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  • Reisman's Blog for June, 2009
    John Stuart Mill Bastiat and Hazlitt and in my own writings The contents of the blog are copyright 2009 by George Reisman All rights reserved Permission is hereby granted to reproduce and distribute individual articles below electronically and or in print other than as part of a book Email notification is requested All other rights reserved George Reisman Ph D is the author of Capitalism A Treatise on Economics Ottawa Illinois Jameson Books 1996 and is Pepperdine University Professor Emeritus of Economics Tuesday June 02 2009 GENERAL MOTORS RIP General Motors was once not only the world s greatest and most prosperous automobile company but the world s greatest and most prosperous manufacturing company indeed the world s greatest and most prosperous company of any kind Its success wealth and economic power were symbolic of the success wealth and economic power of the United States General Motors has now perished brought down by a kind of philosophical and economic tapeworm that consumed the company from within The economic tapeworm was the United Automobile Workers union which transformed the company into a carcass upon which it could feed while tying GM s hands and feet with arbitrary work rules that prevented it from competing and providing any addition to what was to be consumed by the UAW s vultures The philosophical tapeworm lay within the minds of those running the company For decades it led them never to take a stand on principle and forcefully resist the UAW Always the present cost of a major strike was allowed to outweigh the prospect of the ultimate destruction of the company which was never considered fully real because it lay in the future In its last years the company was reduced to the status of a benefits company a company existing primarily for the purpose of paying the pensions medical benefits and exorbitant wages of the UAW members In its last year the company was reduced to the status of a beggar benefits company as it repeatedly turned to the Federal government for the billions of dollars that were needed to keep it in existence for just the next few months in the hope that in that time a miracle would appear that would allow it to survive Now the company is gone along with the billions of dollars of bailout money needlessly spent to rescue it It would have been far simpler not to have given any bailout money and to have allowed the bankruptcy to occur last fall That would not only have saved billions of dollars but it would have avoided the United States Government becoming the major stockholder in the company that will control many or most of the remaining assets of GM General Motors was destroyed by operating under the ignorance stupidity and irrational greed of a labor union From this point on it is to operate under the ignorance stupidity and irrational greed of government officials acting in combination with that same labor union It will survive

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  • Reisman's Blog for May, 2009
    of them went to the trouble of also informing an extensive list of pro free market news commentators and bloggers about what Google was doing It s difficult to be sure what effect this had To my knowledge none of those who wrote to the president of Google ever received a reply Nevertheless I must assume that Google finally unlocked my blog in response to the strong reaction from these readers I want to thank them publicly for their support What this experience has taught me is that I never again want to be dependent on Google Accordingly I ve spent much of the past few weeks reconstructing this blog in Word Press The reconstruction is complete for 2009 and 2008 but has only just begun for 2007 and 2006 I invite readers to visit this new blog at www georgereisman com blogWP Please note that the last two letters must be capitalized in order to bring up the blog It seems incomprehensible to me that Google a company with possibly the most advanced search technology in the world would somehow lack the technical expertise required for its robots to distinguish my blog which has been in existence for over three years and has more than 140 postings on it from a spam blog It is equally incomprehensible to me why if such is the case and they know that their ability to identify spam blogs is inherently fuzzy they would not have a human being spend five minutes looking at a blog they know is very likely a false positive for spam and make a rational judgment about the matter in short order And why they would not have a readily accessible system whereby they could be easily contacted and false positives for spam speedily corrected by that route Whatever the explanation Google in this case has shown itself to be incompetent grossly irresponsible and cowardly It apparently does not care about the consequences of its actions or show any readiness to correct them or willingness even to hear about them Nothing less than a public campaign is required to get its attention This is not a good performance for a company whose motto is supposedly Don t Be Evil What Google has done in this case is evil If any reader knows how to port over links from Google s Blogger to Word Press I hope he will share his knowledge with me The abundance of links to many of the postings on the Google version of my blog serve to keep me tied to Google Please write to me at georgereisman georgereisman com Monday May 4 2009 Letter to Krugman Dear Prof Krugman In your NY Times column of today you write But if everyone takes a pay cut nobody gains a competitive advantage So there s no benefit to the economy from lower wages Meanwhile the fall in wages can worsen the economy s problems on other fronts You overlook the fact that the major benefit

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  • Reisman's Blog for April, 2009
    the wages earn the same total wages and can spend just as much in buying consumers goods as could 9 workers each earning the original wage It s as simple as the fact that 10 times 9 equals 9 times 1 And of course more than 10 workers employed at 90 percent of the wage per worker would earn more collectively and spend more for consumers goods collectively than was possible before The popular version of the Keynesian doctrine also overlooks the fact that even if total wage payments and consumer spending did decline business sales revenues would not decline insofar as reduced wage payments made possible increased expenditures for capital goods Indeed to the extent that additional spending for capital goods took the place of wage payments and the consumer spending supported by wage payments not only would sales revenues in the economic system remain the same but what is particularly important for the process of economic recovery the amount of profit earned on those same total sales revenues would actually increase 1 This result follows because wage payments as a rule show up fairly quickly usually within a matter of weeks or months as equivalent costs that must be deducted from sales revenues in calculating profits In contrast expenditures for machinery will not show up as equivalent costs deducted from sales revenues for several years or more in accordance with the depreciable life of the machines And expenditures for construction materials and the services of construction equipment will not show up as equivalent costs deducted from sales revenues for several decades in accordance with the still longer depreciable lives of buildings and other highly durable assets Because of these considerations if a sum such as 100 billion say could be shifted away from wage payments in the economic system and to the purchase of machinery and plant profits in the economic system might well increase on the order of 90 to 95 billion dollars in the year in which this shift of spending occurred This is because the 100 billion of spending for capital goods that would now take place would represent fully as much spending for goods and thus fully as much business sales revenues as the 100 billion of spending for consumers goods that the wage earners would otherwise have made At the same time while 100 billion of wage payments would have shown up in the same year as 100 billion of costs to be deducted from sales revenues 100 billion of spending for capital goods with a depreciable life ranging from several years to several decades may well show up perhaps as a mere 5 to 10 billion of depreciation cost in any given year The replacement of 100 billion in wage costs with 5 to 10 billion of depreciation cost implies a rise in economy wide profits of 90 to 95 billion Spending for Capital Goods Can Rise at the Same Time that Spending for Consumers Goods Falls Some readers may wonder how it is possible for more to be spent for capital goods at the same time that less is spent for consumers goods Less spending for consumers goods it would seem should imply less spending for the capital goods required to produce the consumers goods The answer lies in the fact that while this may well be true the spending for capital goods to produce consumers goods declines in a lesser degree than does the spending to buy consumers goods This means that it now stands in a higher proportion to the spending for consumers goods In turn the spending to buy the capital goods to produce those capital goods comes to stand in a compounded higher proportion to the spending for consumers goods and so on with the spending for capital goods further compounded at every succeeding stage of production The following series of numbers will help to illustrate what is involved Thus imagine that initially spending for consumers goods in the economic system was 500 units of money the spending for the capital goods to produce those consumers goods was 250 units of money the spending for the capital goods to produce those capital goods 125 units of money and so on with each succeeding amount of spending for capital goods being half of the spending for the capital goods it helps to produce Now imagine that spending for consumers goods falls from 500 to 400 units of money Here is how at the same time spending for capital goods can increase from 500 i e the sum of 250 125 62 50 to 600 units of money The mechanism is that the spending for the capital goods required to produce consumers goods falls from 5 x 500 to 6 x 400 i e from 250 to 240 The spending to produce the capital goods required to produce those capital goods will now be 6 x 240 rather than 5 times 250 Inasmuch as 6 x 240 144 while 5 x 250 125 the spending for capital goods at this stage has actually risen Its rise will be relatively greater at each succeeding stage e g 86 4 versus 62 50 51 84 versus 31 25 and so on Hoarding and the Rate of Profit Finally it should also be realized that the effect even of a decline in total wage payments that was not accompanied by any increase in spending for capital goods would soon be very positive for profits It would not increase profits in absolute amount but it would increase them as a percentage of sales revenues and costs Here it must be kept in mind that wage payments are not only a source of funds for wage earners to spend in buying consumers goods but they also show up equivalently as business costs which must be deducted from sales revenues in computing profits and do so fairly soon Thus a decline in wage payments would quickly result in equal reductions in sales revenues and costs To whatever extent sales revenues were greater than costs to begin with the amount of that excess would remain unchanged because equals subtracted from unequals do not affect the amount of the inequality However the same amount of inequality i e of profit would now represent a larger percentage of the reduced sales revenues and costs The same amount of profit in the economic system would also represent a rise in the rate of return on capital invested in the economic system This would be the result not only of the monetary value of the capital invested shrinking in consequence of reduced spending for labor and capital goods but also and far more immediately of the write down of the value of existing capital assets to correspond with their lower level of replacement costs made possible by widespread declines in wage rates and prices In addition purchases of assets at fire sale prices following bankruptcies contribute to the same result What this implies is that to the extent that savings in the economic system might be unduly held in the form of cash i e hoarded the effect is to raise the rate of return on capital invested and thus to provide a greater incentive for savings being invested rather than being hoarded In other words hoarding is always a self limiting phenomenon It follows that even if a decline in wage rates was initially accompanied not only by a fall in total wage payments but also by a fall in total business spending for labor and capital goods combined the subsequent rise in the rate of return on capital would operate to restore total wage payments and the spending for capital goods Consequently once the underlying aspects of a process of financial contraction have come to an end a fall in wage rates operates at least fairly soon to increase the quantity of labor demanded 100 Percent Hoarding and an Infinite Rate of Profit An implication of this discussion that may appear startling to many readers is that if it were ever the case that people kept all of their savings in the form of cash holdings and spent absolutely nothing for labor or capital goods the rate of profit and interest in the economic system would become infinitely high This is because while there would still be some amount of sales revenues in the economic system resulting from consumption expenditures by those who possessed money there would be no money costs of production to deduct from those sales revenues since no expenditures giving rise to money costs would have been made Thus the amount of profit in the economic system would equal 100 percent of the sales revenues generated by whatever consumer spending existed At the same time it would equal an infinite percentage of the zero money costs of production and an infinite percentage of the zero money value of capital invested These conclusions are confirmed by the fact that the rate of profit and interest is far higher in countries that lack the security of property and developed financial markets and institutions and where as a result a far larger portion of savings takes the form of precious metals and gems rather than investments in business More on Hoarding and the Rate of Profit Hoarding or more precisely an increase in the demand for money for cash holding has two effects on the rate of profit One is its longer run effect which can take place within a period as short as a few months and which is to raise the rate of profit as I have just shown Its other more immediate effect however is to reduce the rate of profit even to the point of wiping it out entirely and replacing profits with losses throughout the economic system This is the effect with which everyone is familiar and in the name of which they desire to do everything possible to avoid reductions in spending of any kind The reason that hoarding first reduces profits is merely the fact that reductions in spending for labor and capital goods exert their effect on business sales revenues to a more or less substantial extent before they exert their effect on the business costs deducted from sales revenues in arriving at profits Business sales revenues decline immediately when spending for capital goods declines for example less spending for steel sheet by an automobile company is less sales revenues for steel companies at the very same moment Sales revenues decline almost immediately when spending to employ labor declines i e as soon as reduced wage payments show up in reduced consumer spending Now some costs deducted from sales revenues also decline immediately in response to reduced business spending notably such costs as typically come under the heading of selling general or administrative expenses But other costs namely those which come under the headings of cost of goods sold and depreciation cost are not immediately affected by declines in current business spending They are determined historically that is by business spending for inventories and plant and equipment that has taken place in the past and which cannot retroactively be reduced Current spending on account of inventories and plant and equipment shows up as costs to be deducted from sales revenues only in the future a future that ranges from days to decades Of course in a major recession or depression long term investment spending falls to a far greater extent than spending required to carry on current operations and as a result further declines in business spending notably for labor and materials almost all show up fairly quickly as declines in costs deducted from sales revenues Long term investment spending falls disproportionately in large part because the wage rates of construction workers and of workers producing construction materials and the various kinds of machinery have not fallen or have not fallen to the point to which it is believed they will fall In that case it pays to postpone such investments and hold cash instead because they would be at a major disadvantage in competition with investments made in the future And when these wage rates and prices do finally fall permitting current long term investment to be worthwhile once again the monetary value of existing plant and equipment can be written down commensurately as previously indicated The effect of the write downs is to reduce depreciation cost on existing plant and equipment For example the annual depreciation charge on plant with an asset value of 1 billion and a remaining depreciable life of 20 years is 50 million But if the value of that plant and equipment were written down to 500 million the annual depreciation charge incurred would also fall by half to 25 million Along with a fall in wage rates and prices an essential condition of economic recovery from a major recession or depression is simply the end of further financial contraction i e further economy wide declines in spending Further financial contraction stops when bank failures and their accompanying declines in the quantity of money stop or better still do not start in the first place and when the demand for money for cash holding has risen sufficiently to satisfy the need to operate without access to loans created on a foundation of credit expansion The additional demand for money for cash holding also includes whatever temporary further component may be necessary to allow for a failure of wage rates and prices to fall and the consequent postponement of long term investments At this point the short run negative effect of less spending on the amount and rate of profit begins to come to an end Its final end is greatly accelerated by the write downs of assets that accompany reductions in wage rates and prices and hence in the replacement cost of existing business assets As indicated purchases of assets at fire sale prices following bankruptcies contribute to the same result These write downs not only serve to reduce costs deducted from sales revenues earned with existing assets thereby increasing current profits but also serve to reduce the money value of the capital invested thereby further increasing the rate of profit on existing assets in the economic system In effect they serve to increase the size of the profit numerator while reducing the size of the capital invested denominator More profit earned on less capital is a two sided increase in the rate of return on capital In this environment reductions in wage rates not yet accompanied by the employment of more workers or by the purchase of more capital goods quickly result in improvement in the rate of profit They do so not only by reducing costs as much as sales revenues but by reducing them by more than sales revenues when the effect of write downs is taken into account The write downs as just shown also raise the rate of profit by reducing the money value of the capital invested in the economic system This rise in the rate of profit and consequently also in the rate of interest operates to reduce the demand for money for cash holding by virtue of making the investment of money relatively more attractive in comparison with the holding of money The reduction in the demand for money for cash holding is greatly furthered by the restoration of the profitability of long term investment that accompanies the necessary fall in wage rates and prices and also by the rise in the rate of profit that takes place pursuant to the putting of funds into longer term investments The net upshot is that the necessary fall in wage rates and prices serves to increase the quantity of labor demanded disproportionately by virtue of calling back into the market funds that had been withheld in anticipation of the fall in wage rates and prices At the same time the increase in the quantity of labor demanded and the corresponding movement of the economic system toward full employment is accompanied by a rise in the rate of profit in the economic system The Keynesian IS LM Doctrine The doctrine of Keynes himself is far more complex than the popular variant It is so complex that it calls to mind a popular song from years ago called Collarbone that described the connection of one bone to another from toe to head The song went Toe bone connected to the ankle bone ankle bone connected to the shin bone shin bone connected to the knee bone neck bone connected to the head bone My reason for associating Keynesian economics with this song is that just as one bone is connected to another in the song so in textbooks expounding the Keynesian system each separate but connected piece of the anatomy of that system a bone if you will is presented in a series of successively connected diagrams totaling as many as eleven in all Each one of the diagrams repeats an axis of the one before it Thus in the Keynesian system the production function is connected to the IS curve the IS curve is connected to the saving function the saving function is connected to the saving equals investment line the saving equals investment line is connected to the marginal efficiency of capital schedule the marginal efficiency of capital schedule is connected back to the IS curve the IS curve is connected to the aggregate demand curve The diagram below which is from the first edition of Joseph P McKenna s Aggregate Economic Analysis depicts all the various relationships involved Anatomy of the Keynesian System Just as in the case of the highly simplified labor union version the ultimate conclusion drawn from this extensive series of connections is that full employment cannot be achieved in a free market because once again a fall in wage rates allegedly turns out to be incapable of increasing the quantity of labor demanded Even though the two versions of Keynesianism reach the same conclusion they differ profoundly in the complexity of their explanations And as a result they require separate critiques In the textbook version the reason that a fall in wage rates allegedly cannot reduce unemployment is not that it automatically reduces spending in the economic system Keynes is willing to concede that initially spending might remain the same or even increase and that at the lower wage rates it would in fact employ additional workers He writes Perhaps it will help to rebut the crude conclusion that a reduction in money wages will increase employment because it reduces the cost of production if we follow up the course of events on the hypothesis most favourable to this view namely that at he outset entrepreneurs expect the reduction in money wages to have this effect It is indeed not unlikely that the individual entrepreneur seeing his own costs reduced will overlook at the outset the repercussions on the demand for his product and will act on the assumption that he will be able to sell at a profit a larger output than before General Theory p 261 The basic problem Keynes contends lies in what would happen next if the fall in wage rates did in fact manage to increase the volume of employment Continuing in the very same paragraph he argues that the effect of the greater employment would be a fall in the rate of profit which he usually calls the marginal efficiency of capital below the lowest rate that is sufficient to induce investment This would serve to make the employment of additional workers no longer worthwhile and result in employment being pushed back to its previous figure In his words to which I ve taken the liberty of adding explanatory comments which appear in brackets If then entrepreneurs generally act on this expectation will they in fact succeed in increasing their profits Only if the community s marginal propensity to consume is equal to unity so that there is no gap between the increment of income and the increment of consumption i e there is no additional saving or if there is an increase in investment corresponding to the gap between the increment of income and the increment of consumption which will only occur if the schedule of marginal efficiencies of capital has increased relatively to the rate of interest i e either the mec schedule must somehow move to the right which there is allegedly no reason for its doing or the rate of interest must fall which it can t do because it is allegedly already at its lowest acceptable rate which is usually assumed to be 2 percent Thus the proceeds realised from the increased output will disappoint the entrepreneurs and employment will fall back again to its previous figure unless the marginal propensity to consume is equal to unity i e there is no additional saving or the reduction in money wages has had the effect of increasing the schedule of marginal efficiencies of capital relatively to the rate of interest and hence the amount of investment Keynes means of course increase the amount of investment that is worthwhile i e yields 2 percent or more For if entrepreneurs offer employment on a scale which if they could sell their output at the expected price would provide the public with incomes out of which they would save more than the amount of current investment entrepreneurs are bound to make a loss equal to the difference and this will be the case absolutely irrespective of the level of money wages I have italicized the last sentence because if any single sentence of Keynes can express the theoretical substance of his doctrine that is the one Here is the line of argument Keynes is presenting in the passage above and which is depicted in the graphical analysis The employment of more workers results in more production which at the same time means more real income By a process of equivocation which I note here but will not make a major issue of real income suddenly becomes interchangeable with money income out of which saving and cash hoarding can potentially take place Saving according to Keynes and his followers is a mathematical function of income such that more income results in more saving e g 20 percent of each additional dollar of income is saved while 80 percent of each additional dollar of income is consumed The extra saving relative to extra income is called the marginal propensity to save while the extra consumption relative to extra income is called the marginal propensity to consume The names of the full mathematical functions are the saving function and the consumption function As the quotation indicates the existence of saving allegedly creates a problem If there were no additional saving as employment and income increased there would be nothing to stop the additional employment achieved as the result of a fall in wage rates from being maintained But saving creates the potential for cash hoarding Cash hoarding in the Keynesian system need not automatically and necessarily occur every time there is saving Potentially additional saving might be offset by equivalent additional investment If it were that would put the money saved back into the spending stream In this case too the additional employment achieved as the result of a fall in wage rates could be maintained The problem that arises according to Keynes and his followers is that the additional investment required is the cause of a fall in the marginal efficiency of capital i e the rate of profit or rate of return on capital The effect of achieving full employment believe the Keynesians would be an increase in the volume of saving to such an extent that it would require an offsetting increase in the volume of investment of such a magnitude that the rate of return on capital would allegedly be driven to an unacceptably low level Below 2 percent is the figure usually assumed In response to a rate of return less than the minimum acceptable rate funds would be withdrawn from investment and hoarded This would reduce spending throughout the economic system and cause the return of unemployment The fundamental problem say the Keynesians is that the existence of full employment would impose an unacceptably low rate of return on capital and therefore could not be maintained if it were achieved The return of unemployment would be necessary because by reducing output income it would reduce the volume of saving since less income results in less saving With saving reduced less investment is required to offset it in order to prevent hoarding And with less investment the rate of return on capital will be higher Keynes s whole argument depends on the rate of profit falling as the end result of the increase in employment and output If the rate of profit did not fall if it stayed the same or rose as employment and output increased on the foundation of a fall in wage rates and prices there would be absolutely nothing standing in the way of the achievement of full employment by means of a fall in wages and prices Clearly it is essential to examine Keynes s argument that the rate of profit mec declines as investment increases For his whole analysis depends on it In explaining it he writes If there is an increased investment in any given type of capital during any period of time the marginal efficiency of that type of capital will diminish as the investment in it is increased partly because the prospective yield will fall as the supply of that type of capital is increased and partly because as a rule pressure on the facilities for producing that type of capital will cause its supply price to increase Thus for each type of capital we can build up a schedule showing by how much investment in it will have to increase within the period in order that its marginal efficiency should fall to any given figure We can then aggregate these schedules for all the different types of capital so as to provide a schedule relating the rate of aggregate investment to the corresponding marginal efficiency of capital in general which that rate of investment will establish We shall call this the investment demand schedule or alternatively the schedule of the marginal efficiency of capital General Theory p 136 Keynes s reference to the prospective yield on capital falling is usually divided into two related aspects a decline in the prospective selling prices of products as stepped up investment increases their supply and also a decline in the physical amount of additional product produced per successive equal increment of additional investment Thus for example each additional 10 billion of investment in the economic system might be imagined to result in increments of product that would sell for less and less because of increases in the supply of products and that would also bring in less and less because the physical size of the increases was smaller and smaller Thus the first 10 billion of additional investment might be imagined to result in 1 million units of additional product that would sell at a price of 100 each The second 10 billion however would supposedly result only in an additional 900 thousand units of product which would sell at a price of say 95 each By the same token the third 10 billion of additional investment might result in only 800 thousand units of additional product that would sell for 90 per unit and so on Clearly the extra revenue accompanying equal extra increments of investment would fall under these conditions And since that extra revenue is the source of the profit on the investment it seems to follow that the rate of profit would decline as investment increased In addition of course Keynes refers to a rising supply price for the various types of capital goods as their production expands in response to the additional demand constituted by additional investment Thus in his view the rate of profit declines as investment increases because more investment both raises the prices of capital goods and at the same time operates to reduce their yields in terms of revenue Keynes s Bait and Switch When Keynes s explanation of the falling marginal efficiency of capital just quoted is taken in conjunction with his previously quoted explanation of why a fall in wage rates allegedly cannot succeed in overcoming unemployment it turns out that what is present is something similar to the technique of a dishonest salesmen who begins by appearing to offer something that is very different from what he actually ends up offering i e the technique known as bait and switch When Keynes tries to explain the alleged impossibility of full employment being achieved by virtue of a fall in wage rates he is clearly talking about the alleged impossibility of a fall in wage rates achieving full employment But when all is said and done what this alleged impossibility turns out to rest upon is not at all consistent with a fall in wage rates To the contrary in the last analysis Keynes s argument against the ability of a fall in wage rates to achieve full employment depends on the absence of a fall in wage rates indeed on their rise The fall in the marginal efficiency of capital rate of profit that supposedly results from investment having to be pushed beyond its worthwhile limit in order to offset all of the saving taking place out of the level of income resulting from full employment and which allegedly prevents full employment from being achieved more than very temporarily that fall turns out to depend on wage rates not falling indeed rising Consider Why should a fall in the selling prices of products serve to reduce profitability if that fall has been preceded by a fall in wage rates and in the prices of existing capital goods i e in the costs of production which is the situation under discussion It would be reasonable to argue that a fall in selling prices serves to reduce profits if it were not preceded by a fall in wage rates and the prices of existing capital goods but not when it is so preceded What Keynes has done here is to substitute the effects of a fall in selling prices on the rate of profit in the absence of a preceding fall in wage rates and the prices of existing capital goods for its alleged effect in the presence of such a preceding fall The same point applies even more strongly to the alleged decline in yields based on declines in physical increments of product accompanying additional increments of investment Here Keynes and his followers take for granted the supply of labor and consider the effects on output merely of successive equal increments of investment But this too is a total contradiction of the situation under discussion That situation recall is whether or not the re employment of masses of previously unemployed workers can be maintained following a fall in wage rates and the prices of existing capital goods Keynes and his followers say no in part because of alleged diminishing physical returns to additional increments of capital investment Here they ignore the fact that the situation under discussion implies an increase in the supply of labor employed far in excess of any secondary derivative increase in the supply of capital goods that might come about as the result of additional saving taking place as the by product of full employment Going from a state of mass unemployment to full employment implies a correspondingly large reduction in the ratio of accumulated capital to labor The supply of existing capital goods is what it is But going from say an unemployment rate of 25 percent such as existed in the depths of the Great Depression of the 1930s to full employment implies in increase in the supply of labor employed in the ratio of 4 3 This in turn implies a fall in the ratio of capital to labor to ¾ of its previous level Thus if in the state of mass unemployment there were 12 units of capital in existence for every 3 workers employed giving a ratio of capital to labor of 4 1 now with the employment of 4 workers for every 3 previously employed the ratio of capital to labor falls to 3 1 With capital now less abundant relative to labor i e scarcer relative to labor successive equal increments of investment should have substantially higher physical yields than they did in the state of mass unemployment Thus if it were the case that physical increments of output accompanying increments of investment had a connection with the rate of profit the rate of profit would have to be expected to rise as the accompaniment of the economic system going from a state of mass unemployment to full employment Even if at some point after many years of full employment and accompanying additional saving the ratio of capital to labor ultimately came to surpass what it had been in the period of mass unemployment it would still be far less than it would be in the face of fresh mass unemployment Always the employment of more labor serves to reduce the ratio of capital to labor and to have a correspondingly positive effect on physical yields to capital all other things being equal The third alleged reason for the rate of profit falling as employment increases turns out to be no less bizarre and contradictory This is Keynes s claim that pressure on the facilities for producing capital will cause its supply price to increase Since when do the prices of capital goods rise on a foundation of falling wage rates and costs of production They would rise in a situation of rising wage rates and costs of production but not falling wage rates and costs of production This is just another aspect of the switch Keynes has pulled off Further Problems with Keynesianism The Keynesian argument is actually absurd on its face If one looks at its so called IS curve one sees a relationship purporting to show that as output and implicitly employment increase along the horizontal axis the marginal efficiency of capital rate of profit falls on the vertical axis The economic system is allegedly locked into a state of permanent mass unemployment because the rate of return is already as low as it is possible for it to go consistent with investment being worthwhile while full employment would result in an even lower rate of return What this means is that the economic system cannot achieve full employment and recovery because if it did the rate of profit would be lower in the recovery than it is in the depths of the depression There is another problem A leading doctrine of the Keynesians is the investment multiplier According to this doctrine every additional dollar of investment results in an induced rise in consumption spending and thus in substantially more than a dollar of additional spending overall perhaps 2 or 3 This additional spending is held to be synonymous with additional national income While national income is composed essentially of profits and wages the Keynesians seem to overlook the fact that additional national income implies additional profits If profits were just 10 percent of national income and the multiplier were just 2 every additional dollar of investment would imply 20 cents of additional profits in the economic system What this in turn implies is that the rate of profit in the economic system must be rising in the direction of 20 percent i e that more investment has a powerful positive effect on the rate of profit In a Recovery Investment and Profits Move Together The Keynesian claim is that the additional investment that accompanies additional employment reduces the rate of profit

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  • Reisman's Blog for March 2009
    Under Obama From Dumb to Dumber and From Bad to Worse A recent article in The New York Times quotes President Obama as saying I don t buy the argument that providing workers with collective bargaining rights somehow weakens the economy or worsens the business environment If you ve got workers who have decent pay and benefits they re also customers for business March 2 2009 p B3 The President s statement reveals a great deal about his understanding or more correctly lack of understanding of economics Collective bargaining is the joining together typically through the instrumentality of a labor union of all workers in a given occupation or industry for the purpose of acting as a single unit in seeking pay and benefits It is an attempt to compel employers to deal with just one party i e the labor union and to come to terms agreeable to that party or to be unable to obtain labor The imposition and maintenance of collective bargaining necessarily depends on compulsion and coercion i e on the use of physical force against both employers and unemployed workers This coercion is necessitated in substantial measure precisely by the seeming success that collective bargaining can achieve That success is measured in terms of the rise in wage rates that it achieves That rise in wage rates is all that labor union leaders and their ignorant supporters are aware of Precisely this success however is the cause of major problems The first is that higher wage rates reduce the quantity of labor that any given amount of capital funds can employ For example at a wage of 20 000 per year 1 million of payroll funds can employ 50 workers for a year But at a wage of 25 000 per year it can employ only 40 workers for a year With every further rise in the wage correspondingly fewer workers are able to be employed Higher wage rates also serve to raise costs of production and thus the selling prices of the products that the higher paid workers are producing These higher selling prices reduce the quantities of the products that buyers are able and willing to buy And thus whether as the result of the reduced purchasing power of capital funds in the face of higher wage rates or the reduced quantities of products demanded by customers in the face of higher product prices the effect of collective bargaining is a reduced quantity of labor employed i e unemployment It is shocking indeed frightening that the President of the United States whose main concern at the moment is supposedly with overcoming mass unemployment and preventing its getting worse does not understand that any policy that drives up wage rates drives up unemployment The unemployment that collective bargaining causes is what explains why it is necessary to resort to coercion against wage earners in order to maintain the system The self interest of the unemployed is to find work and to accept lower wage rates as the means of doing so And taking advantage of that fact is to the self interest of employers Thus there are two parties unemployed workers and employers whose self interest lies with a reduction in the higher wage rates achieved by collective bargaining If these parties are free to act in their self interest the system of collective bargaining must break down How are they to be prevented from acting in their self interest The answer is physical force Stepping outside the system of collective bargaining must be made illegal if the system is not to break down That means employers and unemployed workers must be threatened with fines or imprisonment for acting in their self interest and withdrawing from the system of collective bargaining In the last analysis they must be threatened with the specter of armed officers ready to cart them off to jail if they disobey the requirements of the system and to club and shoot them should they physically resist being carted off to jail It is not always necessary that the physical force that imposes and maintains collective bargaining come directly from the government It can often come from labor unions that the government chooses not to prosecute when their members physically assault strikebreakers surround factories and refuse to allow entry or exit start fires set off stink bombs shoot out tires and perform other acts of vandalism and intimidation In saying I don t buy the argument that providing workers with collective bargaining rights somehow weakens the economy or worsens the business environment President Obama confesses to not knowing that collective bargaining raises prices and causes unemployment He confesses to not knowing that it raises costs and prices not only through the imposition of artificially high wage rates but also in imposing on employers the use of unnecessary labor sometimes as many as four or five workers to do the job that just one could do A classic example of this is the insistence on the use of a carpenter plumber electrician tile setter and drywaller to make a simple repair in a bathroom merely because the separate labor unions involved claim each operation as belonging to their respective members exclusively i e claim a monopoly on that type of operation He confesses to not knowing how the enormous difficulties that labor unions put in the way of firing incompetent workers are responsible for such phenomena as so called Monday morning automobiles That is automobiles poorly made for no other reason than because they happened to be made on a day when too few workers showed up or too few showed up sober to do the jobs they were paid to do The automobiles companies were unable to fire such workers without precipitating a crippling strike to which the system of compulsory collective bargaining gave them no alternative Collective bargaining with its imposition of higher costs and prices and lower product quality is at the root of the destruction of the American

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    was still well above 11 000 All this confirms that the crisis did not originate in any sudden refusal of consumers to consume or in any surge in unemployment To the extent that unemployment is growing and consumption is declining they are both the consequence of the economy s loss of capital The loss of capital is what precipitated a reduction in the availability of credit and a widening wave of bankruptcies which in turn has resulted in growing unemployment and a decline in the ability and willingness of people to consume The collapse in home prices and the more recent collapse in the stock market have also contributed to the decline in consumption and probably to an even greater extent at least up to now Both of these events are also an aspect of the loss of capital and accumulated savings What Economic Recovery Requires What all of the preceding discussion implies is that economic recovery requires that the economic system rebuild its stock of capital and that to be able to do so it needs to engage in greater saving relative to consumption This is what will help to restore the supply of credit and thus help put an end to financial failures based on a lack of credit Recovery also requires the freedom of wage rates and prices to fall so that the presently reduced supply of capital and credit becomes capable of supporting a larger volume of employment and production as I explained in Falling Prices Are Not Deflation but the Antidote to Deflation which was my first article in this series Recovery will be achieved by the combination of more saving capital and credit along with lower wage rates costs and prices In addition recovery requires the rapid liquidation of unsound investments If borrowers are unable to meet their contractual obligation to pay principal and interest the assets involved need to be sold off and the proceeds turned over to the lenders as quickly as possible in order to put an end to further losses and thus salvage as much capital from the debacle as possible In the present situation of widespread financial paralysis firms and individuals can be driven into bankruptcy because they are unable to collect the sums due them from their debtors Thus for example the failure of mortgage lenders would be alleviated if not perhaps altogether avoided in some cases if the mortgage borrowers who were in default on their properties lost their houses quickly with the proceeds quickly being turned over to the lenders In that way the lenders would at least have those funds available to meet their obligations and thus might avoid their own default in either event their creditors would be better off In helping to restore the capital of lenders or what will become the capital of the creditors of the lenders quick foreclosures would serve to restore the ability to originate new loans Recovery requires the end of financial pretense There are banks that do not want to see the liquidation of various types of assets that they own notably collateralized debt obligations CDOs These are securities issued against collections of other securities which in turn were issued against collections of mortgages an undetermined number of which are in default or likely to go into default The presumably low prices that such securities would bring in the market would likely serve to reveal the presence of so little capital on the part of many banks that they would be plunged into immediate bankruptcy To avoid that the banks want to prevent the discovery of the actual value of those securities At the same time they want creditors to trust them Yet before trust can be established the actual market value of the banks assets must be established even if it serves to bankrupt many of them The safety of their deposits can be secured without the banks present owners continuing in that role When these various requirements have been met and the process of financial contraction comes to an end the profitability of business investment will be restored and recovery will be at hand Part II Stimulus Packages The Nature of Stimulus Packages As was shown in Part I of this article economic recovery requires greater saving and the accumulation of fresh capital to make up for the losses caused by credit expansion and the malinvestment and overconsumption that follow from it Yet the imposition of stimulus packages results in the further loss of capital The Keynesians not only do not know this but would not care even if they did know it Because of their ignorance of the role of capital in the economic system and resulting inability to see even the clearest evidence that suggests it the Keynesians can conceive of no cause of a recession or depression but an insufficiency of consumption and no remedy but an increase in consumption This is the basis of their calls for stimulus packages of one kind or another They assume that the economic system always has enough capital indeed that it is in danger of having too much capital and that the problem is simply to get it to use the capital that it has The way that this is done they believe is to get people to consume Additional consumption will be the stimulus to new and additional production When people consume the products of past production are taken off the shelves and disappear from the stores These products the Keynesians believe now require replacement Hence the shops will order replacement supplies and the manufacturers will turn to producing them and thus the economic system will be operating again and recovery will be achieved provided the stimulus is large enough The essential meaning of a stimulus package is the government s financing of consumption indeed practically any consumption by anyone for almost any purpose in the conviction that this will cause an increase in employment and production as the means of replacing what is consumed Despite talk of avoiding wasteful spending and being careful with the taxpayers money the truth is that from the point of view of the advocates of economic stimulus the bigger and more wasteful the project the better This was made brilliantly clear many years ago by Henry Hazlitt who chose the example of government spending for a bridge It is one thing Hazlitt showed if the government builds a bridge because its construction is necessary to facilitate the flow of traffic It is a very different matter he pointed out if the government builds the bridge for the purpose of promoting employment In the first case the government wants the best bridge for the lowest possible cost which implies the employment of as few workers as possible both in the construction of the bridge and in the production of any of the materials that go into it In the second case that of stimulating employment the government wants a bridge that requires as many workers as possible for their employment is its actual purpose The greater the number of workers employed of course the greater must be the cost of the bridge Indeed no one could be more clear or explicit concerning the nature of government fiscal policy and its stimuli than Keynes himself who declared on p 129 of his General Theory that Pyramid building earthquakes even wars may serve to increase wealth if the education of our statesmen on the principles of the classical economics stands in the way of anything better Acts of sheer destruction such as wars and natural disasters appear as beneficial to Keynes and his followers for the same reason that the stimulus of government financed consumption appears beneficial This is because they too create a need for replacement and thus allegedly result in an increase in employment and production So widespread is this view that one can very often hear people openly express favorable opinions about the alleged economic benefits of such things as earthquakes hurricanes and even wars Stimulus Packages Mean More Loss of Capital Despite the fact that what the economic system needs for recovery is saving and the accumulation of new capital to replace as far as possible the capital that has been lost the effect of stimulus packages is further to reduce the supply of capital and thus to worsen the recession or depression The reason that stimulus packages cause a further loss of capital is that their starting point is the consumption of previously produced wealth That wealth is part of the capital of the business firms that own it The stimulus programs offer money in exchange for this wealth and capital But the money they offer does not come from the production of any comparable wealth by the government or those to whom it gives money wealth which has had to be produced and sold and thus put into the economic system prior to the withdrawal that now takes place The starting point for the government and its dependents is an act of consumption which means a using up a loss of previously existing wealth in the form of capital The supporters of stimulus packages look to the fresh production that is required to replace the wealth that has been consumed It will require the performance of additional labor They are delighted to the extent that this fresh production and additional employment materialize They believe that at that point their mission has been accomplished They have succeeded in generating new and additional economic activity new and additional employment The only shortcoming of such a policy they believe is that it may not be applied on a sufficiently large scale Unfortunately there is something they have overlooked And that is the fact that any fresh production and employment that results is incapable by itself of replacing the capital that was consumed in starting the process The reason for this is that all production including any new and additional production called into being by stimulus packages itself entails consumption And this consumption tends at the very least to approximate the fresh production and indeed is capable of equaling or even exceeding it Thus for example we start with the purchase and consumption of a new television set by someone who has not previously produced and sold anything of equivalent monetary value that provided the funds for his now buying the television set He has simply received the money from the government In this case what we have is one television set withdrawn from the capital of the economic system and placed in the hands of a non producing consumer We can assume for the sake of argument that the retailer of the television set will order a replacement set from the wholesaler and that the wholesaler in turn will order a replacement set from the manufacturer We can assume further that the manufacturer will now produce a new television set to replace the one that he sells to the wholesaler from his inventory The production of the replacement television set entails a using up of materials and components and part of the useful life of the plant and equipment required Aspects of such using up of capital goods also take place on the part of the retailer and wholesaler and in the transportation of the television set Very importantly any new and additional workers who may be employed precisely the goal of the whole operation in producing a new television set or in moving a television set through the channels of distribution must be paid wages which they in turn will consume The goods these workers receive when they spend their wages represents a further depletion of inventories on the part of all the retailers with whom they deal In addition the various business firms involved have additional profits or at least diminished losses as the result of the various additional purchases This enables their owners to consume more and probably results in the payment of additional taxes which the government consumes Even whatever depreciation allowances are earned along the way in the various stages of replacing the television set are likely to be consumed This is because in the context of a recession or depression investors are afraid of losses if they invest in private businesses and thus prefer to invest in short term treasury securities such as treasury bills which they consider to be far safer But when depreciation allowances are used to purchase treasury securities they end up financing consumption rather than capital replacement This is because the Treasury uses the proceeds from the sale of its securities to finance nothing but consumption either that of the government itself or that of the private individuals to whom the government gives money The point here is that any replacement of a good consumed by a non producer itself entails very substantial additional consumption of inventories and the useful life of plant and equipment of business firms The same is obviously true of the replacement of goods that have simply been destroyed whether by war or by an act of nature No matter how long the process of spending and respending of the funds introduced into the economic system by a stimulus package might continue no matter how many instances of replacement production there might be following the purchase and consumption of our hypothetical television set or of any other such good the initial loss of capital need never be made up This is because each act of replacement production is accompanied by corresponding additional consumption Thus the initial act of consumption or destruction of wealth and capital may be followed by 10 or 100 acts of subsequent production each carried on in order to replace the goods used up before it But if each of these subsequent acts of production is accompanied by fresh consumption that is equivalent to it the net effect is still one act of consumption As a result the supply of capital is reduced For what is always present is X instances of production respectively following X 1 instances of consumption Now countries have suffered enormous losses of capital and yet still managed to recover and go on to new heights of wealth and prosperity Germany and Japan in the decades following World War II are perhaps the most outstanding examples of this What enabled them to recover was not further acts of consumption not stimulus packages of any kind but increases in production in excess substantially in excess of increases in consumption That is to say it was a process of saving and capital accumulation that made their recovery possible On average people in those countries in those years saved and reinvested a major portion of their income often in excess of 25 percent It is possible but highly unlikely that the replacement production induced by an initial consumption destruction of wealth might itself entail some such new saving If round after round of replacement production were in fact accompanied by some such saving then eventually the original loss of capital would be made good But that would be the case only if such saving was not offset by fresh acts of stimulus or other policies that waste or destroy capital However as I say such an outcome is highly unlikely If for no other reason this is because as I have already pointed out the stimulus packages take place in an environment in which investors fear to invest in private firms As a result they use not only whatever new and additional savings they might make for the purpose of buying safe treasury securities but also even funds they earn that are required for the replacement of capital goods In this way savings are diverted into consumption rather than capital accumulation It is ironic that while if it did manage to occur and was not diverted into consumption such saving might mitigate the effects of a stimulus package it is attacked as undermining the process of recovery Thus for example Paul Krugman the 2008 Nobel Prize winner in economics writes Meanwhile it s clear that when it comes to economic stimulus public spending provides much more bang for the buck than tax cuts because a large fraction of any tax cut will simply be saved New York Times January 26 2009 p A23 In addition to the diversion into consumption of such new savings as might occur subsequent to a stimulus there is the fact that the source of any such saving namely the net product produced is likely to be greatly diminished The net product is the excess of the product produced over the capital goods used up in order to produce it It is what is available for consumption or saving out of current wage profit and interest income The net product is diminished to the extent that production is made to take place in accordance with methods requiring the employment of unnecessary capital goods per unit of output Environmental and consumer product safety legislation provide numerous instances of this kind For example requiring gas stations dry cleaning establishments and many other types of businesses to substantially increase their capital investments merely in order to placate the largely groundless fears of the environmental movement Similarly requiring safety features in automobiles dishwashers display cases ice machines stepladders and countless other goods features that the market does not judge to be worth their cost adds to the cost of the materials and components that enter into the production of products without increasing the perceived value of the products In both instances the result is a larger consumption of capital goods but no increase in production and thus a reduction in the size of the net product produced and thus in the ability to engage in saving out of current income As indicated in Part I of this article the effect of capital decumulation whether caused by stimulus packages or anything else is a reduction in the ability of the economic system to produce to employ labor and to provide credit for each of these things depends on capital The reduced ability to produce and employ labor may not be apparent in the midst of mass unemployment But it will become apparent if and when economic recovery begins At that point the economic system will be less capable than it otherwise would have been because of the reduction in its supply of capital Real wages and the general standard of living will be lower than they otherwise would have been And all along the ability to grant credit will be less than it otherwise would have been Stimulus Packages Are a Drain on the Rest of the Economic System Even though stimulus packages may be able to generate additional economic activity they cannot achieve any kind of meaningful economic recovery Their actual effect is the creation of a system of public welfare in the guise of work That is in the nature of employing people not for the sake of the products they produce but having them produce products for the sake of being able to employ them But stimulus packages are much more costly than simple welfare On top of the welfare dole that allows unemployed workers to live stimulus packages add the cost of the materials and equipment that the workers use in producing their pretended products The work created by stimulus packages is a make believe work that is carried on at the expense of the rest of the economic system It draws products and services produced in the rest of the economic system and returns to the rest of the economic system little or nothing in the way of goods or services that would constitute value for value or payment of any kind In other words stimulus packages and the needless work they create cause the great majority of other people to be poorer I ve already shown how they cause them to have less capital Shortly I will show how they also cause them to consume less For elaboration on this point please see the forthcoming republication of my article Who Pays for Full Employment Rising Prices in the Midst of Mass Unemployment If economic recovery is to be achieved the first thing that must be done is to stop stimulus packages and undo as far as possible any that are already in progress This is because their effect is to worsen the problem of loss of capital that is the underlying cause of the economic crisis in the first place Unfortunately they are not likely to be stopped If they are implemented especially on the scale already approved by Congress the effect will be a decumulation of capital up to the point where scarcities of capital goods including inventories of consumers goods in the possession of business firms start to drive up prices Higher prices of consumers goods will result not only from scarcities of consumers goods which of course are capital goods so long as they are in the hands of business firms but also from scarcities of capital goods further back in the process of production Thus a scarcity of steel sheet will not only raise the price of steel sheet but will carry forward to the price of automobiles via the higher cost of producing automobiles that results from a rise in the price of steel sheet Likewise a scarcity of iron ore will carry forward to the price of steel sheet which again will carry forward to the price of automobiles And of course the pattern will be the same throughout the economic system in such further cases as oil and oil products cotton and cotton products wheat and wheat products and so on A rise in the prices of consumers goods is capable of stopping further capital decumulation stemming from the stimulus packages When the point is reached that additional funds spent on consumers goods serve merely to raise their prices then no additional quantities of them are sold The same quantities are sold at higher prices This ends the decumulation of inventories From this point on the buyers who obtain their funds from the government consume at the expense of people who have earned their incomes but now get less for them Once inventories become scarce in relation to the spending for goods all of the funds that the government has been pouring into the economic system become capable of launching a major increase in prices This rise in prices can take place even in the midst of mass unemployment This is because the abundance of unemployed workers does nothing to mitigate the scarcity of capital goods that has occurred as the result of the attempts to stimulate employment Even though rising prices can deprive stimulus packages of the ability to cause further capital decumulation the inflation of the money supply by the government results in continuing capital decumulation In large part this occurs as the result of the fact that the additional spending resulting from a larger money supply raises business sales revenues immediately while it raises business costs only with a time lag So long as this goes on profits are artificially increased Despite the fact that most or all of the additional profits may be required simply in order to replace assets at higher prices the additional profits are taxed as though they were genuine gains This impairs the ability of firms to replace their assets The destructive consequences of this phenomenon can be seen in the transformation of what was once America s industrial heartland into the rustbelt At the same time throughout the economic system starting long before today s stimulus packages and continuing on alongside them regular almost year in year out government budget deficits do their work of destruction They cause a continuing diversion into consumption not only of a considerable part of whatever savings might be made out of income but also of the replacement allowances for the using up of plant and equipment and all other fixed assets Generations of government budget deficits have sucked up trillions of dollars of what would have been capital funds and have gone a long way toward turning America into an industrial wasteland The blind rush into massive stimulus packages is the culmination of generations of economic ignorance transmitted from professor to student in the guise of advanced revolutionary thinking the Keynesian revolution The accelerating destruction of our economic system that we are now experiencing is the product of a prior destruction of economic thought Our entire intellectual establishment has been the victim the willing victim of a massive intellectual con job that goes under the name Keynesianism And we are now paying the price I say willing victims of an intellectual con job What other description can there be of those who were ready to hail as a genius the man who wrote Pyramid building earthquakes even wars may serve to increase wealth Only a brave few most notably Ludwig von Mises and Henry Hazlitt stood apart from this madness and for doing so they were made intellectual pariahs But the time is coming when it will be clear to all who think that it is they who have had the last word Copyright 2009 by George Reisman George Reisman Ph D is the author of Capitalism A Treatise on Economics Ottawa Illinois Jameson Books 1996 and is Pepperdine University Professor Emeritus of Economics He is also a Senior Fellow at the Goldwater Institute His web site is www capitalism net nd his blog is www georgereisman com blog A pdf replica of his book can be downloaded to the reader s hard drive simply by clicking on the book s title Capitalism A Treatise on Economics and then saving the file when it appears on the screen The book provides an in depth comprehensive treatment of the material discussed in this and subsequent articles in this series and of practically all related aspects of economics Saturday February 07 2009 New York Times Columnist Maureen Dowd Wants Soviet Style Show Trials with Capitalist Defendants in Shackles New York Times columnist Maureen Dowd has written a column January 28 2009 full of withering hatred and contempt for many of today s most prominent businessmen first and foremost the heads of the Wall Street Banks She singles out Citigroup and Merrill Lynch in particular denouncing the first for going ahead with taking delivery of a 50 million luxury jet at the very time the firm was losing billions and the last CEO of the second John Thain for spending 1 million to redecorate his office also in the midst of his firm s suffering major losses Her column leaves the reader with a view of these people and by implication of practically the whole economic class to which they belong i e virtually all businessmen and capitalists as having a mentality that combines the worst features of Marie Antoinette and Nero The former of course was Queen of France until 1793 when she was beheaded She is famous for allegedly having said in response to being informed of the peasantry s lack of bread Let them eat cake And Nero was the Roman emperor who is known for having fiddled while Rome burned and who died in 68 AD committing suicide when he learned that the Roman Senate had ordered that he be flogged to death Having led her readers to such an assessment of these people she concludes her column with the declaration Bring on the shackles Let the show trials begin If they do begin Dowd will be there perhaps with knitting needles in the role of a modern day Madame Defarge the Dickens character who knitted while watching aristocrats being guillotined during the French Revolution The day after Dowd s column appeared a news story in The Times reported that Despite crippling losses multibillion dollar bailouts and the passing of some of the most prominent names in the business employees at financial companies in New York the now diminished world capital of capital collected an estimated 18 4 billion in bonuses for the year That was the sixth largest haul on record according to a report released Wednesday by the New York State comptroller The day after that President Obama called the bonuses shameful The Fate of Capitalism It is very easy to interpret the kind of facts that have been described as an indictment of the capitalist system which is exactly how they are being interpreted Millions of people have lost their jobs millions more fear that they will lose theirs These millions cannot avoid the further fear that they and their families will be utterly impoverished And they are being led to blame their losses on capitalism in large part by being led to blame it on the persons of individual businessmen or capitalists whom they perceive as hateful What is present and being inflamed is the psychology of an angry mob Its sympathies are with innocent victims who have suffered a great wrong It s sure it knows who is responsible and how The next step will be for someone to yell Get a rope Already businessmen and capitalists are starting to cower in fear Corporations are racing to get rid of their private jets Next it will be their private dining rooms and limousines Private profit and personal luxury at any level are in danger before the onslaught of a collectivist mentality that holds that if many are suffering all must suffer and further that those who do not suffer are responsible for the suffering of those who do Anyone whose head is above the crowd will risk being a target This is the time for everyone to recall whatever instances in his life that he remembers when angry mobs turned out to be wrong Perhaps it s only a scene from a movie or book in which someone is able to present a few facts that the mob doesn t know and that begin to place things in a different calmer light Let me be that someone now and begin with one very important and fundamental relevant fact Today s Economic System Is A Mixed Economy Not Laissez Faire Capitalism And that is that even if all of the facts as presented were absolutely true it would not imply any reason whatever to condemn capitalism Capitalism is a system in which absurd self destructive behavior severely punishes whoever is guilty of it Such people suffer losses go bankrupt and lose their ability to have significant further economic influence Their example then serves as a lesson to others to avoid such behavior However we are very far from having capitalism today certainly not capitalism in its logically consistent form of laissez faire capitalism What we have today is a mixed economy that is a severely hampered distorted form of capitalism In such a system such behavior can continue thanks to government subsidies grants of monopoly privilege and suppression of competition and now by means of government bailouts A mixed economy is an economy which remains capitalistic in its basic structure but in which the government extensively intervenes with the initiation of physical force to compel actions that are against the interest of individuals and or to prohibit actions that are in the interest of individuals For example today it compels people to pay an income tax which is against their interest but which they pay in order to stay out of jail It also prohibits them from engaging in various business mergers or paying wages below a certain amount things which it would be to their interest to do but now do not because they wish to avoid being fined or imprisoned In my recent article The Myth that Laissez Faire Is Responsible for Our Financial Crisis I present an extensive description of the extent of government intervention A mixed economy lacks the fundamental moral political principles that are needed to determine what is proper or improper for a government to do Its only principle if one can call it that is that the government can do anything that enough people believe will accomplish what they think is good according to an undefined standard Our mixed economy rests on the effective discarding of the United States Constitution which placed severe limits on government power and thus stood as a bulwark in defense of an economic system that was almost one of laissez faire The Constitutional protections were discarded by a process of pretending that the Constitution could somehow grow or evolve which actually meant nothing other than choosing to ignore it In a mixed economy every significant sized business must fear what the government can do to it It needs protection in the form of political connections It secures these through appointing former government officials to its board of directors paying such officials lavish consulting fees and giving lavish campaign contributions to candidates for public office In these ways it buys the protection it needs But soon businesses learn that their protectors can also be used to gain lucrative government contracts government subsidies and monopolistic privileges ranging from tariffs and licensing laws to antitrust suits against competitors Thus it is not long before the upper echelons of large firms become populated not only with men who cower before the government but also with those who seek to manipulate the government to their advantage which is where we are today Certainly not all big businessmen are this way and probably only a few of those that are are so through and through For the most part they still have real jobs to do in running their companies and to the extent they simply do those jobs they are productive But probably most big businessmen are morally compromised if only because they must live in fear of the government and are helpless to do anything about it Responsibility for the Financial Crisis There is a sense in which an important sub group of businessmen does have genuine responsibility for the present economic crisis and for all previous crises of financial contraction and deflation This is the sub group of commercial bankers Ironically the way in which they have been responsible is by means of doing something that almost everyone very much wants them to do above all the government and even when the crisis comes still wants them to do or to get back to doing as soon as possible This something is the practice of credit expansion Credit expansion is the lending out of new and additional money that is created out of thin air with the encouragement and support of the government Governments value and encourage credit expansion both in the mistaken belief that it is a source of prosperity and in the knowledge that it is a ready source of money to finance government spending Credit expansion is what creates a delusion of prosperity while it lasts and economic depression when it ends It is all that needs to be stopped to end the boom bust cycle In this brief article I must ask the reader who wants to understand the process and how to stop it to be content merely with references to further reading namely Chapters XX and XXXI of Ludwig von Mises s Human Action and Chapters 12 and 19 of my own Capitalism A Treatise on Economics Concerning the role of credit expansion in our present crisis in particular please see my articles The Myth that Laissez Faire Is Responsible for Our Financial Crisis Our Financial House of Cards and How to Start Replacing It With Solid Gold and The Housing Bubble and the Credit Crunch I want now to deal with the subjects of bonuses and corporate jets Bonuses Granting bonuses to employees and buying jet planes are perfectly legitimate for private business firms In today s context this means firms that have not received government bailout money Giving bonuses and buying

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    the midst of the downturn when Bill visits the supermarket he can afford to spend only 5 for bottled water Here s the question At what price per bottle of water would Bill be able to buy for 5 the 10 bottles of water he used to buy for 10 Answer 50 As this question and its answer make clear a fall in prices enables reduced funds available for expenditure to buy as much as previously larger funds could buy This point applies even when lower prices do not result in greater purchases of the particular item whose price has fallen Thus suppose that the price of a gallon of milk is 8 and now falls to 4 Yet Bill and his family do not need more than one gallon in any given week and so won t buy any larger quantity of milk at its now lower price The fall in its price still helps economic recovery It does so by freeing up 4 of Bill s funds to make possible the purchase of other things that he wants but otherwise couldn t afford because of the lack of available funds Another similar example is that of a fall in the price of gasoline or heating oil which helps to increase the ability of people to spend in buying products throughout the economic system As indicated in sharpest contrast to falling prices deflation is a process of financial contraction In our present crisis it is a contraction of credit and of the spending that depends on credit A fall in prices and of course in wage rates too is the essential means of adapting to this deflation and overcoming it Nevertheless the prevailing bizarre confusion of falling prices with deflation stands in the way of economic recovery In regarding falling prices which are the effect of deflation and at the same time the remedy for deflation as somehow themselves being deflation people are led to confuse the solution for the problem with the problem that needs to be solved On the basis of this confusion they advocate government intervention to prevent prices from falling The prices they want to prevent from falling are variously house prices farm and other commodity prices and above all wage rates To the extent that such efforts are successful and prices are prevented from falling the effect is to prevent economic recovery It prevents economic recovery by preventing the reduced level of spending that deflation represents from buying the larger quantity of goods and services that it would be able to buy at lower prices and wage rates Just as falling prices are so far from being deflation that they are the remedy for deflation so too preventing prices from falling is so far from preventing deflation that it actually worsens the deflation This is because it leads people to postpone buying even in instances in which they have the ability to buy They put off buying in the expectation of being able to buy on better terms later on when prices and wage rates have fallen to the extent necessary to permit economic recovery By the same token when prices and wage rates finally do fall sufficiently to permit economic recovery an increase in spending in the economic system will almost certainly occur This is because the funds that people had been withholding from spending awaiting the fall in prices and wages rates will now in the face of the necessary fall be spent Thus the necessary fall in prices and wage rates achieves economic recovery by means of creating greater buying power for a reduced amount of spending It also brings about a partial restoration of spending and thereby definitively ends the deflation Just how far it is necessary for prices and wage rates to fall in order to achieve economic recovery depends on the change that has taken place in what Mises calls the money relation This is the relationship between the supply of money and the demand for money for holding During the boom inflation and credit expansion increase the supply of money and at the same time reduce the demand for money for holding Then in the subsequent bust phase of the business cycle the demand for money for holding rises and the supply of money can actually fall Both of these factors make for a decline in total spending in the economic system and thus the need for a correspondingly lower level of wage rates and prices to achieve economic recovery How far these processes might go in our present circumstances and what might be done consistent with the principle of economic freedom to mitigate them is too large a subject to explain in this one article 1 However I must state here that a decrease in the quantity of money can be altogether prevented and that this would dramatically limit the extent of the decline in overall spending in the economic system Whatever the reduced levels of spending that the changed money relation will support the freedom of wage rates and prices to fall can achieve not only economic recovery but more than economic recovery It can achieve the employment of everyone able and willing to work i e full employment And it could do so with no decline in the real wages of the average worker in the economic system indeed with a significant rise in his real wages Unfortunately this too is a subject too large to discuss further in the present article 2 Bailouts Before closing I must say a few words about the present efforts of the government to overcome the crisis by means of bailouts and their associated financing by budget deficits Ultimately these efforts are an attempt to overcome the effects of a rise in the demand for money for holding by means of a sufficiently large increase in the supply of money In its campaign the government appears to care for nothing but overcoming the crisis of the moment without

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  • Reisman's Blog for November, 2008
    into a gang of bandits massively violating individual rights How does this differ in any essential respect from those who are to receive the loot in the form of 10 000 checks taking matters into their own hands and simply robbing the homes and businesses of the top 1 percent of income earners to the extent of 10 000 each They would give the homeowners and businessmen the same choice of their money or their lives And why should it stop at 800 000 in extra taxes and 10 000 each for the looters If the economic inequality represented by that 800 000 per capita of the top 1 percent of income earners must be done away with why should not all economic inequality be done away with Why not make everyone an equal owner and equal income recipient i e why not go straight for communism That s the logic in what Summers is advocating Not only is Summers advocating the kind of evil committed by criminals but he also displays a degree of lack of thought that is often found among criminals One of the implications of his proposal is that an individual who increased his earnings by just one dollar could be liable for an additional 800 000 in taxes Based on the most recent available data which are for 2006 an individual who increased his earnings from 388 806 to 388 807 would thereby be thrust into the top 1 percent of income earners and thus be made subject to the 800 000 of additional taxes urged by Summers This of course would leave such an individual with an after tax income of minus 411 193 In addition of course all of the ordinary income taxes for which he would be liable at that level of income would also have to be subtracted throwing him still further into Summers Alice In Wonderland world of negative after tax income Summers is probably unaware of this because he appears to focus on the 1 7 million average income of the top 1 percent of income earners This enables him to ignore all the below average incomes of members of that group that would be rendered negative on an after tax basis if his scheme were imposed A proposal this hare brained makes Summers come across more as an intellectual lightweight than as any kind of brilliant thinker able to identify the errors in others thoughts There is actually a reason for Summers advocating a scheme that implies negative after tax income for many upper income taxpayers That s the fact that that is what is necessary to make it appear that redistribution can constitute any kind of significant gain to large numbers of people If one rules out taxes that imply negative after tax income and also taxes that serve to reduce the demand for labor or capital goods it turns out that there is very little to redistribute First of all all of the wealth of businessmen

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  • Reisman's Blog for October, 2008
    faire capitalism that it is closer to the system of a police state than to laissez faire capitalism The ability of the media to ignore all of the massive government interference that exists today and to characterize our present economic system as one of laissez faire and economic freedom marks it as if not profoundly dishonest then as nothing less than delusional Governm ent Intervention Actually Responsible for the Crisis Beyond all this is the further fact that the actual responsibility for our financial crisis lies precisely with massive government intervention above all the intervention of the Federal Reserve System in attempting to create capital out of thin air in the belief that the mere creation of money and its being made available in the loan market is a substitute for capital created by producing and saving This is a policy it has pursued since its founding but with exceptional vigor since 2001 in its efforts to overcome the collapse of the stock market bubble whose creation it had previously inspired The Federal Reserve and other portions of the government pursue the policy of money and credit creation in everything they do that encourages and protects private banks in the attempt to cheat reality by making it appear that one can keep one s money and lend it out too both at the same time This duplicity occurs when individuals or business firms deposit cash in banks which they can continue to use to make purchases and pay bills by means of writing checks rather than using currency To the extent that the banks are then enabled and encouraged to lend out the funds that have been deposited in this way usually by the creation of new and additional checking deposits rather than the lending of currency they are engaged in the creation of new and additional money The depositors continue to have their money and borrowers now have the bulk of the funds deposited In recent years the Federal Reserve has so encouraged this process that checking deposits have been created equal to fifty times the actual cash reserves of the banks a situation more than ripe for implosion All of this new and additional money entering the loan market is fundamentally fictitious capital in that it does not represent new and additional capital goods in the economic system but rather a mere transfer of parts of the existing supply of capital goods into different hands for use in different less efficient and often flagrantly wasteful ways The present housing crisis is perhaps the most glaring example of this in all of history Perhaps as much as a trillion and a half dollars or more of new and additional checkbook money capital was channeled into the housing market as the result of the artificially low interest rates caused by the presence of an even larger overall amount of new and additional money in the loan market Because of the long term nature of its financing housing is especially susceptible to the effect of lower interest rates which can serve sharply to reduce monthly mortgage payments and in this way correspondingly increase the demand for housing and for the mortgage loans needed to finance it Over a period of years the result was a huge increase in the production and purchase of new homes rapidly rising home prices and a further spiraling increase in the production and purchase of new homes in the expectation of a continuing rise in their prices To gauge the scale of its responsibility in the period of time just since 2001 the Federal Reserve caused an increase in the supply of checkbook money capital of more than 70 percent of the cumulative total amount it had created in the whole of the previous 88 years of its existence that is almost 2 trillion dollars 5 This was the increase in the amount by which the checking deposits of the banks exceeded the banks reserves of actual money that is the money they have available to pay depositors who want cash The Federal Reserve caused this increase in illusory capital by means of creating whatever new and additional bank reserves as were necessary to achieve a Federal Funds interest rate that is the rate of interest paid by banks on the lending and borrowing of reserves that was far below the rate of interest dictated by the market For the three years 2001 2004 the Federal Reserve drove the Federal Funds Rate below 2 percent and from July of 2003 to June of 2004 drove it even further down to approximately 1 percent The Federal Reserve also made it possible for banks to operate with a far lower percentage of reserves than ever before Whereas in a free market banks would hold gold reserves equal to their checking deposits or at the very least to a substantial proportion of their checking deposits 6 the Federal Reserve in recent years contrived to make it possible for them to operate with irredeemable fiat money reserves of less than 2 percent The Federal Reserve drove down the Federal Funds Rate and brought about the vast increase in the supply of illusory capital for the purpose of driving down all market interest rates The additional illusory capital could find borrowers only at lower interest rates The Federal Reserve s goal was to bring about interest rates so low that they could not compensate even for the rise in prices It deliberately sought to achieve a negative real rate of interest on capital that is a rate below the rate at which prices rise This means that a lender after receiving the interest due him for a year has less purchasing power than he had the year before when he had only his principal In doing this the Federal Reserve s ultimate purpose was to stimulate both investment and consumer spending It wanted the cost of obtaining capital to be minimal so that it would be invested on the greatest possible scale and for people to regard the holding of money as a losing proposition which would stimulate them to spend it faster More spending ever more spending was its concern in the belief that that is what is required to avoid large scale unemployment As matters have turned out the Federal Reserve got its wish for a negative real rate of interest but to an extent far beyond what it wished It wished for a negative real rate of return of perhaps 1 to 2 percent What it achieved in the housing market was a negative real rate of return measured by the loss of a major portion of the capital invested In the words of The New York Times In the year since the crisis began the world s financial institutions have written down around 500 billion worth of mortgage backed securities Unless something is done to stem the rapid decline of housing values these institutions are likely to write down an additional 1 trillion to 1 5 trillion 7 This vast loss of capital in the housing debacle is what is responsible for the inability of banks to make loans to many businesses to which they normally could and would lend The reason they cannot now do so is that the funds and the real wealth that have been lost no longer exist and thus cannot be lent to anyone The Federal Reserve s policy of credit expansion based on the creation of new and additional checkbook money has thus served to give capital to unworthy borrowers who never should have had it in the first place and to deprive other far more credit worthy borrowers of the capital they need to stay in businesses Its policy has been one of redistribution and destruction The capital it has caused to be malinvested and lost in housing is capital that is now unavailable for such firms as Wickes Furniture Linens N Things Levitz Furniture Mervyns and innumerable others who have had to go bankrupt because they could not obtain the loans they needed to stay in business And of course among the foremost victims have been major banks themselves The losses they have suffered have wiped out their capital and put them out of business And the list of casualties will certainly grow Any discussion of the housing debacle would be incomplete if it did not include mention of the systematic consumption of home equity encouraged for several years by the media and an ignorant economics profession Consistent with the teachings of Keynesianism that consumer spending is the foundation of prosperity they regarded the rise in home prices as a powerful means for stimulating such spending In increasing homeowners equity they held it enabled homeowners to borrow money to finance additional consumption and thus keep the economy operating at a high level As matters have turned out such consumption has served to saddle many homeowners with mortgages that are now greater than the value of their homes which would not have been the case had those mortgages not been enlarged to finance additional consumption This consumption is the cause of a further loss of capital over and above the capital lost in malinvestment A discussion of the housing debacle would also not be complete if it did not mention the role of government guarantees of many mortgage loans If the government guarantees the principal and interest on a loan there is no reason why a lender should care about the qualifications of a borrower He will not lose by making the loan however bad it may turn out to be A substantial number of mortgage loans carried such guarantees For example a New York Times article describes the Department of Housing and Urban Development as an agency that greased the mortgage wheel for first time buyers by insuring billions of dollars in loans The article describes how HUD progressively reduced its lending standards families no longer had to prove they had five years of stable income three years sufficed lenders were allowed to hire their own appraisers rather than rely on a government selected panel lenders no longer had to interview most government insured borrowers face to face or maintain physical branch offices because the government s approval for granting mortgage insurance had become automatic The Times article goes on to describe how Lenders such as Countrywide Financial which was among the largest and most prominent sprang up to serve those whose poor credit history made them ineligible for lower interest prime loans It notes the fact that Countrywide signed a government pledge to use proactive creative efforts to extend homeownership to minorities and low income Americans 8 Proactive creative efforts is a good description of what lenders did in offering such bizarre types of mortgages as those requiring the payment of interest only and then allowing the avoidance even of the payment of interest by adding it to the amount of outstanding principal Such mortgages suited the needs of homebuyers whose reason for buying was to be able to sell as soon as home prices rose sufficiently further Just as vast numbers of houses were purchased based on an unfounded belief in an endless rise in their prices so too vast numbers of complex financial derivatives were sold based on an unfounded belief that the Federal Reserve System actually had the power it claimed to have of making depressions impossible a power which the media and most of the economics profession repeatedly affirmed Derivatives have received such a bad press that it is necessary to point out that the insurance policy on a home is a derivative And many of the derivatives that were sold and which are now creating problems of insolvency and bankruptcy namely credit default swaps CDSs were insurance policies in one form or another Their flaw was that unlike ordinary homeowners insurance they did not have a sufficient list of exclusions Homeowners policies make exclusions for such things as damage caused by war and in many cases depending on the special risks of the local area earthquakes and hurricanes In the same way the more complex derivatives should have made an exclusion for losses resulting from financial collapse brought on by Federal Reserve sponsored massive credit expansion If it is impossible actually to write such an exclusion because many of the losses may occur before the nature of the cause becomes evident then such derivatives should not be written and the market will no longer write them because of the unacceptable risks they entail But decades of brainwashing by the government the media and the educational system had convinced almost everyone that such collapse was no longer possible Belief in the impossibility of depressions played the same role in the creation and sale of collateralized debt obligations CDOs Here disparate home mortgages were bundled together and securities were issued against them In many cases large buyers bundled together collections of such securities and issued further securities against those securities As more and more homeowners have defaulted on their loans the result has been that no one is able directly to judge the value of these securities To do so it will be necessary to disentangle them down to the level of the underlying individual mortgages Such tangles of securities could never have been sold in a market not overwhelmed by the propaganda that depressions are impossible under the government s management of the financial system Finally a discussion of the housing debacle would not be complete if it did not include mention of forms of virtual extortion that served to encourage loans to unworthy borrowers Thus the online encyclopedia Wikipedia writes The Community Reinvestment Act CRA is a United States federal law designed to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities including low and moderate income neighborhoods CRA regulations give community groups the right to comment or protest about banks on compliance with CRA Such comments could help or hinder banks planned expansions The meaning of these words is that the Community Reinvestment Act gives the power to community groups to determine in an important respect the financial success or failure of a bank Only if they are satisfied that the bank is making sufficient loans to borrowers to whom it would otherwise choose not to lend will it be permitted to succeed The most prominent such community group is ACORN Part and parcel of the environment that has made an act such as the CRA possible is threats of slander against banks for being racist if they choose not to make loans to people who are poor credit risks and also happen to belong to this or that minority group The threats of slander go hand in glove with intimidation from various government agencies that exercise discretionary power over the banks and are in a position to harm them if they do not comply with the agencies wishes The same points apply to mortgage lenders other than banks What this extensive analysis of the actual causes of our financial crisis has shown is that it is government intervention not a free market or laissez faire capitalism that is responsible in every essential respect The Laissez Faire Myth and the Marxism of the Media The myth that laissez faire exists in the present day United States and is responsible for our current economic crisis is promulgated by people who know practically nothing whatever of sound rational economic theory or the actual nature of laissez faire capitalism They espouse it despite or rather because of their education at the leading colleges and universities of the country When it comes to matters of economics their education has steeped them entirely in the thoroughly wrong and pernicious doctrines of Marx and Keynes In claiming to see the existence of laissez faire in the midst of such massive government interference as to constitute the very opposite of laissez faire they are attempting to rewrite reality in order to make it conform with their Marxist preconceptions and view of the world They absorb the doctrines of Marx more in history philosophy sociology and literature classes than in economics classes The economics classes while usually not Marxist themselves offer only highly insufficient rebuttal of the Marxist doctrines and devote almost all of their time to espousing Keynesianism and other less well known anti capitalistic doctrines such as the doctrine of pure and perfect competition Very few of the professors and their students have read so much as a single page of the writings of Ludwig von Mises who is the preeminent theorist of capitalism and knowledge of whose writings is essential to its understanding Almost all of them are thus essentially ignorant of sound economics When I refer to the educational system and the media as Marxist I do not intend to imply that its members favor any kind of forcible overthrow of the United States government or are necessarily even advocates of socialism What I mean is that they are Marxists insofar as they accept Marx s views concerning the nature and operation of laissez faire capitalism They accept the Marxian doctrine that in the absence of government intervention the self interest the profit motive the unbridled greed of businessmen and capitalists would serve to drive wage rates to minimum subsistence while it extended the hours of work to the maximum humanly endurable imposed horrifying working conditions and drove small children to work in factories and mines They point to the miserably low standard of living and terrible conditions of wage earners in the early years of capitalism especially in Great Britain and believe that that proves their case They go on to argue that only government intervention in the form of pro union and minimum wage legislation maximum hours laws the legal prohibition of child labor and government mandates concerning working conditions served to improve the wage earner s lot They believe that repeal of this legislation

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