Debt limit nonsense

The sky’s the limit

Some things are stated as fact which are nothing of the kind. Right up until the Congressional deal raising the debt ceiling news anchors were parroting that without it the United States government would default. This is nonsense.

Over the next year the US government will take in around $3 trillion in taxes. The interest payments on its $16.9 trillion debt in that period are estimated at around $240 billion. As long as its income is greater than its debt repayments there is no reason whatsoever why the US government should default on those debt repayments.

It may choose to do so, deciding to anger China rather than domestic recipients of Federal money, but there is nothing automatic about it. But at some point the US government will default on somebody.

Since 2002 US government debt has risen from $6 trillion to nearly $17 trillion, a rise of 183%. Under George W. Bush it increased at $625 billion a year, and in 2008 Senator Obama was moved to declare “That’s irresponsible. It’s unpatriotic.” Under President Obama that debt has increased by $900 billion a year. It now stands at around 73% of GDP, or $131,368 for every man, woman, and child in America. Even with record low interest rates, by 2015 repayments on this debt will come to $50,000 a year for each American family [1].

And the situation is forecast to get worse. The Congressional Budget Office’s September 2013 Long-Term Budget Outlook warns that government spending is set to outstrip revenues in each of at least the next twenty-five years with the gap opening from 2% of GDP at its narrowest point in 2015 to 6.5% of GDP at its widest in 2038, “larger than in any year between 1947 and 2008”. As a result, after a slight improvement between 2014 and 2018, Federal government debt as a percentage of GDP is projected to rise from about 75% to around 100% in 2038.

The CBO identifies the drivers of this increased spending and debt as “increasing interest costs and growing spending for Social Security and the government’s major health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and subsidies to be provided through health insurance exchanges)”. Spending on the “major health care programs and Social Security”, the CBO writes, “would increase to a total of 14 percent of GDP by 2038, twice the 7 percent average of the past 40 years” and “The federal government’s net interest payments would grow to 5 percent of GDP, compared with an average of 2 percent over the past 40 years”.

The CBO’s conclusion is stark; “Unless substantial changes are made to the major health care programs and Social Security, those programs will absorb a much larger share of the economy’s total output in the future than they have in the past”. Sadly for the taxpayers of 2038 these are just the changes President Obama and Congressional Democrats steadfastly refuse to consider.

But a refusal to see reality doesn’t make that reality go away. These sorts of figures are unprecedented in peacetime and unsustainable and as the saying goes, ‘If something can’t continue it won’t’. The essential problem is that the US government, as with other western governments, has made spending commitments its tax base cannot support. And a promise that can’t be kept won’t be kept. Drastic change will come to Medicare, Medicaid, and Social Security, not because of ‘evil’ or ‘heartless’ Republicans, but because of math, because there isn’t the money to pay for them.

The desperately sad truth is that Uncle Sam won’t keep his current promise to pay pensions, pay for medical care for the poor or the elderly at a given level because he won’t be able to. This will amount to defaulting on elderly and sick Americans, the only question is whether it happens through some entitlement reform (whether the Democrats want it or not) or through meeting these commitments with devalued dollars (over to you Janet Yellen). Either way, if ‘default’ means a repudiation of a promise of payment this will be America’s default. The US government has a choice about ‘default’ now, it won’t in the future.

[1] The Telegraph, 8 October 2013.

This article originally appeared at The Cobden Centre

Motown breaks down

The 2,500 seat Eastown Theatre hosted The Who and The Kinks. The Cass Tech High School taught Diana Ross and John DeLorean. Michigan Central Station, almost 100 feet long, 230 feet wide, and graced with 14 grand marble pillars, once had Franklin Roosevelt, Charlie Chaplin, and Thomas Edison pass along its platforms.

Nowadays these buildings are just three of the 78,000 abandoned and blighted structures in Detroit. Reminders of a bygone golden age, the authorities can’t afford to demolish them.

The decline and fall of Detroit, which recently filed for bankruptcy, is a staggering tale. In 1950 Detroit was home to 1,849,568 people, hundreds of thousands of them working in the booming motor industry. In 1955 80% of the planet’s cars were made in America, 40% by Detroit-based General Motors alone. GM’s German subsidiary, Opel, was only a little smaller than the largest non-American car maker, Volkswagen. And Toyota only built 23,000 cars that year compared to GM’s 4 million. In the 1950s the Detroit area had the highest median income and highest rate of home ownership of any major American city.

But as they grew together, so they died together. Between 1955 and 2000 global car production increased by 273% but the US motor industry saw little of that action, increasing its output by just 39%. Even at home, despite a hastily erected wall of tariffs and quotas, US car companies lost market share; between 1970 and 2000 Japanese car companies’ share of sales in the US rose from less than 5% to 30%. In the same period the share of US car manufacturers fell from 86% to a little over 50%.

The reason was productivity. In 2005 the average Toyota worker produced 16% more cars than the average GM worker and a staggering 128% more than the average worker at Daimler/Chrysler. Toyota made a profit of $12.5 billion, GM a loss of $10.9 billion.

In part as a result of the demise of the motor industry, less than half of Detroit’s over 16s are now employed. And as the jobs disappeared so did the workforce. In 2010 the population was down to 713,777, a fall of 61% in 60 years.

But the city’s government was left with the spending commitments and liabilities it had incurred in the not-so-bad times. One half of Detroit’s $18 billion debt is made up of pension and healthcare spending commitments to city employees. The share of city revenues being spent on debt servicing, pensions, and retiree healthcare has risen from 30% in 2010 to 40% today. It is forecast to rise to 65% by 2017.

The city tried to fund these commitments with higher taxes. Detroit imposes a per capita tax burden on its residents 80% higher than neighbouring Dearborn even though its residents have a per capita income 33% lower. Detroit residents face the highest property tax rates of any similarly sized city in Michigan, but with 3 bed, all brick, colonial houses on the market for under $10,000 many don’t bother paying. Nearly a third of property tax owed in Detroit went uncollected in 2011.

So Detroit slashed spending, even on ‘core’ functions of government. 40% of streetlights don’t work and aren’t being repaired. Last winter just 10 to 14 of the city’s 36 ambulances were in service at any time, some with enough miles on the clock to have circled the planet 10 times. In February, Detroit fire fighters were told not to use hydraulic ladders unless there is an “immediate threat to life” because they hadn’t been inspected in years.

But even with this, spending commitments without the tax base necessary to fund them have caused Detroit to add $700 million to its debt in the last seven years and brought it to bankruptcy. This is a real American horror story.

Is the death of Detroit “just one of those things” as Paul Krugman wrote on Monday? Or are there lessons to be drawn for the rest of us?

The essential problem of Detroit, that for decades its leaders have been writing cheques their tax base can’t cash, is true now to varying degrees of all western governments facing ageing populations. As I wrote elsewhere late last year

America’s unfunded liabilities (including Medicare, Medicaid and Social Security), rose by $11 trillion last year to $222 trillion. To put that in context, the entire US economy is just $15 trillion, of which $3 trillion a year is paid in tax. If you expropriated all the wealth of the richest 400 Americans…the $1.7 trillion you would get wouldn’t make a dent.

In Britain the Office of Budget Responsibility reported last week that with zero migration the costs of an ageing population would push government debt up to 174% of GDP by 2062. To hold it where it is Britain would need, the OBR estimates, immigration of 260,000 people a year.

Like the ruins described by Shelley’s “traveller from an antique land” the ruins of Detroit are a warning of hubris and complacency, of the belief that it’ll never happen to us. We should heed the warning.

This article originally appeared at The Cobden Centre

Cyprus and banking

Fractional reserve joyride

This is democracy in the European Union. Last week the Cypriot parliament voted down a proposal to secure the €10 billion funding needed to bail out its crippled banks that would have imposed a one off “solidarity levy” of 6.75% on bank deposits under €100,000 and 9.9% on those over. This week the Cypriots were offered the money in return for a deal which shuts the second biggest bank and scoops up €4.2 billion from uninsured deposits and moves the insured deposits (under €100,000) to the Bank of Cyprus where deposits over the €100,000 will be taxed at 40%. The Cypriot MPs, from Churchill to Quisling in seven days, accepted.

The counterproductive stupidity of the proposal has been widely noted. It’s difficult to see how the aim of shoring up Cypriot banks which have had their capital bases ravaged by haircuts on Greek government debt will be helped by a policy which is almost certain to cause a run on those very same banks.

But the strongest reaction was moral outrage that the Cypriot government, at the behest of the troika, was considering simply helping itself to its citizen’s cash. Personally I’m unclear how this is morally different to what governments do all the time. Indeed, in the age of the welfare state, big government, and redistributive tax and spending, it has become the governments raison d’être to do exactly this day in day out.

But we shouldn’t dismiss the idea so quickly. It stems from the notion that banks act as warehouses for deposits; that we go to the bank, make a deposit, and that that deposit sits there until we go back to the bank and take it out. Of course, under a fractional reserve banking system it doesn’t work like that at all. Just like the garage attendants who took Ferris Bueller’s Ferrari for a joyride round Chicago when he left it in their care, bankers lend multiples of our deposits straight out the back door as soon as we’ve taken them in the front door. In this sense, as Detlev Schlichter points out, deposits in banks are not like sticking your money in a safe; rather they are “loans to highly leveraged businesses”

You might say that no one actually thinks on that level when they deposit their money in a bank. Well, firstly, why wouldn’t they? The very fact that a bank pays interest on deposits (however small that might currently be) should be a warning sign that they are not merely humble warehouses. Ask yourself, how many warehouses pay you for the privilege of storing your stuff? They don’t because a warehouse has operating costs; it needs a building, it needs staff. It has to charge the people who leave stuff there, its depositors, a fee to cover these expenses.

A bank also has operating expenses; it too needs the buildings and the staff and much else besides. Yet, as the bank takes in your deposits and incurs these expenses, unlike the warehouse it pays you. It must, therefore, have another source of income, and it does; the yield on its assets, assets bought with your deposits. The bank is able to pay you interest because it is accumulating assets with your cash; the bankers are taking the Ferrari for a ride. That banks pay interest on deposits proves that they are not simply warehouses.

Secondly, are we sure that people don’t act like that? As a personal example, my old flatmate’s mum had money in Northern Rock and when it hit trouble she demanded a bailout. “Why did your mum put her money into Northern Rock?” I asked “Because they offered good interest rates” she replied.

Of course they did. That’s because their funding model, lending long term at typically higher interest rates with money borrowed short term at relatively lower interest rates was, ultimately, as risky as it sounds. Many Cypriot banks were offering rates of a relatively healthy 6% or more, but then they were investing 160% of Cyprus’ GDP in Greek government bonds.

One of the first things they teach you in GCSE Business Studies is that profit is the reward for risk. The high interest rates offered by Northern Rock and the Cypriot banks were indicators that they were engaged in something relatively risky. If you choose to take that risk on then I wish you all the best, but you should not expect a taxpayer bailout when things go sour to turn your investment into a one way bet; heads I win, tails I don’t lose.

The idea that governments must bail out busted banks is rarely questioned nowadays except by those who wish to be labelled some sort of economic ‘extremist’. In his book ‘How Capitalism Will Save Us’, free marketeer Steve Forbes has four index references to Joseph Schumpeter and 14 for creative destruction including one saying that “Washington should have let GM and Chrysler reorganise under existing bankruptcy laws”. Yet he answers the question of why the bailout of Detroit was wrong and that of Wall Street right by saying “The bailout was a necessary evil to avoid a collapse of the global economy”. Capitalism will not save banking, it seems.

But government bailouts of busted banks turn the investment that depositing is under fractional reserve banking into a no lose situation. This encourages risky investing and is how shaky banks become ‘too big to fail’. Goldman Sachs and JP Morgan were bailed out five times in the 20 years before 2008 so why wouldn’t they pile into subprime mortgage debt?

What is happening in Cyprus is undoubtedly a terrible situation for all involved. But if anyone is going to stump up for the bailout of Cypriot banks, isn’t it both fair and sensible that those who do are their investors?

This article originally appeared at The Cobden Centre

Who needs jobs anyway?

Down with that sort of thing

Nick Cohen is one of my favourite writers but he really has come a cropper with his latest piece on Starbucks and its taxes for the Spectator.

He writes

In the past, right-wingers argued for lower taxes and a smaller state and left-wingers argued for higher taxes and a bigger state. Both agreed, however, that you had to pay what taxes the state set.

But that is what almost everyone still thinks. A company which doesn’t “pay what taxes the state set(s)” is engaging in tax evasion, a criminal activity, and I’m not aware of many people supporting that. Starbucks, to be clear, paid every penny of tax it was legally obliged to and if Cohen has information to the contrary he ought to contact HMRC.

If you think Starbucks should pay more tax then increase its legal obligations. This is a point of view Cohen dismisses, saying “We are not talking about a couple moving assets to keep their tax bill down, but vast corporate structures hiding money in piratical tax havens”

First, notice the loaded language. Cohen could have written “We are not talking about a couple moving assets to keep their tax bill down, but vast corporate structures moving assets to keep their tax bill down” Less emotive sure, but also more accurate and more helpful analytically.

Second, consider the thinking behind it. It’s ok when one set of people do it but when another set of people does it it’s not, that we should apply one law to one set of people but another set to others. This is a major blind spot for a man who considers himself the beleaguered tribune of a dying, liberal England.

The whole piece is an example of the moralistic guff which fogs the debate about tax in this country. One of the silliest phrases in current public policy discourse is ‘aggressive tax avoidance’, which is a little like complaining that someone is ‘aggressively’ quitting smoking when they stop as a result of the tax on cigarettes going up.

Cohen, for example, writes “A good rule of thumb in all circumstances is to ask whether you can defend your actions in public”. Actually Nick, in business that’s a pretty terrible rule of thumb. If you are wondering whether to invest or not you need information upon which to base the calculation of whether that investment will be worth it. Considering that tax is going to effect the return on investment it therefore helps to have a firm idea of what taxes are likely to be. This is why taxes are levied on the basis of laws everyone knows in advance. If we dispensed with taxes raised in this way and, instead, investors had to base their tax calculations based on “What Nick Cohen might think is fair”, well, it’s a far less quantifiable variable.

And there’s the moral question. Can a man who wrote ‘Reports from the Sickbed of Liberal England’ really be advocating the rule of man (himself) or the mob (UK Uncut) over the rule of law? Apparently so.

We have a large and persistent problem in Britain with youth unemployment. Many unemployed youths simply lack the skills to command high wages and so, until either that changes or until capital can be applied to make their labour more productive a job somewhere like Starbucks is probably the best gateway to employment. And if we want to tackle youth unemployment we ought not to be chasing these companies out of the country.

Nick Cohen gleefully instructs David Cameron to “point [Kris Engskov, Starbucks’ UK managing director] westwards, and tell him to keep going until he reaches Heathrow” and writes that “From the point of view of the Exchequer, it is a matter of supreme indifference whether Starbucks stays or goes” But it might be a matter of rather less indifference to Starbucks’ staff. Or maybe Cohen can get those unemployed baristas jobs writing for his tax efficient employers at The Guardian?

This article originally appeared at The Cobden Centre

A tale of two retailers

Spot the customer

HMV stands on the brink of extinction with 4,500 jobs at risk. The shop is a fixture of High Streets up and down the country. It will have a sentimental value for many customers who fondly remember their first album purchase. But online retailers like Amazon and iTunes, able to undercut HMV due to lower staff, property, and inventory costs, have eviscerated HMV’s customer base. In 2010 HMV generated sales of over £2 billion. Last year that was down to £932 million.

This is an excellent example of how the market process enables individuals to work to increase the prosperity of society. To the consumer, the CD purchased from HMV for £7 yields no more satisfaction than the same CD which, thanks to a leaner business model made possible by advances in technology, Amazon can sell you for £3.99. The consumer’s enjoyment of the CD is exactly the same but he or she has money left over that they wouldn’t have had if they had bought the CD from HMV. With this they can buy something else they also enjoy, good or service X or Y. Their total utility, to use the jargon, is increased.

This is not the case for everyone. HMV’s creditors and employees will suffer from this. If the credits extended to HMV represent only a small part of a creditor’s portfolio then the losses will be bearable. For the employees, on the other hand, the loss will be more profound – the greater the share of their income comes from their employment with HMV.

This example shows the market process in action very clearly. It also shows how obstacles can arise.

The utility gains from a new way of providing goods or services can be very large but, spread over society, the gain to each individual can be small (though, of course, if a number of such improvements are taking place at once the cumulative gains to each individual can be large). The losses, however, are concentrated among those who provided the goods or services the old way.

There is an asymmetry here. If the gain to each individual consumer from buying CDs from Amazon rather than HMV is, say, £50 over a year (more accurately, whatever else could be bought with that £50), but the cost to each HMV employee is £5,000 in lost wages (assuming they believe there are other jobs available but paying £5,000 less) then the employees will be incentivised and concentrated and so could agitate for measures to prevent the market process by which the new method takes their market share.

We see this in markets the world over. There are the vast subsidies to US farmers (usually big agribusiness who donate generously to political campaigns) which cost the average American family a few hundred dollars a year but form a large chunk of agricultural income. There are the associations of High Street shops who band together to prevent supermarkets opening nearby although, in that case as in others, the balance of lobbying power can lie with the new method.

Whichever side has the most power, entrenched producers or potential market entrants, doesn’t really matter, what is important is that this moves us from the market process to the political process. Producers try to win market share, not by providing a good or service at a price and quality that is more attractive than others, but by shutting others out of the market. As a rights based argument, we have moved from voluntary contracting to coercion.

As a practical argument, the non-market protection of existing producers at the expense of relatively more efficient new producers decreases the welfare of consumers which eventually decreases the welfare of producers too (insofar as they are  also consumers). The history of all human material progress is the history of increasing productivity; of getting the same output from reduced inputs or more output from the same inputs.

If Amazon or iTunes are able to put Bob Dylan on your turntable or Fritz Lang on your screen with fewer resources than HMV can – the buildings, the staff, and everything that went into producing them – then those resources are freed up to produce something else to increase our enjoyment beyond Blonde on Blonde and Metropolis; good or service X or Y.

This is how the market process enables us to live better and better. Joseph Schumpeter called the market process “creative destruction”. HMV was destroyed but Amazon was created.

This article originally appeared at The Cobden Centre

Class war, Adam Smith, and the Marginal Productivity Theory of Distribution

Father and son

There is a pleasure almost cruel in seeing someone deploy irrefutable logic to destroy an opponent’s arguments. I felt it this week reading George Reisman’s Open letter to Warren Buffett where the well booted doctrines of Karl Marx got another kicking. By now Marx and his followers ought to be used to this sort of punishment at the hands of Austrians. Eugen von Böhm Bawerk produced his devastating destruction of Marx’s economics, Karl Marx and the Close of His System, back in 1896.

But Paul Samuelson was right when he said that “Karl Marx can be regarded as a minor post-Ricardian”. Marx simply took the aggregative, labour value theory based economics of David Ricardo and took them to their dismal and erroneous conclusions. And when Reisman writes “The doctrine of class warfare is a derivative of the exploitation theory, whose best-known proponent is Karl Marx” we ought to point out that it is found also in Ricardo’s predecessor Adam Smith.

Class War in The Wealth of Nations

Book One, Chapter VIII, of The Wealth of Nations is titled ‘Of the wages of labour’.  Smith charts the development from a situation of subsistence production where “the whole produce of labour belongs to the labourer” via the emergence of private property (which gives rise to rent) and stock (which gives rise to profit) to one where a payment for a good must be divided between the labourer (wages), the landlord (rent), and the stockholder (profit).

Smith goes on to say that “It seldom happens that the person who tills the ground has wherewithal to maintain himself till he reaps the harvest. His maintenance is generally advanced to him from the stock of a master, the farmer who employs him and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit” Smith says that “The produce of almost all other labour is liable to the like deduction of profit”.

Here we have the genesis of the Marxist theory of the workers alienation from the means of production, exploitation, and ‘class war’. Workers do not receive the full product of their labour as they did in the “early and rude state of society which precedes…the accumulation of stock and the appropriation of land”. Instead, this product goes to the stockholder as profit and the labourer receives wages.

With wages, Smith states, “The workmen desire to get as much, the masters to give as little as possible”. We have Marx’s “contending classes”. Smith goes on

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily…In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him, but the necessity is not so immediate.

Smith argued that wages would rise when an economy was growing but otherwise he posited a clear general tendency for wages to feel only downward pressures. From this flowed the idea of the ‘subsistence wage’ with which Malthus earned economics the tag of “the dismal science” and Lasalle’s Iron Law of Wages. Wages will stagnate, Smith argues, and profits will rise. Warren Buffett would not disagree.

But looking at the passage from Smith we can see much wrong with it, or at least, much that has no application today.

First, Smith says that stockholders are “fewer in number” than labourers and thus have a kind of oligopoly power. The error here, perhaps less when Smith was writing, is to regard labour as homogeneous. It isn’t. Skills, like capital, can be specific to a certain role and, thus non-transferable. Just as a “tractor is not a hammer”, Joleon Lescott is not Mariah Carey. You wouldn’t consider putting Mariah Carey on Darren Bent at corners and you probably wouldn’t want to hear Joleon Lescott sing Without You.

It follows that workers with different skills are not substitutes for one another; they are not, in other words, in competition. No brain surgeon ever accepted a lower wage from the fear that the hospital might hire a juggler instead.

Of course, where labour is unskilled it is homogeneous and we would expect to see the increased competition for jobs and resultant low wages which we do. At this skill level, also, capital can be substituted for labour providing a further downward pressure. The answer here is not to raise the banner of class warfare but to accumulate skills.

Second, Smith says that stockholders “can combine much more easily”. However, in practical experience, such cartels are always plagued with problems as we see with OPEC. If a cartel sets a minimum price there is always the temptation for one member to sell below that price and capture the market. Although here we are considering the case where a cartel is setting a maximum price for its labour inputs, the analysis is unchanged as we shall see.

Wages and the Marginal Productivity Theory of Distribution

Thirdly, Smith contends that “In all such disputes the masters can hold out much longer”. This might well be true but the question has to be asked; why would they? If, by hiring a worker at £30,000 per year a stockholder would increase his profit by £40,000 per year, why would that stockholder hold out, throwing away £10,000, in an attempt to drive the worker down to £20,000?

It could be said that the stockholder will lose out on £10,000 this year but will gain £20,000 in every subsequent year. But Smith said that stockholders were “fewer in number”, not that there was only one, so there are those cartel problems. Thus, if, in the initial period, stockholder A is willing to forgo £10,000 and hold out for a wage of £20,000 stockholder B will step in and offer the worker £30,000. He will make £10,000 profit while stockholder A makes nothing. There is a saying about stepping over a dollar to pick up a penny, in this case stockholder B picks up both.

Indeed, if the worker adds £40,000 to profits it makes sense for the stockholder to employ them at any wage up to that (tax wedges notwithstanding). We have arrived, as economists did after 1870, at the Marginal Productivity Theory of Distribution. This simply states that a factor (labour or capital) will be paid to the value of its marginal product.

So, if hiring a first barman generates £100 a week extra profit for a pub landlord that barman will be paid up to £100. If, however, hiring a second barman adds only £80 a week the marginal product of bar staff has fallen to £80 a week and so will the wage even of the first. If hiring a third barman adds just £50 a week and no one will take the job at that wage no one else will be hired and £80 a week will be the wage.

Of course, if there are two barmen earning £80 a week one could go on a cocktail course. His mojito’s might prove a draw, his marginal product will rise and so will his wage. By doing the course, ‘upskilling’, the first barman is differentiating his labour from that of barman two. Their labour is heterogeneous.

Smith himself saw a situation where in a growing economy, one in which the profits of stockholders were increasing, demand for labour would also increase. In this case “The scarcity of hands occasions a competition among masters, who bid against one another, in order to get workmen, and thus voluntarily break through the natural combination of masters not to raise wages”.

However, as we’ve seen, because of heterogeneity on both the labour (due to non-transferable skills) and stockholder (due to cartel issues) sides of the wage bargain it is this which is the general case and not the previously enunciated tendency for wages to fall and profits to rise. Because some ‘hands’ are skilled at some things and other ‘hands’ at other things there is at any given time a “scarcity of hands” in any profession requiring a modicum of skill. And because we have a number of potential “masters” we have at any given time “competition among” them.

Both profits and wages can rise together and the zero sum thinking of Marx and Buffett can be discounted. But Adam Smith’s role in this thinking should not be forgotten either.

This article first appeared at The Cobden Centre

The euro – lessons from history

Dinner money

When currencies and monetary arrangements have broken down it has always been because the currency issuer can no longer fight the lure of the seigniorage to be gained by over issue of the currency. In the twentieth century this age-old impulse was allied to new theories that held that economic downturns were caused or exacerbated by a shortage of money. It followed that they could be combated by the production of money.

Based on the obvious fallacy of mistaking nominal rises in wealth for real rises in wealth, this doctrine found ready support from spendthrift politicians who were, in turn, supported by the doctrine.

Time and again over recent history we see the desire for seigniorage allied with the cry for more money to fight a downturn pushing up against the walls of the monetary architecture designed to protect the value of the currency. Time and again we see the monetary architecture crumble.

The classical gold standard

At the start of the twentieth century much of the planet and its major economic powers were on the gold standard which had evolved from the 1870s following Britain’s lead. This was based on the twin pillars of (1) convertibility between paper and gold and (2) the free export and import of gold.

With a currency convertible into gold at a fixed parity price any monetary expansion would see the value of the currency relative to gold decline which would be reflected in the market price. Thus, if there was a parity price of 1oz gold = £5 and a monetary expansion raised the market price to 1oz = £7, it would make sense to take a £5 note to the bank, swap it for an ounce of gold and sell it on the market for £7.

The same process worked in reverse against monetary contractions. A fall in the market price to 1oz = £3 would make it profitable to buy an ounce of gold, take it to the bank and swap it for £5.

In both cases the convertibility of currency into gold and vice versa would act against the monetary expansion or contraction. In the case of an expansion gold would flow out of banks forcing a contraction in the currency if banks wished to maintain their reserve ratios. Likewise a contraction would see gold flow into banks which, again, in an effort to maintain their reserve ratios, would expand their issue of currency.

The gold standard era was one of incredible monetary stability; the young John Maynard Keynes could have discussed the cost of living with Samuel Pepys without adjusting for inflation. The minimisation of inflation risk and ease of convertibility saw a massive growth in trade and long term cross border capital flows. The gold standard was a key component of the period known as the ‘First era of globalisation’.

The judgement of economic historians Kenwood and Lougheed on the gold standard was

One cannot help being impressed by the relatively smooth functioning of the nineteenth-century gold standard, more especially when we contemplate the difficulties experienced in the international monetary sphere during the present century. Despite the relatively rudimentary state of economic knowledge concerning internal and external balance and the relative ineffectiveness of government fiscal policy as a weapon for maintaining such a balance, the external adjustment mechanism of the gold standard worked with a higher degree of efficiency than that of any subsequent international monetary system

The gold exchange standard and devaluation

The First World War shattered this system. Countries printed money to fund their war efforts and convertibility and exportability were suspended. The result was a massive rise in prices.

After the war all countries wished to return to the gold standard but were faced with a problem; with an increased amount of money circulating relative to a country’s gold stock (a problem compounded in Europe by flows of gold to the United States during the war) the parity prices of gold were far below the market prices. As seen earlier, this would lead to massive outflows of gold once convertibility was re-established.

There were three paths out of this situation. The first was to shrink the amount of currency relative to gold. This option, revaluation, was that taken by Britain in 1925 when it went back onto the gold standard at the pre-war parity.

The second was that largely taken by France between 1926 and 1928. This was to accept the wartime inflation and set the new parity price at the market price.

There was also a third option. The gold stock could not be expanded beyond the rate of new discoveries. Indeed, the monetary stability which was a central part of the gold standard’s appeal rested on the fixed or slow growth of the gold stock which acted to halt or slow growth in the currency it backed. So many countries sought to do the next best thing and expand gold substitutes to alleviate a perceived shortage of gold. This gave rise to the gold exchange standard which was put forward at the League of Nations conference in Genoa in 1922.

Under this system countries would be allowed to add to their gold reserves the assets of countries whose currency was convertible into gold and issue domestic currency based on this expanded stock. In practice the convertible currencies which ‘gold short’ countries sought as reserves were sterling and dollars.

The drawbacks were obvious. The same unit of gold could now have competing claims against it. The French took repeated advantage of this to withdraw gold from Britain.

Also it depended on the Bank of England and Federal Reserve maintaining the value of sterling and the dollar. There was much doubt that Britain could maintain the high value of sterling given the dire state of its economy and the dollar was weakened when, in 1927, the Federal Reserve lowered interest rates in order to help ease pressure on a beleaguered sterling.

This gold exchange standard was also known as a ‘managed’ gold standard which, as Richard Timberlake pointed out, is an oxymoron. “The operational gold standard ended forever at the time the United States became a belligerent in World War I”, Timberlake writes.

After 1917, the movements of gold into and out of the United States no longer even approximately determined the economy’s stock of common money.

The contention that Federal Reserve policymakers were “managing” the gold standard is an oxymoron — a contradiction in terms. A “gold standard” that is being “managed” is not a gold standard. It is a standard of whoever is doing the managing. Whether gold was managed or not, the Federal Reserve Act gave the Fed Board complete statutory power to abrogate all the reserve requirement restrictions on gold that the Act specified for Federal Reserve Banks (Board of Governors 1961). If the Board had used these clearly stated powers anytime after 1929, the Fed Banks could have stopped the Contraction in its tracks, even if doing so exhausted their gold reserves entirely.

This was exacerbated in the United States by the Federal Reserve adopting the ‘real bills doctrine’ which held that credit could be created which would not be inflationary as long as it was lent against productive ‘real’ bills.

Many economists, notably Ludwig von Mises and Friedrich von Hayek, have seen the genesis of the Depression of the 1930s in the monetary architecture of the 1920s. While this remains the most debated topic in economic history there is no doubt that the Wall Street crash and its aftermath spelled the end of the gold exchange standard. When Britain was finally forced to give up its attempt to hold up sterling and devalue in 1931 other countries became worried that its devaluation, by making British exports cheaper, would give it a competitive advantage. A round of ‘beggar thy neighbour’ devaluations began. Thirty two countries had gone off gold by the end of 1932 and the practice continued through the 1930s.

Bretton Woods and its breakdown

Towards the end of World War Two economists and policymakers gathered at Bretton Woods in New Hampshire to design a framework for the post war economy. Looking back it was recognised that the competitive devaluations of the 1930s had been a driver of the shrinkage of international trade and, via its contribution to economic instability, to deadly political extremism.

Thus, the construction of a stable monetary framework was of the most utmost importance. The solution arrived at was to fix the dollar at a parity of 1oz = $35 and to fix the value of other currencies to the dollar. Under this Bretton Woods system currencies would be pegged to gold via the dollar.

For countries such as Britain this presented a problem. Any attempt to use expansionary fiscal or monetary policy to stimulate the economy as the then dominant Keynesian paradigm prescribed would eventually cause a balance of payments crisis and put downward pressure on the currency, jeopardising the dollar value of sterling. This led to so called ‘stop go’ policies in Britain where successive governments would seek to expand the economy, run into balance of payments troubles, and be forced to deflate. In extreme circumstances sterling would have to be devalued as it was in 1949 from £1 = $4.03 to £1 = $2.80 and 1967 from £1 = $2.80 to £1 = $2.40.

A similar problem eventually faced the United States. With the dollar having replaced sterling as the global reserve currency, the United States was able to issue large amounts of debt. Initially the Federal Reserve and Treasury behaved reasonably responsibly but in the mid-1960s President Lyndon Johnson decided to spend heavily on both the war in Vietnam and his Great Society welfare program. His successor, Richard Nixon, continued these policies.

As dollars poured out of the United States, investors began to lose confidence in the ability of the Federal Reserve to meet gold dollar claims. The dollar parity came under increasing pressure during the late 1960s as holders of dollar assets, notably France, sought to swap them for gold at the parity price of 1oz = $35 before what looked like an increasingly inevitable devaluation. Unwilling to consider the deflationary measures required to stabilise the dollar with an election due the following year, President Nixon closed the gold window on August 15th 1971. The Bretton Woods system was dead and so was the link between paper and gold.

Fiat money and floating exchange rates

There were attempts to restore some semblance of monetary order. In December 1971 the G10 struck the Smithsonian Agreement which sought to fix the dollar at 1oz = $38 but this broke down within a few months under the inflationary tendencies of the Federal Reserve. European countries tried to establish the ‘snake’, a band within which currencies could fluctuate. Sterling soon crashed out of even this under its own inflationary tendencies.

The cutting of any link to gold ushered in the era of fiat currency and floating exchange rates which lasts to the present day. Fiat currency gets its name because its value is given by governmental fiat, or command. The currency is not backed by anything of value but by a politicians promise.

The effect of this was quickly seen. In 1931 Keynes had written that “A preference for a gold currency is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now” But, as D R Myddelton writes, “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

In 1976 the pound fell below $2 for the first time ever. Pepys and Keynes would now have been talking at cross purposes.

Floating exchange rates marked the first public policy triumph for Milton Friedman who as long ago as 1950 had written ‘The Case for Flexible Exchange Rates’. Friedman had argued that “A flexible exchange rate need not be an unstable exchange rate” but in an era before Public Choice economics he had reckoned without the tendency of governments and central banks, absent the restraining hand of gold, to print money to finance their spending. World inflation which was 5.9% in 1971 rose to 9.6% in 1973 and over 15% in 1974.

The experience of the era of floating exchange rates has been of one currency crisis after another punctuated by various attempts at stabilisation. The attempts can involve ad hoc international cooperation such as the Plaza Accord of 1985 which sought to depreciate the dollar. This was followed by the Louvre Accord of 1987 which sought to stop the dollar depreciating any further.

They may take more organised forms. The Exchange Rate Mechanism was an attempt to peg European currencies to the relatively reliable Deutsche Mark. Britain joined in 1990 at what many thought was too high a value (shades of 1925) and when the Bundesbank raised interest rates to tackle inflation in Germany sterling crashed out of the ERM in 1992 but not before spending £3.3 billion and deepening a recession with interest rates raised to 12% in its vain effort to remain in.

Where now?

This brief look back over the monetary arrangements of the last hundred years shows that currency issuers, almost always governments, have repeatedly pushed the search for seigniorage to the maximum possible within the given monetary framework and have then demolished this framework to allow for a more ‘elastic’ currency.

Since the demise of the ERM the new vogue in monetary policy has been the independent central bank following some monetary rule, such as the Bank of England and its inflation target. Inspired by the old Bundesbank this is an attempt to take the power of money creation away from the politicians who, despite Keynes’ high hopes, have proved themselves dismally untrustworthy with it. Instead that power now lies with central bankers.

But it is not clear that handing the power of money creation from one part of government to another has been much of an improvement. For one thing we cannot say that our central bankers are truly independent. The Chairman of the Federal Reserve is nominated by the President. And when the Bank of England wavered over slashing interest rates in the wake of the credit crunch, the British government noisily questioned its continued independence and the interest rate cuts came.

Furthermore, money creation can reach dangerous levels if the central bank’s chosen monetary rule is faulty. The Federal Reserve has the awkward dual mandate of promoting employment and keeping prices stable. The Bank of England and the European Central Bank both have a mandate for price stability, but this is problematic. As Murray Rothbard and George Selgin have noted, in an economy with rising productivity, prices should be falling. Also, what ‘price level’ is there to stabilise? The economy contains countless different prices which are changing all the time; the ‘price level’ is just some arbitrarily selected bundle of these.

An extreme example, as noted by Jesús Huerta de Soto, is the euro. Here a number of governments agreed to pool their powers of money creation and invest it in the European Central Bank. The euro is now widely seen to be collapsing. So it may be, but is this, as is generally assumed, a failure of the architecture of the euro itself?

Let us remember that the purpose of erecting a monetary structure where the power to create money is removed from government is to stop the government running the printing presses to cover its spending and, in so doing, destroy the currency.

The problem facing eurozone states like Greece and Spain is presented as being that they are running up debts in a currency they cannot print at will to repay these debts. But is the problem here that these countries cannot print the money they need to pay their debts or that they are running up these debts in the first place? The solution is often offered that either these countries need to leave the euro and adopt a currency which they can expand sufficiently to pay their debts or that the ECB needs to expand the euro sufficiently for these countries to be able to pay their debts. But there is another solution, commonly called ‘austerity’, which says that these countries should just not run up these debts. As de Soto argues, the euro’s woes are really failures of fiscal policy rather than monetary policy.

It is thus possible to argue that the euro is working. By halting the expansion of currency to pay off debts and protecting its value and, by extension, preventing members from running up evermore debt, the euro is doing exactly what it was designed to do.

There is a growing clamour inside Europe and outside that ‘austerity’ alone is not the answer to the euro’s problems and that monetary policy has a role to play. The ECB itself seems to be keen to take on this role. But it is simply the age-old idea, based on the confusion between the real and the nominal, that we will get richer if we just produce more money. Germany is holding the line on the euro but history shows that far sounder currency arrangements have collapsed under the insatiable desire for a more elastic currency.


ANDERSON, B.M. 1949. Economics and the Public Welfare – A Financial and Economic History of the United States 1914-1946. North Shadeland, Indiana: Liberty Press

BAGUS, P. 2010. The Tragedy of the Euro. Auburn, Alabama: Ludwig von Mises Institute.

CAPIE, F., WOOD, G. 1994. “Money in the Economy 1870-1939.” The Economic History of Britain since 1700 vol. 2: 1860-1939. Roderick Floud and D.N. McCloskey, ed. Cambridge: Cambridge University Press, pp. 217-246.

DRUMMOND, I. 1987. The Gold Standard and the International Monetary System 1900-1939. London: Macmillan

FRIEDMAN, M. 1950. “The Case for Flexible Exchange Rates” Essays in Positive Economics. 1953. Friedman, M. Chicago: University of Chicago Press, pp. 157-203.

HOWSON, S. 1994. “Money and Monetary Policy in Britain 1945-1990.” The Economic History of Britain since 1700 vol. 3: 1939-1992. Roderick Floud and D.N. McCloskey, ed. Cambridge: Cambridge University Press, pp. 221-254.

HUERTA DE SOTO, J. 2012. “In defence of the euro: an Austrian perspective”. The Cobden Centre, May 29th

KENWOOD, A.G., LOUGHEED, A.L. 1992. The Growth of the International Economy 1820-1990. London and New York: Routledge

KINDLEBERGER, C.P. The World in Depression 1929-1939. London: Pelican

MYDDELTON, D.R. 2007. They Meant Well – Government Project Disasters. London: Institute of Economic Affairs

ROTHBARD, M. 1963. America’s Great Depression. BN Publishing

SAMUELSON, R.J. 2010. The Great Inflation and its Aftermath – The Past and Future of American Affluence. New York: Random House

SELGIN, G. 1997. Less Than Zero – The Case for a Falling Price Level in a Growing Economy. London: Institute of Economic Affairs

TIMBERLAKE, R. 2008. “The Federal Reserve’s Role in the Great Contraction and the Subprime Crisis”. Cato Journal, Vol. 28, No. 2 (Spring/Summer 2008), James A. Dorn, ed. Washington DC: Cato Institute, pp. 303-312.

VAN DER WEE, H. 1986. Prosperity and Upheaval – The World Economy 1945-1980. London: Pelican

This article originally appeared at The Cobden Centre

As easy as ABCT

Wise guys

In economics as with medicine any cure must begin with a sound diagnosis. But if economists were doctors the patient would have died on the table. Despite its pretensions to scientific exactitude, the discipline has offered a bewildering array of diagnoses; the doctors still arguing.

Some diagnoses can be ruled out. The Marxist theory of economic cycles with its declining rate of profit is clearly useless; businesses were making record profits on the eve of the bust. There was no shock to Total Factor Productivity which a Real Business Cycle explanation would require. Keynesian ‘animal spirits’ are also unsatisfactory. The flight from mortgage backed assets was a totally rational response to the Federal Reserve raising interest rates between 2004 and 2007.

But there is another diagnosis which fits the symptoms quite well; Austrian Business Cycle Theory (ABCT), so called because it grows out of the Austrian School of economics founded in Vienna by Carl Menger in the nineteenth century. It describes the causes and course of the current crisis better than any other theory and offers some insights in to what lies ahead.

ABCT starts with the idea that the interest rate is a price like any other matching the supply of something to the demand for it. Funds for investment are supplied (via saving); savings are demanded (for investment). If people cut back on current consumption and save more to increase future consumption then the interest rate falls and firms are able to borrow more to invest in the means to supply that future consumption. And when people begin drawing down their savings to fund current consumption the interest rate rises and firms cut back on investing for future consumption.

The key insight is that the interest rate is a real phenomenon. As the Austrian School economist Eugen von Böhm-Bawerk put it, it reflects the ‘time preference’ of economic agents, the value they place on consumption of something now compared to the value they place on consumption of the same thing at some given point in the future. The interest rate reflects the compensation/incentive for abstinence on the part of the saver.

But in the real world we have central banks. In response to something like the bursting of the dot com bubble the Federal Reserve can lower interest rates, as it did in that instance, from 6.25% to 1.75% over the course of 2001.

However, the interest rate is not falling because of increased saving (or decreasing time preference), rather it is being forced down artificially by the expansion of credit; the creation of phony capital in other words.

As interest rates fall firms see ever more marginal investment opportunities becoming profitable. They borrow and undertake them. A boom is underway.

But eventually the inflation caused by this credit expansion starts to show even in the central bank’s cooked figures as when inflation went above 4% in the US in 2006. Interest rates are raised; the Fed Funds rate went above 5% the same year. Those marginal investments that looked viable at 1% are now scuppered.

This is the bust. All the enterprises undertaken in the expectation of catering for the demand for future consumption indicated by low interest rates discover that there is, in fact, no such demand. There never was. They are revealed as ‘malinvestments’, with no hope of ever producing a return above their borrowing costs unless interest rates are kept artificially low and cheap credit is kept flowing.

The recession is not some mysterious collapse in aggregate demand which can be stopped with a dose of government spending. It is the liquidation of these unviable credit positions and it will not be over until this process is complete.

The Austrian School economist Ludwig von Mises wrote

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved

This is the Austrian choice; recognize the liquidation and allow zombie banks to collapse and stop soaking up scarce capital so we can get the recovery going or keep putting it off with more monetary and fiscal stimulus. And, as another Austrian Schooler, Friedrich von Hayek, warned,

The magnitude of unemployment caused by a cessation of inflation will increase with the length of the period during which such policies are pursued

True, this is a grim prospect, but that matters less than whether it’s correct. Anyone who says there is a third option, a painless way out which can be found simply by ticking a different box on a ballot paper, truly is peddling snake oil.

This article originally appeared at The Cobden Centre

More regulation is not a good thing

Courtesy of the Financial Times

A common interpretation of the credit crunch and ensuing global turmoil is that it was all down to unregulated or under-regulated financial institutions and markets. As a result, one of the most commonly advanced solutions is for more and/or better regulation. Indeed, this call is about as close as we get to a firm demand from the presently fashionable ‘occupy’ protests.

There are many things wrong with this view. First, the underlying causes of the recent boom and bust could be found, as so often, in monetary disturbances. In comparison to the damage wrought by a deluge of credit, any regulatory deficiencies are just hundreds and thousands atop a cake that was always going to turn out pretty sour.

Secondly, nothing says ‘profit opportunity’ to financial institutions quite like some new financial regulation. To give just one of countless examples, the Eurodollar market sprang into life thanks to attempts like Regulation Q to impose limits on interest rates. The financial innovators will only ever be one step behind the regulators for as long as it takes them to read the regulation. Then they streak ahead.

And thirdly, it is a mistake to think that financial markets were notably under-regulated. After redesigning British financial regulation almost from scratch, the Labour government never ceased tinkering with it. As Terry Arthur and Philip Booth wrote recently (PDF)

To obtain permission to carry out regulated activities an organisation must meet certain qualifying conditions. These include having adequate resources (financial resources as well as internal systems and procedures). The conditions are laid out in the FSA’s Integrated Handbook…Regulation is bureaucratic in the extreme. It is no longer possible to determine the number of pages in the handbook, but an indication is given by the following example. There are ten main sections in the book. One of those main sections…is that on ‘Listing, prospectus and disclosure’. This contains three subsections which have between nine and 23 sub-subsections each. Taking one of those sub-subsections, under the ‘Listing rules’, there are six sub-sub-subsections

Fortunately we can look at the economic impact of regulation worldwide with the release by the International Finance Corporation of the World Bank of its annual ‘Doing Business’ report which compares regulatory environments and the ease of doing business across countries. The reports message is unequivocal; regulation is mostly bad and those calling for more of it are calling for economic suicide.

A report on the report by The Economist picked out some notably egregious examples

A typical company in Congo with a gross profit margin of 20% faces a tax bill equivalent to 340% of profits…How long, for example, does it take to register a company? In New Zealand it takes one day and costs 0.4% of the local annual income per head. In Congo it takes 65 days, involves ten steps and costs 551% of income per head…Other procedures the IFC measures include registering a property (which takes one day in Portugal, 513 in Kiribati); obtaining a construction permit (five steps in Denmark, 51 in Russia); enforcing a simple contract through the courts (150 days in Singapore, 1,420 in India); and winding up an insolvent firm (creditors in Japan recover 92.7 cents on the dollar, those in Chad get nothing at all)…A young entrepreneur in Liberia who builds a new warehouse must wait on average 586 days to connect it to the power grid. In Ukraine it takes 274 days; in Germany only 17. Guess which of these countries has a thriving manufacturing sector?”

The chart below illustrates the point

Source: ‘Doing Business 2010′ (PDF) and International Monetary Fund ‘World Economic Outlook Database’ – Puerto Rico, Palau, the Marshall Islands, Micronesia and West Bank and Gaza are omitted for lack of a comparable data point

We see that while a light regulatory environment is not a guarantee of wealth, it is a necessary precondition. Not surprisingly, The Economist sees a causal relationship

Cutting red tape makes countries richer, if the 873 peer-reviewed articles and 2,332 working papers that use the “Doing Business” data are anything to go by. A study in Mexico found that simplified municipal licensing led to a 5% increase in the number of registered companies and a 2.2% increase in jobs. It also lowered prices for consumers. Bankruptcy reform in Brazil caused the cost of credit to fall by 22%. Countries with flexible labour rules saw real output rise by 17.8% more than those with rigid ones”

Calls for more regulation are both pointless and dangerous; pointless in that it won’t solve the undoubted problems in our present economic system and dangerous in that it could end up making us even worse off. More regulation is not the answer.

This article originally appeared at The Cobden Centre

Why mathematics and modeling should not be equated with economics and human action

A long way from the pin factory

A very intelligent friend of mine of markedly different political persuasions said the other day that he avoided “technical economic arguments” with me as I’ve just graduated with a degree in economics. I was rather sad to hear this.

The simple truth is that after doing a module called, say, ‘Introduction to Economic Principles and Policy’, you will not study very much more which will add greatly to your understanding of the subject. Beyond that, in an ‘Intermediate Microeconomics’ course for example, you are simply ladling mostly unnecessary algebra onto the subject.

Take this from a course in ‘Intermediate Macroeconomics’ for example:

This is actually some of the more accessible math involved in modern economics. Furthermore, the concepts it is dealing with, constant returns to scale and the per worker production function, are pretty straightforward. Yet many, including almost all university economics lecturers, will tell you that this is economics. It is, in fact, simply applied algebra – mathematics looking for a real world application. Economists eager to give their art the patina of science and mathematicians searching for real world relevance have combined to render economics impenetrable.

This trend also stems from the view of economics as the study of a mechanism. People may now laugh at the model of the economy A.W. Phillips built in the basement of the London School of Economics in 1949 with its gurgling pipes full of different coloured liquids representing money literally sloshing around an economy controlled by sluice gates. But it isn’t conceptually different from the computerised models that are in use today guiding research and government policy.

These models often fail. If your model is based on erroneous assumptions, such as the creation of phantom capital called Quantitative Easing actually stimulating an economy, you will get erroneous outputs; Garbage In Garbage Out as they say. But there is a more fundamental problem. There is no exogenous ‘thing’ called ‘The Economy’ which can be quantified and controlled, there is only each of us doing what we do every day. That is why Ludwig von Mises called his great treatise on economics ‘Human Action’. Or as Friedrich von Hayek rapped recently “The economy’s not a car. There’s no engine to stall. No experts can fix it. There’s no “it” at all. The economy is us”.

It is little wonder that even intelligent people feel themselves cowed and run in terror from the thicket of abstraction that shrouds modern economics. It needn’t be like this. The great works of the discipline, those of Adam Smith or Carl Menger for example, managed to lay the foundations of the subject without it.

And it is sad that people like my friend feel put off because the economy affects all of us and, to return to the point made by the rapping Hayek, it is the study of all of us. Given this we all have economic insights by virtue of being human beings, the very subject of economics itself. As von Mises wrote:

Economics must not be relegated to classrooms and statistical offices and must not be left to esoteric circles. It is the philosophy of human life and action and concerns everybody and everything. It is the pith of civilization and of man’s human existence.

Do not leave economics to the abstract eggheads. Pick up Economics in One Lesson by Henry Hazlitt, Free to Choose: A Personal Statement by Milton Friedman or even Eat the Rich: A Treatise on Economics by P.J. O’Rourke: writers who, in these books and others, passed the economist Armen Alchian’s test of whether they truly understood the subject – they could explain it to someone who doesn’t know a darn thing about it.

Economics is about you. It is your subject. Reclaim and enjoy it.

This article originally appeared at The Cobden Centre