Liberty Is Not Complicated - David Gordon - Mises Daily

Liberty Is Not Complicated - David Gordon - Mises Daily

What Is a Scientific Theory? - Mark R. Crovelli - Mises Daily

What Is a Scientific Theory? - Mark R. Crovelli - Mises Daily

Why We hould Cheer for Scott Walker

The claim that "this presidential election is the most important election ever" is an enduring political cliché, and it's almost always wrong. Consider this year. It's likely the 2012 race for the White House won't even be the most important contest of this year, much less of all time.

Wisconsin Gov. Scott Walker is currently the target of a recall effort spearheaded by national public employee unions. If his opponents get enough signatures by Jan. 17, Wisconsin will hold a gubernatorial election this summer. The outcome is crucial to the future of the country.
"Wisconsin has emerged as a central battleground in the fight over the outsized political role played by, and the enormous privileges enjoyed by, public employee unions." - Nick Schulz
Wisconsin has emerged as a central battleground in the fight over the outsized political role played by, and the enormous privileges enjoyed by, public employee unions. The collective bargaining entitlement enables public sector workers to extract excessive compensation, benefits, and pension packages at the expense of taxpayers.

In March, Walker signed what is now nationally famous legislation that reformed public employee collective bargaining. The bill was crucial to putting Wisconsin on a sustainable fiscal path. Public employee unions fought bitterly, albeit unsuccessfully, to block Walker's reforms. Now they are trying to recall him.

Guess what? It's working

They face a tough fight, however. While the clash over collective bargaining garnered national attention, Walker has additional accomplishments to highlight. The Milwaukee Journal Sentinel, which opposed Walker's collective bargaining reforms, recently noted, "The governor did balance the budget … he did reduce the structural deficit significantly; he did put a lid on property tax increases; he did give schools and municipalities more control over their budgets than they've had in years."

What's more, the reforms pushed by Walker are themselves already having a beneficial effect. Milwaukee Mayor Tom Barrett was Walker's opponent in the 2010 election and later attacked his proposals to reform collective bargaining. But with the reforms on the books, Barrett used some of the bill's provisions to help reduce the city's health care bill, saying that the alternative was to cut 300 to 400 city jobs.

Here's why the stakes in Wisconsin are so high. Public employee unions understand that the legitimacy of collective bargaining privileges is now in question, as cash-strapped states struggle under the burden of a costly public sector. If they can knock off Walker, they send a powerful signal to other reform-oriented governors not to target collective bargaining.

Interestingly, many labor-friendly figures have long understood that collective bargaining rights for public employees are illegitimate. "All Government employees should realize that the process of collective bargaining, as usually understood, cannot be transplanted into the public service," a pro-labor Franklin D. Roosevelt said in 1937. "It has its distinct and insurmountable limitations when applied to public personnel management."

Electing your own boss

As political scientist Daniel DiSalvo notes in a recent issue of National Affairs, "public-sector unions have significant advantages over traditional unions. For one thing, using the political process, they can exert far greater influence over their members' employers — that is, government — than private-sector unions can. Through their extensive political activity, these government-workers' unions help elect the very politicians who will act as 'management' in their contract negotiations — in effect handpicking those who will sit across the bargaining table from them … Such power led Victor Gotbaum, the leader of District Council 37 of the AFSCME in New York City, to brag in 1975: 'We have the ability, in a sense, to elect our own boss.' "

Collective bargaining reform is also needed to enable genuine education reform. The collective bargaining privilege gives teacher unions political power that is used to block reform efforts and shield K-12 education from entrepreneurial disruptions that threaten established ways of doing things.

In a recent discussion, Walker told me that "collective bargaining in the public sector is not a right; it's an expensive entitlement." The struggle to rein in and reform expensive entitlements will define American politics for the next generation. A key front line is in Wisconsin.
Nick Schulz is the DeWitt Wallace fellow at the American Enterprise Institute and editor of American.com.

Gold Price: “We’re Going to Kill the Dollar,” Senior Obama Official

Gold Price: “We’re Going to Kill the Dollar,” Senior Obama Official

John L. Chapman and John A. Allison

A Return to Gold?

© Copyright 2011 Freeman - Ideas on Liberty

 

December 2011 • Volume: 61 • Issue: 10 • Print This Post • 9 comments

“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. . . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society. . . .The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” — John Maynard Keynes
This summer marked the 40th anniversary of President Richard M. Nixon’s decision to sever the U.S. dollar’s official link to gold. On August 15, 1971, Nixon took to the airwaves in a national address from the Oval Office to declare that the U.S. Treasury would no longer honor foreigners’ demands to redeem dollars for gold. Because the United States was then the last country in the world with a currency defined by gold, it represented a complete and historic decoupling of the globe’s currencies—literally the money of the entire world—from the yellow metal.
For the first time in at least 2,700 years, dating to the Lydian coinage in what is now Turkey, gold was used as official money nowhere in the world. And for the first time ever the world’s monetary affairs were defined by a system of politically managed fiat currencies—that is, paper money run by governments or their central banks. The story behind Nixon’s catastrophic mistake, and the lessons it contains for today, suggest a framework for monetary policy and reforms that will induce strong and sustainable economic growth in the future.
It is important to understand what many current central bankers seem to have forgotten: the seminal importance of sound money—dependably valued, honest money whose value is not intentionally manipulated—as an institution in a modern exchange economy. Economies grow, and material wealth and welfare advance, through three interconnected phenomena, all of which are crucially supported by a well-functioning monetary unit: 1) efficient use of scarce resources via a system of prices and profit-and-loss, both of which encourage optimizing behavior on the part of all; 2) saving and the accumulation of capital for investment; and 3) the division of labor, specialization, and trade.
Regarding the last phenomenon, we would all be poor, and indeed most of us dead due to starvation, if we had to make and produce all our own food, housing, clothing, and other necessities and modern luxuries. As Adam Smith explained in his famous examination of a pin factory, dividing up the metal-straightening, wire-cutting, grinding, pin-head fashioning, and fastening and bundling operations into 18 separate steps increased the productivity of labor in the factory by at least 240-fold. (This of course dramatically increased productive output and raised workers’ real incomes.) And of course for society at large this specialization was not confined to single factories but spread across industries and agriculture: The baker, the butcher, the brewer, and the cobbler could all focus on their productive specialties and produce for a market wherein they could exchange with other specialists for desired goods.
Via economies of scale and scope, then, specialized production and exchange help to create a material horn of plenty for all in a society that’s felicitously based on peaceful, harmonious social cooperation. And here’s the key: None of this would be possible without a dependable monetary unit that serves as a medium for this exchange. Absent sound money, in fact, a division of labor, with all its specialized knowledge and skills, could hardly be exploited, because barter would mean that, say, a neurosurgeon would have to find a grocer who coincidentally needed brain surgery every time he wanted to obtain food. A barter society is by definition a primitive and poor one.
Similarly, the explosion in human progress in the last three centuries was propelled by the accumulation of capital, the tools, machinery, and other assets that increase per capita output and dramatically increase living standards. And here again, a well-functioning monetary unit facilitates the saving that allows for capital accumulation: Income need not be consumed immediately but can be transferred to others to invest productively in return for future payment streams. Sound money, in short, greatly enhances wealth-creating exchange and transfer of resources between present and future, and in doing so often assists in the development of higher output capacity in the future.
There is a third crucial way in which sound money serves to advance civilized human progress: By providing a common denominator for the expression of all exchange prices between goods, money greatly facilitates trade among all parties, thus extending the breadth of markets as far as money’s use itself, which in turn intensifies the division of labor that increases productive output and per capita incomes. Think about it: Without a monetary unit of account there would be an infinite array of prices for one good against all other goods; for example, the bread-price of shoes, the book-price of apples, and so on. In turn, calculation of profit and loss, on which effective use of scarce resources so critically depends, would be impossible.
In sum the institutional development and use of money has been an immense human achievement, every bit as important as language, property rights, the rule of law, and entrepreneurship in the advancement of human civilization. And it is important to note that while several commodities were tried as monetary exchange media over the centuries, from fish to cigarettes, the precious metals and especially gold were seen to be most effective, as they are valuable, highly divisible, durable, uniform in composition, easily assayable, transportable, and bear high value-to-bulk, along with being relatively stable in annual supply. In short, in an ever-changing world of imperfection, gold has been found to be a near-perfect, and certainly dependably valued, form of money.

Money, International Trade, and Economic Growth

To understand much about our current economic challenges and what to do to meet them, it is important to understand why gold, after several centuries of trial and error, came to be seen as sound money versus paper, other commodities, and even silver. The term sound money is especially important to grasp: It is meant to describe a reliable, dependably valued medium of exchange and account, not subject easily to manipulation, which can therefore effectively perform the three functions of money described above, all of which lead to prosperity and an advancing economy. This is critical for a civilized society whose economy is based on monetary exchange, because money is literally one-half of every transaction. So when the value of the monetary unit is volatile—when money becomes more or less unsound—it changes the intended terms of trade between parties, especially when that transaction involves exchange between present and future, as in capital investment. This in turn can cause such exchanges to break down or lead to distortions in trade that bring malinvestment of assets and waste of scarce resources.
No better illustration of this can be seen than in the German hyperinflation of 1923. German war reparations mandated by Versailles had so burdened the German economy that the German government took literally to printing the currency known as the papiermark in massive quantities. This rapidly depreciated the value of the currency until in the fall of 1923 workers were paid in wheelbarrows of cash twice daily. The velocity of spending skyrocketed, as workers immediately rushed to trade the quickly worthless paper money for anything of tangible value, buying commodities they often did not need. Saving and investment were stunted, price inflation soared out of control, and civil society lurched toward a complete breakdown by the end of 1923, when $1, which had bought 5.21 marks in 1918, now bought 4.2 trillion of them.
Seen another way, the German hyperinflation is an example of a “virus” infecting the economy, distorting prices in every transaction, every entrepreneurial investment decision, and the value of every bank account. Every calculation of profit and loss was changed in real terms as well, thus causing resources to be inefficiently used or traded—that is, wasted. While the harm caused by unsound money is usually less than what occurred in 1923 in Germany, it was no less real in a 1970s-style inflation, a 1930s-style deflation, or a 2000s-style housing bubble fueled by falsified interest rates thanks to the Fed’s over-creation of money.
Conversely it was sound money, based on the international gold standard, that greatly impelled the fantastic rise in living standards across the nineteenth century in many parts of the globe. Gold as a common medium facilitated dramatic increases in trade and the international division of labor. With a dependably valued international medium of exchange and unit of account, long-term investment could be undertaken, and ever-increasing volumes of mutually profitable trading developed between nations, increasing jobs, output, and living standards dramatically. The century up to 1914 was a golden age of prosperity and harmony among nations, and while not devoid of all war, recessions, or panics, it was comparatively more peaceful and productive than any other period in human history.

The Rise of Central Banking

While the Bank of England was created in 1694, the United States did not get a central bank until the creation of the Federal Reserve System in 1913; by 1935, with the creation of the Bank of Canada, all modern nations had central banks. In theory a central bank, through monopoly banknote issue and effective control of a nation’s money supply, serves as a stabilizing influence in an economy by acting as a banker’s bank, a lender of last resort providing liquidity in panics, and a regulator of commercial banks and thus governor of their excesses. (However, in a recent exhaustive study, economists George Selgin and William Lastrapes of the University of Georgia and Lawrence White of George Mason University show that recessions were shorter and less severe, inflation and unemployment lower, and economic growth stronger and more durable in the century before 1913 than since the Fed’s creation). At the least, the central bank’s mandate included—and seemed to assure—maintenance of the value of the currency.
Beginning with World War I, and continuing through the Great Depression and World War II, the links to gold were for the most part effectively severed from most nations’ currencies, including the U.S. dollar. In the summer of 1944 economists (led by John Maynard Keynes and Harry Dexter White) met at Bretton Woods, New Hampshire, to design a postwar monetary system conducive to international trade. The resulting mechanism, known as the gold-exchange standard, tried to resurrect the beneficial aspects of the nineteenth century’s classical gold standard and lasted until Nixon scrapped it in 1971. In short the Bretton Woods agreement charged the U.S. government with defining the dollar in gold ($35 per ounce) and maintaining convertibility at this rate only with foreign governments and central banks. (Pointedly, there was no similar obligation to U.S. banks or citizens; gold had disappeared from circulation in the United States after Franklin Roosevelt’s 1933 decree.) In turn all foreign nations were to peg their currencies to the dollar, thereby preserving a regime (however illusory) of fixed exchange rates so as to promote certainty in international exchange and encourage cross-border trade and investment.
By the 1960s this system was beginning to break down on all sides. Foreign governments announced periodic devaluations against the gold-linked dollar to promote exports and allow for domestic government spending, and the United States ramped up “guns-and-butter” federal spending on both the Great Society and the Vietnam War. Inflation slowly crept into the U.S. economy, and gold-redemption requests spiked by the late 1960s at the U.S. Treasury’s gold window.
Nixon thus made his fateful decision in the summer of 1971, freeing the government from any redemption obligations. This had two immediate effects: It amounted to an automatic, if stealthy, repudiation of U.S. debt in real terms because it devalued all dollar-denominated assets and currency at once. It also allowed the U.S. government, in concert with a technically independent Federal Reserve, to manage the U.S. money supply for its own political ends indefinitely.

The Predictable Aftermath of 1971

In developing his theory of money and credit a century ago, the great economist Ludwig von Mises explained why a system of fiat currencies was bound to break down: The politicians’ urge to inflate the money supply in order to commandeer the resources of the real economy via expanded government spending would prove too great. Further, because the dollar was the de facto reserve currency of the globe post-Nixon (replacing gold itself), any U.S. inflation would encourage other nations’ monetary expansions and competitive devaluations in tandem. And indeed, an era of predictable instability has been the result: A trenchant stagflation in the 1970s was followed by banking and S&L crises in the 1980s; Russian, Asian, and Latin American banking crises in the 1980s–90s; overleveraged financial institutions and moral hazard-based bailouts of too-big-to-fail institutions in the 1990s–2000s; and in the last decade or so two Fed-induced bubbles and subsequent crashes. The second of those, based in the housing sector, “went viral” across the world thanks to the huge nominal amount of funds plus leverage of U.S.-based mortgage debt, coupled with the expectation on the part of investors that the U.S. government would guarantee any mortgage-bond losses.
This instability has starkly proven another tenet of Mises’s seminal work: Fiat currencies managed by central banks with a monopoly on note issue, rather than being a source of macro stability, are themselves the causal agents of repeated boom-and-bust business cycles. By increasing the money supply at zero effective cost, central banks encourage government spending and cause interest rates to fall below their natural rate, which induces private investment and a temporary boom. But this boom, usually in capital-equipment sectors or long-term durables, is not based on real individual and institutional savings. That is, the accumulation of capital is not “backed” by the real resources of society. By definition such a boom is inherently unsustainable and unstable, and must end in a bust and painful retrenchment. The greater and longer the creation of fiat money by the central bank, the harder and longer will be the ensuing recession.

A Path to Reform

The best solution to the myriad problems caused by the Fed’s post-Nixon fiat currency management is to return to sound money generated by private markets and intermediated by freely competing banks issuing their own notes. These notes could be backed by any commodity but most likely would involve a return to gold. Banks would compete for customer deposits and loan business on the basis of the soundness of their balance sheets and thus could not over-issue—or else they’d face redemption of their outstanding notes and a potential collapse from a bank-run. Such a system is far more stable than a monopoly central bank without constraints, subject to the inexorable pull of political designs (that is, malfeasance).
But there are many challenges to developing and implementing such a free-banking system with commodity money; this is the subject of work to be published in the future. Meanwhile a second-best solution would be for the Federal Reserve to cease and desist with any further fiat money creation—in essence, freeze the monetary base where it is, permanently. The Fed could then announce an intent to return to full gold convertibility, and any new notes it issued (and used by Fed member banks) would be 100 percent backed by gold. Any maturing securities held as assets on the Fed’s balance sheet would be used to purchase gold to build the Fed’s reserves. The permanent price of gold would be set over a period of months after the announcement of the new regime, as gold itself and competing currencies traded at new (lower) levels based on the U.S. government’s new commitment to dollar stability.
The results of this reform program would be electric and dramatic. Capital investment would soar in the United States, as America became a haven for high-productivity ventures once again. The entire U.S. economy would in effect be recapitalized. While an end to activist Fed monetary policy would raise the short end of the yield curve, over time real interest rates would revert to historic low levels due to dollar stability. Such monetary reform implies pro-growth fiscal reforms as well; the U.S. government’s profligacy would have to end because fiscal laxity would no longer be supported by an accommodating Fed. A new, sound dollar and a passive Fed would also engender other pro-growth reforms in banking, such as a reduction in or end to deposit insurance and a lower burden of regulations that stunt growth. The banking sector would at once be more competitive, better capitalized, less brittle, and on sounder footing itself.
To bring this about monetary policy must again become a big political issue—the dominating political issue—in a way it has not been since the presidential election of 1896, when William Jennings Bryan railed against a “cross of gold.” Indeed this can happen if people come to understand that the main culprit of U.S. booms and busts since 1971, and indeed the primary progenitor of the global disaster of 2008—from which we have yet to recover—is the political management of money by the Federal Reserve. Sound money, honest money, besides being a necessary cause of sustainable economic growth itself, is the antidote to the tragically unnecessary torpor of our modern world.

Some Additional Reflections on the Economic Crisis and the Theory of the Cycle

Mises Daily: Thursday, December 29, 2011 by Jesus Huerta de Soto

The three years that have passed since the world financial crisis and subsequent economic recession hit have provided Austrian economists with a golden opportunity to popularize their theory of the economic cycle and their dynamic analysis of social conditions. In my own case, I could never have imagined at the beginning of 1998, when the first edition of my book Money, Bank Credit, and Economic Cycles appeared, that 12 years later, due undoubtedly to a financial crisis and economic recession unparalleled in the world since the Great Depression of 1929, a crisis and recession which no other economic paradigm managed to predict and adequately explain, my book would be translated into 14 languages and published (so far) in nine countries and several editions (two in the United States and four in Spain). Moreover, in recent years I have been invited to and have participated in many meetings, seminars, and lectures devoted to presenting my book and discussing its content and main assertions. On these occasions, some matters have come up repeatedly, and though most are duly covered in my book, perhaps a brief review of them is called for at this time. Among these matters, we will touch on the following:

1. The Relationship between Credit Expansion and Environmental Damage

"Free-market-environmentalism" theorists (Anderson and Leal 2001) have shown that the best way to preserve the environment is to extend entrepreneurial creativity and the principles of the free market to all natural resources, which requires their complete privatization and the efficient definition and defense of the property rights that pertain to them. In the absence of these rights, economic calculation becomes impossible, the appropriate allocation of resources to the most highly valued uses is prevented, and all sorts of irresponsible behaviors are encouraged, as is the unjustified consumption and destruction of many natural resources.
Nevertheless, free-market-environmentalism theorists have overlooked another major cause of the poor use of natural resources: the credit expansion that central banks orchestrate and cyclically inject into the economic process through the private banking system, which operates with the privilege of using a fractional reserve. In fact, the artificial expansion of fiduciary media triggers a speculative-bubble phase in which there is an "irrational exuberance." This phase ends up placing an unwarranted strain on the real economy by making many unprofitable projects appear profitable (Huerta de Soto 2009). The result is unnecessary pressure on the entire natural environment: trees that should not be cut down are cut down; the atmosphere is polluted; rivers are contaminated; mountains are drilled; cement is produced; and minerals, gas, oil, etc., are extracted in an attempt to complete overly ambitious projects that in reality consumers are not willing to demand, etc.
Eventually the market will impose the judgment of consumers, and many capital goods will remain idle, thus revealing that they have been produced in error (that is, distributed incorrectly in space and time), because entrepreneurs have allowed themselves to be deceived by the easy-credit terms and low interest rates decreed by monetary authorities. The result is that the natural environment is harmed needlessly, since consumers' standard of living has not increased at all. On the contrary, consumers become poorer with the malinvestment of society's scarce real savings in nonviable, excessively ambitious projects (for example, 1 million homes in Spain without buyers). Hence, credit expansion hinders sustainable economic development and needlessly damages the natural environment.
This brief analysis points to an obvious conclusion: nature lovers should defend a free monetary system, without a central bank, a system in which private bankers operate with a 100 percent reserve requirement on demand deposits and equivalents, a system that rests on a pure gold standard. This is the only way to eradicate the recurring stages of artificial boom, financial crisis, and economic recession, which do so much harm to the economic environment, mankind, and the process of social cooperation.

2. Then Is Credit Expansion Really Necessary to Boost Economic Growth?

A popular argument (employed and nourished by more than a few prestigious economists like Schumpeter) holds that credit expansion and low interest rates facilitate the introduction of technological and entrepreneurial innovations, which foster economic development. The argument is contemptible. In a market economy it is as important to provide financing for solvent, viable entrepreneurial projects as it is to deny it for nonviable, harebrained ones: many "entrepreneurs" are like runaway horses, and we must limit their chances of trampling on society's scarce resources.

"A popular argument holds that credit expansion and low interest rates facilitate the introduction of technological and entrepreneurial innovations, which foster economic development. The argument is contemptible."

The problem is that only the market is capable of distinguishing between these two types of projects, and it does so by a social process in which key elements are precisely the indicator of the real amount of saved resources and the social rate of time preference, which helps separate the projects that should be financed from those whose time has not yet come and which therefore must remain "in the pipeline." It is true that every artificial expansion of credit and of the fiduciary media that back it provoke a redistribution of income in favor of those who first receive the new available funds and that this does not permit us to theorize about the net effects the process will have on society's real saving. (That will depend on how the time preference of those who come out ahead compares with that of those who come out behind.) However, there are more than enough signs that inflation discourages real saving, if only because it generates an illusion of wealth, which stimulates spending on consumer goods and capital consumption.
Furthermore, in the end ("ex post") it is clear that only what has been previously saved can be invested. Even then, what has been previously saved can be invested wisely or foolishly. Credit expansion promotes the waste and malinvestment of scarce factors of production in unsustainable and unprofitable investment projects. This means that the model of economic development based on artificial credit expansion cyclically destroys a high volume of capital goods, which leaves society substantially poorer (compared with the standard of living that could be reached in the long term with sustainable growth unforced by credit expansion and more in keeping with the true wishes of consumers with respect to their valuations of time preference).
Moreover, let it not be said that fiduciary inflation at least serves to employ idle resources, since the same effect can be achieved without malinvestment and waste by making the corresponding labor and factor markets more flexible. In the long run, credit expansion generates unsustainable jobs, erroneous investments, and therefore, less economic growth.

3. Is It True that Banks Caused the Crisis by Incurring Risks Disproportionate to Their Capital?

To attribute the crisis to the bad conduct of bankers is to confuse the symptoms with the causes. After all, during the stage of speculative euphoria, bankers merely responded to the incentives (null or negative real interest rates and the artificial expansion of credit) created by central banks. Now, in a display of hypocrisy and manipulation of the citizenry, central bankers throw up their hands in horror, blame others for the consequences of their own unsound policies, and try to appear as saviors to whom we must be grateful for the fact that we are not in the grip of an even more severe depression. And we need not repeat that it is precisely during the boom stage that inflation in the prices of financial assets was so high that bankers were able to show considerable equity capital in their balance sheets, which, at least in appearance, gave them substantial leverage and permitted them to incur risks with little difficulty. This was all in an environment of null or even negative real interest rates and an extraordinary abundance of liquidity promoted deliberately by central banks. Under such conditions, no one should be surprised that increasingly, peripherally, financing was granted for investment projects that were more and more risky, and less and less profitable (and less certain of producing profit).

4. So the Problem with the Banking System Is that Bankers Did Not Manage to Properly Harmonize the Deadlines of Loans Granted with Those of Deposits Received?

No, the problem is that banks have operated with a fractional reserve; i.e., they have not maintained a 100 percent reserve with respect to demand deposits and their equivalents. The requirement of a 100 percent reserve on demand deposits avoids credit expansion and liquidity problems in the banking system, because it permits the investment of only what has been previously saved; and if investors make a mistake concerning the term of maturity and their projects are viable, they can request new loans (based on prior, real saving) to repay those that fall due. In contrast, credit expansion derived from fractional-reserve banking gives rise to a widespread malinvestment of resources that is confused by many with a failure to harmonize terms of maturity, when the problem is much deeper: investments that are unsustainable due to a lack of real saving. The fundamental economic problem does not stem from an error in the matching up of terms but from the absence of a 100 percent reserve requirement; in other words, it stems from fractional-reserve banking.

5. Can an Isolated Bank Escape Unscathed in the Case of Widespread Credit Expansion?

Those in charge of an individual bank may hope it will emerge unharmed from a process of credit expansion if (a) they believe they will be able to lend money peripherally for the most profitable and secure projects (those that will be least affected when the crisis hits); and (b) they believe that once they begin their credit expansion on these projects, the rest of the banks will follow the same expansionary policy at the same pace at least, and thus the bank will not end up alone nor will it lose reserves.

"Many 'entrepreneurs' are like runaway horses, and we must limit their chances of trampling on society's scarce resources."

In practice, b usually happens (generalized credit expansion orchestrated by the central bank itself); but a is highly unlikely to ever happen and amounts to a mere illusion: the new fiduciary media (created deposits) can only be lent at relatively reduced interest rates and can only be placed in the market as loans for projects that are increasingly lengthy (i.e., that mature in a more distant future) and risky (uncertain). These projects merely appear to be profitable at reduced rates, but as soon as rates increase, they immediately cease to be viable due to insufficient real saving.
Furthermore, any bank whose directors tenaciously decide to keep it out of the credit-expansion process will see its market share dwindle and will run the risk of becoming an exotic irrelevance. This should make it obvious that fractional-reserve banking exerts a corrupting effect on the entire banking system (an argument already put forward by Longfield in the 19th century). In addition, banking practice has continually offered confirmation of this phenomenon. (For instance, several presidents of Spanish banks have told me that during the boom stage they knew a large percentage of the real-estate loans they were granting were unlikely to be viable in the long term and were very risky, but they were "forced" to participate in many syndicated loans and questionable transactions under pressure from analysts, market agents, and their bank's need to grow or at least maintain its market share.)

6. Savings as a "Flow" Magnitude versus Cash Balances in the Form of Deposits as a "Stock" Magnitude

Money is not a consumer good (except for greedy Scrooge McDuck), nor is it a factor of production. It is a third type of good: a commonly accepted medium of exchange. Moreover, only as a present good does money fulfill its function as a medium of exchange. However, it can be lent, in which case it becomes a financial asset for the lender, for whom it ceases to provide services as a medium of exchange.
Therefore, it is absurd to claim that deposited money that forms part of an actor's cash balances has been "saved." The deposit is a cash balance and thus a stock magnitude. The flow of unconsumed income gives rise to the flow of savings that is invested in financial assets or directly in capital goods, unless someone decides to indefinitely increase his or her cash balances (a rise in the demand for money). Furthermore, cash balances can be increased not only by reducing the flow of consumption but also by reducing the flow of investment (or both).
The problem is that with a specific, stable flow of savings, if someone decides to channel his or her cash balances into demand deposits in a fractional-reserve bank, the flow of loans and investment swells without any increase in the flow of real savings, and this is precisely what sets the economic cycle in motion.
Only free banking with a 100 percent reserve requirement prevents the above anomaly by making it impossible for bankers to make the following accounting entry:

Loans to Deposits
----------x---------- 

It is this kind of entry that reflects banks' main activity, but in a free banking system with a 100 percent reserve requirement, all deposits would be backed in cash by the corresponding balance, in keeping with general legal principles:

Cash to Deposits 
---------x--------- 

7. Does Leland Yeager Offer a Sound Argument when He Asserts that It Is Impossible to Distinguish between Demand Deposits and Very Short-Term Loans?

When the principles and theory are well understood (that demand deposits and their equivalents must be backed at all times by a 100 percent reserve), the market invariably finds the most practical and operational solutions.
In an ideal banking system, with a 100 percent reserve requirement, short-term loans (from one to three months) would definitely be easy to distinguish from demand deposits, and the agents involved would undertake the usual operations necessary to match flows, operations that are so efficiently carried out in the free market, based on well-proven and deep-rooted principles of prudence.
"False" loans that disguise deposits would be easy to identify, especially if we take into account that on the edge of the very short term (from one week to one month), the demand for true loans is very weak (except under highly exceptional circumstances, and assuming the matching of flows is properly carried out).
In short, what is important is whether or not an actor subjectively considers that a "time" deposit or a (false) "loan" forms part of his or her immediately available cash balances. If so, we are dealing with true "demand" deposits, which require a 100 percent reserve.

8. What Are the Possible Scenarios in the Event of a Crisis like the Present One?

There are basically four:

1. The bubble is created again, with massive doses of new expansion. (This is practically the worst-case scenario, since the depression is only postponed at the cost of making it much more severe later: this is what happened in 2001–2002, when the expansionary stage was prolonged six additional years, but at the cost of a financial crisis and an economic recession unlike any in the world since 1929.)
2. The opposite extreme: the failure, as if by the domino effect, of all fractional-reserve banks and the disappearance of the financial system (a tragedy that has been avoided "in extremis" with the bailout of the banking system in the entire world).
3. The "Japanization" of the economy: government intervention (in the fiscal and credit spheres) is so intense that it blocks the spontaneous market processes that tend to rectify the investment errors committed in the bubble stage, and hence the economy remains in a recession indefinitely.

And 4, the most probable course of events: With great difficulty, the market, which is very dynamically efficient, ends up rectifying investment errors: companies and households put their balances on a sound footing by reducing costs (particularly labor costs) and repaying loans. The companies that remain have become "healthy" and the increase in saving permits the financing of new investment projects that are actually sustainable in the long term. Climbing unemployment reaches its peak when the reorganization has concluded, and at that point the top priority is to liberalize the labor market as much as possible (hiring, wages, dismissal, and collective bargaining) so that the unemployed can again enter the (now healthy) production chain to work on viable projects. Furthermore, maximum budget austerity is necessary in the public sector; it is important to avoid tax increases and to reduce bureaucracy and government intervention in the economy.

9. What Measures in the Right Direction Could Now Be Adopted to Bring Us Closer, Even If Timidly, to the Ideal Financial System of a True Free-Market Economy?

The following table offers an answer to this question:

Ideal Monetary Model	(Very) Timid Measures in the Right Direction
A pure gold standard (Growth in the world's stock of gold ≤ 2% per year)	Rigorous compliance with a limit of 2% per year to growth in the money supply, M. Fixed exchange rates. Euro.
A 100 percent reserve requirement (Bank crises are not possible.) The abolition of the central bank.	The central bank limits itself to providing liquidity to banks in trouble to avoid bank crises.
What is deposited is not lent, and there is a proper matching of the flows of savings and investment. The business of providing liquidity is separate from that of financial intermediation.	A radical separation between commercial banking and investment banking. (Glass-Steagall Act of 1933)

In many areas of the controlled market, which must be reformed (the privatization of streets, liberal immigration, etc.), it is a grave error to believe it necessary to eliminate all regulation until the ideal reform takes place. Quite the opposite is true. Until the reform occurs, a minimum of regulation is needed to simulate, as far as possible, the results of the ideal system: in the monetary sphere, a pure gold standard with a 100 percent reserve requirement and no central bank. Nevertheless, we must repeat again and again that, instead of trying awkwardly to replicate with doubtful half measures what the market would achieve, without a doubt the best and ultimately unavoidable line of action is to implement the definitive, radical reform demanded by the ideal monetary model.

$50.00 $35.00

10. Conclusion: Bewilderment among Theorists and Citizens

Society is confused and bewildered by the crisis. The gulf between people and politicians is nearly unbridgeable. Moreover, the ignorance and confusion of the latter is also spectacular. However, the worst part of the situation is that most economic theorists themselves are drawing a blank in terms of theory, and they are not managing to grasp what is happening, why it has happened, and what could happen in the future.
The loss of prestige suffered by neoclassical economics (the hypothesis of market efficiency, the theory of rational expectations, faith in "self-regulation," the principle of agent rationality, etc.) is complete and is mistakenly interpreted as a market failure that justifies more state intervention. (Keynesians attribute the crisis to the sudden financial "panic" and to a lack of aggregate demand for which the state must compensate.) Theorists of different camps fail in their understanding of the market, and thus in their analyses and prescriptions. Well into the 21st century, the theoretical void is enormous. Fortunately, the Austrian theory of the cycle, in general, and my book Money, Bank Credit, and Economic Cycles in particular, are there to fill this void and clear up the present confusion.

Jesús Huerta de Soto, professor of economics at King Juan Carlos University, is Spain's leading Austrian economist. As an author, translator, publisher, and teacher, he also ranks among the world's most active ambassadors for classical liberalism. He is the author of Money, Bank Credit, and Economic Cycles as well as Socialism, Economic Calculation and Entrepreneurship (Edward Elgar 2010), The Austrian School (Edward Elgar 2008) and The Theory of Dynamic Efficiency (Routledge 2009). Send him mail. See Jesus Huerta de Soto's article archives.
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References

Anderson, T.L. and D.R. Leal. 2001. Free Market Environmentalism. Rev. ed. New York: Palgrave Macmillan.
Huerta de Soto, J. 2009. Money, Bank Credit, and Economic Cycles. 2d ed. Auburn, Alabama: Ludwig von Mises Institute.

property rights are human rights

It is often asserted by critics of the free-market economy that they are interested in preserving “human rights” rather than property rights. This artificial dichotomy between human and property rights has often been refuted by libertarians, who have pointed out (a) that property rights of course accrue to humans and to humans alone, and (b) that the “human right” to life requires the right to keep what one has produced to sustain and advance life. In short, they have shown that property rights are indissolubly also human rights. They have, besides, pointed out that the “human right” of a free press would be only a mockery in a socialist country, where the State owns and decides upon the allocation of newsprint and other newspaper capital.[29]

There are other points that should be made, however. For not only are property rights also human rights, but in the most profound sense there are no rights but property rights. The only human rights, in short, are property rights. There are several senses in which this is true. In the first place, each individual, as a natural fact, is the owner of himself, the ruler of his own person. The “human” rights of the person that are defended in the purely free-market society are, in effect, each man’s property right in his own being, and from this property right stems his right to the material goods that he has produced.

In the second place, alleged “human rights” can be boiled down to property rights, although in many cases this fact is obscured. Take, for example, the “human right” of free speech. Freedom of speech is supposed to mean the right of everyone to say whatever he likes. But the neglected question is: Where? Where does a man have this right? He certainly does not have it on property on which he is trespassing. In short, he has this right only either on his own property or on the property of someone who has agreed, as a gift or in a rental contract, to allow him on the premises. In fact, then, there is no such thing as a separate “right to free speech”; there is only a man’s property right: the right to do as he wills with his own or to make voluntary agreements with other property owners.

The concentration on vague and wholly “human” rights has not only obscured this fact but has led to the belief that there are, of necessity, all sorts of conflicts between individual rights and alleged “public policy” or the “public good.” These conflicts have, in turn, led people to contend that no rights can be absolute, that they must all be relative and tentative. Take, for example, the human right of “freedom of assembly.” Suppose that a citizens’ group wishes to demonstrate for a certain measure. It uses a street for this purpose. The police, on the other hand, break up the meeting on the ground that it obstructs traffic. Now, the point is that there is no way of resolving this conflict, except arbitrarily, because the government owns the streets. Government ownership, as we have seen, inevitably breeds insoluble conflicts. For, on the one hand, the citizens’ group can argue that they are taxpayers and are therefore entitled to use the streets for assembly, while, on the other hand, the police are right that traffic is obstructed. There is no rational way to resolve the conflict because there is as yet no true ownership of the valuable street-resource. In a purely free society, where the streets are privately owned, the question would be simple: it would be for the streetowner to decide, and it would be the concern of the citizens’ group to try to rent the street space voluntarily from the owner. If all ownership were private, it would be quite clear that the citizens did not have any nebulous “right of assembly.” Their right would be the property right of using their money in an effort to buy or rent space on which to make their demonstration, and they could do so only if the owner of the street agreed to the deal.

Let us consider, finally, the classic case that is supposed to demonstrate that individual rights can never be absolute but must be limited by “public policy”: Justice Holmes’ famous dictum that no man can have the right to cry “fire” in a crowded theater. This is supposed to show that freedom of speech cannot be absolute. But if we cease dealing with this alleged human right and seek for the property rights involved, the solution becomes clear, and we see that there is no need at all to weaken the absolute nature of rights. For the person who falsely cries “fire” must be either the owner (or the owner’s agent) or a guest or paying patron. If he is the owner, then he has committed fraud upon his customers. He has taken their money in exchange for a promise to put on a motion picture, and now, instead, he disrupts the performance by falsely shouting “fire” and creating a disturbance among the patrons. He has thus willfully defaulted on his contractual obligation and has therefore violated the property rights of his patrons.

Suppose, on the other hand, that the shouter is not the owner, but a patron. In that case, he is obviously violating the property right of the theater owner (as well as the other patrons). As a guest, he is on the property on certain terms, and he has the obligation of not violating the owner’s property rights by disrupting the performance that the owner is putting on for the patrons. The person who maliciously cries “fire” in a crowded theater, therefore, is a criminal, not because his so-called “right of free speech” must be pragmatically restricted on behalf of the so-called “public good,” but because he has clearly and obviously violated the property rights of another human being. There is no need, therefore, of placing limits upon these rights.

Since this is a praxeological and not an ethical treatise, the aim of this discussion has not been to convince the reader that property rights should be upheld. Rather, we have attempted to show that the person who does wish to construct his political theory on the basis of “rights” must not only discard the spurious distinction between human rights and property rights, but also realize that the former must all be absorbed into the latter. - Murray Rothbard