Liberty and the Power of Ideas

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author author from an essay first published in the February 1979 issue of FEE’s journal, “The Freeman.”


A belief which I stressed again and again in my classes when I taught economics at Northwood University in Michigan was the belief that we are at war—not a physical, shooting war but nonetheless a war which is fully capable of becoming just as destructive and just as costly.

The battle for the preservation and advancement of liberty is a battle not against personalities but against opposing ideas. The French author Victor Hugo declared that “More powerful than armies is an idea whose time has come.” Armies conquer bodies, but ideas capture minds. The English philosopher Carlyle put it this way many decades ago: “But the thing a man does practically believe (and this is often enough without asserting it to himself, much less to others): the thing a man does practically lay to heart, and know for certain, concerning his vital relations to this mysterious Universe, and his duty and destiny there, that is in all cases the primary thing for him, and creatively determines all the rest.”

In the past, ideas have had earthshaking consequences. They have determined the course of history. For good or ill, they bring down governments and raise other ones up.

The system of feudalism existed for a thousand years in large part because scholars, teachers, intellectuals, educators, clergymen and politicians propagated feudalistic ideas. The notion of “once a serf, always a serf’ kept millions of people from ever questioning their station in life. Under the mercantilism practiced from the 16th through the 18th Centuries, the widely-accepted concept that the world’s wealth was fixed prompted men to take what they wanted from others in a long series of bloody wars.

The publication of Adam Smith’s The Wealth of Nations in 1776 is a landmark in the history of the power of ideas. As Smith’s message of free trade spread, political barriers to peaceful cooperation collapsed and virtually the whole world decided to try freedom for a change.

In arguing against freedom of the press in 1924, Lenin made the famous statement that “ideas are much more fatal than guns.” To this day, ideas by themselves can get you a prison sentence in a lot of places around the world.

Marx and the Marxists would have us believe that socialism is inevitable, that it will embrace the world as surely as the sun will rise in the east tomorrow. As long as men have free will (the power to choose right from wrong) however, nothing that involves this human volition can ever be inevitable! Men do things because they are of the mind to do them; they are not robots programmed to carry out some preordained dictum.

Winston Churchill once said that “Socialism is the philosophy of failure, the creed of ignorance, and the gospel of envy. Its inherent trait is the equal sharing of misery.” Socialism is an age-old failure, yet the socialist idea constitutes the chief threat to liberty today. So it is that believers in liberty, to be effective, must first identify and isolate the socialist notions which have taken their toll on liberty. In doing that, and then refraining from advancing those ideas, we can at the same time advance liberty. As I see it, socialism can be broken down into five ideas.

The Pass a Law Syndrome. Passing laws has become a national pastime in most Western countries. When a problem in society is cited, the most frequent response seems to be, “Pass a law!” Business in trouble? Pass a law to give it public subsidies or restrict its freedom of action. Poverty? Pass a law to abolish it. Perhaps we need a law against passing more laws.

In 1977 the American Congress enacted 223 new laws. It repealed hardly any. During that same year, the Washington bureaucracy wrote 7,568 new regulations, all having the force of law. (Thirty-three years later, the situation is even worse. Now, few in Congress even read the bills they vote for, some of which are in the thousands of pages).

James Madison in 1795 identified this syndrome as “the old trick of turning every difficulty into a reason for accumulating more force in government.” His observation leads one to ask, “Just what happens when a new law goes on the books?” Almost invariably, a new law means: a) more taxes to finance its administration; b) additional government officials to regulate some heretofore unregulated aspect of life; and c) new penalties for violating the law. In brief, more laws mean more regimentation, more coercion. Let there be no doubt about what the word “coercion” means: force, plunder, compulsion, restraint. Synonyms for the verb form of the word are even more instructive: impel, exact, subject, conscript, extort, wring, pry, twist, dragoon, bludgeon, and squeeze!

When government begins to intervene in the free economy, bureaucrats and politicians spend most of their time undoing their own handiwork. To repair the damage of Provision A, they pass Provision B. Then they find that to repair Provision B, they need Provision C and to undo C, they need D, and so on until the alphabet and our freedoms are exhausted.

The Pass a Law Syndrome is evidence of a misplaced faith in the political process, a reliance on force which is anathema to a free society. It’s also a sign that people have abandoned confidence in themselves and would prefer dependence upon politicians and largely unaccountable bureaucrats who usually are among the least capable in society to run the lives of others.

The Get Something From Government Fantasy. Government by definition has nothing to distribute except what it first takes from people. Taxes are not donations!

In the welfare state, this basic fact gets lost in the rush for special favors and giveaways. People speak of “government money” as if it were truly “free.” It may not be an exaggeration to say that perhaps the welfare state is so named because the politicians get well and the rest of us pay the fare.

One who is thinking of accepting something from government which he could not acquire voluntarily should ask, “From whose pocket is it coming? Am I being robbed to pay for this benefit or is government robbing someone else on my behalf?” Frequently, the answer will be both. The end result of this “fantasy” is that everyone in society has his hands in someone else’s pockets.

The Pass the Buck Psychosis. Recently a welfare recipient wrote her welfare office and demanded, “This is my sixth child. What are you going to do about it?”

An individual is victim to the Pass the Buck Psychosis when he abandons himself as the solver of his problems. He might say, “My problems are really not mine at all. They are society’s, and if society doesn’t solve them and solve them quickly, there’s going to be trouble!”

Socialism thrives on the shirking of responsibility. When men lose their spirit of independence and initiative, their confidence in themselves, they become clay in the hands of tyrants and despots. I might add: The only thing socialism has ever really done for poor people is to give them lots of company.

The Know-It-All Affliction. Leonard Read, in The Free Market and Its Enemy, identified “know-it-allness” as a central feature of the socialist idea. The know-it-all is a meddler in the affairs of others. His attitude can be expressed in this way: “I know what’s best for you, but I’m not content to merely convince you of my rightness; I’d rather force you to adopt my ways.” The know-it-all evinces arrogance and a lack of tolerance for the great diversity among people.

In government, the know-it-all refrain sounds like this: “If I didn’t think of it, then it can’t be done, and since it can’t be done, we must prevent anyone from trying.”

A group of West Coast businessmen ran into this snag recently when their request to operate a barge service between the Pacific Northwest and Southern California was denied by the Interstate Commerce Commission because the agency felt the group could not operate such a service profitably!

The miracle of the market is that when men and women are free to try, they can and do accomplish great things. Leonard Read’s well-known admonition that there should be “no man-concocted restraints against the release of creative energy” is a powerful rejection of the Know-It-All Affliction. (Leonard Read was the founder of the Foundation for Economic Education and you can read more about him here: http://www.thefreemanonline.org/featured/leonard-e-read-crusader/).

The Envy Obsession. Coveting the wealth and income of others has given rise to a sizable chunk of today’s socialist legislation. Envy is the fuel that runs the engine of redistribution. Surely, the many soak the-rich schemes are rooted in envy and covetousness.

What happens when people are obsessed with envy? They blame those who are better off than themselves for their troubles. Society is fractured into classes and faction preys upon faction. Civilizations have been known to crumble under the weight of envy and the disrespect for property which it entails.

A common thread runs through these five socialist ideas. They all appeal to the darker side of man: the primitive, noncreative, slothful, dependent, demoralizing, unproductive, and destructive side of human nature. No society can long endure if its people practice such suicidal notions!

Consider the freedom philosophy. What a contrast! It is an uplifting, regenerative, motivating, creative, exciting philosophy! It appeals to and relies upon the higher qualities of human nature such as self-reliance, personal responsibility, individual initiative, respect for property, and voluntary cooperation.

Nobel laureate economist F. A. Hayek (author of the seminal 1944 book, “The Road to Serfdom”) called attention to the power of ideas in preserving liberty: “Unless we can make the philosophic foundations of a free society once more a living intellectual issue, and its implementation a task which challenges the ingenuity and imagination of our liveliest minds, the prospects of freedom are indeed dark.”

The verdict in the struggle between freedom and serfdom depends entirely upon what percolates in the hearts and minds of men. At the present time, in every nation of the world, the jury is still deliberating.

The High Cost of Government Schooling

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author from an essay first published in the February 2001 issue of FEE’s journal, “The Freeman.” The author wishes the reader to know that the conditions he described in 2001 are no better a decade later and neither are the public policies that produced them.


Public (government) education in America costs a princely sum, and it isn’t getting any cheaper. But what taxpayers shell out for the government school monopoly doesn’t tell the whole story. What others in society must pay to correct the shortcomings of that failed monopoly is huge and a painful testimony to the need for a big dose of choice, competition, and private enterprise.

Because government schools perform on a par with government farms, government factories, and government stores in the typical socialized society, we have in America what is commonly called “remedial education.” The government school establishment doesn’t like the term because of its pejorative nature, so its minions have lately come up with their own: “developmental education.” I have nothing to cover up, so I’ll use the former.

Remedial education is what has to happen when students graduate from high school lacking basic skills in reading, writing, and mathematics. They have a diploma, but it doesn’t certify that they know anything; these days, the only thing you can be sure a diploma certifies is that lots of people paid through the nose for at least 12 years before the government was done with you. When employers and universities have to spend money to bring high school graduates up to speed—to do what the K-12 system did not do—that’s remedial education.

Getting a handle on the costs of this corrective work in Michigan was the purpose of a study released in 2000 by the Mackinac Center for Public Policy.

The Cost of Remedial Education: How Much Michigan Pays When Students Fail to Learn Basic Skills” by education policy scholar Jay P. Greene, captured page-one headlines all across the state and shook the very foundations of the government school establishment. It made a lot of people rethink their longstanding, rarely questioned assumptions about government schooling.

First, it’s important to understand what the study did not count. It did not include the cost of college-level work that has been “watered-down” but not labeled either “remedial” or “developmental.” Talk to most university professors these days and you’ll know what I mean.

The study accounted for the expense of instructional services, but did not count expenditures on technology to accommodate the lack of basic skills. Increasingly, businesses are investing in software and gadgets to do, in effect, an end-run around workers who lack basic skills. Many businesses these days buy cash registers that make change for customers because employees can’t be relied on to count accurately. Some fast-food chains actually provide cash registers with pictures of the food items on them so adult employees who can’t read “cheeseburger” can still use them.

And finally, the study did not count the costs incurred personally by either high school dropouts or graduates who have been short-changed by the system: the later costs of tutors and self-study, and the cost of lower incomes.

This study looked only at Michigan and only at the costs of remedial education incurred just by businesses and universities in that state. At a minimum, one-third and probably something closer to one-half of all students graduating from Michigan public high schools lack basic skills. By using five different strategies for calculating these costs, Greene arrived at $601 million as a conservative estimate of what Michigan businesses and universities spend each year to remediate high school graduates lacking basic skills. That is a considerable sum on top of the $13 billion state and local governments spend on public education each year in Michigan, and yet it’s surely too low because of all the costs that were not part of the calculation.

The government school establishment is quick to suggest that the problem isn’t entirely the fault of the schools. Parents, they say, are partly to blame when they don’t prepare kids well or see that they do their homework. While it’s true that many parents have abdicated their responsibilities in the education of their children, it’s also true that many parents who do take education seriously find that they must constantly fight the public schools on matters of proper course content and academic rigor. Many parents believe the report cards their kids bring home, not realizing that grade inflation and poor teaching render the meaning of those report cards dubious. And schools, not parents, are the outfits that issue the diplomas that once implied a mastery of at least basic skills. If a student doesn’t have those skills, it’s deception when his school graduates him as if he did.

Janet Dettloff, chair of the Math and Sciences Division at Wayne County Community College in Detroit, says the remedial problem is acute and goes beyond a simple lack of knowledge: “Most of the students who come to us not only lack math and English skills, but they lack basic academic skills too. They have no idea what is expected of them at the college level. They don’t know how to take notes. They don’t read the assigned material. And many of them don’t even come to class.”

Others from both the business and university communities told the author what education reformers have long understood: government schools are doing a poor job of imparting critical thinking skills. Logic and reason have largely been supplanted by appeals to emotion. In place of rigorous analytical processes, students are asked to tell how they feel about a particular issue. The “self-esteem” craze that has swept public education essentially produces students by the boatload who don’t really know much, don’t know that they don’t know, but feel real good about their ignorance.

Getting the public to think about the high costs of remedial education is proving to be a catalyst for advancing real reform. If you favor more choice, competition, and private enterprise in education—irrespective of your preference for vouchers or tax credits or privatization and complete separation of school and state as a means to do that—the remediation problem provides new and powerful arguments: It vividly demonstrates that there are costs to not scrapping the status quo. People who are uncomfortable with the thought of change have some startling new numbers to wrestle with.

Apologists for government schooling love to spurn the arguments of reformers with the line, “You’re not being fair because, after all, public schools have to take all comers. They can’t pick and choose as private schools can.” Well, thanks to eye-opening studies like this one on the remedial problem, we know that whether public schools take everybody or not, it’s clear that atrociously high numbers of those they take are not getting educated.

A Student’s Essay That Changed the World

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author from an essay first published in the May 2005 issue of FEE’s journal, “The Freeman.”)

As a former university professor, I read thousands of student-authored essays through the years — sometimes joyously, but probably just as often, painfully.  Occasionally, the process of researching and writing exerted significant influence over a student’s future interests, thinking and perhaps even behavior.  But of all the student essays ever written anywhere, I doubt that any had as profound an effect on its author and the world as one that was penned 220 years ago at Cambridge.

Throughout Britain, the annual Latin essay contest at Cambridge was known and the honor of winning it coveted.  The topic for the 1785 competition was prompted by a horrific human tragedy a few years before: Near the end of a long voyage from Britain to Africa to the West Indies, the captain of the British slave ship “Zong” had ordered his crew to throw 133 chained black Africans overboard to their deaths.  He reckoned that by falsely claiming the ship had run out of fresh water, he could collect more for the “cargo” from the ship’s insurer than he could fetch at a slave auction in Jamaica.

No one in the Zong affair was prosecuted for murder.  A London court ruled the matter a mere civil dispute between an insurance firm and a client.  As for the Africans, the judge declared their drowning was “just as if horses were killed,” which, as horrendous as that sounds today, was not a view far removed from the conventional wisdom that prevailed worldwide in 1785.  Slavery, after all, was an ancient institution.  Even to this day, the number of people who have walked this earth in bondage far outnumbers those who have enjoyed even a modest measure of liberty.

Moved by the fate of the Zong’s victims and the indifference of the court, the university vice-chancellor in charge of selecting the topic for the 1785 contest at Cambridge chose this question: “Anne liceat invitos in servitutem dare?” – Is it lawful to make slaves of others against their will?”

Enter a man who, with a handful of compatriots armed only with the printed and spoken word, would clutch the public by the neck and not let go until it consigned slavery to the moral ash heap of history.

Born in Wisbech in 1760, Thomas Clarkson was a 25-year-old Cambridge student who hoped to be a minister when he decided to try his luck in the essay contest.  Slavery was not a topic that had previously interested him, but he plunged into his research with the vigor and meticulous care that, with the passion that his findings later sparked, would come to characterize nearly every day of his next sixty-one years.   Drawing from the vivid testimony of those who had seen the unspeakable cruelty of the slave trade first-hand, Clarkson’s essay won first prize.

What Clarkson had learned wrenched him to his very core.  Shortly after claiming the prize, and while riding horseback along a country road, his conscience gripped him.  Slavery, he later wrote, “wholly engrossed” his thoughts.  He could not complete the ride without making frequent stops to dismount and walk, tortured by the awful visions of the traffic in human lives.  At one point, falling to the ground in anguish, he determined that if what he had written in his essay was indeed true, it could lead to only one conclusion: “it was time some person should see these calamities to their end.”

Adam Hochschild, author of a splendid recent book on the history of the campaign to end slavery in the British empire titled “Bury the Chains,” explains the significance of those few minutes in time:

“If there is a single moment at which the antislavery movement became inevitable, it was the day in 1785 when Thomas Clarkson sat down by the side of the road at Wades Mill . . . . For his Bible-conscious colleagues, it held echoes of Saul’s conversion on the road to Damascus.  For us today, it is a landmark on the long, tortuous path to the modern conception of universal human rights.”  More than two centuries on, that very spot is marked by an obelisk, not far from London.

No man can rightfully lay claim, moral or otherwise, to owning another.  That became Clarkson’s all-consuming focus.  Casting aside his plans for a career as a man of the cloth, he mounted a bully pulpit and risked everything for the single cause of ending the evil of slavery.  At first, he sought out and befriended the one group — the Quakers — who had already gone on record on the issue.  But the Quakers were few in number and were written off by British society as fringe weirdos.  Quaker men even refused to remove their hats for any man, including the king, because they believed it offended an even higher authority.  Clarkson knew that anti-slavery would have to become a mainstream, fashionable, grassroots, educational effort if it had any hope to succeed.

On May 22, 1787, Clarkson’s organizational skills brought together twelve men, including a few of the leading Quakers, at a London print shop to plot the course.  Alexis de Tocqueville would later describe the results of that meeting as “extraordinary” and “absolutely without precedent” in the history of the world.  This tiny group, which named itself the Committee for the Abolition of the African Slave Trade, was about to take on a firmly established institution in which a great deal of money was made and on which considerable political power depended.  The broad public knew little about the details of slavery and what it did know, it had accepted for the most part as perfectly normal since time immemorial.

“Looking back today,” writes Hochschild, “what is more astonishing than the pervasiveness of slavery in the late 1700s is how swiftly it died.  By the end of the following century, slavery was, at least on paper, outlawed almost everywhere.”  Thomas Clarkson was the prime architect of “the first, pioneering wave of that campaign” (the movement in Britain) which Hochschild properly describes as “one of the most ambitious and brilliantly organized citizens’ movements of all time.”

William Wilberforce is most often given the lion’s share of the credit for ending slavery in the British empire.  He was the long-time Parliamentarian who never gave in to overwhelming odds, introducing bill after bill to abolish first the trade in slaves and later, slavery itself.  Hero he certainly was, but it was Thomas Clarkson who first proposed to Wilberforce that he be the movement’s man in Parliament.  And it was information Clarkson gathered by crisscrossing 35,000 miles of British countryside on horseback that Wilberforce often used in parliamentary debate.  Clarkson was the mobilizer, the energizer, the barnburner, the fact-finder, and the very conscience of the movement.

He translated his prize-winning essay from Latin into English and supervised its distribution by the tens of thousands.  He gave lectures and sermons.  He wrote articles and a least one book.  He helped British seamen escape from the slave-carrying ships they were pressed against their will to serve on.  He filed murder charges in courts to draw attention to the actions of fiendish slave ship captains.  He convinced witnesses to speak.  He gathered testimony, rustled up petition signatures by the thousands, and smuggled evidence from under the very noses of his adversaries.  His life was threatened many times and once, surrounded by an angry mob, he very nearly lost it.  The long hours, the often thankless and seemingly fruitless forays to uncover evidence, the risks and the costs that came in every form, the many low points when it looked like the world was against him — all of that went on and on year after year.  None of it ever made so much as a perceptible dent in Thomas Clarkson’s drive.

When Britain went to war with France in 1793, Clarkson and his committee saw early progress in winning converts evaporate.  The opposition in Parliament argued that abandoning the slave trade would only hand a lucrative business to a mortal enemy.  And the public saw winning the war as more important than freeing people of another color from another continent.  But Clarkson did not relent.  He, his ally in Parliament Wilberforce, and the committee Clarkson had formed, kept spreading the message and looked for the best opportunities to press it forward.

It was at Clarkson’s instigation that a diagram of a slave ship became a convincing tool in the debate.  Depicting hundreds of slaves crammed like sardines in horrible conditions, it proved to be pivotal in winning the public mind.  Clarkson’s committee enlisted the help of famed pottery maker Josiah Wedgwood in producing a famous medallion with the image of a kneeling black man, chained, uttering the words, “Am I not a man and a brother?”  Indeed, Clarkson’s imprint was on almost everything the committee did.  It even produced one of the first newsletters and one of the first direct-mail campaigns for the purpose of raising money.

The effort finally paid off.  The tide of public opinion swung firmly to the abolitionists.  The trade in slaves was outlawed by act of Parliament when it approved one of Wilberforce’s bills in 1807.  Twenty-six more years of laborious effort by Clarkson, Wilberforce and others were required before, in 1833, Britain freed all slaves within its realm and became a model for peaceful emancipation everywhere.

Clarkson died at the age of 86, having outlived the other eleven he had called together at the print shop back in 1787.  Hochschild tells us that the throngs of mourners “included many Quakers, and the men among them made an almost unprecedented departure from sacred custom” by removing their hats.

An essay lit a match, which started a fire, which saved millions of lives and changed the world.  If you ever hear anyone dismissing the power of pen and ink, just tell them the story of Thomas Clarkson and his prize-winning essay.

Great Myths of the Great Depression

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay is drawn from the author’s longer monograph available here. Readers can also view a speech by the author on this very subject here.

Many volumes have been written about the Great Depression and its impact on the lives of hundreds of millions of citizens around the world. Historians, economists, and politicians have all combed the wreckage searching for the “black box” that will reveal the cause of this legendary tragedy. Sadly, all too many of them decide to abandon their search, finding it easier perhaps to circulate a host of false and harmful conclusions about the events of eight decades ago.

How bad was the Great Depression? Generally speaking, it was worse in America than in Western Europe and Canada and my focus here is on the U.S. Over the four years from 1929 to 1933, production at America’s factories, mines, and utilities fell by more than half. Real disposable incomes dropped 28 percent. Stock prices collapsed to one-tenth of their pre-crash height. The number of unemployed Americans rose from 1.6 million in 1929 to 12.8 million in 1933. One of every four workers was out of a job at the Depression’s nadir, and ugly rumors of revolt simmered for the first time since the Civil War of the 1860s.

Old myths never die; they just keep showing up in college economics and political science textbooks. Students today are frequently taught that unfettered free enterprise collapsed of its own weight in 1929, paving the way for a decade-long economic depression full of hardship and misery. President Herbert Hoover is presented as an advocate of “hands-off,” or laissez-faire, economic policy, while his successor, Franklin Roosevelt, is the economic savior whose policies brought us recovery. This popular account of the Depression belongs in a book of fairy tales and not in a serious discussion of economic history, as a review of the facts demonstrates.

The Great, Great, Great, Great Depression

To properly understand the events of the time, it is appropriate to view the Great Depression as not one, but four consecutive depressions rolled into one. Professor Hans Sennholz has labeled these four “phases” as follows: the business cycle; the disintegration of the world economy; the New Deal; and the Wagner Act.[1]

The first phase explains why the crash of 1929 happened in the first place; the other three show how government intervention kept the economy in a stupor for over a decade.

Phase I: The Business Cycle

The Great Depression was not America’s first depression, though it proved to be the longest. The common thread woven through the several earlier debacles was disastrous manipulation of the money supply by government. For various reasons, government policies were adopted that ballooned the quantity of money and credit. A boom resulted, followed later by a painful day of reckoning. None of America’s depressions prior to 1929, however, lasted more than four years and most of them were over in two. The Great Depression lasted for a dozen years because the government compounded its monetary errors with a series of harmful interventions.

Most monetary economists, particularly those of the “Austrian school” (represented by such notable economists as Ludwig von Mises and Nobel laureate F. A. Hayek) have observed the close relationship between money supply and economic activity. When government inflates the money and credit supply, interest rates at first fall. Businesses invest this “easy money” in new production projects and a boom takes place in capital goods. As the boom matures, business costs rise, interest rates readjust upward, and profits are squeezed. The easy-money effects thus wear off and the monetary authorities, fearing price inflation, slow the growth of or even contract the money supply. In either case, the manipulation is enough to knock out the shaky supports from underneath the economic house of cards.

One of the most thorough and meticulously documented accounts of the Federal Reserve’s inflationary actions prior to 1929 is America’s Great Depression by the late Murray Rothbard. Using a broad measure that includes currency, demand and time deposits, and other ingredients, Rothbard estimated that the Federal Reserve expanded the money supply by more than 60 percent from mid-1921 to mid-1929.[2] The flood of easy money drove interest rates down, pushed the stock market to dizzy heights, and gave birth to the “Roaring Twenties.”

By early 1929, the central bank was taking the punch away from the party. It choked off the money supply, raised interest rates, and for the next three years presided over a money supply that shrank by 30 percent. This deflation following the inflation wrenched the economy from tremendous boom to colossal bust.

The “smart” money—shrewd investors like Bernard Baruch and Joseph Kennedys who watched things like money supply—saw that the party was coming to an end before most other Americans did. Baruch actually began selling stocks and buying bonds and gold as early as 1928; Kennedy did likewise, commenting, “only a fool holds out for the top dollar.”[3]

When the masses of investors eventually sensed the change in Fed policy, the stampede was underway. The stock market, after nearly two months of moderate decline, plunged on “Black Thursday”—October 24, 1929—as the pessimistic view of large and knowledgeable investors spread.

The stock market crash was only a symptom—not the cause—of the Great Depression: the market rose and fell in near synchronization with what the Fed was doing.

Phase II: Disintegration of the World Economy

If this crash had been like previous ones, the subsequent hard times might have ended in a year or two. But unprecedented political bungling instead prolonged the misery for twelve long years.

Unemployment in 1930 averaged a mildly recessionary 8.9 percent, up from 3.2 percent in 1929. It shot up rapidly until peaking out at more than 25 percent in 1933. Until March 1933, these were the years of President Herbert Hoover—the man that anti-capitalists depict as a champion of noninterventionist, laissez-faire economics.

Did Hoover really subscribe to a “hands off the economy,” free-market philosophy? His opponent in the 1932 election, Franklin Roosevelt, didn’t think so. During the campaign, Roosevelt blasted Hoover for spending and taxing too much, boosting the national debt, choking off trade, and putting millions of people on the dole. He accused the president of “reckless and extravagant” spending, of thinking “that we ought to center control of everything in Washington as rapidly as possible,” and of presiding over “the greatest spending administration in peacetime in all of history.”

Roosevelt’s running mate, John Nance Garner, charged that Hoover was “leading the country down the path of socialism.”[4] Contrary to the modern myth about Hoover, Roosevelt and Garner were absolutely right.

The crowning folly of the Hoover administration was the Smoot-Hawley Tariff, passed in June 1930. It came on top of the Fordney-McCumber Tariff of 1922, which had already put American agriculture in a tailspin during the preceding decade. The most protectionist legislation in U.S. history, Smoot-Hawley virtually closed the borders to foreign goods and ignited a vicious international trade war. Professor Barry Poulson notes that not only were 887 tariffs sharply increased, but the act broadened the list of dutiable commodities to 3,218 items as well.[5]

Officials in the administration and in Congress believed that raising trade barriers would force Americans to buy more goods made at home, which would solve the nagging unemployment problem. They ignored an important principle of international commerce: trade is ultimately a two-way street; if foreigners cannot sell their goods here, then they cannot earn the dollars they need to buy here.

Foreign companies and their workers were flattened by Smoot-Hawley’s steep tariff rates, and foreign governments all across the world soon retaliated with trade barriers of their own. With their ability to sell in the American market severely hampered, they curtailed their purchases of American goods. American agriculture was particularly hard hit. With a stroke of the presidential pen, farmers in the U.S. lost nearly a third of their markets. Farm prices plummeted and tens of thousands of farmers went bankrupt. With the collapse of agriculture, rural banks failed in record numbers, dragging down hundreds of thousands of their customers.

Hoover dramatically increased government spending for subsidy and relief schemes. In the space of one year alone, from 1930 to 1931, the federal government’s share of GNP increased by about one-third.

Hoover’s agricultural bureaucracy doled out hundreds of millions of dollars to wheat and cotton farmers even as the new tariffs wiped out their markets. His Reconstruction Finance Corporation ladled out billions more in business subsidies. Commenting decades later on Hoover’s administration, Rexford Guy Tugwell, one of the architects of Franklin Roosevelt’s policies of the 1930s, explained, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.”[6]

To compound the folly of high tariffs and huge subsidies, Congress then passed and Hoover signed the Revenue Act of 1932. It doubled the income tax for most Americans; the top bracket more than doubled, going from 24 percent to 63 percent. Exemptions were lowered; the earned income credit was abolished; corporate and estate taxes were raised; new gift, gasoline, and auto taxes were imposed; and postal rates were sharply hiked.

Can any serious scholar observe the Hoover administration’s massive economic intervention and, with a straight face, pronounce the inevitably deleterious effects as the fault of free markets?

Phase III: The New Deal

Franklin Delano Roosevelt won the 1932 presidential election in a landslide, collecting 472 electoral votes to just 59 for the incumbent Herbert Hoover. The platform of the Democratic Party whose ticket Roosevelt headed declared, “We believe that a party platform is a covenant with the people to be faithfully kept by the party entrusted with power.” It called for a 25 percent reduction in federal spending, a balanced federal budget, a sound gold currency “to be preserved at all hazards,” the removal of government from areas that belonged more appropriately to private enterprise, and an end to the “extravagance” of Hoover’s farm programs. This is what candidate Roosevelt promised, but it bears no resemblance to what President Roosevelt actually delivered.

In the first year of the New Deal, Roosevelt proposed spending $10 billion while revenues were only $3 billion. Between 1933 and 1936, government expenditures rose by more than 83 percent. Federal debt skyrocketed by 73 percent.

Roosevelt secured passage of the Agricultural Adjustment Act (AAA), which levied a new tax on agricultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle. Federal agents oversaw the ugly spectacle of perfectly good fields of cotton, wheat, and corn being plowed under. Healthy cattle, sheep, and pigs by the millions were slaughtered and buried in mass graves.

Even if the AAA had helped farmers by curtailing supplies and raising prices, it could have done so only by hurting millions of others who had to pay those prices or make do with less to eat.

Perhaps the most radical aspect of the New Deal was the National Industrial Recovery Act (NIRA), passed in June 1933, which set up the National Recovery Administration (NRA). Under the NIRA, most manufacturing industries were suddenly forced into government-mandated cartels. Codes that regulated prices and terms of sale briefly transformed much of the American economy into a fascist-style arrangement, while the NRA was financed by new taxes on the very industries it controlled. Some economists have estimated that the NRA boosted the cost of doing business by an average of 40 percent—not something a depressed economy needed for recovery.

Like Hoover before him, Roosevelt signed into law steep income tax rate increases for the high brackets and introduced a 5 percent withholding tax on corporate dividends. In fact, tax hikes became a favorite policy of the president’s for the next ten years, culminating in a top income tax rate of 94 percent during the last year of World War II. His alphabet agency commissars spent the public’s tax money like it was so much bilge.

For example, Roosevelt’s public relief programs hired actors to give free shows and librarians to catalogue archives. The New Deal even paid researchers to study the history of the safety pin, hired 100 Washington workers to patrol the streets with balloons to frighten starlings away from public buildings, and put men on the public payroll to chase tumbleweeds on windy days.

Roosevelt created the Civil Works Administration in November 1933 and ended it in March 1934, though the unfinished projects were transferred to the Federal Emergency Relief Administration. Roosevelt had assured Congress in his State of the Union message that any new such program would be abolished within a year. “The federal government,” said the President, “must and shall quit this business of relief. I am not willing that the vitality of our people be further stopped by the giving of cash, of market baskets, of a few bits of weekly work cutting grass, raking leaves, or picking up papers in the public parks.”

But in 1935 the Works Progress Administration came along. It is known today as the very government program that gave rise to the new term, “boondoggle,” because it “produced” a lot more than the 77,000 bridges and 116,000 buildings to which its advocates loved to point as evidence of its efficacy.[7] The stupefying roster of wasteful spending generated by these jobs programs represented a diversion of valuable resources to politically motivated and economically counterproductive purposes.

The American economy was soon relieved of the burden of some of the New Deal’s excesses when the Supreme Court outlawed the NRA in 1935 and the AAA in 1936, earning Roosevelt’s eternal wrath and derision. Recognizing much of what Roosevelt did as unconstitutional, the “nine old men” of the Court also threw out other, more minor acts and programs which hindered recovery.

Freed from the worst of the New Deal, the economy showed some signs of life. Unemployment dropped to 18 percent in 1935, 14 percent in 1936, and even lower in 1937. But by 1938, it was back up to 20 percent as the economy slumped again. The stock market crashed nearly 50 percent between August 1937 and March 1938. The “economic stimulus” of Franklin Roosevelt’s New Deal had achieved a real “first”: a depression within a depression!

Phase IV: The Wagner Act

The stage was set for the 1937–38 collapse with the passage of the National Labor Relations Act in 1935—better known as the Wagner Act and organized labor’s “Magna Carta.” To quote Hans Sennholz again:

This law revolutionized American labor relations. It took labor disputes out of the courts of law and brought them under a newly created Federal agency, the National Labor Relations Board, which became prosecutor, judge, and jury, all in one. Labor union sympathizers on the Board further perverted this law, which already afforded legal immunities and privileges to labor unions. The U.S. thereby abandoned a great achievement of Western civilization, equality under the law.[8]

Armed with these sweeping new powers, labor unions went on a militant organizing frenzy. Threats, boycotts, strikes, seizures of plants, and widespread violence pushed productivity down sharply and unemployment up dramatically. Membership in the nation’s labor unions soared; by 1941 there were two and a half times as many Americans in unions as in 1935.

From the White House on the heels of the Wagner Act came a thunderous barrage of insults against business. Businessmen, Roosevelt fumed, were obstacles on the road to recovery. New strictures on the stock market were imposed. A tax on corporate retained earnings, called the “undistributed profits tax,” was levied. “These soak-the-rich efforts,” writes economist Robert Higgs, “left little doubt that the president and his administration intended to push through Congress everything they could to extract wealth from the high-income earners responsible for making the bulk of the nation’s decisions about private investment.”[9]

Higgs draws a close connection between the level of private investment and the course of the American economy in the 1930s. The relentless assaults of the Roosevelt administration—in both word and deed—against business, property, and free enterprise guaranteed that the capital needed to jumpstart the economy was either taxed away or forced into hiding. When Roosevelt took America to war in 1941, he eased up on his anti-business agenda, but a great deal of the nation’s capital was diverted into the war effort instead of into plant expansion or consumer goods. Not until both Roosevelt and the war were gone did investors feel confident enough to “set in motion the postwar investment boom that powered the economy’s return to sustained prosperity.”[10]

On the eve of America’s entry into World War II and twelve years after the stock market crash of Black Thursday, ten million Americans were jobless. Roosevelt had pledged in 1932 to end the crisis, but it persisted two presidential terms and countless interventions later.

Along with the horror of World War II came a revival of trade with America’s allies. The war’s destruction of people and resources did not help the U.S. economy, but this renewed trade did. More important, the Truman administration that followed Roosevelt was decidedly less eager to berate and bludgeon private investors, and as a result, those investors came back into the economy to fuel a powerful postwar boom. The years 1945-46 brought huge reductions in government spending and much lower tax rates on business, along with smaller reductions in tax rates on individuals.

The genesis of the Great Depression lay in the inflationary monetary policies of the U.S. government in the 1920s. It was prolonged and exacerbated by a litany of political missteps: trade-crushing tariffs, incentive-sapping taxes, mind-numbing controls on production and competition, senseless destruction of crops and cattle, and coercive labor laws, to recount just a few. It was not the free market that produced twelve years of agony; rather, it was political bungling on a scale as grand as there ever was.


Notes

1. Hans F. Sennholz, “The Great Depression,” The Freeman, April 1975, p. 205.

2. Murray Rothbard, America’s Great Depression (Kansas City: Sheed and Ward, Inc., 1975), p. 89.

3. Lindley H. Clark, Jr., “After the Fall,” Wall Street Journal, October 26, 1979, p. 18.

4. “FDR’s Disputed Legacy,” Time, February 1, 1982, p. 23.

5. Barry W. Poulson, Economic History of the United States (New York: Macmillan Publishing Co., Inc., 1981), p. 508.

6. Paul Johnson, A History of the American People (New York: HarperCollins Publishers, 1997), p. 741.

7. Martin Morse Wooster, “Bring Back the WPA? It Also Had A Seamy Side,” Wall Street Journal, September 3, 1986, p. A26.

8. Sennholz, pp. 212–13.

9. Robert Higgs, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War,” The Independent Review, Spring 1997, p. 573.

10. Ibid., p. 564.

Iceland and the Western Banking System

By Gordon Kerr

1. Introduction


Mr Feio, Mr Pichonnier, ladies and gentlemen, thank you for inviting me to address you today.  We are here to explain and hopefully start to resolve the Icelandic banking collapse.

By way of brief personal introduction I am a banker.  In my 29 year career I have experienced several banking crises.  In the early 80’s I worked on Paris Club restructurings for Latin American sovereign defaulters.

Later in the 80’s I travelled frequently to the US in connection with the Savings and Loan crisis.  In the early 90’s I worked mainly in Stockholm on mortgage backed transactions during the Swedish banking collapse.

A few years later I designed instruments that would in turn play a small but significant role in precipitating the collapse of the Western banking system.  These instruments were called synthetic capital structures. They  created the appearance of an increase in capital on bank balance sheets when in reality the economic risk and return positions of the banks concerned were essentially the same after the transactions as before.

I am a member of the Advisory Board of a London based banking educational charity – The Cobden Centre, and I work for a small investment banking firm in London.

My message to you today is simple.  There is nothing specific about the way the Icelandic authorities managed its economy or its banking system that caused this massive failure.  The root of the problem lies within the very essence of the banking system itself.  Iceland, as a very small country with an aggressive banking industry, was just at the tipping point when the system itself failed, and has therefore suffered to a disproportionately greater extent than others.

2.  Were the Western Governments correct to bail out the banks?

Imagine the feeling of going to see a doctor with a puzzling medical condition, having both legs amputated, and three months later experiencing a recurrence of the symptoms.  You are admitted to hospital again, but this time the doctor who greets you post examination is far more sombre.

He explains that you have had a pancreatic tumour all along.  Had it been correctly diagnosed on first consultation the tumour would have been annulled, but now it is out of control and certain to kill you.

This, I believe, is a fair parallel with the way in which banks in the UK and many other European countries have been rescued.  I believe the bailouts are having the opposite effect to that which was intended.  They are not helping to re-stimulate lending to small and medium sized businesses – the engines of these economies.

A smarter observer than I has compared the UK solution to the actions of an alcoholic, accepting with equanimity inevitable long term pain as the consequence of his inability to resist the temptation of one more short term, fuzzy high.

There is a danger that solutions presently proposed could accidentally cut the legs off Iceland and condemn its economy to years of stasis, instead of helping to cure its crippled banking condition.

Let us look now at the banking system itself.  The legal rules which allow banks to gamble depositors’ demand funds on long term investments have simply created a liquidity pyramid scheme which, enhanced by various other banking developments, have boosted a variety of assets to unsustainable price levels that cannot be supported by the wealth of the relevant underlying economy.  Iceland, being both part of this system and a tiny country with its own currency, simply sits at the pinnacle of this Western banking system crisis.

3. Iceland and the Global Collapse

I urge you to resist the temptation of embracing  the political exculpation  of  ‘global credit crunch’.  Although the crisis was truly global this simple linguistic term seeks if anything to discourage serious analysis of what went wrong.

Many papers and speeches I have read  are good quality diarised timelines of events in Iceland, without presenting credible cures or accurate analyses of the cause.

Iceland’s collapse was clearly related to the global failure, but each country does not necessarily need a global solution.  Indeed, whenever I hear of a problem that can only be solved by global accord I cannot avoid the conclusion that such a problem is being expressed as intractable.  The climate change issue is but one other example of a problem looking for a global solution.

Before addressing Iceland’s unique challenges, may I present some of the “banking developments” to which I referred earlier.  I am about to set out just some of the features of permitted banking activity which have combined to create an unsustainable pyramid of asset prices which Western liquidity may struggle to support.

Most of the features I am about to describe do not appear on the radar screen of the press or blissfully ignorant politicians. For brevity I will set out only five such features:

a)     The circular effect whereby asset prices are inflated merely by the creation of loans provided by banks to finance the purchase of such assets.  I have many times witnessed competitive bidding wars between two purchasers wherein the independent valuer has simply up valued the assets each time one side or the other’s bank has issued   a larger loan offer.  It is essentially the case that the size of the loan  determines the asset price, not the other way around.  Therefore it is impossible to divorce the independent valuation of assets from the quantity of debt which banks are willing to issue against the assets.

b)    Under EU fractional reserve regulations banks are required to maintain a minimum of say 8% “fraction” of their exposures as capital.  Since the bulk of European banks are shareholder owned, market forces virtually compel them to push fractional reserve regulation to the limit.  It is very difficult for the CEO of a major bank to keep his job if he is not fully leveraged in supposedly stable market conditions.

c)     The absurd accounting regime that encourages banks to transfer as much exposure as possible into derivative format.  The derivatives accounting regime  presents two important benefits to banks: 1) the front ending of multi year’s hoped for income as Day 1 “profit”, and 2) the ability of a bank to leverage its capital not 12 times (the reciprocal of the 8% basic capital ratio) but up to 200 times (the reciprocal of 1/16 of the basic capital ratio).  The 200 times leverage rule has historically been the starting point for calculating the capital to be reserved against derivative exposures, and now, under  Basel 2 rules, this higher level of leverage is permitted against any AAA rated assets even in non-derivative format provided the bank concerned is regarded as sufficiently sophisticated).

I have a second confession to make.    I was involved in designing the early forms of credit derivatives.  I have written articles about this activity on the Cobden Centre website and I am grateful to its founder, Toby Baxendale, for inviting me to write about this.  Let me clarify for the record one frequently confused point.  The motivation behind the emergence of credit derivatives was not the enabling of banks to distribute loans to non-banks.  That activity was operating perfectly well before the advent of credit derivatives via other financial instruments.

The overriding motive behind the emergence of credit derivatives was in the accounting rules.  Credit derivatives allow banks to book multi-year profits, subject to supposedly conservative reserves, before they have been realised or earned in a sense that would satisfy an accountant in any industry other than banking.

d)    I referred earlier to the liquidity pyramid that results from the legal relationship between banks and depositors.  Depositors’ money belongs in law to the bank, not depositors.  The EU seems aware of this concern and some proposed new regulations talk about inhibiting banks’ future ability to mismatch the maturities of assets and liabilities.  This mismatching has, I believe, been a major contributor to the crisis in a very simple way:

  • Person ‘A’ deposits £100 of cash into his instant-access bank account and receives a promise to return the cash on demand.
  • The bank retains a small reserve (say £3), and lends out £97 to Person ‘B’.
  • Person B purchases £97 worth of goods from person C who in turn redeposits the money in the bank.
  • Both ‘A’ and ‘C’ both have a claim to instant access on this money.
  • In three steps, the bank has turned £100 into £197 of useable money.

e) The use of the ECB discount window to finance banks purchase of assets post crisis.  There has, in the last 10 months, been a gradual rise in the prices of large volumes of the very type of banking assets that many UK commentators have termed “alphabet soup”.  Less kind commentators have termed some of these assets a “Liverpudlian Stew” – a rather unpleasant menu item, even by British culinary standards.  It is  in essence an attempt to present undigestible left over food as attractively as possible. (On behalf of Liverpool may I thank the EU for ordaining it as European City of Culture in 2008).

These price rises seem inconsistent with present reduced liquidity within the banking system. The only explanation I can reach is that some financial institutions have been able to fund their purchases of such assets via the central bank discounting windows such as the ECB itself.  Banks are then, as rational players in a regulated industry, motivated to make money by the monetisation of unrealised future profits by entering into synthetic arrangements on these same assets.  If true this effect will dash all our hopes that we may be coming out of the crisis.

4. ICELAND

Let us look at Iceland more specifically.  The root of the problem lay not in the failure of Iceland’s specific regulators or its national regulation system per se, but in the simple combination of three factors:

  1. i.         Its small size and status as a country;
  2. ii.        Its banks seeking aggressive growth;
  3. iii.       Its acceptance of the Western bank regulatory regime.

The scale of the problem measured against Iceland’s GDP was simply incredible.  The country effectively staked its economic future on international banking, raising capital internationally and lending it out in highly leveraged packages relying on rating agencies and more experienced capital markets arrangers.

The deposit base which lay at the root of the banks’ efforts to prop up the pyramid should have collapsed before the problems became quite so bad, but thanks to Iceland’s status as a sovereign state and international conventions whereby one country’s banks can be “passported” to raise deposits in another, Iceland’s banks succeeded in raising considerable sums of demand deposits from other countries’ savers, in particular the UK and the Netherlands.  Those savers looked only to their own national regulators who, under passporting rules, in capital markets parlance simply “wrapped” the Icelandic Central Bank.’’

Ironically the taxpayers of countries such as the UK and Netherlands in effect wrote credit default protection on Iceland, and now, having been called on this protection, seek to exercise rights of subrogation against the Icelandic taxpaying citizenry.  But if the Icelandic people did not understand what was going on, are these actions not akin to luring the demented old lady next door into leaving you her house in her will and thereby disinheriting her children?

Icelanders who had saved in its major banks, supervised by its national regulators, were effectively performing the function of a junior mezzanine investor (ie just above the shareholders) in the capital structure of a typical “alphabet soup” investment whose fragility was almost impossible for the ordinary taxpayer to understand.

And so, the pyramid inflated further until September 29 2008.  On that date Glitnir, on seeing its credit lines withdrawn following the collapse of Lehman, knew it was unable to raise funds to satisfy a €750 million payment due on October 15th and approached the Central Bank of Iceland for an emergency loan.  The loan request was turned down and instead Glitnir was forced to accept €600m from the central bank in return for a 75% stake.  Its shareholders were practically wiped out[i].

Iceland therefore suffered like no other country, and at a rapacious rate.  At less than 6% of GDP, government debt was tiny at the beginning of 2008.  Under an FRB system that mirrored that of all major European countries its banking system was quickly destroyed and its people burdened with unimaginable levels of debt.

5. What Should Iceland Do?

We have just heard from Dr. Tryggvi Thor Herbertsson MP that there is great doubt as to whether it will join the Euro.  Even if the Eurozone states can fund the PIGS and other bailouts presently planned, should Iceland ask for an EU bailout?

The short term appeal is obvious, is the longer term outlook as rosy?  What of the concerns of abandonment of control over fiscal and monetary policy?  Are these measures consistent with the Icelandic character and way of doing things?

Let us consider Greece very briefly.  The calm 2 weeks  ago when the Greek bailout was announced has been replaced by concern.  The austerity measures the EU would impose will be as unpopular in Iceland as they are in Greece.

There is clearly a gulf between the positions of the bailor and  the bailee.   As I prepare this speech I read in February 25th Daily Telegraph the following report by Ambrose Evans Pritchard:

“Hans-Werner Sinn, head of Germany’s IFO economic institute, said Athens was holding Euroland to ransom, threatening to set off mayhem if there is no bail-out. “Greece should never have entered the euro zone because they did not qualify and they are now blackmailing other European countries via the euro. It’s not for the EU to help Greece. We have an institution that is very experienced in bailing-out activities: the IMF,” he said.

Otmar Issing, former doyen of the European Central Bank, echoed this view in Germany’s Bundestag last Wednesday, warning that a Greek rescue would “open the floodgates” for serial bail-outs and destroy EMU discipline. “The crisis is made in Greece. It is the result of bad policy, not outside forces like an earthquake.” “

Does this rhetoric imply that life under the EU will be much better for Icelanders?  That is clearly a decision for Iceland’s Government and people.

If Iceland joins the EU then I would urge the EU to reform its own regulatory regime fundamentally to protect Iceland from further catastrophe.  Relying on rating agencies as the basis of regulation, rather than markets, makes little sense.

It is not impossible to devise a fractional reserve regulatory system that will work if its practitioners are expert bankers and fully appraised of everything that its banks are engaged in post reform.  But this is fraught with risks.

A far easier solution for Iceland is to make one simple law change.  Grant depositors title to their deposits, stipulate that the state and taxpayers will never again bail out the banks, and allow free market forces to create a safe and transparent banking system.  A ban on the maturity mismatching of assets, combined with a clear policy of NOT bailing out the banks in future, will enable free markets to flourish.

Do not blame the bankers, they were merely acting like rational capitalist players in a wrongly regulated system.  If we are to allocate blame then look to yourselves right here in the Brussels Parliament.  It is you rulemakers who have made the mistakes.  You should have worked this out.

6. Conclusion

The way forward for Iceland should be to look to itself.  Tryggvi, your people have a powerful sense of identity.  You have a wonderful natural economy, a well educated population and a well documented strength of character.  You can fix your problems yourselves, but maybe with a little help from my firm! The detail of implementation needs to be set in the context of modern banking.  A restructured banking system as proposed today would ensure:

1)   Depositors could NEVER AGAIN lose their money;

2)   Credit would resume flowing from savers to entrepreneurs;

3)   The reopening of the international capital markets to Iceland

Without these measures I fear it will be back to the operating theatre in a year or two, with little prospect of a speedy recovery.

Mr Feio, Mr Pichonnier, ladies and gentlemen, thank you for your time.

END

Gordon Kerr  – March 2nd 2010

EU Parliament, Brussels

[i] What the Icelandic Collapse has Taught Us, February 2009, Tryggvi Thor Herbertsson

This article has been published with the Cobden Centre‘s permission.

Economic Opportunity Needs A Moral Dimension

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author from an essay he first published in the June 1994 issue of FEE’s journal, “The Freeman.”


In every election year, expect to be barraged with rhetoric about “getting the country moving again,” “creating jobs, jobs, jobs,” and “stimulating the economy.”

Politicians love to promise the future and ignore their own handiwork of the past. They typically spend much more time concocting new schemes for intervention than they spend searching for old ones that deserve to be repealed.

What really deserves our attention are those specific barriers to economic opportunity erected by government—regulations, taxes, licensure laws, unfunded mandates, building and zoning codes, special privileges for organized labor, subsidies to business, chronic budget deficits that consume needed capital, a welfare system that puts a premium on idleness and a penalty on work, and an education monopoly that fails to teach children as it vacuums their parents’ wallets, to name a few.

Dozens of studies have shown that excessively restrictive zoning laws, building codes, and property taxes constitute the greatest obstacles to affordable housing for the poor. Minimum wage laws, by making it illegal to employ people whose skills are worth less than government decrees, keep hundreds of thousands from getting a start in the job market. Endless regulations designed to curtail entry into markets from trucking to taxis freeze out many a would-be entrepreneur from creating new businesses.

I’m not talking about basic laws which prevent or punish harm to others. I’m talking about the primary social disease of our age—government beyond its proper bounds, playing Robin Hood, Santa Claus, and Mother Hen all at the same time, inflicting real damage to real people who have victimized no one. Economists, at least, are increasingly taking a critical eye to such policies.

It must be understood, however, that economic analysis will not by itself make the case for ridding ourselves of these man-made obstructions. It is powerful, but still not enough, to simply add up the numbers and show how many jobs are erased by particular actions of government. It is not enough to produce graphs and models that plot the fluctuations in Gross National Product.

What is sorely needed in the discussion is a recognition of the moral backwardness that so many of these barriers to economic opportunity represent. Dismantling the barricade requires that we who advocate freedom of enterprise seize the high ground. We must appeal to what most people instinctively know is right, not just what makes the cash register sing. We must learn to speak of the deleterious actions of government in terms of trampled rights, broken dreams, and ruined lives.

For instance, when the city of Detroit in Michigan imposes—as it does—a tax burden that is several times the average burden in Michigan municipalities, that is not simply bad economics. It is an affront to every citizen of that city who wants the best for his family, who wants simply a chance to be productive. Those high taxes should evoke visions of hungry children, of a boarded-up business that was once someone’s dream, of homes torn apart because of the breadwinner’s inability to pay the bills of irresponsible politicians.

Why is it that people who go to work for government as officeholders or bureaucrats are known as “public servants”—even when highly paid? Why isn’t “public servant” a term reserved for those entrepreneurial heroes in the private sector who create jobs, invent machines, cure illnesses, build businesses, serve customers, and pay the bills of government through their taxes? When the barriers erected by “public servants” crush the self-reliance of enterprising citizens, where is the outcry of righteous indignation from the public or the press?

What taxers and regulators do to people and their business dreams and what countless other acts of government inflict upon people every day is morally repugnant. Such deeds are throwbacks to less enlightened times when the common thief and the uncommon prince were indistinguishable but for their robes.

The campaign to restore our liberties and enhance our economic opportunities must incorporate a personal, moral dimension at its core. A law which suffocates the aspirations of enterprising men and women is more than bad economics. In a free society, it ought to be a moral outrage.

Time to Reverse an Unprecedented Success?

Johnny Munkhammar is a Swedish writer and entrepreneur, also Research Director at European Enterprise Institute and the author of “The Guide to Reform”.

Thirty years after Margaret Thatcher came to power and 20 years after the fall of the Berlin Wall, economic freedom has decreased in half of the major economies last year. Governments are intensely chasing banks, tax havens, hedge funds, corporations and tax.

New regulations, increased public spending and protectionist measures are rife in the policy agendas of the Western world. Is ever increasing government the new trend, a reverse of the past decades of economic freedom?

So it would seem. The stimulus response to the crisis is a major step, building debt, which has to be paid for by future taxes. The demographic development and consumer demands will lead to a massive cost increase in several public systems for decades to come.

Actually, the so-called Anglo-Saxon countries – supposedly the freest major economies – had already begun to expand government before the crisis. Public spending in the US increased between 2000 and 2008 from 35 to 39 per cent of GDP, and in the UK from 37 to 47 per cent.

Costs for health care and elderly care are rising, as well as pensions. In Japan, Italy and Spain, costs for pensions will explode. Even the United States seems to be unable to avoid a rise in public expenditure, due to so-called entitlements, to today’s French or German levels.

For a number of reasons, this would be a very harmful development. First, there is no sign that the stimulus packages improved long-term growth. Huge amounts of the tax-payer’s money were thus wasted, increasing debt, which will increase future tax burdens.

Second, the past quarter-century of increased economic freedom has been an unprecedented success. Global GDP per capita rose by 50 per cent, extreme poverty was cut in half and more people than ever enjoy western-style living standards.

Third, economic freedom is strongly correlated with other important aims, such as environmental protection, social progress and indicators of quality of life.

Fourth, despite the crisis, the results of liberalization remain. Since 1990, GDP per capita has increased by 64 per cent in the US and 47 per cent in the UK – but only by 35 per cent in France, 23 per cent in Germany and 16 per cent in Japan.

And finally, if there is one lesson Europeans should have learned, it is to avoid big government. Since Eastern and Central Europe abandoned the command economies, their living standards improved more than anyone dared to imagine in 1989.

It would be devastating for our living standards to ignore this lesson and return to pre-Thatcher policies. But is that not the apparent direction right now? Happily, not. The way the policy tide has turned around may be described in one word: Massachusetts.

As voters made Republican Scott Brown the senator to succeed Ted Kennedy, Democrats lost the necessary majority to pass their health care reform. It was like a referendum on big government and it lost.

Major changes can often be traced to minor events like this. President Obama will now have to move to the center. And though American voters are different from European voters, it is unlikely that this will pass unnoticed in Europe.

Several European countries responded to the crisis by continuing free-market reforms, especially in Eastern and Central Europe, but also Sweden, for example. Their success will put more pressure on the countries that chose the fraught path of big government.

In the end, facing the economic power of the BRIC countries, even reluctant reformers like EU President Herman van Rompuy see reform as a matter of survival. Europe has reformed during the past two decades, and must continue to do so.

The stimulus should be rolled back, but the main challenge arises in the long term, and includes the US and Japan too. To avoid exploding costs in health care, elderly care and pensions, public expenditures must be transformed into private expenditures.

This is the only way to avoid ever-bigger government, with all its problems. And it would actually bring many benefits. People would be allowed more choice, suppliers would compete, and that should improve quality as well as efficiency.

Transforming the welfare state into a welfare society may not be easy or quick, which is exactly why the debate about how to do it must take place now. Politicians may fear public opinion and prefer to wait. But we have already waited far too long.

And regarding public opinion – let Massachusetts strengthen our resolve.

Our Economics Knowledge Deficit

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author from an essay he first published in the September 1994 issue of FEE’s journal, “The Freeman.”

Economics is a subject that dominates public life and important policy discussions these days, but most people who rely on what they’ve learned of it in the schools are entering the intellectual battle unarmed.

Economics courses in high school are few and far between and often deal with little more than “consumer” issues: how to balance a checkbook, how to find the best deals in the market, or how to borrow money at the lowest interest rate. Those are all useful things to know, but the mental tools and essential principles needed to analyze and evaluate the paramount issues of the day are too often missing.

Moreover, even a cursory examination of textbooks used in high school economics courses reveals a dismal level of understanding or outright bias by the text authors themselves. Students are sometimes reading, for instance, that citizens are under-taxed, that government spending creates new wealth, and that politicians are better long-term planners than private entrepreneurs. It is not uncommon for texts to portray free market competition and private property in a suspicious light while presenting government intervention with little or no critical scrutiny. It therefore may actually be a blessing rather than a curse that so few students are exposed to what passes these days in the schools as “economics.”

Stripped of bias, the study of economics is immensely important. Indeed, without it we miss an understanding of much of what makes us the unique, thinking creatures we are. Economics is the study of human action in a world of limited resources and unlimited wants—a lively topic that cannot be reduced to lifeless graphs and mind-numbing equations that occupy the pretentious planner’s time.

What Economics Teaches

Economics teaches us that everything of value has a cost. It informs us that higher standards of living can only come about through greater production. It tells us that nations become wealthy not by printing money or spending it, but through capital accumulation and the creation of goods and services. It tells us that supply and demand are harmonized by the signals we call prices and that political attempts to manipulate them must produce harmful consequences.

Economics explains that good intentions are worse than worthless when they flout inexorable laws of human action. It reminds us to think of the long-term effects of what we do, not just the short-term or the flash-in-the-pan effects. It tells us a great deal about the critical role of incentives in shaping human behavior.

In short, economics is a blueprint for a free and sound economy, which is indispensable to satisfying human material needs and wants. When the subject is well understood, people learn that leaving other people alone is a far more likely path to well-being than shoving them around with political dictates.

When people have little or no economic understanding, they embrace the “quick fix” and support impractical “pie-in-the-sky” solutions to problems. They may think that whatever the government gives must really be “free,” and that all it has to do to foster prosperity is to command it.

Economically illiterate people are easy prey for currency cranks who argue that manufacturing more money will make us wealthier. They may even think that trade is a bad thing, that if we shut the borders to the flow of goods our living standards will rise. They will be not only unable to identify economic snake oil, but also untrained to detect its harmful consequences.

Arguably, America’s great economic problems have their roots in widespread ignorance of economic principles. When the noted economist John Maynard Keynes was asked in the late 1930s if we should be concerned about rising debt and printing press money, he reportedly responded with this flippant remark: “In the long run, we’re all dead.” The truth is, as the much greater economist Henry Hazlitt once said, that “Today is the tomorrow that yesterday’s bad economists like Keynes told us we could safely—but wrongly—ignore.”

Citizens are being asked every day to form judgments and cast votes for programs and proposals that are largely economic in nature. It would behoove us to start talking about how we provide the missing tools we need to make those and other such decisions, so that we don’t dig ourselves deeper in the muck of poor thinking and bad public policy.

Mandates Are Not the Answer

So, you say, the answer is to mandate the teaching of economics! If the schools aren’t teaching the subject, well, then let’s make them do it! Oh, there’s that tempting but utterly counterproductive “quick fix” again—a symptom, in fact, of the very illness I am describing.

Passing laws to require the teaching of economics is precisely not the answer. In public education, that can only politicize the subject and guarantee that too many people who don’t understand it or don’t want to teach it are instructing bored youngsters who couldn’t care less. The vast majority of government school teachers are decent citizens of good will and great talent, but as government employees they labor in an environment naturally hostile to the critiques of government action that sound economics inevitably produces.

The idea of government-mandated economics teaching strikes me as likely to be no more effective than government-mandated teaching of anything else. Aren’t we in the midst of an education crisis as it is, with test scores and other measures of student aptitude plummeting to disgraceful levels? Is there any reason to believe that government can teach us economics any better than it teaches us mathematics?

The remedy for our economics knowledge deficit is really the same remedy for our general knowledge deficit: a combination of de-monopolizing the education system through competition, and diligent self-instruction.

If economics is as important as I’ve suggested, then a market-driven, choice-focused, performance-based, and fully accountable education system would surely do a better job of teaching it than a government monopoly that gets subsidized whether it teaches for the real world or not. Make education a product of the marketplace instead of politics and much more than just economics will be taught, and taught well.

Formal schooling, though, even in a thoroughly privatized environment, can only be part of the economics teaching equation. What we learn on our own, especially if we hope to inspire and persuade others, may be just as important. Looking back on my own economics training, I note that most of it was under the auspices of private groups like the Foundation for Economic Education and by way of publications such as The Freeman.

In any event, the relative absence of economics from classrooms is a problem that requires our attention. Many private efforts to solve it deserve our support. But no one should be fooled into thinking that putting government in charge will resolve it.

How much is your pound or dollar actually worth since government has been in control of money?

This is a guest post from Toby Baxendale, Chairman of The Cobden Centre.


The answer is that the US dollar has lost 98.17% of its purchasing power and the pound sterling 99.42% of its purchasing power. Well done then, I suppose, for surpassing even the great tyrants of old who plagued the citizenry of both nations!

Some History

Gold was money for a large part of mankind’s history.

It was discovered by early man to be the most marketable of commodities. As such, the free interaction of people led to this commodity being adopted as the final thing for which all goods and services were traded. This discovery allowed man to lift himself from direct exchange, or barter, of his goods and services to indirect exchange. This indirect exchange allowed the universal application of the division and specialization of labour that has, in turn, given us all the material prosperity we have today. The discovery of money, then, must rank along with language as arguably the most important invention or discovery in the whole course of human history.

Note that, like language, money was not created by the State but by the private and spontaneous interaction of free individuals.

There are many stories in history of wicked monarchs who, to fund their various despotic regimes or lifestyles, would call in the coinage of the realm, extract a small percentage of gold — a “clip” — and then add an impurity before giving them back to the public; this is debasing of the monetary unit. This embezzlement was unlawful for the minter in the private sector and many people over the ages have been executed for stealing from money owners in this way but the monarch usually got away with it. One of the most notable examples in history was when Emperor Nero reduced the value of the denarius from being pure silver weighing 4 grams to 3.8 grams. His financial gain was enormous.

Another great example of history is our very own tyrant per excellence, Henry the VIII. He reduced the weight of sliver in the silver penny to 1/3rd of its purity from 0.925 to 0.250. By the reign of Elizabeth I, the Tudor financier Sir Thomas Gresham had to negotiate a loan from the Antwerp traders to provide more money for her nation. Sir Thomas came back and said

It may please your majesty to understand, that the first occasion of the fall of exchange did grow by the King majesty, your late father, in abasing his coin … which was the occasion that all your fine gold was conveyed out of this your realm.

What became know as Gresham’s law is that “Bad money drives out good under legal tender laws”. In Europe this is know as the Copernicus Law, as he was saying the same thing on the continent. The great medieval philosopher and theologian Nicole d’Oresme was the inspiration of Copernicus on this matter.

Economics of the Matter

A debasement always meant an inflation. Why? As there was more coinage in circulation chasing a similar amount of goods and services for sale, prices rose.

No less a figure than John Maynard Keynes in Economic Consequences of the Peace (1920), said:

By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.

This is from a man whose current disciples are inflating the western world’s money supply to a point that can only lead to rampant inflation.

We should remember the names which we have used to label money historically.  In the UK “sterling” and in the USA “dollar” each described a fixed weight of gold . Gold was the money unit, not sterling or dollar in itself.

Before World War I the pound sterling was worth $4.86856 and a dollar was worth 1/20th of an ounce of gold. For the sake of simplicity I will say that the pound sterling was defined as ¼ of an ounce of gold and the USA dollar 1/20th of an ounce.

So How Much is my Pound Sterling Worth Today?

The Maths
One ounce of gold today is worth $1,093.40 and 1/20 oz therefore $54.67 but the dollar pre World War I was just a name in the USA for 1/20 of an ounce of gold: what would have cost $1 before World War I would cost $54.67 today. The dollar has lost its purchasing power. In fact it has lost 98.17% of its purchasing power in 100 years. One dollar today should buy something like a single person’s weekly food shop, not a single daily newspaper.

The fate of the pound sterling has been even worse than that of the dollar. One ounce of gold today is £692.26. So if a pound sterling pre World War I was just a name in the UK for 1/4 of an ounce of gold, it would imply that the pre World War I purchasing price was 1/4 of £692.26 or £173.06. In fact the pound sterling has lost 99.42% of its purchasing power in 100 years. One pound should buy something like a good week’s food shop for a familiy of four and not just one daily newspaper like it would today.

Conclusion

Our modern day Neros and Henry VIIIs are those we call our Prime Ministers and our Presidents. We are told they are all well meaning men and women. That may well be the case. They have however, since World War I, sat on the single greatest debasement of our wealth in human history.

They do this via the monetization of their nations’ debt. A politician in power might have promised to give X, Y or Z group of people £X, £Y and £Z in exchange for voting for them. If the tax revenue is not enough, then they simply, out of thin air, either create more money — old style monetizing the debt to pay off the debt obligation — or, with a computer key, they open up a new bank deposit for themselves to pay or buy back some of their debt. This is called “QE” or Quantitive easing and we discuss the errors associated with it here.

Last year the UK raised over £200 billion by one part of the government issuing debt and the other part buying it. So £200 billion of new money is now in circulation. Nero and Henry VIII would blush at the brashness of this debasement. This is done wholly at the expense of yours and my very own purchasing power.

The Cobden Centre exists to promote honest money and social progress. Honest money is money that cannot be debased by governments to pay off liabilities they have incurred over and above their tax revenue. I outlined a banking reform proposal which advocated 100% reserve money here.  Staying within the existing paper money regime, one would need a bill to prevent the new issuance of either paper money or computer generated new bank deposits by the government. Ultimately, we must look at fully re rooting our paper money back into solid commodities that the government cannot destroy or create at will.

Further Reading

Toby Baxendale is an entrepreneur who owns, amongst other things, the UK’s largest fresh fish supplier to the Food Service sector, see www.directseafoods.co.uk. Toby is dedicated to furthering the teaching of the Austrian school of economics. He established and funded the 1st Distinguished Hayek Visiting Teaching Fellowship Program at the LSE in Honour of the Nobel Laureate F A Hayek. Toby is Chairman of The Cobden Centre. Richard Cobden’s timeless principles of the abolition of legal privilege of the few at the expense of the many – the Corn Laws, unilateral free trade, sound honest money and international peace – are worthy in this day and age to promote.

Reviving Civil Society

Lawrence W. Reed is president of the Foundation for Economic Education in Irvington, New York—www.fee.org.This essay has been adapted for CEIL by the author from his essay of the same title in the September 1996 issue of FEE’s journal, “The Freeman.”


“Taxes,” said Oliver Wendell Holmes, Jr., “are what we pay for civilized society.” But as economist Mark Skousen once argued, a much better case can be made that taxation is actually the price we pay for the lack of civilization. If people took better care of themselves, their families, and those in need around them, government would shrink and society would be stronger as a result.

Skousen put it well when he stated, “[E]very time we pass another law or regulation, every time we raise taxes, every time we go to war, we are admitting failure of individuals to govern themselves. When we persuade citizens to do the right thing, we can claim victory. But when we force people to do the right thing, we have failed.” The triumph of persuasion over force—people helping people because they want to and not because government tells them they must—is the sign of a civilized people and a civil society.

For all people interested in the advancement and enrichment of our culture, this is a crucial observation with far-reaching implications. Cultural progress should not be defined as taking more and more of what other people have earned and spending it on “good” things through a government bureaucracy. Genuine cultural progress occurs when individuals solve problems without resorting to politicians or the police and bureaucrats they employ.

When the French social commentator Alexis de Tocqueville visited a young, bustling America in the 1830s, he cited the vibrancy of civil society as one of this country’s greatest assets. He was amazed that Americans were constantly forming “associations” to advance the arts, build libraries and hospitals, and meet social needs of every kind. If something good needed doing, it rarely occurred to our ancestors to expect politicians and bureaucrats, who were distant in both space and spirit, to do it for them. “Amongst the laws which rule human nature,” wrote Tocqueville in Democracy in America, “there is none which seems to be more precise and clear than all others. If men are to remain civilized, or to become more so, the art of associating together must grow and improve.”

It ought to be obvious today, with government in America and most Western countries consuming 40 to 60 percent of personal income, that lots of people don’t think, act, and vote the way their forebears did in Tocqueville’s day. So how can we restore and strengthen the attitudes and institutions that form the foundations of a vibrant, free and civil society?

Certainly, we can never do so by blindly embracing government programs that crowd out private initiatives or by impugning the motives of those who raise legitimate questions about those government programs. We cannot restore civil society if we have no confidence in ourselves and believe that government has a monopoly on compassion. We’ll never get there if we tax away 40 or 60 percent of people’s earnings and then, like children who never learned their arithmetic, complain that people can’t afford to meet certain needs.

We can advance civil society only when people get serious about replacing government programs with private initiative, when discussion gets beyond such infantile reasoning as, “If you want to cut government subsidies, you must be in favor of starving the elderly.” Civil society will blossom when we understand that “hiring” the expensive middleman of government is not the best way to “do good,” that it often breaks the connection between people in need and caring people who want to help. We’ll make progress when the “government is the answer” cure is recognized for what it is—false charity, a “cop-out,” a simplistic non-answer that doesn’t get the job done well, even though it makes its advocates smug with self-righteous satisfaction.

Restoring civil society won’t be easy. Bad habits and short-term thinking die hard. It is especially difficult to get the civil society message through the major news media’s filter unscathed. A recent editorial in a major Michigan newspaper is a good case in point. In arguing against suggested cuts in the state’s budget, the editorial equated the restoration of civil society with subjecting human life “to the largesse of the highest bidder in the marketplace.” What a shame that so many newspapers will routinely lament the superficiality of political campaigns and then employ bumper-sticker slogans when it comes to serious proposals to remove the bane of Big Government from our lives.

That editorial did not feed, clothe, or house a single needy person. It probably did very little to comfort the afflicted. It did not inspire a single act of voluntarism on behalf of a troubled family. It may, however, have lulled some readers into a deeper sleep of complacency. Government, after all, is taking care of things and that, the editorial implied, is as it should be.

Meanwhile, more thoughtful writers are noticing some encouraging trends. A remarkable article in a recent issue of U.S. News & World Report trumpeted the “revival of civic life.” Among the examples it cited was that of Frankford, Pennsylvania. Frankford had become a highly taxed, depressed, and government-dependent community desperate for answers. A spark of civil society was lit, and now people are solving problems themselves. “When a record 30 inches of snow was dumped on the city, . . . Frankford didn’t stand around moaning about the inefficiency of city workers. Residents rented snowplows and split the cost,” the article noted.

Perhaps if Tocqueville were to visit this little Pennsylvania town today, he would see a glimmer of the greatness he witnessed in the 1830s. He would be impressed with the spirit of the community and might even suggest that people everywhere should take note. The citizens, Tocqueville might remark, are not sitting back, bemoaning their plight, and editorializing about how the politicians should save them. “Once you get past the resentment of the government not doing it for you, you get it done yourself,” one local resident put it.

We can learn a whole lot more from the Frankfords of the world than from those who think charity means spending someone else’s money or just pontificating about social needs from behind a word processor. Restoring civil society requires that we “Just Say No” to shirking our personal responsibilities and expecting government to do for us what we can and should do on our own, within our personal lives, our families, and our local communities. It requires us to think creatively about stimulating private initiative, and then just doing it.

In fact, the more I think about it, the more I realize that doing it, not just talking about it or expecting others to do it for you, is one of the primary differences between adults and children. Maybe we all need to just grow up—and thereby grow out of the stultifying environment of the welfare state.