they have never quite decided whether this figure should be a month-to-month bureaucratic goal, or embodied in a law, or nailed into the Constitution. Nor have they ever definitely decided whether the figure itself should be 2 or 3 or 4 or 5. They can apparently hold their ranks together only by remaining vague.

Continuous Political Pressure

It is obvious that once the premises of this system were adopted there would be continuous political pressure for inflation. Those who contended that an annual increase of 2 per cent in the money stock would be enough would constantly have to combat the fears of their colleagues that this might be too low, and threaten to bring on recession. The 3 percenters, again, would have to fight a ceaseless rearguard action against the advocates of 4 per cent, or these in turn against the champions of 5 per cent. And so ad infinitum. Every time a recession seemed imminent, it would be blamed on the lowness of the existing rate of money increase. Agitation would be resumed to boost it.

None of this is a figment of my imagination. It is occurring today. On February 20, 1975, Henry Ford II, in presenting the disappointing annual report of his motor company, emphasized the need of measures to “assure strong recovery.” Among these, he stipulated: “The Federal Reserve must raise the monetary growth rate to the range of 6 to 8 per cent for a short period.”

I cite this as only one among scores of examples. It was especially instructive because it came from a businessman and not from a politician.

A month later there was a far more striking illustration. On March 18 the Senate of the U.S. adopted unanimously, 86 to 0, a resolution urging the Federal Reserve Board to expand the money supply in a way “appropriate to facilitating prompt economic recovery.” It also asked the board to consult with the House and Senate Banking Committee every six months on “objectives and plans” concerning the money supply. This was in effect an order to the Fed to continue inflating, and presumably to increase the rate of inflation. It also put the Fed on notice that whatever it may have previously supposed, it is not independent, but is subject to the directions of the politicians in office. The substance of this resolution was later adopted by the full Congress.

The monetarists’ program would inevitably make the monetary system a political football. What else could we expect? Isn’t it the height of naïveté deliberately to put the power of determining the money supply in the hands of the State, and then expect existing officeholders not to use that power in the way they think is most likely to assure their own tenure of office?

The first requisite of a sound monetary system is that it put the least possible power over the quantity or quality of money in the hands of the politicians.

This brings us to gold. It is the outstanding merit of gold as the money standard that it makes the supply and the purchasing power of the monetary unit independent of government, of office holders, of political parties, and of pressure groups. The great merit of gold is precisely that it is scarce; that its quantity is limited by nature; that it is costly to discover, to mine, and to process; and that it cannot be created by political fiat or caprice. It is precisely the merit of the gold standard, finally, that it puts a limit on credit expansion.

Fractional or Full Reserve?

But there are two major kinds of gold standard. One is the fractional-reserve system, and the other the pure gold or 100 per cent reserve system.

The fractional-reserve system is the one that developed and prevailed in the Western world in the century from 1815 to 1914. It is what we now call the classical gold standard. It had the so-called advantage of elasticity. And it made possible — we might justly say it was responsible for — the business cycle, the recurrent round of prosperity and recession, of boom and bust.

With the fractional-reserve system what typically happened is that in a given country — let us say Ruritania — borrowers would be given credit by the banks, in the form of demand deposits, and they would launch upon various enterprises. The new money so created, perhaps after taking up any slack in business and employment, would increase Ruritanian prices. Ruritania would become a better place to sell to, and a poorer place to buy from. The balance of trade or payments would begin to turn against it. This would be reflected in a fall in the exchange rate of the Ruritanian currency until the “gold export point” was reached. Gold would then flow out to other countries. In order to stop it, interest rates in Ruritania would have to be raised. With a higher interest rate or a smaller gold base, the volume of currency would be contracted. This would often mean a deflation or a crisis followed by a slump.

In brief, the gold standard with a fractional-reserve system tended almost systematically to bring about the cycle of boom and slump.

Under such a system, there is constant political pressure to reduce interest rates or the reserve requirements so that credit expansion — i.e., inflation — may be encouraged or continued. It is supposed to be the great advantage of a fractional-reserve system that it allows credit expansion. But what is overlooked is that, no matter how long the required legal reserve is set, there must eventually come a point when the permissible legal credit expansion has been reached. There is then inevitable political pressure to reduce the percentage of required reserves still further.

This has been the history of the system in the United States. The effect — and partly the intention — of the Federal Reserve Act was enormously to increase the potential volume of credit expansion. The required reserves for member banks were reduced under the new Federal Reserve Act from a range of 15 to 25 per cent for the previous national banks to 12 to 18 per cent for the new Federal Reserve member banks. In 1917 the required reserves for member banks were reduced still further to a range of 7 to 13 per cent.

Pyramiding Credit

But on top of the inverted pyramid of credit that the member banks were allowed to create, the newly established Federal Reserve Banks, which now held the reserves of the member banks, were permitted to erect a still further inverted credit pyramid of their own. The Reserve Banks were required to carry only a 35 per cent reserve against their deposits and a 40per cent gold reserve against their notes.

Later the Federal Reserve authorities became more strict in imposing reserve requirements on the member banks (they raised these sharply beginning in 1936, for example). But they continued to be very lenient in setting their own reserve requirements. Between June of 1945 and March of 1965 the reserve requirements were reduced from 35 and 40 per cent to a flat 25 per cent. And then they were dropped altogether.

So much for history. What of the future?

If the world, or at least this country, ever returns to its senses, and decides to re-establish a gold standard, the fractional-reserve system ought to be abandoned. If by some miracle the U.S. government were to make this decision tomorrow, it could not of course wipe out the already existing supply of fiduciary money and credit, or any substantial part of it, without bringing on a devastating and needless deflation. But the government would at least have to refrain from any further increase in the supply of such fiduciary currency. Assuming that the government were then able to fix upon a workable conversion rate of the dollar into gold — a rate that was sustainable and would not in itself lead to either inflation or deflation — the U.S. could then return to a sound currency and a sound gold basis.

But in the world as it has now become — sunk in hopeless confusion, inflationism, and demagogy — the likelihood of any such development in the foreseeable future is practically nil. The remedy I have suggested rests on the assumption that our government and other governments will become responsible, and suddenly begin doing what is in the long-run interest of the whole body of the citizens, instead of only in the short-run interest — or apparent interest —of special pressure groups. Today this is to expect a miracle.

But the outlook is not hopeless. I began by pointing out that for more than a century individual economists have tried to design an ideal money. Why have they not agreed? Why have their schemes come to nothing? They have failed, I think, because they have practically all begun with the same false assumption — the assumption that the creation and “management” of a monetary system is and ought to be the prerogative of the State.

This has become an almost universal superstition. It is tantamount to agreeing that a monetary system should be made the plaything of the politicians in power.

The proposals of the would-be monetary reformers have failed, in fact, for two main reasons. They have failed partly because they have misconceived the primary functions that a monetary system has to serve. Too many monetary reformers have assumed that the chief quality to be desired in a money is to be “neutral.” And too many have assumed that this “neutrality” would be best achieved if they could create a money that would lead to a constant and unchanging “price level.”

This was the goal of Irving Fisher in the 1920’s, with his “compensated dollar.” It is the goal of his present-day disciples, the “monetarists,” and their proposal for a government-managed increase in the money supply of 3 to 5 per cent a year to keep the “price-level” stable.

I believe that this goal itself is a c questionable one. But what is an even more serious and harmful error on their part is the method by which they propose to achieve this goal. They propose to achieve it by giving the power to the politicians in office to manipulate the currency according to the formula prescribed in advance by the monetarists.

Self-Serving Politicians

What such reformers fail to recognize is that once the politicians and their appointees are granted such powers, they are less likely to use them to pursue the objectives of the reformers than they are to pursue their own objectives. The politicians’ own objectives will be those that seem best calculated to keep them in power. The particular policy they will assume is most likely to keep them in power is to keep increasing the issuance of money; because this will:

(1)   increase “purchasing power” and so presumably increase the volume of trade and employment;

(2)   keep prices going up as fast as union pressure pushes up wages, so that continued employment will be possible; and

(3)   give subsidies and other handouts to special pressure groups without immediately raising taxes to pay for them. In other words, the best immediate policy for the politicians in power will always appear to them to be inflation.

In sum, the belief that the creation and management of a monetary system ought to be the prerogative of the State — i.e., of the politicians in power — is not only false but harmful. For the real solution is just the opposite. It is to get government, as far as possible, out of the monetary sphere. And the first step libertarians should insist on is to get our government and the courts not only to permit, but to enforce, voluntary private contracts providing for payment in gold or in terms of gold value.

A Movement Toward Gold

Let us see what would happen if this were done. As the rate of inflation increased, or became more uncertain, Americans would tend increasingly to make long-term contracts payable in gold. This is because sellers and lenders would become increasingly reluctant to make long-term contracts payable in paper dollars, or in irredeemable money-units of any other kind.

This would apply particularly to international contracts. The buyer or debtor would either have to keep a certain amount of gold in reserve, or make a forward contract to buy gold, or depend on buying gold in the open spot market with his paper money on the date that his contract fell due. In time, if inflation continued, even current transactions would increasingly be made in gold.

Thus there would grow up, side by side with fiat paper money, a private domestic and international gold standard. Each country that permitted this would then be on a dual monetary system, with a daily changing market relation between the two monies. And there would be a private gold system ready to take over completely on the very day that the government’s paper money became absolutely worthless — as it did in Germany in November 1923, and in scores of other countries at various times.

A Private Gold Standard?

Could there be such a private gold standard? To ask such a question is to forget that history and prehistory have already answered it. Private gold coins, and private gold currencies, existed centuries before governments decided to take them over — to nationalize them, so to speak. The argument that the kings and governments put forward for doing this — and it was a plausible one — was that the existing private coins were not of uniform and easily recognizable size, weight, and imprint; that the fineness of their gold content, or whether they were gold at all, could not be easily tested; that the private coins were crude and easily counterfeited; and finally that the legal recourse of the receiver, if he found a coin to be underweight or debased, was uncertain and difficult. But, the kings went on to argue, if the coins were uniform, and bore the instantly recognizable stamp of the realm, and if the government itself stood ever ready to prosecute all clippers or counterfeiters, the people could depend on their money. Business transactions would become more efficient and certain, and enormously less time-consuming.

Still another specious argument for a government coinage applied especially to subsidiary coins. It was impossible, it was contended, or ridiculously inconvenient, to make gold coins small enough for use in the millions of necessary small transactions, like buying a quart of milk or a loaf of bread.

What was needed was a subsidiary coinage, which represented halves, quarters, tenths, or hundredths of the standard unit. These coins, regardless of what they were made of, or what their intrinsic value might be, would be legally accept-table and convertible, at the rates stamped on them, into the standard gold coins.

It would be very difficult, I admit, to provide for this with a purely private currency, with everybody having the legal power to stamp out his own coins and guarantee their conversion by him into gold. A private coinage system might conceivably be able to solve this problem, but I confess I personally have been unable to think of any solution that would not be complicated, cumbersome, or undependable.

It is clear, in short, that a government-provided or a government-regulated coinage has some advantages. But these advantages are bought at a price. That price seemed comparatively low in the nineteenth century and until 1914; but today the price of government control of money has become excessive practically everywhere.

The basic problem that confronts us is not one that is confined to the monetary sphere. It is a problem of government. It is in fact the problem of government in every sphere. We need government to prevent or minimize internal and external violence and aggression and to keep the peace. But we are obliged to recognize that no group of men can be completely trusted with power. All power is liable to be abused, and the greater the power the greater the likelihood of abuse. For that reason, only minimum powers should be granted to government. But the tendency of government everywhere has been to use even minimum powers to increase its powers. And any government is certain to use great powers to usurp still greater powers. There is no doubt that the two great World Wars since 1914 brought on the present prevalence of the quasi-omnipotent State.

But the solution of the overall problem of government is beyond the province of this article. To decide what would be the best obtainable monetary system, if we could get it, would be a sufficiently formidable problem in itself. But a major part of the solution to this problem, to repeat once more, will be how to get the monetary system out of the hands of the politicians. Certainly as long as we retain our nearly omnipotent redistributive State, no sound currency will be possible.

This article has been published with FEE‘s permission and has been originally published at The Freeman November 1975 • Volume: 25 • Issue: 11.

Inflation in One Page

Henry Hazlitt

A correspondent, heading a group of “Inflation Fighters,” recently sent me a one-page typewritten summary of their case against inflation, and asked for my opinion of it. The statement was sincere and well-intentioned, but as with the great bulk of what is being written about infla tion, it was confused in both its analysis and its recommendations.

I wrote approving his effort to “do something,” and approving also his idea of trying to state the cause and cure for inflation on a single page, but suggested the following substitute statement.

Cause and Cure of Inflation

1. Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation—if we misuse the term to mean the rising prices themselves—is caused solely by printing more money. For this the government’s monetary policies are entirely responsible.

2. The most frequent reason for printing more money is the existence of an unbalanced budget. Unbalanced budgets are caused by extravagant expenditures which the government is unwilling or unable to pay for by raising corresponding tax revenues. The excessive expen ditures are mainly the result of government efforts to redistribute wealth and income—in short, to force the productive to support the unproductive. This erodes the working incentives of both the productive and the unpro ductive.

3. The causes of inflation are not, as so often said, “multiple and complex,” but simply the result of printing too much money. There is no such thing as “cost-push” inflation. If, without an increase in the stock of money, wage or other costs are forced up, and producers try to pass these costs along by raising their selling prices, most of them will merely sell fewer goods. The result will be reduced output and loss of jobs. Higher costs can only be passed along in higher selling prices when consumers have more money to pay the higher prices.

4. Price controls cannot stop or slow down inflation. They always do harm. Price controls simply squeeze or wipe out profit margins, disrupt production, and lead to bottlenecks and shortages. All government price and wage control, or even “monitoring,” is merely an attempt by the politicians to shift the blame for inflation on to producers and sellers instead of their own monetary policies.

5. Prolonged inflation never “stimulates” the economy. On the contrary, it unbalances, disrupts, and misdirects production and employment. Unemployment is mainly caused by excessive wage rates in some industries, brought about either by extortionate union demands, by minimum wage laws (which keep teenagers and the unskilled out of jobs), or by prolonged and over-generous unemployment insurance.

6. To avoid irreparable damage, the budget must be balanced at the earliest possible moment, and not in some sweet by-and-by. Balance must be brought about by slashing reckless spending, and not by increasing a tax burden that is already undermining incentives and pro duction.

Henry Hazlitt had a long and distinguished career as economist, journalist, author, editor, and literary critic.This article Inflation in One Page is published with FEE‘s permission.

The House that Uncle Sam Built: The Untold Story of the Great Recession of 2008

by Steven Horwitz and Peter Boettke, Edited by Lawrence W. Reed

Introduction

The theme of “The House that Uncle Sam Built: The Untold Story of the Great Recession of 2008” is that government policy, not a failure of free markets, caused the economic trauma we have been experiencing. We do not live in a free market. We live in a mixed economy. The mixture varies by industry. Technology is primarily free. Financial Services is primarily government. It is not surprising that the most government regulated and controlled segment of the economy, financial services, experienced the biggest problems. These problems were created by actions by the Federal Reserve combined with government housing policy (especially the government- sponsored enterprises – Freddie Mac and Fannie Mae). Misguided government interference in the market is the real culprit in laying the foundation for the Great Recession.

This paper provides a “common sense” and understandable outline of fundamental causes and cures. The analysis is based on long proven economic laws. Despite the wishes and hopes of politicians, economic laws are just as immutable as the laws of physics. If you jump off a ten story building, hitting the ground will not be pleasant. If the Federal Reserve holds interest rates below the natural market rate by rapidly expanding the money supply (“printing” money) as Alan Greenspan did, individuals and businesses will make bad investment decisions and there will be negative consequences to our long term economic well-being. There are no free lunches.

When a doctor misdiagnoses a disease, his treatment will likely make the patient sicker. If we misdiagnose the causes of the Great Recession, our treatment will reduce our long term standard of living. While the U.S. economic system is highly resilient, and we will likely have some form of economic recovery, almost every significant government policy action taken in response to the Great Recession will reduce the quality of life in the long term. Understanding that failed government policies, not market failure, caused our economic challenges is critical to defining the appropriate cures. Since government created the problem, i.e. caused the disaster, it is irrational to believe that more government is the cure. We owe it to ourselves and to our children and grandchildren to take these issues very seriously.

John Allison, Chairman, BB&T

The House that Uncle Sam Built

The man who parties like there is no tomorrow puts his body through an “up” and a “down” course that looks a lot like the business cycle. At the party, the man freely imbibes. He has a great time before stumbling home at 2:00 a.m., where he crashes on the sofa. A few hours later, he awakens in the grip of the dreaded hang- over. He then has a choice to make: get a short-term lift from another drink or sober up. If he chooses the latter and endures a few hours of discomfort, he can recover. In any event, no one would say the hangover is when the harm is done; the harm was done the night before and the hangover is the evidence.

The Great Recession (or the Great Hangover) that began in 2008 did not have to happen. Its causes and consequences are not mysterious. Indeed, this particular and very painful episode affirms what the best nonpartisan economists have tried to tell our politicians and policy-makers for decades, namely, that the more they try to inflate and direct the economy, the more damage the rest of us will suffer sooner or later. Hindsight is always 20-20, but in this instance, good old-fashioned common sense would have provided all the foresight needed to avoid the mess we’re in.

In this essay, we trace the path of the recession from its origins in the housing market bubble to the policies offered to cure the aftermath.

There is no better way to understand a crisis that began in the housing sector than to begin by thinking about a house.

A house must be built on a firm, sustainable foundation. If it’s slapped together with good intentions but lousy materials and workmanship, it will collapse prematurely. If too much lumber and too many bricks are piled on top of a weak support structure, or if housing material is misallocated throughout the house, then an apparently solid structure can crumble like sand once its weaknesses are exposed. Americans built and bought a lot of houses in the past decade not, it turns out, for sound reasons or with solid financing. Why this occurred must be part of any good explanation of the Great Recession.

But isn’t home ownership a great thing, the very essence of the vaunted “American Dream”? In the wealthiest country in the world, shouldn’t everyone be able to own their own home? What could be wrong with any policy that aims to make housing more affordable? Well, we may wish it were not so, but good intentions cannot insulate us from the consequences of bad policies.

Politicians became so enthralled with home ownership and affordable housing – and the points they could score by claiming to be their champions – that they pushed and shoved the economy down an artificial path that invited an inevitable (and painful) correction. Congress created massive, government-sponsored enterprises and then encouraged them to degrade lending standards. Congress bent tax law to favor real estate over other investments. Through its reckless easy money policies, another creation of Congress, the Federal Reserve, flooded the economy with liquidity and drove interest rates down. Each of these policies encouraged too many of the economy’s resources to be drawn into the housing sector. For a substantial part of this decade, our policy-makers in Washington were laying a very poor foundation for economic growth.

Was Free Enterprise the Villain?

Call it free enterprise, capitalism or laissez faire – blaming supposedly unfettered markets for every economic shock has been the monotonous refrain of conventional wisdom for a hundred years. Among those making such claims are politicians who posture as our rescuers, bureaucrats who are needed to implement the rescue plans and special interests who get rescued. Then there are our fellow academics – the ones who add a veneer of respectability – trumpeting the “stimulus” the rest of us get from being rescued.

Rarely does it occur to these folks that government intervention might be the cause of the problem. Yet, we have the Federal Reserve System’s track record, thousands of pages of financial regulations, and thousands more pages of government housing policy that demonstrate the utter absence of “laissez faire” in areas of the economy central to the current recession.

Understanding recessions requires knowing why lots of people make the same kinds of mistakes at the same time. In the last few years, those mistakes were centered in the housing market, as many people overestimated the value of their houses or imagined that their value would continue to rise. Why did everyone believe that at the same time? Did some mysterious hysteria descend upon us out of nowhere? Did people suddenly become irrational? The truth is this: People were reacting to signals produced in the economy. Those signals were erroneous. But it was the signals and not the people themselves that were irrational.

Imagine we see an enormous rise in the number of traffic accidents in a major city. Cars keep colliding at intersections as drivers all seem to make the same sorts of mistakes at once. Is the most likely explanation that drivers have irrationally stopped paying attention to the road, or would we suspect that something might be wrong with the traffic lights? Even with completely rational drivers, malfunctioning traffic signals will lead to lots of accidents and appear to be massive irrationality.

Market prices are much like traffic signals. Interest rates are a key traffic signal. They reconcile some people’s desire to save – delay consumption until a future date – with others’ desire to invest in ideas, materials or equipment that will make them and their businesses more productive. In a market economy, interest rates change as tastes and conditions change. For instance, if people become more interested in future consump- tion relative to current consumption, they will increase the amount they save. This, in turn, will lower interest rates, allowing other people to borrow more money to invest in their businesses. Greater investment means more sophisticated production processes, which means more goods will be available in the future. In a normally functioning market economy, the process ensures that savings equal investment, and both are consistent with other conditions and with the public’s underlying preferences.

As was made all too obvious in 2008, ours is not a normally functioning market economy. Government has inserted itself into almost every transaction, manipulating and distorting price signals along the way. Few interventions are as momentous as those associated with monetary policy implemented by the Federal Reserve. Money’s essence is that it is a generally accepted medium of exchange, which means that it is half of every act of buying and selling in the economy. Like blood circulating in the body, it touches everything. When the Fed tinkers with the money supply, it affects not just one or two specific markets, like housing policy does, but every single market in the entire economy. The Fed’s powers give it an enormous scope for creating economic chaos.

When central banks like the Federal Reserve inflate, they provide banks with more money to lend, even though the public has not provided any more savings. Banks respond by lowering interest rates to draw in new borrowers. The borrowers see the lower interest rate and believe that it signals that consumers are more interested in delayed consumption relative to immediate consumption. Borrowers then begin to invest in those longer-term projects, which are now relatively more desirable given the lower interest rate. The problem, however, is that the demand for those longer-term projects is not really there. The public is not more interested in future consumption, even though the interest rate signals suggest otherwise. Like our malfunctioning traffic signals, an inflation-distorted interest rate is going to cause lots of “accidents.” Those accidents are the mistaken investments in longer-term production processes.

Eventually those producers engaged in the longer processes find the cost of acquiring their raw materials to be too high, particularly as it becomes clear that the public’s willingness to defer consumption until the future is not what the interest rate suggested would be forthcoming. These longer-term processes are then abandoned, resulting in falling asset prices (both capital goods and financial assets, such as the stock prices of the relevant companies) and unemployed labor in sectors associated with the capital goods industries.

So begins the bust phase of a monetary policy-induced cycle; as stock prices fall, asset prices “deflate,” overall economic activity slows and unemployment rises. The bust is the economy going through a refitting and reshuffling of capital and labor as it eliminates mistakes made during the boom. The important points here are that the artificial boom is when the mistakes were made, and it is during the bust that those mistakes are corrected.

From 2001 to about 2006, the Federal Reserve pursued the most expansionary monetary policy since at least the 1970s, pushing interest rates far below their natural rate.

In January of 2001 the federal funds rate, the major interest rate that the Fed targets, stood at 6.5%. Just 23 months later, after 12 successive cuts, the rate stood at a mere 1.25% – more than 80% below its previous level. It stayed below 2% for two years then the Fed finally began raising rates in June of 2004. The rate was so low during this period that the real Federal Funds rate – the nominal rate minus the rate of inflation – was negative for two and a half years. This meant that, in effect, banks were being paid to borrow money! Rapidly climbing after mid-2004, the rate was back up to the 5% mark by May of 2006, just about the time that housing prices started their collapse. In order to maintain that low Fed Funds rate for that five year period, the Fed had to increase the money supply significantly. One common measure of the money supply grew by 32.5%. A lot of economically irrational investments were made during this time, but it was not because of “irrational exuberance brought on by a laissez-faire economy,” as some suggested. It is unlikely that lots of very similar bad investments are the resut of mass irrationality, just as large traffic accidents are more likely the result of malfunctioning traffic signals than lots of people forgetting how to drive overnight. They resulted from malfunctioning market price signals due to the Fed’s manipulation of money and credit. Poor monetary policy by an agency of government is hardly “laissez faire.”

What about housing?

With such an expansionary monetary policy, the housing market was sent contradictory and incorrect signals. On one hand, housing and housing-related industries were given a giant green light to expand. It is as if the Fed supplied them with an abundance of lumber, and encouraged them to build their economic house as big as they pleased.

This would have made sense if the increased supply of lumber (capital) had been supported by the public’s desire to increase future consumption relative to immediate consumption – in other words, if the public had truly wanted to save for the bigger house. But the public did not. Interest rates were not low because the public was in the mood to save; they were low because the Fed had made them so by fiat. Worse, Fed policy gave the would-be suppliers of capital – those who might have been tempted to save – a giant red light. With rates so low, they had no incentive to put their money in the bank for others to borrow.

So the economic house was slapped together with what appeared to be an unlimited supply of lumber. It was built higher and higher, drawing resources from the rest of the economy. But it had no foundation. Because the capital did not reflect underlying consumer preferences, there was no support for such a large house. The weaknesses in the foundation were eventually exposed and the 70-story skyscraper, built on a foundation made for a single-family home, began to teeter. It eventually fell in the autumn of 2008.

But why did the Fed’s credit all flow into housing? It is true that easy credit financed a consumer-borrowing binge, a mergers-and-acquisitions binge and an auto binge. But the bulk of the credit went to housing. Why? The answer lies in government’s efforts to increase the affordability of housing.

Government intervention in the housing market dates back to at least the Great Depression. The more recent government initiatives relevant to the current recession began in the Clinton administration. Since then, the federal government has adopted a variety of policies intended to make housing more affordable for lower and middle income groups and various minorities. Among the government actions, those dealing with government-sponsored enterprises active in mortgage markets were central. Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are the key players here. Neither Fannie nor Freddie are “free-market” firms. They were chartered by the federal government, and although nominally privately owned until the onset of the bust in 2008, they were granted a number of government privileges in addition to carrying an implicit promise of government support should they ever get into trouble.

Fannie and Freddie did not actually originate most of the bad loans that comprised the housing crisis. Loans were made by banks and mortgage companies that knew they could sell those loans in the secondary mortgage market where Fannie and Freddie would buy and repackage them to sell to other investors. Fannie and Freddie also invented a number of the low down-payment and other creative, high-risk types of loans that came into use during the housing boom. The loan originators were willing to offer these kinds of loans because they knew that Fannie and Freddie stood ready to buy them up. With the implicit promise of government support behind them, the risk was being passed on from the originators to the taxpayers. If homeowners defaulted, the buyers of the mortgages would be harmed, not the originators. The presence of Fannie and Freddie in the mortgage market dramatically distorted the incentives for private actors such as the banks.

The Fed’s low interest rates, combined with Fannie and Freddie’s government-sponsored purchases of mortgages, made it highly and artificially profitable to lend to anyone and everyone. The banks and mortgage companies didn’t need to be any greedier than they already were. When banks saw that Fannie and Freddie were willing to buy virtually any loan made to under-qualified borrowers, they made a lot more of them. Greed is no more to blame for these bad mortgages than gravity is to blame for plane crashes. Gravity is always present, just like greed. Only the Federal Reserve’s easy money policy and Congress’ housing policy can explain why the bubble happened when it did, where it did.

Of further significance is the fact that Fannie and Freddie were under great political pressure to keep housing increasingly affordable (while at the same time promoting instruments that depended on the constantly rising price of housing) and to extend opportunities to historically “under-served” groups. Many of the new mortgages with low or even zero-down payments were designed in response to this pressure. Not only were lots of funds available to lend, and not only was government implicitly subsidizing the purchase of mortgages, but it was also encouraging lenders to find more borrowers who previously were thought unable to afford a mortgage.

Partnerships among Fannie and Freddie, mortgage companies, community action groups and legislators combined to make mortgages available to many people who should never have had them, based on their income and assets. Throw in the effects of the Community Reinvestment Act, which required lenders to serve under-served groups, and zoning and land-use laws that pushed housing into limited space in the suburbs and exurbs (driving up prices in the process) and you have the ingredients of a credit-fueled and regulatory-directed housing boom and bust.

All told, huge amounts of wealth and capital poured into producing houses as a result of these political machinations. The Case-Shiller Index clearly shows unprecedented increases in home prices prior to the bust in 2008. From 1946-1996, there had been no significant growth in the price of residential real estate. In contrast, the decade that followed saw skyrocketing prices.

It’s worth noting that even tax policy has been biased toward fostering investments in housing. Real estate investments are taxed at a much lower rate than other investments. Changes in the 1990s made it possible for families to pocket any capital gains (income from price appreciation) on their primary residences up to $500,000 every two years. That translates into an effective rate of 0% versus the ordinary income tax rates that apply to capital gains on other forms of investment. The differential tax treatment of capital gains made housing a relatively better investment than the alternatives. Although tax cuts are desirable for promoting economic growth, when politicians tinker with the tax code to favor the sorts of investments they think people should make, we should not be surprised if market distortions result.

Former Fed chair Alan Greenspan had made it clear that the Fed would not stand idly by whenever a crisis threatened to cause a major devaluation of financial assets. Instead, it would respond by providing liquidity to stem the fall. Greenspan declared there was little the Fed could do to prevent asset bubbles but that it could always cushion the fall when those bubbles burst. By 1998, the idea that the Fed would always bail out investors after a burst bubble had become known as the “Greenspan Put.” (A “put” is a financial arrangement where a buyer acquires the right to re-sell the asset at a pre-set price.) Having seen the Fed bailout investors this way in a series of events starting as early as the 1987 stock market crash and extending through 9/11, players in the housing market had every reason to expect that if the value of houses and other instruments they were creating should fall, the Fed would bail them out, too. The Greenspan Put became yet another government “green light,” signaling investors to take risks they might not otherwise take.

As housing prices began to rise, and in some areas rise enormously, investors saw opportunities to create new financial instruments based on those rising housing prices. These instruments constituted the next stage of the boom in this boom-bust cycle, and their eventual failure became the major focus of the bust.

Fancy Financial Instruments – Cause or Symptom?

Banks and other players in the financial markets capitalized on the housing boom to create a variety of new instruments. These new instruments would enrich many but eventually lose their value, bringing down several major companies with them. They were all premised on the belief that housing prices would continue to rise, which would enable people who had taken out the new mortgages to continue to be able to pay.

Mortgages with low or even nonexistent down payments appeared. The ownership stake the borrower had in the house was largely the equity that came from the house increasing in value. With little to no equity at the start, the amount borrowed and therefore the monthly payments were fairly high, meaning that should the house fall in value, the owner could end up owing more on the house than it was worth.

The large flow of mortgage payments resulting from the inflation-generated housing bubble was then converted into a variety of new investment vehicles. In the simplest terms, financial institutions such as Fannie and Freddie began to buy up these mortgages from the originating banks or mortgage companies, package them together and sell the flow of payments from that package as a bond-like instrument to other investors. At the time of their nationalization in the fall of 2008, Fannie and Freddie owned or controlled half of the entire mortgage market. Investors could buy so-called “mortgage-backed securities” and earn income ultimately derived from the mortgage payments of the homeowners. The sellers of the securities, of course, took a cut for being the intermediary. They also divided up the securities into “tranches” or levels of risk. The lowest risk tranches paid off first, as they were representative of the less risky of the mortgages backing the security. The high risk ones paid off with the leftover funds, as they reflected the riskier mortgages.

Buyers snapped up these instruments for a variety of reasons. First, as housing prices continued to rise, these securities looked like a steady source of ever-increasing income. The risk was perceived to be low, given the boom in the housing market. Of course that boom was an illusion that eventually revealed itself.

Second, most of these mortgage- backed securities had been rated AAA, the highest rating, by the three ratings agencies: Moody’s, Standard and Poor’s, and Fitch. This led investors to believe these securities were very safe. It has also led many to charge that markets were irrational. How could these securities, which were soon to be revealed as terribly problematic, have been rated so highly? The answer is that those three ratings agencies are a government-created cartel not subject to meaningful competition.

In 1975, the Securities and Exchange Commission decided only the ratings of three “Nationally Recognized Statistical Rating Organizations” would satisfy the ratings requirements of a number of government regulations.Their activities since then have been geared toward satisfying the demands of regulators rather than true competition. If they made an error in their ratings, there was no possibility of a new entrant coming in with a more accurate technique. The result was that many instruments were rated AAA that never should have been, not because markets somehow failed due to greed or irrationality, but because government had cut short the learning process of true market competition.

Third, changes in the international regulations covering the capital ratios of commercial banks made mortgage- backed securities look artificially attractive as investment vehicles for many banks. Specifically, the Basel accord of 1988 stipulated that if banks held securities issued by government-sponsored entities, they could hold less capital than if they held other securities, including the very mortgages they might originate. Banks could originate a mortgage and then sell it to Fannie Mae. Fannie would then package it with other mortgages into a mortgage-backed security. If the very same bank bought that security (which relied on income from the mortgage it originated), it would be required to hold only 40 percent of the capital it would have had to hold if it had just kept the original mortgage.

These rules provided a powerful incentive for banks to originate mortgages they knew Fannie or Freddie would buy and securitize. The mortgages would then be available to buy back as part of a fancier instrument. The regulatory structure’s attempt at traffic signals was a flop. Markets themselves would not have produced such persistently bad signals or such a horrendous outcome. Once these securities became popular investment vehicles for banks and other institutions (thanks mostly to the regulatory interventions that created and sustained them) still other instruments were built on top of them. This is where “credit default swaps” and other even more complex innovations come into the story. Credit default swaps were a form of insurance against the mortgage-backed securities failing to pay out. Such arrangements would normally be a perfectly legitimate form of risk reduction for investors but given the house of cards that the underlying securities rested on, they likely accentuated the false “traffic signals” the system was creating.

By 2006, the Federal Reserve saw the housing bubble it had been so instrumental in creating and moved to prick it by reversing monetary policy. Money and credit were constricted and interest rates were dramatically raised. It would be only a matter of time before the bubble burst.

Deregulation, a False Culprit

It is patently incorrect to say that “deregulation” produced the current crisis [See Appendix A]. While it is true that new instruments such as credit default swaps were not subject to a great deal of regulation, this was mostly because they were new. Moreover, their very existence was an unintended consequence of all the other regulations and interventions in the housing and financial markets that had taken place in prior decades. The most notable “deregulation” of financial markets that took place in the 10 years prior to the crash of 2008 was the passing during the Clinton administration of the Gramm-Leach-Bliley Act in 1999, which allowed commercial banks, investment banks and securities firms to merge in whatever manner they wished, eliminating regulations dating from the New Deal era that prevented such activity. The effects of this Act on the housing bubble itself were minimal. Yet, its passage turned out to be helpful, not harmful, during the 2008 crisis because failing investment banks were able to merge with commercial banks and avoid bankruptcy.

The housing bubble ultimately had to come to an end, and with it came the collapse of the instruments built on top of it. Inflation-financed booms end when the industries being artificially stimulated by the inflation find it increasingly difficult to buy the inputs they need at prices that are profitable and also find it increasingly difficult to find buyers for their outputs. In late 2006, housing prices topped out and began to fall as glutted markets and higher input prices due to the previous years’ race to build began to take their toll.

Falling housing prices had two major consequences for the economy. First, many homeowners found themselves in trouble with their mortgages. The low- or no-equity mortgages that had enabled so many to buy homes on the premise that prices would keep rising now came back to bite them. The falling value of their homes meant they owed more than the homes were worth. This problem was compounded in some cases by adjustable rate mortgages with low “teaser” rates for the first few years that then

jumped back to market rates. Many of these mortgages were on houses that people hoped to “flip” for an investment profit, rather than on primary residences. Borrowers could afford the lower teaser payments because they believed they could recoup those costs on the gain in value. But with the collapse of housing prices underway, these homes could not be sold for a profit and when the rates adjusted, many owners could no longer afford the payments. Foreclosures soared.

Second, with housing prices falling and foreclosures rising, the stream of payments coming into those mortgage-backed securities began to dry up. Investors began to re-evaluate the quality of those securities. As it became clear that many of those securities were built upon mortgages with a rising rate of default and homes with falling values, the market value of those securities began to fall. The investment banks that held large quantities of securities were forced to take significant paper losses. The losses on the securities meant huge losses for those that sold credit default swaps, especially AIG. With major investment banks writing down so many assets and so much uncertainty about the future of these firms and their industry, the flow of credit in these specific markets did indeed dry up. But these markets are only a small share of the whole commercial banking and finance sector. It remains a matter of much debate just how dire the crisis was come September. Even if it was real, however, the proper course of action was to allow those firms to fail and use standard bankruptcy procedures to restructure their balance sheets.

The recession is the recovery

The onset of the recession and its visible manifestations in rising unemployment and failing firms led many to call for a “recovery plan.” But it was a misguided attempt to “plan” the monetary system and the housing market that got us into trouble initially. Furthermore, recession is the process by which markets recover. When one builds a 70-story skyscraper on a foundation made for a small cottage, the building should come down. There is no use in erecting an elaborate system of struts and supports to keep the unsafe structure aloft. Unfortunately, once the weaknesses in the U.S. economic structure were exposed, that is exactly what the Federal government set about doing.

One of the major problems with the government’s response to the crisis has been the failure to understand that the bust phase is actually the correction of previous errors. When firms fail and workers are laid off, when banks reconsider the standards by which they make loans, when firms start (accurately) recording bad investments as losses, the economy is actually correcting for previous mistakes. It may be tempting to try to keep workers in the boom industries or to maintain investment positions, but the economy needs to shift its focus. Corrections must be permitted to take their course. Otherwise, we set ourselves up for more painful downturns down the road. (Remember, the 2008 crisis came about because the Federal Reserve did not want the economy to go through the painful process of reordering itself following the collapse of the dot.com bubble.) Capital and labor must be reallocated, expectations must adjust, and the economic system must accommodate the existing preferences of consumers and the real resource constraints that producers face. These adjustments are not pleasant; they are in fact often extremely painful to the individuals who must make them, but they are also essential to getting the system back on track.

When government takes steps to prevent the adjustment, it only prolongs and retards the correction process. Government policies of easy credit produce the boom. Government policies designed to prevent the bust have the potential to transform a market correction into a full-blown economic crisis.

No one wants to see the family business fail, or neighbors lose their jobs, or charitable groups stretched beyond capacity. But in a market economy, bankruptcy and liquidation are two of the primary mechanisms by which resources are reallocated to correct for previous errors in decision-making. As Lionel Robbins wrote in The Great Depression, “If bankruptcy and liquidation can be avoided by sound financing nobody would be against such measures. All that is contended is that when the extent of mal- investment and over indebtedness has passed a certain limit, measures which postpone liquidation only tend to make matters worse.”

Seeing the recession as a recovery process also implies that what looks like bad news is often necessary medicine. For example, news of slackening home sales, or falling new housing starts, or losses of jobs in the financial sector are reported as bad news. In fact, this is a necessary part of recovery, as these data are evidence of the market correcting the mistakes of the boom. We built too many houses and we had too many resources devoted to financial instruments that resulted from that housing boom. Getting the economy right again requires that resources move away from those industries and into new areas. Politicians often claim they know where resources should be allocated, but the Great Recession of 2008 is only the latest proof they really don’t.

The Bush administration made matters worse by bailing out Bear Sterns in the spring of 2008. This sent a clear signal to financial firms that they might not have to pay the price for their mistakes. Then after that zig, the administration zagged when it let Lehman Brothers fail. There are those who argue that allowing Lehman to fail precipitated the crisis. We would argue that the Lehman failure was a symptom of the real problems that we have already outlined. Having set up the expectations that failing firms would get bailed out, the federal government’s refusal to bail out Lehman confused and surprised investors, leading many to withdraw from the market. Their reaction is not the necessary consequence of letting large firms fail, rather it was the result of confusing and conflicting government policies. The tremendous uncertainty created by the Administration’s arbitrary and unpredictable shifts – most notably Bernanke and Paulson’s September 23, 2008 unconvincing testimony on the details of the Troubled Asset Relief program – was the proximate cause of the investor withdrawals that prompted the massive bailouts that came in the fall, including those of Fannie Mae and Freddie Mac.

The Bush bailout program was problematic in at least two ways. First, the rationale for such aggressive government action, including the Fed’s injection of billions of dollars in new reserves, was that credit markets had frozen up and no lending was taking place. Several observers at the time called this claim into question, pointing out that aggregate new lending numbers, while growing much more slowly than in the months prior, had not dropped to zero.

Markets in which the major investment banks operated had indeed slowed to a crawl, both because many of their housing-related holdings were being revealed as mal-investments and because the inconsistent political reactions were creating much uncertainty. The regular commercial banking sector, however, was by and large continuing to lend at prior levels.

More important is this fact: the various bailout programs prolonged the persistence of the very errors that were in the process of being corrected! Bailing out firms that are suffering major losses because of errant investments simply prolongs the mal-investments and prevents the necessary reallocation of resources.

The Obama administration’s nearly $800 billion stimulus package in February of 2009 was also predicated on false premises about the nature of recession and recovery. In fact, these were the same false premises which informed the much-maligned Bush Administration approach to the crisis. The official justification for the stimulus was that only a “jolt” of government spending could revive the economy.

The fallacy of job creation by government was first exposed by the French economist Bastiat in the 19th century with his story of the broken window. Imagine a young boy throws a rock through a window, breaking it. The townspeople gather and bemoan the loss to the store owner. But eventually one notes that it means more business for the glazier. And another observes that the glazier will then have money to spend on new shoes. And then the shoe seller will have money to spend on a new suit. Soon, the crowd convinces them- selves that the broken window is actually quite a good thing.

The fallacy, of course, is that if the window was never broken, the store owner would still have a functioning window and could spend the money on something else, such as new stock for his store. All the breaking of the window does is force the store owner to spend money he wouldn’t have had to spend if the window had been left intact. There is no net gain in wealth here. If there was, why wouldn’t we recommend urban riots as an economic recovery program?

When government attempts to “create” a job, it is not unlike a vandal who “creates” work for a glazier. There are only three ways for a government to acquire resources: it can tax, it can borrow or it can print money (inflate). No matter what method is used to acquire the resources, the money that government spends on any stimulus must come out of the private sector. If it is through taxes, it is obvious that the private sector has less to spend, leading to losses that at least cancel out any jobs created by government. If it is through borrowing, that lowers the savings available to the private sector (and raises interest rates in the process), reducing the amount the sector can borrow and the jobs it can create. If it is through printing money, it reduces the purchasing power of private sector incomes and savings. When we add to this the general inefficiency of the heavily politicized public sector, it is quite probable that government spending programs will cost more jobs in the private sector than they create.

The Japanese experience during the 1990s is telling. Following the collapse of their own real estate bubble, Japan’s government launched an aggressive effort to prop up the economy. Between 1992 and 1995, Japan passed six separate spending programs totaling 65.5 trillion yen. But they kept increasing the ante. In April of 1998, they passed a 16.7 trillion yen stimulus package. In November of that year, it was an additional 23.9 trillion. Then there was an 18 trillion yen package in 1999 and an 11 trillion yen package in 2000. In all, the Japanese government passed 10 (!) different fiscal “stimulus” packages, totaling more than 100 trillion yen. Despite all of these efforts, the Japanese economy still languishes. Today, Japan’s debt-to-GDP ratio is one of the highest in the industrialized world, with nothing to show for it. This is not a model we should want to imitate.

It is also the same mistake the United States made in the Great Depression, when both the Hoover and Roosevelt Administrations attempted to fight the deepening recession by making extensive use of the federal government and only made matters worse. In addition to the errors made by the Federal Reserve System that exacerbated the downturn that it created with inflationary policies in the 1920s, Hoover himself tried to prevent a necessary fall in wages by convincing major industrialists to not cut wages, as well as proposing significant increases in public works and, eventually, a tax increase. All of these worsened the depression.

Roosevelt’s New Deal continued this set of policy errors. Despite claims during the current recession that the New Deal saved us from economic disaster, recent scholarship has solidly affirmed that the New Deal didn’t save the economy. Policies such as the Agricultural Adjustment Act and the National Industrial Recovery Act only interfered with the market’s attempts to adjust and recover, prolonging the crisis. Later policies scared off private investors as they were uncertain about how much and in what ways government would step in next. The result was that six years into the New Deal, unemployment rates were still above 17% and GDP per capita was still well below its long-run trend.

In more recent years, President Nixon’s attempt to fight the stagflation of the early 1970s with wage and price controls was abandoned quickly when they did nothing to help reduce inflation or unemployment. Most telling for our case was the fact that the Fed’s expansionary policies earlier this decade were intended to “soften the blow” of the dot.com bust in 2001. Of course those policies gave us the inflationary boom that produced the crisis that began in 2008. If the current recession lingers or becomes a second Great Depression, it will not be because of problems inherent in markets, but because the political response to a politically generated boom and bust has prevented the error-correction process from doing its job. The belief that large-scale government intervention is the key to getting us out of a recession is a myth disproven by both history and recent events.

The future that awaits our children

Commentators have had a field day adding up the trillions of dollars that have been committed in the Bush bailout, the Obama stimulus, and the administration’s proposed budget for 2010. The explosion of spending and debt, whatever the final tab, is unprecedented by any measure. It will “crowd out” a significant portion of private investment, reducing growth rates and wages in the future. We are, in effect, reducing the income of our children tomorrow to pay for the bills of today and yesterday.

Large government debt is also a temptation for inflation. In order for governments to borrow, someone must be willing to buy their bonds. Should confidence in a government fall enough (China, notably, has expressed some reluctance to continue buying our debt), it is possible that buyers will be hard to come by. That puts pressure on the government’s monetary authorities to “lubricate” the system by creating new money and credit from thin air.

So, even if the economy gets a lift in the near-term from either its own corrective mechanisms or from the government’s reinflation of money and credit, we have not recovered from the hangover. More of what caused the Great Recession of 2008 – easy money, regulatory interventions to direct capital in unsustainable directions, politicians and policy-makers rigging financial markets – is not likely to produce anything but the same outcome; asset price inflation and an eventual “adjustment” we call a recession or depression. Along the way, we will accumulate monumental debts which accentuate the future downturn and saddle us with new burdens.

Unless we can begin to undo the mistakes of the last decade or more, the future that awaits our children will be one that is poorer and less free than it should have been. With politicians mortgaging future generations to the tune of trillions, running and subsidizing auto and insurance companies, spending blindly and printing money hand- over-fist – all while blaming free enterprise for their own errors, we have a great deal to learn.

As Albert Einstein famously said, doing the same thing over and over again and expecting different results is the definition of insanity. The best we can hope for is that we learn the right lessons from this crisis. We cannot afford to repeat the wrong ones.

Attachment A: The Myth of Deregulation

Appendix B: Government Interventions During Crisis Create Uncertainty


Lawrence W. Reed is president of the Foundation for Economic Education – www.fee.org – and president emeritus of the Mackinac Center for Public Policy.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University in Canton, NY. He has been a visiting scholar at Bowling Green State University and the Mercatus Center at George Mason University.

Peter J. Boettke is the Deputy Director of the James M. Buchanan Center for Political Economy, a Senior Research Fellow at the Mercatus Center, and a professor in the economics department at George Mason University.

John Allison served as the Chief Executive Officer of BB&T Corp. until December 2008. Mr. Allison has been the Chairman of BB&T Corp., since July 1989. He serves as a Member of American Bankers Association and The Financial Services Roundtable.

This article has been published with permission of the FEE.

Courage, Fear and Immigration:The Significance of Welcoming Newcomers in a Free Economy

Ken Schoolland is an Associate Professor of Economics and Political Science at Hawaii Pacific University and a member of the Board of Directors for the International Society for Individual Liberty.
This speech was delivered at the International Society for Individual Liberty Conference, Phoenix, Arizona on January 8th, 2010.


Immigrants’ voyages to this land, following upon preparations that required extraordinary effort and often pain, have been among the most exciting and noble of human endeavors. Women and men and children have been strong and brave. They have undertaken their inevitably-frightening transits to a new place for the best of motives: the desire to improve their own lot and that of their families; the urge to leave countries whose governments they could not abide; and the willingness to help build another country where persons can live in freedom and dignity.

Julian Simon, A Life Against the Grain

HERE WE ARE, a room full of freedom-loving people, where it is safe to cheer for freedom and to denounce repression. Yet even in such a room of fellow travellers, there is one topic that is sure to stir up anxiety and friction.

And that topic is ‘immigration’, which can divide a room faster than almost any other. So whenever I get nervous about addressing a group on the topic of immigration, I take courage from immigrants themselves.

COURAGE

I think of the amazing courage it takes to flee oppression, to leave behind everything that is familiar, and to chance the hostility of a completely alien culture in order to find freedom, opportunity and a better life. When I think of that courage, I am greatly emboldened. How much easier it is to speak to a friendly audience than it is to risk one’s life in a rickety boat facing storms, pirates and sharks.  Or to risk one’s life crawling under fences and trudging for hours or days without water across a desert in temperatures exceeding 120°.

I cannot fault those who try. I admire them. Some of my ancestors probably tried something similar, very long ago, and it has benefited me. I can only hope I would have had the same courage had I been in their shoes.

But if I had been a German or Polish Jew in the 1930s, I’m not sure I would have had the courage to flee an increasingly hostile Nazi regime. Would I have defied the authorities and tried to sneak into Switzerland or the US, even though these nations had declared their quotas for German and Polish Jews were full?1 Or would I have watched my family being exterminated?

If I had been a Cuban or North Korean in the 1990s, would I have had the courage to hand over a lifetime’s savings to the novice captain of a crowded, leaky boat and chance the dangers of the open sea? Or would I have accepted the tyranny of a communist or military dictator who would enslave and impoverish me and my family for decades?

If I had been a Black slave in the antebellum South in the early 1800s, would I have risked the underground railroad – to run from a slave master? Would I have fled to a Northern state where I was considered illegal runaway property that stole itself, and where most people would have been eager to turn me over to the authorities for a swift return to my owner? Or would I have been content to stay where I was, legal and unfree, and watch my family live under tyranny?

All this reminds me of a cherished American hero, Patrick Henry, whose words appear in every American history schoolbook: ‘Give me liberty or give me death!’

While these words are cherished, do we really cherish those who act upon them? I hope I never have to face such a dilemma. But there are people who do. For the world is still filled with nation masters, rulers who see people as slaves to their will.

FEAR

What about those who argue against open immigration? Aren’t any of the arguments valid? I say no.

Of course there are problems which arise when people move around the planet. I don’t deny that. But I don’t blame those problems on liberty. Instead I look to see if it is the repression of liberty itself which is causing those problems. And it usually is.

In order to solve problems I don’t ask, ‘What can the government do?’ Instead, I ask, ‘What has the government done to cause or contribute to these problems in the first place?’ Undo that and you have a solution.

Underlying every argument against the movement of people to freedom is fear. Such fears are sometimes openly expressed, but more often they are veiled or disguised. The fear of immigrants denotes the absence of courage.

Courage welcomes competition. Fear shuts it out. Courage embraces the newcomer. Fear expels him or her. Courage champions liberty. Fear denies it.

When I think of this fear, I think of the official term for immigrants: ‘aliens’. The authorities call them ‘aliens’, and give them ‘alien registration’ cards.

I’ve seen a few movies about aliens. Alien, Aliens, Aliens 3 and Alien Resurrection. The movie books show more that 20 listings about aliens, all from outer space.

Such movies are very popular because they tap primal xenophobic fears. The alien movies are typically about hideous foreign creatures who disguise themselves by invading the bodies of beautiful, loving Hollywood humans and their children. All this is done with the purpose of gaining strength and power from the host. The aliens then suddenly break out, conquering and devouring all life as we know it. This approximates the subconscious fear that people everywhere have of immigrants – throughout history.

What are these fears that immigrants arouse? The basic fears have to do with race, culture, change, livelihood, security and crowds. And the rationalisations for exclusion are disguised in many forms.

SLOTHFUL IMMIGRANTS?

One of the most frequent arguments used by Americans against opening of borders is that immigrants come for welfare and that innocent US taxpayers are compelled to pay for these slothful immigrants. It is an interesting contrast: people fear immigrants for working too hard and taking away jobs, and for working too little and taking away welfare. So which is it?

I am always asking my students about supposedly ‘slothful immigrants’. I ask them to imagine being an employer who is facing two prospective employees. Little is known about the job applicants except this: one is an American citizen and the other is an immigrant. Now which prospective employee do the students identify as the harder worker of the two: the American citizen or the immigrant? They always, always, always say that the immigrant would be the harder worker.

Those who move from one country to another are often the most energetic, the most courageous and enterprising. They leave behind everything that is familiar in order to go to a place where everything is unfamiliar and where everyone is potentially hostile.

When immigrants start businesses in America, hire Americans and offer to sell products to Americans, it is the right of the consumer to buy from these immigrants if he chooses.

And what of American employers? Do employers have a right to hire immigrants if they choose? Consider the words of Robert W. Tracinski, a senior writer for the Ayn Rand Institute:

The irrational premise behind our nation’s immigration laws is that a native-born American has a ‘right’ to a particular job, not because he has earned it, but because he was born here. To this ‘right,’ the law sacrifices the employer’s right to hire the best employees – and the immigrant’s right to take a job that he deserves. To put it succinctly, initiative and productiveness are sacrificed to sloth and inertia.

The ‘American dream’ is essentially the freedom of each individual to rise as far as his abilities take him. The opponents of immigration, however, want to repudiate that vision by turning America into a privileged preserve for those who want the law to set aside jobs for them – jobs they cannot freely earn through their own efforts….Any immigrant who wants to come to America in search of a better life should be let in – and any employer who wants to hire him should be free to do so.2

TREASURES OF THE EARTH

And what of the economic consequences of immigrants coming to work? The practical questions have already been answered by the brilliant work of Julian Simon.3 According to Simon,  immigrants provide extraordinary benefits to a nation. Most immigrants come when they are in their most productive years.

Overall, new immigrants average only one year less in education than the native population of the US, but their children are highly motivated and excel beyond the level of native Americans in school. Immigrants have a higher proportion of advanced degrees than the native population, especially in high productivity areas of science and engineering. Of immigrants who have a background in science and engineering when they go to the US, more than a third are from India. The Economic Times reported last month that median income of Indian-Americans in the US is $60,000, 50% greater than the average in America.4

Immigrants to the US, even those from poor countries says Simon, are healthier in general than natives of the same age. Family cohesion, with a tradition of hard work, is stronger than among natives. Simon also reports on 14 separate studies concluding that immigrants do not cause native unemployment, even among very sensitive categories of low-paid, minority, low-skilled or even high-skilled groups of natives.

Another 12 studies revealed that immigrants do not have a negative effect on wages. There is no fixed number of jobs. Enterprising immigrants come with arms, legs and brains that create employment and wealth wherever they settle. Those who have little education have traditionally had the motivation to take on the four D’s, work that is either too difficult, too dangerous, too dirty or too dark for most American workers.

Simon concluded from a review of the research that, when they are not prohibited from working by anti-labour laws, immigrants contribute more in taxes than they draw out from government welfare services. And over the years, immigrant earnings exceed the earnings of comparable native groups. Julian Simon asserted that the continuation of welfare benefits for aging citizens may well depend on the contributions of youthful immigrants.5

If this is so, why aren’t immigrants treated as treasures of the earth? Why aren’t politicians the world-over competing with each other to lure these valuable human resources to their land in the same manner that they compete to lure capital investment, the product of all this human labour? Why aren’t immigrants seen as an inspiration – as were the immigrants Mikhail Baryshnikov, Enrico Ferme, Irving Berlin and Albert Einstein?

Except for well-to-do tourist, student and business visitors, those newcomers who wish to settle inspire xenophobic fear. This fear will not stop immigrants from the most natural of human impulses, the striving for freedom and opportunity.

During class debates, my students hear all the arguments about immigration with an impressive array of documentation, both pro and con. As the debate rages, the students find themselves torn by the dilemma between fear and ethics.

For me, the ethics are clear: if I do not have the right to stop a person from peacefully pursuing freedom and opportunity, then I do not have a right to ask a politician to do this for me. The law may declare someone illegal, but if his or her actions are moral, then it is the law that is immoral.

HIGH WELFARE CORRELATES WITH OUT-MIGRATION

This view of personal ethics satisfies many free-marketers in virtually every aspect of economics except immigration. They may accept immigration theoretically, but only after all forms of welfare have been abolished. Which is to say – ‘Not in my lifetime!’6

Is it correct to suppose that in-migration is caused by the existence of welfare? If it is true that immigrants go to America for the welfare, then it would follow that once in the country, immigrants would move to the states with the most welfare. But just the opposite is true.

Both the native-born population and the foreign-born population flee states with the highest welfare and move to those with the lowest welfare.

Take Hawaii, for example. According to Michael Tanner and Stephen Moore of the cato Institute,7 the six basic welfare benefits in Hawaii (six among a possible 77 welfare programs) could have provided a mother and two children with the equivalent of a pre-tax income of $36,000 or a wage of $17.50 an hour, the highest benefits in the nation. This, however, is not associated with net domestic in-migration to Hawaii. According to recent data from the US Census Bureau for the decade of the 1990s, Hawaii experienced net domestic out-migration to other states of both the native-born and the foreign-born population.

Among the ten states that provided the greatest levels of welfare, there was a net out-migration of 1,500,000 native-born and almost 500,000 foreign-born individuals.8 Eight of the ten highest welfare states experienced out-migration of the native-born.


LOW WELFARE CORRELATES WITH IN-MIGRATION

Contrast this with states that grant little welfare. Eight of the ten states offering the lowest levels of welfare experienced net domestic in-migration of the native-born population. And nine of the ten low welfare states experienced net domestic in-migration of the foreign-born population.

Hourly wage equivalent of welfare (1995) Native net domestic migration: (Number) Foreign-born domestic net migration: (Number)
 
TOP 10:
Hawaii $17.50 –  65,505 –    10,628
Alaska $15.48 –  31,040 +       542
Massachusetts $14.66 –  56,324 +    1,616
Connecticut $14.23 –  66,950 +    2,340
Wash. D.C. $13.99 –  35,515 –     9,816
New York $13.13 -669,102 –  205,146
New Jersey $12.74 -186,933 +    4,104
Rhode Island $12.55 +   2,320 +       916
California $11.59 -518,187 –  237,349
Virginia $11.11 + 59,364 +   16,366
       
       
Top 10 average $13.70
Total Pop Chg. – 1,567,872 –  437,055
       
       
BOTTOM 10:
Mississippi $5.53 +  25,845 +  1,085
Alabama $6.25 +  25,158 +     665
Arkansas $6.35 +  35,049 +  7,067
Tennessee $6.59 +135,615 +10,699
Arizona $6.78 +275,814 +40,334
Missouri $7.16 +  42,397 +  3,656
West Virginia $7.31 –    9,778 –      976
Texas $7.31 +131,538 +16,702
Nebraska $7.64 –   20,160 +  4,807
S. Carolina $7.79 +124,151 +  8,054
Bottom 10 Ave $6.87
 
Total Pop Chg. +765,629 + 92,093
CATO US Census US Census

Moore, Stephen, “Why Welfare Pays,” Wall Street Journal, September 28, 1995
“Migration of Natives and the Foreign Born: 1995-2000,” US Census Bureau, August 2003

There are some high-profile exceptions, but most migration results from a desire for opportunity, not for welfare. People who are too lazy to work are also too lazy to leave everything that is familiar to them and go to a place that is unfamiliar and potentially hostile. This is even more true of people who move across national borders at great personal risk.

In refuting the ‘welfare magnet theory’, the ethical argument is far more appealing than the practical argument. To say that immigrants are responsible for welfare in the US is a collectivist notion. The ethics of individual liberty oblige US to hold people accountable for their own actions, not for the actions of others. Immigrants are no more responsible for oppressive welfare laws in the US than they are for the oppressive tyranny in the country they are fleeing.

We are fortunate that US politicians are beginning to take hold of the runaway welfare system of recent decades. The share of the US population living below the poverty line has fallen to a 21-year low, the number of people on welfare and the percent of the population on welfare have both been cut in half.9

The welfare system is not a given. Welfare need not be an excuse for prohibiting immigration. A system of welfare that was created by politicians can also be changed by politicians.

Some opponents of immigration say that refugees ought to stay in their home country to change the political and economic system rather than to move away. I reply that the best judge of this option is the immigrant himself or herself.

Sometimes refugees –  in the tradition of Ludwig von Mises, Friedrich Hayek and Ayn Rand –did more to change their homeland from a distance than they would have had they remained behind – to be killed, to rot in the dreary confines of some dungeon, or to slave away at backbreaking toil for a few pennies a day. The immigrant is the best judge of his or her own options, as is the case of all earlier immigrants to America.

TROJAN HORSE?

Another fear, especially in America these days, is concerned with national security. This has certainly commanded a lot more attention since the 9/11 terrorist attack on the World Trade Center. Some have cried out for an end to immigration as a means of keeping terrorists far away. Every ship, barge and airplane is perceived as a potential Trojan Horse.

To the extent that government has any legitimate function, it is to protect the people from a conquering invasion, and it should be intelligent enough to figure this out. I have no problem with denying visas to an invading army, though I suspect that if the North Korean government gave orders to invade the United States in this manner, virtually every starving soldier would become a defector the instant he crossed the border.

It is understandable that, in the aftermath of such a tragic crisis as 9/11, people will, and must, clamour for protective measures against terrorists. But reason must prevail over collectivist repression in order to gain real protection.

The US government has had no shortage of defence expenditures, ‘spending more than the rest of the world combined’.10 Nevertheless, the US intelligence and security agencies – despite the abundance of wealth, personnel and technology at their disposal – came up short in a decades-long effort to root out a terrorist network with global tentacles which originated in some of the poorest nations of the world.

The villains of 9/11 had long said they wanted an attack on America. The villains had attempted attacks before, even on some of the same targets. The villains are reported to have been within the US government’s grasp on earlier occasions, but were not pursued.11

Will such attacks in the future be forestalled by stopping all immigration? I think not. This sentiment was recently echoed by the US Secretary of State, Colin Powell.

Some argue that we should raise the drawbridge and not allow in any more foreign visitors. They are wrong. Such a move would hand a victory to the terrorists by having US betray our most cherished principles. For our own well being, and because we have so much to give, we must keep our doors open to the world…

Openness is fundamental to our success as a nation, economically, culturally and politically. Our economy will sputter unless America remains the magnet for entrepreneurs from across the world. Our culture will stagnate unless we continue to add new richness to our mosaic. And our great national mission of spreading freedom will founder if our own society closes its shutters to new people and ideas. Openness also is central to our diplomatic success, for our openness is a pillar of American influence and leadership…12

Secretary Powell recognised the importance of openness to leadership, but his department has been closing the door on this leadership. The number of visas granted to scientists and engineers for work in the US has been cut by two-thirds in the past two years.13 The fear of foreigners has also led to a tremendous reduction in the number of student visas issued over the past three years. There was, according to Nature magazine, ‘a 19 percent decrease in the number of foreign students admitted to graduate programmes in the life sciences and a 17 percent drop in admissions in the physical and earth sciences. Admissions from China, India, and South Korea, which between them provide the lion’s share of foreign students in the United States, were all down sharply.’14

Indicative of the effect of increased visa restrictions, the University of Hawaii announced a decline of international student enrollment by 28 percent for next year. These students, with all of their talent and leadership, will go elsewhere to take their classes.

Asking for a sweeping end to all immigration sidesteps responsibility for the need to have good intelligence and effective police work. It scapegoats the very refugees who are also the victims of terror. Far better that individual criminal conspirators be effectively – effectively – tracked and brought to justice.

One way to approach the security issue is to examine the actions of government which may have placed American security at risk. For guidance on this, I think two early American Presidents, George Washington and Thomas Jefferson, had it right two centuries ago when they advised against entangling alliances. Jefferson declared in his 1801 inaugural address, ‘Peace, commerce, and honest friendship with all nations – entangling alliances with none.’

What entangling alliances might Jefferson have warned US against?

He might have warned US government officials against the overthrow of the democratically-elected leader of Iran in 1953, placing a tyrant in power for the next 26 years.15 Thomas Jefferson would have warned US government officials against the arming of Saddam Hussein for his eight-year-long invasion of Iran. And he might have been suspicious of US government support of Osama bin Laden in the Afghan war in the 1980s.

Interventionist policy makers in the US government may have thought they knew how to manipulate the affairs of foreign nations. But they were dead wrong. Washington and Jefferson had more foresight and were right to warn against such arrogance.

HUMAN TRAFFIC

According to the US State Department, there are thousands of slaves in the United States. Unbelievable? The Economist magazine reports, ‘Every year, on State Department estimates, about 50,000 people, the vast majority women and children, are forcibly trafficked into the United States from all over the world – Eastern Europe, Asia, Central America, Africa.… They are forced to work as virtual slaves, for the traffickers’ profit, in the sex industry, on farms and in factories.’16 Beyond that, there are an estimated four million slaves worldwide.17

Why don’t these slaves in the US today simply run to the police for protection? That’s what the police are for, aren’t they? But no. As enforcers for deportation, the police unwittingly collaborate to empower black market slave owners. Black market slaves don’t run to the police because the police will only deport them to a nation-state where the official slave masters are perceived to be worse. It isn’t an attractive choice.

It is for the same reason that, during the 1850s in the US, runaway plantation slaves would not have gone to the police for protection. The police openly collaborated with slave owners. Running away was illegal, but it was moral. The law was immoral.

Runaway slaves could be abused by employers, denied payment for work, beaten or even raped. The slave didn’t dare turn to the police for help because the so-called ‘help’ would be deportation to a ‘state plantation’ master where conditions were perceived to be worse. That wasn’t an attractive choice either.

This is why slavery persists around the world today. It continues as Burmese, Sudanese, Cubans and North Koreans are hustled back to slave states. Americans are even fined $3000 per head for the ‘crime’ of rescuing refugees at sea and bringing them ashore.18 Hard as it is to accept, we have not progressed from the horrible time when runaway slaves were captured and forcibly returned to their plantation masters.

It persists because immigration laws provide collaboration with tyranny. These immigration laws should be condemned just as the Fugitive Slave Law of the 1850s was condemned by abolitionists 150 years ago in America.

It isn’t enough that the US Coast Guard captures runaways throughout the Caribbean Sea in order to return them to their state masters. The US Department of Homeland Security now seems to consider the whole world an American ‘homeland’, sending the Coast Guard thousands of miles to the shores of Ecuador where it has detained more than 4,000 suspected illegal migrants and sunk a dozen emptied boats by setting them ablaze and firing on them with their .50-caliber guns.19

A former student of mine, a member of the US Coast Guard, said he really felt he was in a dilemma because these intensely crowded boats are not at all seaworthy. ‘Imagine,’ said Craig, ‘just imagine falling off one of these boats and seeing it sail off without you.’ Yet this near-certainty of death, of a very ghastly death at sea awaiting them, highlights the desperation of refugees. Every trip echoes Patrick Henry, ‘Give me liberty or give me death!’

It isn’t the turbulent water and the rickety boat that kills. If I want to travel to Haiti or Ecuador, I can fly in safety and comfort for a few hundred dollars. The only reason these refugees spend many thousands of dollars for a dangerous journey on a deathtrap is because of border laws.

TYRANT AND CORPORATE WELFARE

Americans should not be worried about welfare for immigrants, but there are other forms of welfare, however, that Americans should be alarmed about. Two kinds of welfare help to drive immigrants from their homes: ‘tyrant aid’ welfare and ‘corporate protectionist’ welfare.

The US taxpayer has been compelled to provide tyrant welfare to an extremely sordid gang of thugs over decades: from Duvalier, Mobutu and Marcos, to Pahlavi, Noriega, Suharto – even a billion dollars for Saddam Hussein.

The Center for Defense Information20 states that the US sells weaponry to the political elite in 150 nation-states – four-fifths of these nation-states are undemocratic, and two-thirds are listed by the US State Department as having governments that are abusive of human rights.

Since the end of the Cold War and the beginning of endless drug wars, the American share of worldwide arms transfers climbed spectacularly to 70 percent,21 most of which is paid for, directly or indirectly, by US taxpayers. This has surely contributed to the ten-fold increase of refugees in recent decades.

Still another form of welfare directly leads to immigration. This is corporate welfare known as ‘protectionism’. Because of trade barriers, American, Japanese and European consumers are prohibited from buying products that workers and entrepreneurs are willing to produce abroad. This is especially true in agricultural and textile sectors that are particularly well-suited to development in less developed countries.

The OECD says that Europe’s agricultural protectionism increases food prices by as much as 20 percent. At the same time, farmers and textile manufacturers in poorer countries are hobbled in their efforts to export, and they find subsidised commodities dumped on their domestic markets.22

It is much the same in the US where trade barriers currently quadruple the price of sugar for US citizens, from the world market price of 5 cents per pound to the US domestic price of 20 cents per pound. To accomplish these high prices for US consumers, beet farmers were recently paid to plow under 120,000 acres of growing sugar beets. Immigrant farmers are forbidden from coming to the US. Lower income neighbours abroad are banned from selling to US consumers. And many US food processing companies are driven to move abroad.

This is not wise policy. This is lunacy – for the benefit of powerful special interest groups and politicians who betray the public trust.

‘If rich countries were to remove the subsidies [to agriculture]…poor countries would benefit by more than three times the amount of all the overseas development assistance they receive each year.’23 This has been equally true of textile barriers.

The politics of protectionism contributes mightily to the economic troubles of poorer nations. And since politics and economics are so intertwined, why are immigrants separated into two categories: political immigrants and economic immigrants?

I have no sympathy for this distinction. People have troubles with their economic life not because they speak out against their rulers, but because they often wish to act in the marketplace in defiance of their rulers. One cannot separate politics from the economic consequences of politics.

People have a right to their own reasons for moving from one place to another. They do not have to articulate their protest in political forums to be genuine refugees from political repression. In this sense, voluntary economic behaviour is a political action that risks imprisonment, or worse, if one resists the long arm of authority.

RUNAWAY SLAVES

Slaves who ran away from Southern plantations before America’s Civil War, may not have articulated their opposition to the political system, but they were political refugees nonetheless, simply in their pursuit of economic freedom. And they had a right to move from areas of low economic freedom to areas of relatively high economic freedom.

It is no accident that whenever trade barriers are raised against poor nations, there is more poverty, more civil strife, more drug running and more migration. Whenever a US president travels to neighbouring countries asking for help in fighting the drug war or for help in stemming immigration, he is always greeted with the request for the US to simply open its doors to trade, especially in farming and textiles. But these requests have fallen on deaf ears.

Finally this month, after decades of restriction, we will have a reduction in world textile barriers. But agricultural barriers remain.

The wealthy nations of the world have it within their power to massively increase prosperity and investment in poorer countries by simply practising what they preach about free trade, but they don’t.

When a tsunami ravaged nations of the Indian Ocean a couple weeks ago, the wealthy nations raised great fanfare and noise about the emergency relief aid they were giving. On the other hand, these same wealthy nations have been stone silent about the decades of trade protectionism against exports from Sri Lanka, Indonesia, India, Bangladesh, Malaysia and Thailand. These exports could have increased earnings, investment and prosperity so much that people of the region could have prepared themselves against such calamity with better roads and bridges, better homes and hospitals, better flood control and civil defence warning systems.

Economic growth makes the world much safer from natural disasters. Reports Carlo Stagnaro, ‘Thanks to scientific progress and a stronger control over nature, the number of victims due to natural disasters is declining. Death rate has fallen by 98 percent in the last century…In absolute terms, this means that – despite the demographic boom which occurred in the meantime – the numbers killed has fallen from 1.2 million casualties at the beginning of the [20th] century to 77,000 at the end of it. This is still too many, but it has significantly improved in the last few decades.’ 24 Of course, this is not possible when economic development is blocked.

This is certainly not to say that wealthy nations are solely responsible for poor growth in much of the world. Corruption, inflation, trade barriers and repression are among the political practices that have been crucial factors in preventing many Latin American nations from achieving the extraordinary growth rates of the Asian Tigers.

While starting from roughly the same base in 1950, the Asian Tigers have grown much more than the nations of Latin America. In 50 years, GDP per capita has multiplied 20 to 40 times in the Asian Tiger nations versus two to three times in most Latin American nations. Rigoberto Stewart and José Cordiero demonstrated that freer economic systems can make the difference.25 And policies of the wealthy nations can either be a help or a hindrance in doing so.

RESOURCE  SCARCITY?

In 1783, America’s first president, George Washington, proclaimed, ‘…the bosom of America is open to receive not only the opulent and respectable stranger, but the oppressed and persecuted of all nations and religions, whom we should welcome to a participation of all our rights and privileges.’

My critics say, ‘Okay, so George Washington would have welcomed immigrants two hundred years ago. But in today’s world there’s not enough room and not enough resources.’

This is false.

In a free society, human beings produce a growing abundance of everything they need. Again, it was Julian Simon to the rescue. Simon demonstrated over and over that resources are not running out, but are constantly becoming more abundant and cheaper.

Michael Cox wrote in an issue of Reason magazine, ‘Capitalism creates wealth. During the last two centuries, the United States became the world’s richest nation as it embraced an economic system that promotes growth, efficiency and innovation.’ Real GDP per capita in the US has now reached $36,000.26

Okay, there’s growing wealth, but what about the land? Land is fixed. It doesn’t increase. Isn’t the US too crowded?

Indeed, when people think of opening the borders north of Mexico, my critics imagine crowds of immigrants pouring in. ‘Where would they all fit?’

While there are a lot of people trying to get into the United States, it is arrogant to assume that everyone in the world wants to be there. Already there are as many as 10 million US citizens who have chosen to live outside of the United States.

While many Americans live abroad, they have the security of knowing they could return during a time of danger. Many immigrants to the US hope to return to their native country as well, when they have established a greater measure of prosperity and security in their lives. Many from India and China are doing this today.

The Fraser Institute publishes a report on Economic Freedom of the World, which shows a high correlation of economic freedom to economic growth. It is the natural impulse of human beings to move to areas of greater economic freedom, where they have greater opportunity to use their talents. Scientists and engineers from India have established some of the most dynamic computer industries in Silicon Valley, and, as regions of India become more economically free, many of these scientists and engineers are now returning there.

This also explains why native American researchers are currently moving away from the US to places like Singapore, which rank even higher in degrees of economic freedom. Reports Charles Piller of the Los Angeles Times, ‘Salaries in Singapore are comparable to the United States, but living costs here are lower…Even with full-time domestic help, they save more money than would be possible back home.’ 27

This is precisely what happened in the European Union when Spain was admitted to the EU. Once it became clear that the borders were to open, there was a net homeward migration of those who had previously come illegally. Just last year the EU was enlarged by ten new member nations in Eastern Europe. This didn’t lead to a mass migration. If anything, it has led to a massive increase of investment opportunities and prosperity for the whole of the EU – or they wouldn’t keep enlarging the EU every few years.

People want the opportunities that freedom brings, and most people would be delighted to have that freedom in the land that is most familiar to them. When it isn’t possible, they move.

In recent years the economic policies of China and India have been more free and there has been more growth. But the policies are not the same everywhere in China. The Fraser Institute reports that economic freedom in various provinces range from the most free to the least free in the world. It is the most free provinces that have become the engines of growth and attracted the most in-migration.

This change is happening in India as well. Several years ago, Nobel prize winning economist Milton Friedman was quoted in an American news special saying, “Indians can do well everywhere except in India. They do so badly because they are not allowed to use their abilities in India. The government tells them what to do.”  (“Is America #1,” ABC News Special, September 19, 1999) But this is changing by region and Indians are moving internally to regional engines of growth.

Part of the concern about immigrants is due to a frightening perception of the population bomb. These fears are unfounded. The United Nations reports that fertility rates in both rich and poor countries have been falling for 30 years and continue to fall. In the rich countries, fertility rates are below the replacement rate, which means that without immigration the overall population would decline. One day this will be the case everywhere.

But what about now? The critics say that no country could accommodate the vast number of refugees in the world today!

The earth is far more accommodating than people realise. There is plenty of room for humanity. For a perspective, let’s consider the 30 million refugees in the world today.

This includes 12 million refugees who have fled across international borders as well as 18 million more who are estimated to have been displaced within national borders due to civil strife.28 Compare this with Hong Kong and just one tiny US state, Hawaii.

LIBERTY AND DENSITY

Hong Kong is known to be one of the most densely crowded places on the face of the earth with 17,500 people per square mile and a per capita income rivaling that of the United Kingdom. Yet few people are aware that living conditions are only as crowded as they are in Hong Kong because 40 percent of the land area is zoned by the government as country park – where people are not allowed to live.

The same is true of Hawaii. There is no lack of land, but there is lack of politically approved zoning. In all of the Hawaiian Islands, less than five percent of the land area is zoned for all commercial and residential use. There would be plenty of room for newcomers on these tiny islands in the Pacific if only the government stood out of the way.

In fact, if people in Hawaii were willing to accept even a third of the population densities of Hong Kong, then all the refugees of the world could live on the Hawaiian Islands – and still 40 percent of the land area could be zoned as country park. If those people were allowed to farm the agriculturally-zoned sugar plantations that have mostly all gone bankrupt in recent years due to high US labour costs, there is no doubt that diligent Chinese, Vietnamese and Filipino newcomers could turn the land into one of abundance without a penny of government subsidy.

Or just take one portion of federal land in the US that is 65 times as great as the Hawaiian Islands, the lands of the Bureau of Land Management. The BLM leases its 270 million acres of land to a few favored cattle ranchers at one-seventh the market rate. This means that for $1.43 per month, the federal government provides them with enough land to sustain a cow and a calf. 29

Surely there are a lot of people around the world who would be willing to pay more than $1.43 per month to live on ten acres (five hectares) in a free country? Aren’t human beings worth more consideration than cattle? This is especially true at a time when Western governments are paying extraordinary sums to farmers not to use their land.

Surely each generation believes that living space is a problem. In 1800 there were five million people living in the United States, some of them complaining about the crowds of newcomers. How could anyone in 1800 imagine a nation of 281 million people living in the United States today?

The nation isn’t poorer for having 56 times as many people as 200 years ago. It is much richer. People accept the changes of the past much more easily than they accept the change that is yet to come. The future will bring US ever greater riches, yet people are still afraid.

Afraid? Why? Because, without confidence in the marvelous potential of a free market, people will always be afraid of the unknown.

Donald Boudreaux argues that, by historical standards, the percentage of immigrant population is relatively small and America is far richer and far more capable of absorbing immigrants than ever before.

Compared to 1920, America now has twice as many physicians per person, three times as many teachers per person, and 50 percent more police officers per person than 80 years ago. There is more food, more health care, more residential living space, and there are more jobs than ever before. Says Boudreaux, ‘The fact is America today is much wealthier, healthier, [more] spacious, and resource-rich than it was a century ago. And we owe many of these advances to the creativity and effort of immigrants.’30

BOTH MORE CROWDS AND MORE SPACE

What is the capacity of the United States in the ‘worst’ case scenario – or ‘best’ – depending on your perspective?

The land area of the United States, 30 percent of which is owned by the federal government, could support ten times the current population and it would still be less densely populated than Japan is today. If only one percent of that number was allowed into the US, the country could accommodate the entire refugee population of the world.

The fact is that, aside from the fraction of federal land that is set aside for national parks, the bulk of federal land is managed for the benefit of a very few, privileged citizens. What was once taken from Indians does not now belong to me or to all US citizens. It effectively ‘belongs’ to whoever has power in the councils of government: foresters, cattlemen, miners and environmentalists.

A study of one national forest found that the government spent $13 building logging roads for every $1 of revenue earned from the sale of timber. This isn’t frugal management, this is plunder of the taxpayer for the benefit of special interest lobbies.

I would much rather see governments give greater respect to the private ownership of justly acquired land, rather than taking lands by force with the condemnation powers of eminent domain. And where the government holds land, it should be open to those with a just claim or to homesteading. If this means a livelihood for millions of people instead of cows and prairie dogs, then so be it.

Do US citizens prefer open space to cities? Do they need rolling hills and great expanses between each other? For some, yes. And there is more and more of both types of living, cities and open space, for all.

Generally speaking, Americans are like people everywhere and they prefer to live and work in cities or suburbs, which account for less than 3 percent of the land area of the contiguous 48 states.31 Most people like crowded cities or they wouldn’t go there. That’s where the action is.

That explains why, in the decade of the 1990s, the population of New York State declined, while the population of Metropolitan New York City increased. Likewise, the population of California State declined, while the population of Metropolitan Los Angeles City increased. So there is both more open space in the countryside and more action in crowded cities.

As anyone who has flown across the United States can affirm, the population is highly concentrated in certain regions. One can fly for hours across vast expanses of land which are virtually uninhabited. Even the most desolate of land becomes inviting when the law permits freedom.

The number one travel destination for residents of Hawaii is to the deserts of Nevada, not for the open spaces, but for the crowded casinos of Las Vegas where gambling is allowed. Legalising games of chance has made Las Vegas one of the fastest growing regions of the country.

When these cities have troubles, it isn’t because of the number of people, it is because of the failure of governments to provide the primary protection services that politicians so often promise. Washington DC, the crime capital of the US, is a prime example.

We shouldn’t use poor government performance as an excuse for excluding newcomers. Instead, we should seek to improve performance with market alternatives wherever possible.

THE ETHICS OF LIBERTY

Every Fourth of July, the people of the United States proudly reaffirm the bold words of Thomas Jefferson that, ‘We hold these Truths to be self-evident, that all Men Are Created Equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty, and the Pursuit of Happiness.’  Jefferson’s words are as true today as when first written.

To reiterate, I wish to say in the strongest terms I can muster, emboldened by the courage and fortitude of immigrants throughout the world and throughout history, that we should not be devising schemes and rationalisations for the restriction of liberty.

Rather, let US take part in the fight against fear, prejudice, custom and law to champion freedom. This is practical, humanitarian and, above all, ethical. Let US be a part of the drive for liberty today. Let US champion the millions of immigrants who are seeking liberty in the same manner that we would if we were in their shoes.32

Footnotes

1. Horberger, Jacob G., “Locking Out the Immigrant,” The Case For Free Trade and Open Immigration, p. 93, The Future of Freedom Foundation, Fairfax, Virginia, 1995, “Nostra Culpa,” The Economist, March 30, 2002, pp.27-28

2. Tracinski, Robert W., “Opposition to Immigration is Un-American: Restrictions on ‘H-1B’ Visas Punish Ability and Trample the Rights of Employer and Employee, Ayn Rand Institute, http://www.aynrand.org/medialink/immigration.txt

3. Simon, Julian, Immigration: The Demographic and Economic Facts, The Cato Institute, Washington, D.C., 1995, pp. 3-5. Another excellent source is Population: The Ultimate Resource, edited by Barun Mitra, President of the Liberty Institute, New Delhi, India, 2000

4. Ferguson, Ellyn, “Skilled US workers lose jobs: Visa programs give positions to recruits from overseas,” Honolulu Advertiser, December 20, 2004, see also  “NRI’s among US’s superachievers,” The Economic Times, December 30, 2004, http://economictimes.indiatimes.com/articleshow/msid-975426,curpg-1.cms

5. Simon, Julian, op. cit., pp. 3-5

6. An excellent presentation of various arguments can be found in The Journal of Libertarian Studies, 13:2 (Summer 1998), www.vonmises.org. Hans-Hermann Hoppe presents his case with “The Case for Free Trade and Restricted Immigration.” Walter Block’s essay, “A Libertarian Case for Free Immigration,”  is the best defense of open immigration that I have seen anywhere. Also excellent is: Horberger, Jacob G., “Locking Out the Immigrant,” The Case for Free Trade and Open Immigration, Future of Freedom Foundation, Fairfax, Virginia, 1995, www.fff.org

7. Moore, Stephen, “Why Welfare Pays,” Wall Street Journal, September 28, 1995

8. “Migration of Natives and the Foreign Born: 1995-2000,” US Census Bureau, August 2003

9. “An End to Poverty?” Investors Business Daily, October 19, 2000

10. “World Defense Spending,” Investors Business Daily, October 18, 2002, p. A16

11. Ijaz, Mansoor, “Clinton let bin Laden get away,”  Honolulu Advertiser, December 7, 2001 and “Inept National Security,” The Economist, March 23, 2002

12. Powell, Colin, “Secure Borders, Open Doors,” Wall Street Journal, April 21, 2004

13. Ferguson, Ellyn, op. cit., p. C3

14. Brumfiel, Geoff,  “Security restrictions lead foreign students to snub US universities,” News@nature.com, September 15, 2004

15. “Iran coup mastermind Kermit Roosevelt dies,” Honolulu Advertiser, 6/11/00, see also, Solberg, Carl, Oil Power)

16. “A cargo of exploitable souls,” The Economist, June 1, 2002, p. 30

17. Shapiro, Treena, “Conference to spotlight trafficking in humans,” Honolulu Star-Bulletin, June 13, 2002, p. A6

18. “$24,000 cruise ship fine for rescuing 8 Cubans,” Honolulu Advertiser, Oct. 22, 1993 and “Piracy done with fines,” Honolulu Advertiser, Nov. 6, 1993

19. Finley, Bruce, US takes border war on the road: Boats being sunk near Ecuador, Denver Post, December 19, 2004, http://www.denverpost.com/Stories/0,1413,36~11676~2606736,00.html

20. Center for Defense Information, America’s Defense Monitor, Washington, D.C., www.cdi.org. The data cited in the text of this article was derived from their film, “The Human Cost of America’s Arms Sales,” Nov. 8, 1998,

21. Omicinski, John, “US dealers dominating world arms market,” Honolulu Advertiser, April 17, 1994

22. “Europe’s Farms,” The Economist, 7/13/02, p 42

23. “Patches of Light: Special Report on Agricultural Trade,” The Economist, June 9, 2001

24. Stagnaro, Carlo, “When Your Mother Kills,” Tech Central Station, December 28, 2004, http://www.techcentralstation.com/122804B.html

25. Stewart, Rigoberto, Ph.C., Limon Real: A Free and Autonomous Region, Litografia e Imprenta LIL, S.A, San Jose, Costa Rica, 2000, drawing from the excellent research of José Cordiero of Venezuela, including The Great Taboo: A True Nationalization of the Venezuelan Petroleum, 1998.

26. Cox, W. Michael and Alm, Richard, “Off the Books,” Reason, August 2002, p 48

27. Piller, Charles, “ ‘Brain drain’ flowing from US to Asia,” Honolulu Advertiser, December 12, 2004

28. “Refugees: Exporting misery,” The Economist, Apr. 17, 1999

29. “Subsidized cow chow,” The Economist, March 9, 2002, p. 39

30. Boudreaux, Donald, “Absorbing Immigrants,” Ideas on Liberty, Foundation for Economic Education, June 2002, p. 54

31. Ibid, p. 54

32. Schoolland, Ken, “Immigration: An Abolitionist Cause,” Ideas on Liberty, January 2002.

Introduction by professor de Soto

Mitä valtio on tehnyt rahallemme?

CIEL has the honor to publish professor Jésus Huerta de Soto’s Introduction for the Finnish edition of Murray N. Rothbard’s influencial book What Has Government Done to Our Money? The book is published by Lumo Kustannus and pre-orders are available from today.

Introduction
Jesús Huerta de Soto

The theory of money, bank credit, and economic cycles poses the greatest theoretical challenge for economic science in the first decade of the twenty-first century.  In fact, now that a “theoretical gap” has been filled with the analysis of the impossibility of socialism and the study of the contradictions inherent in interventionism (exemplified in the past by the fall of real socialism and the widespread crisis of the welfare state), the least-known, and thus the most critical, sphere has become that of money.  Indeed, this field is still rife with methodological errors, scientific confusion, gross ignorance at the popular and political levels, and in consequence of it all, institutional manipulation and systematic coercion by governments and central banks.  For the social relationships which involve money are by far the most abstract and difficult to understand, and hence the flows of information and social knowledge they produce are the most massive, complex, and elusive to the individual observer.  On the one hand, these circumstances have facilitated systematic coercion in the monetary sphere by governments and central banks, and on the other hand, they have made this coercion far and away the most damaging and detrimental to the spontaneous processes of social cooperation which constitute the market.  In fact, the combination of the intellectual lag in monetary and banking theory with the systematic intervention in financial markets by governments and central banks has not failed to exert serious and often traumatic effects on the evolution of the world economy, which well into the twenty-first century, continues to go through severe financial crises and recurring cycles of boom and recession.

Furthermore, it seems as if the very defenders of the market economy were unable to agree in the area of money.  Thus, there are many different opinions on whether it is necessary to maintain the central bank or whether it would be better to replace it with a free-banking system, and in the latter case, what sort of substantive rules should apply to private bankers (a fractional reserve or a 100-percent reserve requirement on demand deposits).  The central bank emerged as a result of a series of coercive government interventions, though on many occasions these were sought and promoted by the agents of the financial sector themselves (especially bankers), who did not hesitate to demand state support to insure the survival of their business ventures in recurrent stages of economic crisis.  Does this mean the central bank is an “inevitable” by-product in the evolution of a market economy?  Or rather, that private bankers’ particular business practices, which at certain points in history have become legally corrupt, have given rise to financial activity that is unsustainable in the absence of a lender of last resort?  These and other monetary issues are of vital theoretical and practical importance and should be the object of the most careful analysis.  In short, the goal should be none other than to develop a comprehensive research program aimed at clarifying once and for all what monetary, financial, and banking system a free society ought to have.

In this sense, the small book by Rothbard you are now holding in your hands is the best and most brilliant introduction to Austrian monetary theory.  A number of special characteristics make this a landmark book, and the reader could scarcely miss them.  Nevertheless, while by no means an exhaustive list, the following attributes are particularly worthy of mention:

First, the book is written with great clarity.  Indeed, if any trait characterizes Rothbard, it is his ability to present economic theories in a manner perfectly understandable to any person, even one not initially familiar with his method and concepts.  For Rothbard, scientific accuracy must never be at odds with clarity and simplicity of exposition.  Quite the contrary:  despite appearances, obtuse or difficult explanations merely conceal a lack of scientific validity, along with the intellectual confusion of their authors, who, paradoxically, often become surrounded by a false aura of scientific prestige nourished by the reverential fear of all those who do not wish to appear ignorant, though they do not fully grasp what they read.  The clarity, freshness, erudition, and even courage of Rothbard’s economic analysis contrast sharply with the nature of much of the scientific literature the academic world produces.

Second, Rothbard’s constant goal is to seek scientific truth regardless of the expectations of political correctness or acceptability that prevail at any given time.  A scientific economist must never betray this principle, if only because a failure to frankly state, with no strings attached, what he believes to be true in any particular instance will mean that no one does, and thus he will be abandoning his very purpose and depriving society and his colleagues of knowledge which in the long run is essential to the advancement of civilization.

Third, as we have already indicated, Rothbard always writes from the theoretical viewpoint of the Austrian school of economics.  This European school of continental origin runs counter to the Anglo-Saxon tradition of the English classical school.  The Austrian school began with Carl Menger in 1871 and reached its highest level of development at the hands of Ludwig von Mises and Friedrich A. Hayek during the second half of the twentieth century.  Today the Austrian approach is the chief scientific alternative to the neoclassical paradigm in its different versions (Keynesianism, Walrasianism, the Chicago school, etc.), which share a research focus on equilibrium models and overlook the dynamic market processes entrepreneurship drives.  Such processes are the focal point of Austrian study.  Rothbard was an ardent disciple of Mises, whose praxeological perspective on economics and subjectivist methodology, in contrast with positivism and social engineering, he adopted almost to the letter.[1] Today the Austrian school has entered an exciting phase of expansion worldwide, and the publication of this first Dutch edition of Rothbard’s book is one more sign of the much-needed paradigm shift which is leading away from the unrealistic assumptions and obsessive mathematical analysis of equilibrium models and toward the much more realistic, dynamic, and multidisciplinary analysis of market processes that characterizes the Austrian school.  In this context, the criticism which, at various points in his book, Rothbard directs at the analysis and monetary recommendations of the Chicago school in general, and of Milton Friedman in particular, is especially relevant.  This is so mainly because the identification, at a popular and even at an academic level, of both the Austrian and Chicago schools as defenders of the free market and the capitalist free-enterprise economic system (though with clearer and more consistent principles in the case of the Austrian school, when compared with the greater ideological “tepidness” and tendency toward political compromise in the case of the Chicago theorists) has led many people to mistakenly believe the two schools somehow coincide in their methods, theoretical developments, and conclusions.  However, nothing could be further from the truth.  From the Austrian standpoint, Chicago theorists have fallen into the clutches of a narrow, reductionist, maximizing approach which, in the search for “operational” solutions, ends up justifying a sort of social engineering lethal to the free functioning of the market.  To put it another way, Chicago theorists’ defense of the market is theoretical flawed.  We must defend the market because it is a process which continually fosters creativity and entrepreneurial coordination, and not because it is in equilibrium (which is never reached), nor much less because it is “perfect” or Pareto efficient, as Chicago theorists mistakenly believe, thus exposing countless flanks to facile, self-interested criticism from all enemies of a free economy.[2] Moreover, as Rothbard skillfully reveals in this book, the prescriptions of the Chicago school in the monetary sphere (monetary nationalism and free floating exchange rates) have proven particularly unfortunate and have on a broad scale exerted a corrupting influence on the course of economic events (international monetary chaos, competitive depreciation as a trade weapon, and the loss of the function of money on an international level).

Fourth, we should note the importance Rothbard attaches to the history of economic and monetary events as an illustration and application of the theoretical analysis.  In fact, his book is divided into two very distinct parts.  In the first, he sets out the theoretical basis for money and the critical analysis of state intervention in the monetary sphere in general, and of the privileged exercise of fractional-reserve banking in particular.[3] In the second, he applies the lessons taught in the first to explain in a logical, connected manner the way in which the state has destroyed step by step the monetary system which had spontaneously emerged in the market following a prolonged period of evolution.  Rothbard considers nine successive phases which run from the height of the classical gold standard in 1815 to the destruction of the Bretton Woods system and the emergence, beginning in 1973, of international monetary chaos based on floating exchange rates.  The conclusion to be drawn from this review of past events in the monetary sphere is truly depressing, and it more than justifies the attractive title Rothbard gave to his work:  What Has Government Done to Our Money? The conclusion is especially depressing in light of the fact that today, well into the twenty-first century, even following the nearly worldwide collapse of real socialism and, at least in theoretical terms, of economic interventionism and the welfare state, the monetary sphere, as we indicated at the beginning, continues to suffer forceful intervention, monopolization, and planning by central banks and governments, which continually generate cycles of boom and recession that systematically destabilize and discoordinate the world economy.

It is truly disheartening to realize that from the very last time Rothbard was able to examine his book for reprinting until now, little or no progress has been made.  During this period, particularly for readers in the European area, the most significant development has undoubtedly been the introduction of the euro as the single currency of a large part of Europe ten years ago.  In this context, we must emphasize that criticism of the European Central Bank and the European single currency must rest, in keeping with Rothbard’s thinking, on their distance from the ideal of a pure gold standard with a 100-percent reserve requirement for banking,[4] and not, as many “free market” theorists (influenced chiefly by the erroneous teachings of the Chicago school) assert, on the fact that they preclude the survival of disruptive monetary nationalism with floating exchange rates.  For although the accomplishments of the European Central Bank over the last ten years leave much to be desired, a single monetary standard for all of Europe, one which is as rigid as possible, besides being a healthy move toward the ideal of a pure gold standard as the single international monetary system, may help to complete the institutional framework for the European free trade system, by preventing monetary interference and manipulation on the part of each member state and obliging the members, especially the most rigidly structured ones, to implement the flexibilizing reforms necessary to remain competitive in an environment in which it is no longer possible to resort to an inflationary national monetary policy to accommodate institutional rigidities.  If the euro is to have a brilliant, promising future, it will have to rest on its total separation and independence from the monetary recklessness and laxity which, under the pretext of a poorly understood pragmatism based invariably on theoretical error, have become typical features of monetary policy in the Anglo-Saxon world since the creation of the Federal Reserve in 1913 and the triumph of macroeconomics, first the Keynesian and then the Chicago-school version, from World War II onward.

Finally, it is fitting to wrap up these introductory remarks with a brief biographical sketch of the work’s author.  Murray Newton Rothbard was born in New York in 1926, into a family of Jewish emigrants from Poland.  He earned his doctorate at New York’s Columbia University under the direction of Joseph Dorfman and the mentorship of his neighbor, the famous economist Arthur Burns.  A coincidence brought him into contact at a very young age with the seminar Ludwig von Mises was leading at the time at New York University, and Rothbard immediately became one of his most brilliant and devoted disciples.  Rothbard would later become a Professor of Economics at New York Polytechnic Institute and subsequently, the S. J. Hall Distinguished Professor of Economics at the University of Nevada, Las Vegas.  Rothbard was one of the most consistent and tenacious champions of freedom on all levels and of its grounding in the philosophy of natural law.  He wrote over twenty books full of great clarity, freshness, erudition, and even good humor, qualities which pervade the most profound and rigorous theoretical analysis.  His primary contributions to economic theory are his economic treatise, Man, Economy, and State (1962), and Power and Market (1973).  Among his chief writings on the history of economic thought and events, we find important works such as The Panic of 1819 (1962), America’s Great Depression (1963), a history of the American colonial period in four volumes entitled Conceived in Liberty (1975-1979), and the extraordinary two volumes published posthumously under the title An Austrian Perspective on the History of Economic Thought (1995).  His main contributions to political philosophy, in which he lays the foundations for the anarchocapitalist system, include his books For a New Liberty:  The Libertarian Manifesto (1973) and The Ethics of Liberty (1982), as well as hundreds of articles and essays.  Rothbard played a key role in the founding of the American Libertarian Party and was also a co-founder of the Cato Institute, the Ludwig von Mises Institute (which publishes the Quarterly Journal of Austrian Economics), and the Center for Libertarian Studies (which publishes the Journal of Libertarian Studies).  Endowed with a great capacity for intellectual pursuits, vast erudition, multidisciplinary scientific knowledge, along with a superb sense of humor, Rothbard has become one of the classic names in the defense of liberty in the second half of the twentieth century.  He died of a heart attack at the office of his ophthalmologist in New York on January 7, 1995.  With his death, the world lost one of its intellectual giants whose work, like that of Tocqueville, Acton, Mises, and Hayek, will endure, bear fruit, and be remembered always with particular admiration and reverence by all those who love liberty and grasp its crucial importance.

Madrid, August 19, 2009

Jesús Huerta de Soto
Professor of Political Economy
Universidad Rey Juan Carlos


[1] On the differences between the neoclassical mainstream and the Austrian paradigm, see J. Huerta de Soto, The Austrian School:  Market Order and Entrepreneurial Creativity (Cheltenham, UK:  Edward Elgar, 2008).

[2] Hayek himself went so far as to assert that Keynes’s General Theory and Milton Friedman’s Essays in Positive Economics are equally dangerous books.  See F. A. Hayek, Hayek on Hayek:  An Autobiographical Dialogue, eds. Stephen Kresge and Leif Wenar (London and New York:  Routledge, 1994), 145.

[3] On the corruption of general legal principles which accompanies fractional-reserve banking, and on the way in which this practice provokes recurring cycles of boom and recession and makes the appearance of a central bank inevitable, see (firmly rooted in Rothbardian thought) Huerta de Soto, J., Money, Bank Credit, and Economic Cycles (Auburn, AL:  Ludwig von Mises Institute, 2006).

[4] See Murray N. Rothbard, The Case for a 100 Percent Gold Dollar, 2d ed. (Auburn, AL:  Ludwig von Mises Institute, 2005).  This work contains a preface in which Rothbard himself offers his interpretation of monetary events between 1973 and 1991 (a period which could be considered phase 10 of his historical interpretation), a study which perfectly complements the book we are now commenting on.