With the beginning of 2015, what might be a “New Year’s resolution” for a friend of freedom? I would suggest that one answer is for each of us to do our best to become “lights of liberty” that will attract others to the cause of freedom and the free society.
For five years, from 2003 to 2008, I had the opportunity and privilege to serve as the president of the Foundation for Economic Education. FEE, as it is also called, was founded in 1946 by Leonard E. Read, with the precise goal of advancing an understanding of and the arguments for individual freedom, free markets, and constitutionally limited government.
One of the reasons that I accepted the position as president was that FEE had been influential in my own intellectual development in appreciating the meaning and importance of liberty from the time that I was a teenager, both through the pages of its monthly magazine, The Freeman and the books that it published and distributed at heavily discounted prices.
I wanted to assist in continuing the work that Leonard Read had begun at FEE, especially among the young whose ideas and actions would greatly influence the chances for liberty in the decades to come.
Self-Improvement as Lights of Liberty
In fact, it is now just over forty years ago, in June 1974 when I was in my mid-20s, that I first attended a weeklong FEE summer seminar at its, then, headquarters in a spacious and charming mansion building in Irvington-on-Hudson, New York.
There were many impressive speakers at the seminar that week, including the famous free-market journalist, Henry Hazlitt, and the riveting Austrian School economist, Hans Sennholz.
But I must confess that I only recall the content of one of the lectures that week, delivered by Leonard Read, himself. He pointed out that many of us wish we could change the world in ways that we consider to be for the better. But changing the world can only happen through changes in the attitudes, ideas, and actions of the individual members of any society.
He asked, out of all the people in the world, over whom do you have the most influence? The answer, he said, is, obviously, yourself. Therefore, changing the world begins with improving one’s own understanding and ability to explain and persuasively articulate the case for freedom and free markets.
At one point in his talk he asked that the lights be turned off in the classroom. In the darkness he slowly started to turn up the light of an electric candle that he held in his hand, asking us to notice how all eyes were drawn to it, however dim the illumination.
As the candle brightened he pointed out that more and more of the darkness was pushed away into the corners, enabling us to see more clearly both the objects and the people in the room.
If each of us learned more about liberty, we would become ever-brighter lights in the surrounding collectivist darkness of the society in which we lived. Our individually growing enlightenment through self-education and self-improvement would slowly but surely draw others to us who might also learn the importance of freedom.
Through this process more and more human lights of freedom would sparkle in the dark until finally there would be enough of us to guide the way for others so that liberty would once again triumph. And collectivism would be pushed far back into the corners of society.
Anything That’s Peaceful and First Principles
Central to Read’s philosophy of freedom was a commitment to first principles as the Archimedean point from which the logic of liberty flows. As Read explained in his book Anything That’s Peaceful(1964):
“I mean let anyone do anything that he pleases that’s peaceful and creative; let there be no organized restraint against anything but fraud, violence, misrepresentation, predation; let anyone deliver the mail, or educate, or preach his religion or whatever, so long as it’s peaceful. Limit society’s agency of organized force – government – to juridical and policing functions . . . Let the government do this, and leave all else to the free, unfettered market!”
What are the “first principles” of liberty, and what do they imply?
Each Individual’s Right to His Own Life
Firstly, and most importantly, liberty means the right of the individual to live his own life for himself. The starting axiom of freedom is that right of the individual to his life, liberty, and honestly acquired property.
Either the individual has “ownership” over himself, or it must be presumed that the collective, the tribe, the group has the authority to dispose of his life and the fruits of his mental and physical labors.
If he does not have a right to his own life, then he is at the mercy of the wishes, whims and coercive caprice of others who claim to speak and act in political authority in the name of “society.”
Only the individual knows what will bring happiness, satisfaction, fulfillment, meaning and purpose to his own life. If this is taken away from him, then he is a slave to the purposes and brute power of others.
Respect for the Equal Rights of All
Secondly, liberty means for each of us to respect the equal right of every other individual to his life, liberty, and honestly acquired property. We cannot expect others to respect our own right to these things, if we do not, as a matter of principle, forswear any claim to their life and property.
To not recognize and abide by the reciprocity of respect for and defense of such unmolested individual rights is to abrogate any principle of human association other than force and plunder – the enslavement and spoliation by the intellectually manipulative and physically stronger over others in society.
On what basis or by what principle can we appeal not to be murdered, physically violated or robbed by others, if we do not declare and insist upon the right of each individual to his life, liberty and property, ours and everyone else’s, as a starting moral premise in society?
Voluntary Consent and Peaceful Agreement
Thirdly, this means that all human associations and relationships should be based on peaceful and voluntary consent and agreement. No one may be coerced or intimidated through the threat of force to act in any way other than he freely chooses to do.
Each of us only enters into those associations and exchanges from which we expect to be made better off, as we define and desire an improvement in our lives.
This does not mean that we often do not wish that the terms under which another is willing to trade with us would be more favorable to ourselves. But the fact that we may choose to exchange at some agreed terms that is minimally acceptable to ourselves as well as to the other person means that, all things considered, we anticipate that our circumstances will be better than if we passed up this trading opportunity.
The only time that it is clear that a trade or an association with others is not considered by us as a source of personal betterment is when we are forced or coerced into the relationship. Why would compulsion have to be used or threatened against us, if we did not view what we are being compelled to do is an action or a commitment that we evaluate as making us worse rather than better off?
The Mutual Respect of Private Property
Fourthly, liberty means that each individual’s honestly acquired property is respected as rightfully his, and may not be plundered or taxed away by others, even when majorities may think that some minority has not paid some supposed “fair share.”
What makes something the rightful property of an individual? When he has either appropriated unclaimed and previously unowned land and resources through their transformation in some manner through his mental and physical labor, or when he has acquired it through peaceful and non-fraudulent trade with another in exchange for something he has to offer in the form of a desired good or his labor services at voluntarily agreed-upon terms of trade.
The use of force by either private individuals or those in political authority to seize such rightful property or compel its use or sale on terms other than those freely chosen and agreed to by its owner is, therefore, unjust and indefensible in a free society.
A Free Market of Goods and Ideas
Fifthly, liberty means respect for the free, competitive interactions of people in the marketplace of goods and ideas, out of which comes the creative and innovative energy of mind and effort that bring about rising standards of living for all in society.
The free market is the arena of human association in which each individual is at liberty to make his own choices and decisions as both producer and consumer.
Yet, as has been understood since the time of Adam Smith in the eighteenth century, each individual, in his own self-interest, necessarily must apply his abilities in ways that take into consideration the circumstances and desires of others in society.
Since, in the society of liberty, no individual may acquire what he desires through murder, theft or fraud, he is left with only one avenue to obtain what others have that he wants. He must offer to those others something that he can produce or provide that those others value more highly than what they are asked to trade away to get it.
Thus, in the free market each receives in voluntary trade what they value more highly in exchange for what they value less highly. And each serves the interests of others as the means to his own end of the personal improvement of his self-defined circumstances.
Thus, the free market as a moral and starting principle eschews all forms of compelled self-sacrifice in the networks of human association.
Liberty and Limited Government
And, sixthly, a society of liberty means a limited government, a government whose purpose is to protect each individual in his freedom and peaceful market and social affairs, and is not to be an agency of political oppression or economic favoritism through special privileges and benefits that are given to some at the expense of others in society.
Compulsory redistribution of wealth and income, and regulatory coercions over the means and methods of production, and the peaceful buying and selling of goods and services are all inconsistent with the ideal of a society of free men and women, each secure in their individual rights to their life, liberty and honestly acquired property.
These are not easy rules and ideals to live by, but they are what America was founded upon and made it originally great as a land of liberty – a land of both wide individual freedom and rising prosperity.
Winning Others Over to Liberty, One Person at a Time
They are, also, ideas not always easy to get others around us to understand and appreciate the way we see them, ourselves. This gets us back to Leonard Read’s conception of self-improvement in our own understanding of what he called the “freedom philosophy.”
Our New Year’s resolution should be to do all that we individually can to better understand the principles of liberty, their logic, their moral rightness, and their convincing application to the political and economic issues of our day.
As we each become more enlightened and articulate spokespersons for freedom we widen the circle of people able to persuasively draw others into that illumination of liberty. And step-by-step, one person at a time, the supporters and advocates of collectivism will be reduced and the proponents and enthusiasts for freedom will be increased.
Make it your goal, therefore, to bring at least one person over to the cause of liberty in 2015, and if we all do this we will have, at a minimum, doubled the friends of freedom in this New Year. If we repeat this same process of reasoned persuasion in 2016, that larger number can and will be doubled again. And, then, again in 2017, and 2018, and . . .
Through this means of peaceful persuasion the friends of freedom can become the majority of Americans in our own lifetime. All it requires is enough of us willing to try.
“Give me control of a Nation’s money supply, and I care not who makes its laws.”
This quote frequently is attributed by conspiracy theorists to Mayer Amschel Rothschild, founder of the Rothschild banking dynasty.
A comparable quote is attributed to his son, Nathan:
I care not what puppet is placed upon the throne of England to rule the Empire on which the sun never sets. The man who controls Britain’s money supply controls the British Empire, and I control the British money supply.
There are some really big problems with these claims.
First, thorough research has uncovered no evidence whatsoever that either Rothschild ever said such a thing.
Skeptoid: Critical Analysis of Pop Phenomena — an award-winning weekly science podcast — searched for a primary source and reported:
In fact, that famous quote from Nathan Rothschild about “controlling the British money supply” turns out to be a fabrication. I found no original source for the quote at all, though it’s repeated in dozens of conspiracy books and on tens of thousands of conspiracy websites. I did a thorough search of all available newspaper archives from Nathan’s lifetime, and had some friends check various university library systems. No such quote appears in the academic literature. After such a thorough search, I feel confident stating that he never made such a statement.
But the quote doesn’t appear to be completely made up by the conspiracy theorists. It’s most likely a revised and restyled version of this quote attributed to Nathan’s father, the original Mayer Rothschild:
“Give me control of a Nation’s money supply, and I care not who makes its laws.”
But like the longer, more specific quote from Nathan, even this one turns out to be apocryphal. Author G. Edward Griffin did manage to track it down, though. He found that this saying was:
Quoted by Senator Robert L. Owen, former Chairman of the Senate Committee on Banking and Currency and one of the sponsors of the Federal Reserve Act, National Economy and the Banking System, (Washington, D.C.: U.S. Government Printing Office, 1939), p. 99. This quotation could not be verified in a primary reference work. However, when one considers the life and accomplishments of the elder Rothschild, there can be little doubt that this sentiment was, in fact, his outlook and guiding principle
And this is certainly true. In Rothschild’s day, before banking regulation and antitrust laws existed, it was indeed possible for small groups to gain controlling interests in enough financial institutions that it could be argued that they “controlled” a nation’s money supply. Evidently the Senator made up the quote to support whatever speech he was making, and attributed it to a famous name to give it some clout.
Second, reckless falsehoods play into the hands of the most sinister elements of society. In the case of the Rothschild family itself, Skeptoid reminds its readers that a “1940 German movie called Die Rothschilds Aktien auf Waterloo(was) described as ‘the Third Reich’s first anti-Semitic manifesto on film.'” “Nazi Germany devastated the Austrian Rothschilds and seized all of their assets. The family members escaped to the United States, but lost their entire fortunes to the Nazis, including a number of palaces and a huge amount of artwork.”
The tenor of both apocryphal quotes echoes an authentic, lyrical and deeply discerning observation by Scottish writer, politician, and patriot Andrew Fletcher of Saltoun who wrote, in a letter to the Marquis of Montrose in 1703:
I said I knew a very wise man so much of Sir Christopher’s sentiment, that he believed if a man were permitted to make all the ballads he need not care who should make the laws of a nation, and we find that most of the ancient legislators thought that they could not well reform the manners of any city without the help of a lyric, and sometimes of a dramatic poet.
This sentiment has become well known in paraphrased form, “Let me make the ballads of a nation, and I care not who makes its laws.” This writer infers that Fletcher’s words may have been the inspiration for the malevolently confabulated sinister sentiments attributed to the Rothschilds.
By my analysis, the Rothschilds are best thought of not as an evil shadow conspiracy, but as a great success story of rags to riches, Jewish slum to financing the defeat of Napoleon. The price of gold is fixed twice a day by five members of the London Bullion Association: Barclays Capital, Deutsche Bank, Scotiabank, HSBC, and Societe Generale, and they conduct their twice-daily meeting over the telephone. Today this is mere financial necessity, but until 2004, it was also a century-old tradition as great as the ringing of the bell at the New York Stock Exchange. The five distinguished representatives included a Rothschild, and they met in person in a paneled room at the London office of N M Rothschild & Sons. That ritual is now a thing of the past, as is the power of the world’s greatest financial dynasty.
This piece originated at http://thegoldstandardnow.org/key-blogs-6/1645-silly-conspiracy-theory-1
A major problem with the mainstream framework of thinking is that people are presented as if a scale of preferences were hard-wired in their heads.
Regardless of anything else this scale remains the same all the time.
Valuations however, do not exist by themselves regardless of the things to be valued. On this Rothbard wrote,
There can be no valuation without things to be valued.1
Valuation is the outcome of the mind valuing things. It is a relation between the mind and things.
Purposeful action implies that people assess or evaluate various means at their disposal against their ends.
An individual’s ends set the standard for human valuations and thus choices. By choosing a particular end an individual also sets a standard of evaluating various means.
For instance, if my end is to provide a good education for my child, then I will explore various educational institutions and will grade them in accordance with my information regarding the quality of education that these institutions are providing.
Observe that the standard of grading these institutions is my end, which is to provide my child with a good education.
Or, for instance, if my intention is to buy a car then there is all sorts of cars available in the market, so I have to specify to myself the specific ends that the car will help me achieve.
I need to establish whether I plan to drive long distances or just a short distance from my home to the train station and then catch the train.
My final end will dictate how I will evaluate various cars. Perhaps I will conclude that for a short distance a second hand car will do the trick.
Since an individual’s ends determine the valuations of means and thus his choices, it follows that the same good will be valued differently by an individual as a result of changes in his ends.
At any point in time, people have an abundance of ends that they would like to achieve. What limits the attainment of various ends is the scarcity of means.
Hence, once more means become available, a greater number of ends, or goals, can be accommodated—i.e., people’s living standards will increase.
Another limitation on attaining various goals is the availability of suitable means.
Thus to quell my thirst in the desert, I require water. Any diamonds in my possession will be of no help in this regard.
1. Murray N. Rothbard, Towards a Reconstruction of Utility and Welfare Economics.
[Editor’s Note: this piece, by Ivo Mosley, first appeared at http://defendinghistory.com/antisemitism-banking/69351]
A good deal of today’s nationalist and right-wing antisemitism rests upon the fantasy that “the Jews” control the world through finance and banking. Nor is the same fantasy entirely absent from left-wing antisemitism, which currently tends to concentrate itself on criticism of Israel.
The fact that some Jews are very good at banking is, apparently, enough to justify race-hate in the antisemite’s mind. Of course, a number of Jews are also prominent as scientists, civil rights activists, generals, hairdressers, actors, musicians, historians, etcetera, without anyone blaming science, civil rights, theatre, hairdressing, war, music, history, etcetera on “the Jews.” This highlights one of the traditional functions of antisemitism: if something is obviously bad, “the Jews” can be reached for as a scapegoat.
The object of this article is twofold: first, to analyze what is rotten in the world of capitalism and finance; second, to show that while it has nothing to do with “the Jews” as a people or as a tradition, it has everything to do with a tradition that for centuries excluded “the Jews.”
Capitalism and Predatory Capitalism
There are two stories about how capitalism is financed. One is commonly believed and accepted, but not true. The other is true, but hidden under veils of obscurity.
The familiar story is that citizens save up bits of money: banks gather up those bits of money and lend them to capitalists, who put them to good use for the benefit of all. This, however, is not what banks do – nor is it necessarily what capitalists do.
The unfamiliar, but true, story is that banks create money out of nothing when they lend to capitalists, who use the new money to purchase assets and/or labor, from which they expect to make a profit.
The first story needs no elaboration: as well as being untrue, it is simple and widely understood. The second needs to be explained, however, because though it is not so very complicated, it is unfamiliar to most people.
Economists generally avoid mentioning the fact that banks create money, but central bankers are happy to state it and even on occasion to try to explain it. The Bank of England website states simply: “Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.” And again: “The majority of money in the modern economy is created by commercial banks making loans.” The same article explains that this fact is not recognized by most economists: “rather than banks lending out deposits that are placed with them, the act of lending creates deposits — the reverse of the sequence typically described in textbooks.” (Quotes from the Bank of England Quarterly Bulletin, 2014/1.)
The way bankers create money today requires two things: a “magic trick” by which a small quantity of money held by the banker becomes a great deal of money in circulation; and laws which make the “’magic trick” not just legal, but binding on all citizens.
The “Magic Trick” of Banking
“A banker may accommodate his friends without the payment of money merely by writing a brief entry of credit; and can satisfy his own desires for fine furniture and jewels by merely writing two lines in his books,” wrote Tommaso Contarini, Venetian Banker and Senator in 1584.
The Encyclopedia Britannica of 1950 states firmly and definitively, “A bank does not lend money.” So just what does it do, when we think it is lending money? The answer is: it writes two numbers into a ledger, just as Tommaso Contarini did in 1584. Those numbers represent two equal-and-opposite claims, with a time lapse in between. The borrower gets a claim on cash belonging to the bank, which it can exercise immediately. The bank gets a delayed claim against the borrower, which it may exercise when the loan is due for repayment. In the meantime, the bank charges the borrower interest. When both claims have been exercised, the bank’s creation – the loan – disappears.
The claim which the bank creates for the borrower is called “credit.” “Credit” means “believes,” meaning whoever owns the claim believes they can get cash from the bank when they want it. This is where the “magic trick of banking”’ begins. If people believe they can get cash from a claim, they are happy to receive a claim in payment, so long as they too can use the claim to get cash from the bank. Joseph Schumpeter observes: “There is no other case in which a claim to a thing can, within limits to be sure, serve the same purpose as the thing itself: you cannot ride a claim to a horse, but you can pay with a claim to money.”
The second bit of the magic trick is for the banker to create many claims on the same bit of money – or, to put it another way, to create claims on money that isn’t there. Banks, naturally enough, want to maximize their profits, so they create as many claims as they think they can get away with, bearing in mind the regulators and people’s demand for cash. By creating fictitious claims a bank turns a billion, say, of cash into sixty billion, say, of credit.
The magic trick may seem somewhat technical in nature, but it has enabled bankers, with the active connivance of governments and capitalists, to replace money we can own with money we must rent off governments and banks. The effects of this substitution are immense, incalculable, far-reaching, all-pervasive (more on this later).
The Legal Underpinnings and Authority for Bank-Money
For a claim to pass from hand to hand as money, completing the “magic trick of banking,” one more thing is needed: the law must recognize it as a valid claim.
Normally, people are not allowed to create claims on property they don’t have. You can’t, for instance, create a claim on Buckingham Palace – unless you happen to own it. Nor can you mortgage your house sixty times over, and spend the money. Banks alone may do this kind of thing. Only banks (and “other depository institutions”) are authorized in law to create claims on property they do not have.
For centuries, banks operated in a legal grey area. Their activities were restricted to merchants, who understood the risks involved, and to what might be called the “higher criminal class” of rulers and potentates. Lending to princes often carried an interest rate of 100% — but still, most bank-crashes occurred when monarchs defaulted on their debts.
The watershed in banking history came during the decades on either side of 1700, when the English House of Commons, newly-all-powerful and consisting of rich men voted in by other rich men, wanted to exploit the fruits of bank-credit for their own devices of war and profit.
The Lord Chief Justice of the time, Sir John Holt, was supporting the traditional legal position that a claim on property was valid only if the claim was on a specific piece of property. Parliament passed an Act of Parliament (the Promissory Notes Act of 1704) to overrule him. Over the next three centuries, other countries followed the English example and “credit-creation” — creating claims on assets that don’t exist — is now authorized for bankers all across the world.
The Two Traditions: Money-Lending and Banking
Within the European tradition, Jews were long known as money-lenders. The relatively straightforward nature of money-lending, as a freely-negotiated contract between lender and borrower, was complicated by moral and social issues.
Usury (lending money at interest) was deplored in the Judeo-Christian tradition, but Jews were allowed (by their own religious laws and by self-interested Christian monarchs) to lend to non-Jews. A pattern was established: monarchs licensed Jewish money-lenders to lend to their subjects; agents of the monarch helped them collect their debts, then the monarch would rob the money-lenders of much of their profits. Throughout much of Europe, discriminatory laws forbade Jews to earn a living any other way. Although money-lending was a despised and hated occupation, it could make people very rich.
Meanwhile, banking — the creation of credit — was developing in an entirely separate tradition via the activities of merchants, exchange-dealers and civic banks. The tradition was Christian, protective of its own, and often openly antisemitic. When these early bankers “lent” money they were not lending hard cash, they were lending claims written into ledgers.
Failure to distinguish between banking and money-lending, and the superior social status of bankers (who being in close collusion with the State are liable to pick up honors as well as great wealth) have led many writers to claim that Jewish money-lenders were bankers, i.e. creators of credit. This in turn has fed the delusions of antisemitic pseudo-historians. In reaction to this false history, most serious historians of banking have found themselves making statements similar to this from Raymond de Roover: “Unlike the Christian moralists, the rabbis paid little attention to exchange dealings or cambium, because, as Yehiel da Pisa explains, this business was not practiced by Jews. This is further evidence that the latter confined their activities to money-lending on a small scale and that the leading international bankers, such as the Medici or the Fuggers, were all Christians. There is, therefore, nothing to support Sombart’s thesis according to which the Jews were the originators of international finance and the founders of modern capitalism.”
All this, of course, was a long time ago, and nowadays bankers are Anglo-Saxon, Chinese, African, Indian, Jewish, Christian, Islamic or whatever: assorted individuals who have no more consuming interest than to make lots of money.
What is Wrong With Creating Money as Fictitious Credit?
Bank-credit — money created as credit on assets that don’t exist — has many features that may be viewed as negative. It replaces money owned outright with money rented out, and is therefore (in the words of John Taylor of Virginia, 1753-1824) a “machine for transferring property from the people to capitalists.” Along the same lines, it allocates new money to borrowers on the mere promise of profit: as a result, much of it goes to inflating asset prices, again increasing inequality. It enables governments to borrow with little accountability, and to charge interest and repayment to “the people”: these charges make domestic labor more expensive, and therefore less competitive. It is created in large quantities during booms, and disappears during busts as loans are retired or “go bad,” thereby exacerbating business cycles. It encourages the production of arms and war by providing unaccountable finance to both governments and arms manufacturers, at the expense of their peoples. It encourages large concentrations of power in government, corporations, and individual “oligarchs,” reducing independence among citizens. It has an endogenous (inbuilt) insatiability: money drifts to the ownership of capitalists and only economic growth, state hand-outs and war (when governments create new money for working people rather than for banks) can supply consumer-money to the poor. The effects of this insatiability on the environment are literally devastating. It gives vast wealth to an elite who care only for making more money: the tastes of this elite have corrupted human culture. Lastly, because the process is not widely understood and is conducted largely in secret, it makes Western claims to political “democracy” dubious at best.
Given all this, it might be a good idea to contemplate reform, which would have to include (i) the replacement of credit money with digital money owned outright and (ii) withdrawal of the license allowed banks, to create claims on assets they don’t have.
Most people familiar with the reality of bank-credit also profit from it. Reason gives way to self-interest in human affairs, so enlightenment and reform are hardly to be expected from among the powers-that-be. As for antisemitism, mental disease is also resistant to reason, so the targets of criticism in this essay are unlikely to be affected by the contents of this article. However, the majority of humanity have strong reasons to desire both financial reform and less racial hate and I hope this essay has made a small contribution to those ends by shedding light on a topic that is not at present widely understood.
[This article was written for BMS World Mission and can be found here.]
I want an end to poverty. I want a social system which operates justly in the general interest without boom and bust. I want to force even the most selfish into the service of others. I want to bring good news to the poor.
We do not live in the Garden of Eden. Scarcity is a fundamental fact. I see a world in which I cannot survive alone. In so far as we enjoy abundance, it is because we share the work of providing for one another.
That sharing of work implies a serious problem: how shall we decide how much of what to produce?
There is a choice: either voluntary ownership, control and risk bearing in the means of production, or collective ownership through the state plus economic planning. We must choose between capitalism or socialism.
Capitalism allocates effort and resources through the price system plus profit and loss accounting. When prices are formed through voluntary exchange of the goods and services people want, a profit shows that value is being created for customers, in their opinion. A loss indicates the collective opinion of society that value is being destroyed.
Only the price system reveals the shifting preferences in the minds of billions of individuals. That is why economic planning by authority always fails. It is why actual socialist societies are highly authoritarian: ever more power is applied in a futile attempt to make planning work.
Understanding our present plight requires insight into the financial system.
Banks lend money into existence. They do not merely lend what people have saved. When a loan is made, bank deposits are created out of nothing. That’s why the UK money supply tripled between 1997 and 2010 from about £700 billion to just over £2.2 trillion.
A society simply cannot triple its money supply in 13 years without profound consequences. Understand that new money went first into the financial system and housing, London and the South East and you have a good explanation for the structural problems in our economy.
We had a chronic oversupply of credit, then sudden undersupply. It is a typical failure of economic planning by authority, a failure of central banking.
The “greedy bankers” argument is inadequate. Thanks to various state-provided guarantees, bankers were gambling with other people’s money, at other people’s risk. Of course they frequently succumbed to temptation. Then governments forced us to bail them out. The injustice of it is palpable.
Look at the cost of energy, the queues on our roads or land use decisions and the story is the same: comprehensive regulation failing to produce the right results. Yes, there is often private investment but it is protected by legal privileges. Even without considering the high level of state spending, it is impossible to sustain the argument that our economy has been too free.
We have preached capitalism but practiced socialism before blaming inevitable failure on the market.
The Peruvian economist Hernando De Soto asked why people in the developing world do not prosper despite being clever, industrious and willing to take risks. Marx believed the problem is that the poor have formal rights but no property.
De Soto demonstrated the opposite. The poorest of the poor in the developing world possess $9.3 trillion worth of land, roughly the size of US GDP and over 70 times the entire world’s foreign aid budget. It turns out the poor in developing countries possess real property but inadequate rights. Co-operation cannot work for the common good without strong property rights and contractual exchange.
We have lived through a deep crisis of the Third Way. How we respond to it is crucial. Is justice and sustained, inclusive prosperity to be delivered through a return to comprehensive economic planning by authority or should we try freedom?
The only system capable of co-ordinating the shared work of providing for one another in this world of scarcity is founded on property rights, voluntary exchange, prices, profit and loss. It is the only system capable of bending even the most selfish to the service of others. Governments must stop deranging it if we are to bring good news to the poor through voluntary co-operation in free markets.
[Editor’s Note: this first appeared on mises.org]
Last week marked the 100 Anniversary of the beginning of World War I. That war, which produced over 37 million casualties, not counting the related famines and epidemics that came in the war’s wake, also destroyed the political systems of numerous countries, setting the stage for fascism and communism in Europe. In the United States, and of course also throughout Europe, the war led to paranoia and political repression rarely seen during the previous century, and in the United States, the Wilson administration’s “anti-sedition” efforts led to a large-scale destruction of basic American liberties unmatched even by the Alien and Sedition acts of the eighteenth century.
For Americans especially, the war and the more than 100,000 American war dead gained nothing more than a post-war depression. While some Europeans could at least claim to be fighting against physical invasion, the Americans fought for nothing except to defend some authoritarian regimes from some other authoritarian regimes. The idea that the war had something to do with “democracy” was obviously untrue even at the time, and in retrospect, the claim is all the more ridiculous given the rise of totalitarianism, which was fostered by the Treaty of Versailles.
The deadly effects of the war, the repressive measures enacted by supposedly enlightened regimes, and how the war paved the way for its even bloodier sequel twenty-five years later, have been covered by a number of excellent historians and economists, including Ralph Raico, Robert Higgs, Hunt Tooley, and Murray Rothbard. The war led to revolutions in ideology, public administration, government, and war itself. Few of these changes improved the lives of ordinary people, and most of these changes led to the commodification and cheapening of human life and human freedom.
The revolutionary nature of the war is little disputed today, but rather than focus on the war itself or its aftermath, it may also be helpful to consider what the war relegated to the dustbin of history.
The Economics of the Bourgeois Century
What some historians now call “the bourgeois century” was the ninety-nine years between the Napoleonic Wars and the beginning of the First World War. From 1815 to 1914, there was no major war in Europe and the standard of living increased far beyond anything ever witnessed before as industrialization, mechanization, and the resulting increases in worker productivity spread throughout the continent.
During the middle of the century, free trade became more widespread than ever, with labor and capital enjoying never-before-seen freedom to move across national borders. Throughout much of central and western Europe, no passport was necessary to move between nation states. Indeed, passports and border checkpoints became associated with despotic and backward countries like Russia.
It was during this period that we saw the rise of the Cobdenites (also known as the Manchester liberals) in Britain who, beginning with the Anti-Corn Law League, slowly rolled back the mercantilist rule of the landed nobility who opposed free trade. The rise of the middle classes both economically and politically were buttressed by mass movements of classical liberalism Europe-wide that demanded greater economic freedoms for themselves and fewer tax-funded privileges for the ruling classes.
As free trade spread, and lessened the advantages of controlling foreign colonies, imperialism receded as well, and an international peace movement arose with John Cobden, dubbed “the international man” as one of its celebrities.
At the same time, many luxuries became available to the middle classes, and this was a time when much of what we now take for granted was quite novel. It was during this time that something that might be recognized as “the weekend” became known. For most people it was still just a one-day affair (Sunday), but it was the first time in human history that average people had the ability to not only stop work for a few hours, but to actually spend some money on recreation such as a short trip to the seaside, or shopping, organized sports, or a trip to a museum, play, or other cultural event.
The new economic realities led to major changes in families as well. For the first time, a large number of parents could afford to formally educate their children in schools or with books. More leisure and income also meant that parents could give children individual attention, play games in the home, read books as a family and more. Fewer and fewer children needed to work to help the family maintain a subsistence living. With the economic liberation of children also came much better conditions for women who became far better educated, and became valued for their ability to manage complex tasks such as the education of children, household hygiene (no small matter in a nineteenth century city) twice-a-day food shopping and more. Moreover, men and women began to engage in the odd practice of marrying for reasons of “sentiment and physical attraction” as marrying for financial reasons became less a matter of life and death. Just as leisure on Sundays allowed for more public recreation, leisure time within the family allowed for more “private” recreation as well, which was complimented by marriage manuals, such as those found in France, that reminded men to tend to women’s sexual needs.
The Rise of Imperialism and the Road to World War I
Naturally, sex, family, and an afternoon at the beach struck many conservative politicians and “deep thinkers” as frivolous wastes of time. Family time and leisure was wasted on mere ordinary people when far more “honorable” pursuits such as nation-building, colonial adventurism, and the art of war were being neglected.
Certainly Otto von Bismarck, a great enemy of the liberals, was expressing contempt for such domestic pursuits when he declared his disdain for the Manchester liberals as “Manchester moneybags” who were concerned not with the glory of the nation-state, but with making money.
By the late nineteenth century, bourgeois liberalism was in decline. Assaulted on one side by the Marxists and other socialists, and on the other side by conservatives, nationalists, and imperialists, the great powers of Europe began to sink back into mercantilism, nationalism, and imperialism. The Scramble for Africa was representative of the new imperialism as the European great powers looked ever more aggressively for new colonies. Meanwhile, the British tightened their grip on India while inventing the concentration camp in its efforts to starve the Boers into submission.
In the late nineteenth century, Bismarck was hard at work inventing the welfare state and hammering together Germany into one unified nation-state. By the turn of the century, one of the few remaining liberals, Vilfredo Pareto in Italy, was able to declare that socialism had finally triumphed in Europe.
In the decade before the First World War, The generation of European liberals such as Gustav de Molinari, Cobden, John Bright, Herbert Spencer, Eugen Richter, and others were dead or near death. There were few young, new liberal scholars to replace them.
At the same time, trade barriers abound throughout Europe as the great powers turned to the economics of imperialism characterized by mercantilism, tariffs, border controls, regulation, and militarism.
Europe during the bourgeois century was certainly no utopia. The new cities were filled with disease, pollution, and crime. Medical science had yet to achieve what it would in the twentieth century, and of course, standards of living remained low when compared to today. But even if we consider these problems, which plague many societies even today, the enormous gains made for ordinary people, thanks to industrialization and the rise of free trade, were fostered all the more by the rise of classical liberalism which actively sought to avoid war, political repression, and economic intervention as the means to a more prosperous society.
Indeed, historian Daniel Yergin would come to refer to this period as the time of “the first era of globalization” and to note that “the world economy experienced an era of peace and growth that, in the aftermath of the carnage of World War I, came to be remembered as a golden age.”
Liberalism was already deeply in decline by 1914, but the First World War was perhaps the final nail in the coffin. Following the war, depression followed, and for Europe, this was followed by hyperinflation in many places, political instability, a declining standard of living — and finally — fascism, communism, and war. In the United States, which managed to avoid most of the destruction of the war, prosperity was achieved during the 1920s, only to be lost and followed by fifteen years of depression and war.
One hundred years after the beginning of the end for bourgeois Europe, we are fortunate to be looking on a new classical liberalism, now known as libertarianism, which is not in decline, but instead is making great strides globally in the face of a still-ascendant ideology of interventionism, mercantilism, and war. We can hope that a third world war will not bring it all crashing down.
[Editor’s Note: We will keep our readers apprised of developments in the exchange between Paul Krugman and The Cobden Centre regular Ralph Benko.]
Professor Paul Krugman, in his New York Times blog last week, says my most recent column, about him, is “funny and scary.” Last week’s column here inferred that Prof. Krugman is leaving Princeton in quiet disgrace. It drew pretty wide attention.
It also drew over 150 comments. Many commentators merrily berated me. (Comes with the territory.) The column, quite flatteringly, even drew a riposte from Prof. Krugman himself, in hisTimes blog, entitled Fantasies of Personal Destruction:
A correspondent directs me to a piece in Forbes about yours truly that is both funny and scary.
Yep, scurrying away with my tail between my legs, I am, disgraced for policy views shared only by crazy people like the IMF’s chief economist (pdf).
One thing I’ve noticed, though, is how many people on the right are drawn to power fantasies in which liberals aren’t just proved wrong and driven from office, but personally destroyed. Does anyone else remember this bit from the O’Reilly scandal?
“Look at Al Franken, one day he’s going to get a knock on his door and life as he’s known it will change forever,” O’Reilly said. “That day will happen, trust me. . . . Ailes knows very powerful people and this goes all the way to the top.”
And people wonder why I don’t treat all of this as a gentlemanly conversation.
English: Paul Krugman at the 2010 Brooklyn Book Festival. (Photo credit: Wikipedia)
Prof. Krugman’s prestige, and the immense influence provided him by the New York Times, gives his opinions enormous political weight. What he writes has impact in liberal, and Democratic, quarters. Yet he by no means is infallible.
The critique this columnist offered drew on commentaries by figures of real stature. One of these is Niall Ferguson, economic historian, Harvard professor (and Senior Research Fellow of Jesus College, Oxford University, and Senior Fellow at the Hoover Institution, Stanford University). The other commentary came from Paul Volcker who made a disparaging comment fairly interpreted as aimed at Prof. Krugman.
What’s really odd about Prof. Krugman’s Fantasies of Personal Destruction is its abrupt segue into likening my critique to a statement made by someone this columnist never met to someone this columnist never met. What could have motivated this non sequitur?
Perhaps some psychological force is at work? Prof. Krugman, echoing a clever critique by Keynes, himself has invoked Freud as key to understanding proponents of the gold standard. Freud,speculating on subconscious associations between excrement and money, referenced the Babylonian doctrine that “gold is the feces of Hell.” Thus, implies Prof. Krugman, proponents of a gold standard are stuck in an infantile “anal-retentiveness.”
Keynes, perhaps not getting it quite right, alludes to Freud in Auri Sacra Fames(September 1930):
Dr. Freud relates that there are peculiar reasons deep in our subconsciousness why gold in particular should satisfy strong instincts and serve as a symbol.
It presumably is this to which Prof. Krugman obscurely alludes in a blog entitled The She-Devil of Constitution Avenue:
I’ve been saying for a long time that we aren’t having a rational argument over economic policy, that the inflationista position is driven by politics and psychology rather than anything the other side would recognize as analysis. But this really proves it beyond a shadow of a doubt; if you really want to understand what’s going on here, the Austrian you need to read isn’t Friedrich Hayek or Ludwig von Mises, it’s Sigmund Freud.”
Put aside the demonstrable fact of Prof. Krugman’s consistently sloppy conflation of gold investors and gold standard proponents. Put aside his failure to engage with the arguments of the many gold standard proponents not predicting imminent virulent inflation. (Such as this writer.)
Eruditely ridiculing gold proponents as, well, full of s*** is clever. It likely will tickle those readers who find monkeys flinging poo at each other hilarious. Ridicule is much easier, and cheaper, than grappling with scholarly analyses such as that from the Bank of England which provided, in 2011, Financial Stability Paper No. 13, a genuinely interesting critique of the real world performance of fiduciary currency.
That paper is a rigorous analysis of the empirical performance of the fiduciary Federal Reserve Note standard in comparison to the Bretton Woods gold-exchange standard and the classical gold standard. It does not, at least not explicitly, advocate for either predecessor standard. It simply assesses that the Federal Reserve Note standard in practice has proved substantially worse than its predecessors (and calls for the exploration of a rule-based system). A thoughtful response by Prof. Krugman to this paper would be far more interesting, and edifying, than sly scatological insults.
One of the wittier of the commentators to last week’s column accused me of impudence. Guilty as charged. This writer confesses to having committed, in broad daylight, an act of lèse-majesté against the Great and Imperious Krugman. My critics are right to point out that this columnist is a minor figure. Still, do consider: the counsels of integrity to Pinocchio by the tiny Talking Cricket proved, in the end, well founded. One, also, could wish that more of Prof. Krugman’s defenders would tender more persuasive arguments (say, fact-based) than their many variants of “How dare you!”
In responding to my column Prof. Krugman states that “many people on the right are drawn to power fantasies in which liberals aren’t just proved wrong and driven from office, but personally destroyed.” Given Prof. Krugman’s vilification of his adversaries this could be dismissed as rich with irony. Yet there may be more to say.
Prof. Krugman has introduced the great Sigmund Freud into the conversation. Thus it might be fair to say that his consistently rude denigration of his adversaries appears to be what Freud called “projection” (“in which humans defend themselves against unpleasant impulses by denying their existence in themselves, while attributing them to others“).
Consider Prof. Krugman’s public admission that he does not regularly read that which he presumes to criticize. Prof. Krugman states forthrightly:
Some have asked if there aren’t conservative sites I read regularly. Well, no.
Carefully reading one’s opponents’ arguments is not a requisite in life. Yet critiquing arguments one has not thoroughly assimilated is lazy, louche, intellectually slovenly, and — one might fairly infer — unacceptably beneath the standards of, say, Princeton University.
Prof. Krugman dismisses me as “funny and scary.” My several columns pointing out the errors of fact and unsupportable interpretations in his op-eds had been — and surely again will fall — beneath his notice. Still, inaccurately presenting that which one is criticizing is just bad journalism. Readers should be able to rely on editors to assure that a columnist is shooting straight.
As many of my commentators correctly point out I do not command (nor do I presume to deserve) the elite social status of Prof. Krugman. Yet had Prof. Krugman taken even a moment to aim before he fired he could have discovered a right winger who has offered many respectful words, and, when warranted, praise for Barack Obama,Hillary Clinton, Elizabeth Warren, George Soros, MoveOn.org, and Occupy Wall Street (among others with whom he has disagreements). There’s no agenda of “personal destruction.”
If Prof. Krugman had dug a little deeper he might have discovered that my columns routinely are informed by The New York Review of Books, the New Yorker, theAtlantic Monthly, and, yes, the New York Times, all of which I read regularly, usually with pleasure. He would discover that my use of them is not, by and large, to ridicule but to learn and, when in disagreement, to present their claims fairly and dispute them honestly.
Scary stuff? Prof. Krugman, if you find the words of this extremely minor pixel-stained wretch “scary” … what does that say? Perhaps speaking truth to power is scary … to those with power? Yet let me speak a little truth to the powerful, and indispensable,New York Times.
The Nobel Prize in Economics is one of the greatest laurels bestowed in that field. Should Prof. Krugman be permitted to rest on this laurel? Joseph Pulitzer’s directive still applies: “Put it before them… above all, accurately….”
It is not the purpose of this column to see Paul Krugman driven from his virtual office within the paragovernmental New York Times. This columnist makes only a modest call for the Times to assign an editor to fact check his work and help him refrain from reckless disregard for the truth.
The following text is from the notes I made of a talk that I gave to the “End of The World Club” at the Institute of Economic Affairs on 18 April 2014.
If there is one feature of human society that makes it successful, it is the capacity that human beings have of choosing to satisfy short-term appetites or to defer gratification. This ability to distinguish between short term and long term interests is at the heart of economics.
But why defer consumption? Why save at all?
One reason is the transmission of wealth from one generation to the next. Another is to ensure security in hard times.
A complaint of American academics about French savings in the 19th century is that they were too conservative. Easy for them to say.
The population of France grew more slowly than any other industrialising nation in the 19th century (0.2% per year from 1870 to 1913, compared with 1.1% for Germany and 0.9% for Great Britain). The figures would be even worse if emigration from the British Isles were added to the headcount.
This slower rate of population growth would tend to mean a slower rate of economic growth: smaller local markets, fewer opportunities for mass production. This was well known to be a problem in France. In fact Jean-Baptiste Say was sent to England in 1815 to study the growth of English cities such as Birmingham and its effect on the economy (here in French).
The causes of low investment must surely include political and social instability.
Here are the changes of regime in France during the 19th century:
1800-1804: The Consulate
1804-1814: The Empire
1814: The First Restoration
1814-1815: The Return of Napoleon
1815-1830: The Return of the Restoration
1830-1848: The British Experiment
1848-1851: The Second Republic
1851-1852: The military coup-d’état
1852-1859: The Empire Strikes Back
1860-1870: The Free Trade Experiment (supported by Richard Cobden)
1870-1871: Three sieges of Paris, two civil wars, one foreign occupation
1870-1879: The State Which Dare Not Speak Its Name (retrospectively declared to be a republic)
1879-1914: La Belle Epoque (including the anarchist bombings 1892-1894 and the Dreyfus Affair 1894-1906)
If instability discourages savings, it is remarkable how much there actually was.
Five billion francs in gold, raised by public subscription to pay for the German army of occupation to leave France after the Franco-Prussian War. The amount was supposed to be impossible to pay and designed to provide an excuse for a prolonged German occupation. It was paid in full in two years. 80% of the money (equivalent to over two and half times the national government’s total annual spending, was raised in one day).
What the modern academics decried was that these sorts of sums weren’t invested in industry or agricultural technology. In 1880, French private investments amounted to 7.3 billion Francs, but this was less than half of all investments (48%), versus 52% for government bonds.
You can’t pick up your factory machines and run away from the Uhlans, or the Communards.
Gold was one preferred wealth storage option. It still is in France.
Government bonds were generally considered a good deal: backed by the power of taxation, and, unlike gold, they earned interest.
One constant concern of French governments in the 19th century was the diplomatic isolation enforced by the 1815 Congress of Vienna. Various attempts were made to break this, some successful like the split of Belgium from the Netherlands in 1830, the Crimean War (co-operation with the British), others failed (Napoleon III’s Mexican adventure, the Franco-Prussian War).
By 1882, Germany looked like getting economic and military supremacy in Europe, with an Triple Alliance with Austria-Hungary and Italy. With the British playing neutral, the best bet was to build up Russia.
The first Russian bonds sold in France were in 1867 to finance a railroad. Others followed, notably in 1888. At this point the French government decided on a policy of alliance with Russia and the encouragement of French savers to invest in Russian infrastructure. From 1887 to 1913, 3.5% of the French Gross National Product is invested in Russia alone. This amounted to a quarter of all foreign investment by French private citizens. That’s a savings ratio (14% in external investment alone) we wouldn’t mind seeing in the UK today!
A massive media campaign promoting Russia as a future economic giant (a bit like China in recent years) was pushed by politicians. Meanwhile French banks found they could make enormous amounts of commission from Russian bonds: in this period, the Credit Lyonnais makes 30% of its profits from it’s commission for selling the bonds.
In 1897, the ruble is linked to gold. The French government guarantees its citizens against any default. The Paris Stock Exchange takes listings for, among others: Banque russo-asiatique, la Banque de commerce de Sibérie, les usines Stoll, les Wagons de Petrograd.
The first signs of trouble come in 1905, with the post-Russo-Japanese War revolution. A provisional government announced a default of foreign bonds, but this isn’t reported in the French mainstream media or the French banks that continue to sell (mis-sell?).
During the First World War, the French government issued zero interest bonds to cover the Russian government’s loan repayment, with an agreement to sort out the problem after the war. However, in December 1917, Lenin announced the repudiation of Tsarist debts.
The gold standard was abolished, allowing the debasement of the currency, private citizens were required to turn over their gold for government bonds.
Income tax was introduced (with a top rate of 2%) after the assassination in Sarajevo of the Archduke Ferdinand and his wife.
In 1923, a French parliamentary commission established that 9 billion Francs had effectively been stolen from French savers in the Russian bonds affair. Bribes had been paid to bankers and news outlets to promote the impression of massive economic growth in Russia. Many of the later bonds were merely issued to repay the interest on earlier debt.
For the next 70 years, protest groups attempted to obtain compensation, either from the Russian government or from the French government that had provided “guarantees”. You won’t be surprised to know that some banks managed to sell their bonds to private investors after 1917, having spread false rumours that the Soviets would honour the bonds.
Successive French governments found themselves caught between the requirements of “normal” relations with the USSR and the clamour of dispossessed savers and their relatives.
In November 1996, the post-Soviet Yelstin government agreed a deal to settle the Russian bonds for $400 million. The deal covered less than 10% of the families demanding compensation. Despite this, 316,000 people are thought to have received some compensation, suggesting that over 3 million families were affected by the Russian bonds scandal.
There are similarities with the present day but also significant differences.
First, the role of government guarantees and links with favoured banks, ensuring savers were complacent.
Second the manipulation of economic data by the Russian government, which looks a lot like what’s been happening in China.
Third the fragility of the situation: war can break out. All sorts of assumptions we can make about safe investments go out of the window.
One specifically French response to all this is something I would like to see an academic study of. What changes to consumption and savings would follow from growing up in a family where savings have been wiped out by government action (Russian or one’s own)? If three million people were directly involved, most French people would have known someone who had deferred consumption and been robbed. To what extent does the post-1945 explosion in mass consumption in France reflect a view that deferring consumption is foolish when savings can be stolen with the connivance or lack of concern of one’s own government?
Editor’s Note: This article was previously published in The Amphora Report, Vol 5, 09 May 2014.
“Capitalism is not chiefly an incentive system but an information system.” -George Gilder
“Don’t shoot the messenger” is an old aphorism taken primarily to mean that it is unjust to take out the frustrations of bad news on he who provides it. But there is another reason not to shoot the messenger: News, good or bad, is information, and in a complex economy information, in particular prices, has tremendous value. To suppress or distort the information industry by impeding the ability of messengers to do their jobs would severely damage the economy. As it happens, messengers in the price signals industry are normally referred to as ‘speculators’ and the importance of their economic role increases exponentially with complexity. So don’t shoot the speculator. Embrace them. And if you feel up to it, consider becoming one yourself. How? Read on.
IN ADMIRATION OF SPECULATION
Back in high school my sister had a boyfriend who was quite practical by nature and, by working odd jobs, saved up enough money for the down payment on a 4WD pickup truck before his 18th birthday. It was a powerful truck and as a result he was able to generate additional business doing landscaping and other work requiring off-road equipment transport.
His truck also had a winch, which was of particular use one night in 1982. A severe storm hit, flooding the primary commuting routes north of San Francisco. Hundreds of motorists got stranded in water on roads stretching all the way to the Sonoma County borders. The emergency services did their best but the gridlock severely curtailed their ability to reach many commuters, who ended up spending the night in the cars. Fortunately, it was not particularly cold, and the conditions, while unpleasant, were hardly life-threatening.
As word got round just how bad the situation was, among others, my sister’s boyfriend headed out in his truck and sought out stranded commuters to winch out of the water. Sure, he wanted to help. But he also had payments to make on his truck. And he needed money generally, not being from a wealthy family. So naturally he expected to get paid for his services. What he didn’t expect, at least not at first, was just how much he could get paid.
As he told the story the next day, at first he was charging $10 to winch a car to safety. But as it dawned on him just how much demand there was and how few motorists he could assist-attaching a winch to a car and pulling it to safety could take as long as 20mins-he began to raise his prices in response. $10 became $20. $20 became $50. By midnight, stranded drivers were willing to pay as much as $100 for his assistance (Marin County is a wealthy county so some drivers were not just willing but also able to pay this amount.)
I forget exactly, but I believe he earned nearly $3,000 that night, enough money to pay off the lease on the truck! He was thrilled, my sister was thrilled and my parents were duly impressed. Yet the next day the local papers contained stories disparaging of ‘price-gouging’ by those helping to rescue the stranded commuters, who also noted and complained about the lack of official emergency services.
This struck me as a bit odd. The way my sister’s boyfriend told the story, he thought he was providing a valuable service. At first he was charging very little but as people were obviously willing to pay more, he raised his prices in return. The price discovery went on into the wee hours and reached $100 in the end. Did he plan things that way? Of course he had no idea he would be in the right place, at the right time, to make nearly $3,000 and pay off the lease in one go. But to hear some of the stranded commuters talk as if he was a borderline criminal just didn’t fit.
I didn’t think of it at the time, but as I began the study of economics some years later and learned of the role that speculators play in a market-based economy, I recalled this episode as one that fit the definition rather well. Speculators provide essential price information. Yet their most important role, where they really provide economic value, is not when market conditions are simply ‘normal’-when supply and demand are in line with history-but rather when they help to determine prices for contingent or extreme events, such as capacity constraints. Without sufficient capacity for a rainy day-or a VERY rainy day such as that in 1982-consumers will find at critical times that they can’t get access to essential services at ANY price.
In that rare moment, when prices soar, it might be tempting to shoot the messenger-blame the speculator-but this is unfair. Sometimes they take big risks. Sometimes they take huge losses or reap huge rewards. But regardless, they provide essential price discovery signals that allow capacity to be built that otherwise might not exist.
Consider those who speculate in electricity prices as another example. Electricity demand naturally fluctuates. But electricity providers are normally contractually required to meet even unusually large surges in peak demand. Occasionally, due to weather or other factors, there are extreme spikes in demand and capacity approaches its limit. If there is a tradable market, the price then soars. At the limit of capacity, the last kw/hr goes to the highest bidder, much as at the end of an auction for a unique painting. Such is the process of price discovery.
Absent the unattractive option of inefficient and possibly corrupt central planning, how best to determine how much capacity should be made available? Who is going to finance the infrastructure? Who will assume the risks? Well, as long as there is a speculative market in the future price of electricity, the implied forward price curve provides a reference for determining whether or not it is economically attractive to add to available capacity or not, with capacity being an option, rather than the obligation, to produce power at a given price and point in time.
My sister’s boyfriend’s truck thus represented an undervalued ‘option’ with which to winch cars to safety. Under normal conditions this option had little perceived value. But on the occasion of the flood, it had tremendous value and the option was ‘exercised’ at great profit. Valuing the truck without speculating on the possibility of such a windfall would thus be incorrect. And failing to appreciate the essential role that speculators play in building and maintaining economic capacity generally, for all goods and services, can result in a temptation to shoot the messenger, rather than to get the message.(1)
HOW DO SPECULATORS SURVIVE?
If speculators are the ‘messengers’ of market economies, how are they compensated? Obviously, those who are consistently right generate trading profits. But what of those on the other side who are consistently wrong? How can speculators as a group, right and wrong, make money? And if they can’t, how can they exist at all? (Of course, if they are too big to fail, they can count on getting bailed out. But I’ve already flogged that dead horse in many a report.)
This was once one of the great mysteries of economics, but David Ricardo, Ludwig von Mises and others eventually figured it out. Speculators do more than just speculate, although from their perspective that is what they see. Speculators also provide liquidity for hedgers, that is, those who wish NOT to speculate. And they charge a small implied fee for doing so, in the form of a ‘risk premium’. This risk premium is what keeps them going through the inevitable ups and downs of markets. They assume risks others don’t want to take and are compensated for doing so. In practice, it is impossible to determine precisely what this implied fee is, although economists do have ways to approximate the ‘liquidity risk premium’ that exists in a market.
Hedgers can be those who have a natural exposure to the underlying economic good. Take wheat for example. A highly competent farmer running an efficient farm might want to concentrate full-time on his operations and leave the price risk of wheat to someone else. He can do so by selling his estimated production forward in the futures markets. On the other side, a baked goods business might prefer to focus on their operations too. In principle, the farmer and the baker could deal directly with one another, but this arrangement would give them little flexibility to dynamically adjust hedging positions as estimated wheat production or the demand for bread shifted, for example. With speculators sitting in the middle, the farmer and the baker needn’t waste valuable time seeking out the best counterparty and can easily hedge their risk dynamically. Yes, they will pay a small liquidity risk premium to the speculators by doing so, but advanced economies require a high degree of specialisation and thus the professional speculator is an essential component.
While it is nice to receive a small risk premium in exchange for providing essential price information and liquidity, what speculators most want is to be right. Sadly, pure speculation (ie between speculators themselves, not vis-à-vis hedgers) is a zero sum game. For every ‘right’ speculator there is a ‘wrong’ speculator. While there is an extensive literature regarding why some traders are more successful than others, I will offer a few thoughts.
THE UNWRITTEN ‘RULES’ OF SUCCESSFUL SPECULATION
There are several unwritten rules in speculation, and I would confirm these through my own experience. The first is that it is the rare trader who is right more than 60% of the time, so most successful traders are right within the narrow range of 51-60%. Then there is the second rule, that 20% of traders capture 80% of the available profits. Combining these two rules, what you have is that 20% of traders are correct 51-60% of the time: So 0.2 * 0.5 or 0.6 = 0.10 to 0.12 or 10-12% of all trades initiated are winning trades for winning traders. The remaining 88% are either losing trades or they are winning trades spread thinly amongst the less successful traders.
These numbers should make it clear that successful traders are largely just risk managers: Yes, they succeed in identifying the 10-12% of trades that really matter for profits but they are also wrong 40%+ of the time so they must know how to manage their losses as well as when to prudently take profits on the 10-12% of winning trades.
Internalising this negative skew in trading returns is an essential first step toward becoming a good trader. Just accept that something on the order of 50% of trades are going to go against you, possibly even more. Accept also that only 10-12% of your trades are going to drive your profits. Focus on finding these but keep equal focus on minimising exposure to the other 88-90% of trades that either don’t matter, or that could overwhelm the 10-12%.
At Amphora, we have an investment process that we believe is particularly good at identifying and isolating the most attractive trades in the commodities markets. Sure, we make mistakes, but our investment and risk management processes are designed to keep these mistakes to a minimum. Indeed, we miss out on many potentially winning trades because we are highly selective. So while speculation may have a cavalier reputation of bravado trading, day in and day out, the Amphora process is more patient; an opportunistic tortoise rather than a greedy, rushed hare.
CURRENT OPPORTUNITIES IN THE EQUITIES AND COMMODITIES MARKETS
In my last Report discussing the financial and commodities markets outlook, 2014: A YEAR OF INVESTING DANGEROUSLY, I took the view that the equity market correction (or crash) that I anticipated from spring 2013 was highly likely to occur in 2014, for a variety of reasons (2). While I did not anticipate that the Ukraine crisis would escalate as much as it did, as quickly as it did, thereby causing some concern, I did expect that corporate revenues and profits would increasingly disappoint, as they most certainly have done year to date. This is due in part to weaker-than-expected economic growth, with the drag from excessive inventory growth plainly visible in the Q1 US GDP data. But the news is in fact much worse than that, because labour productivity growth has gone sharply negative due to soaring costs. These costs may or may not be specifically associated with the ‘(Un?)Affordable Care Act’ depending on who you ask, but the fact that productivity has plunged is terrible news for business fixed investment, which is the single most important driver of economic growth over the long-term. While a recession may or may not be getting underway, the outlook is for poor growth regardless, far below what would be required to justify current corporate earnings expectations, as implied by P/Es, CAPEs and other standard valuation measures. For those who must hold an exposure to equities, my key recommendation from that previous Report holds:
[I]t is time to rotate into defensive, deep-value, income-generating shares. These could include, for example, infrastructure, consumer non-discretionary and well-capitalised mining shares, including gold miners. That may seem an odd combination, but it so happens that even well-capitalised miners are trading at distressed levels at present, offering unusually good value.
Turning to the commodities markets, I expressed a preference for ‘defensive’ commodities in the Report (Although I did recommend taking initial profits in coffee). Indeed, basic foodstuffs, in particular grains, have outperformed strongly of late, continuing their rise from the depressed levels reached last year. However, the large degree of such outperformance now warrants some rotation out of grains and into industrial metals, including copper, aluminium, iron and nickel. Yes, these are exposed to the business cycle, which does appear to be rolling over in the US, China, Japan, Australia and most of Asia, but the extreme speculative short positioning and relative cheapness of industrial metals at present makes them an attractive contrarian play.
Precious metals have not underperformed to the same degree and they are normally less volatile in any case, but given the nearly three-year bear market, attractive relative valuations and the potential for a surge in risk-aversion, I would add to precious metals. Silver in particular looks cheap, although gold is highly likely to be the better performer in a risk-off environment. My recommendation would be to favour gold until the equity markets suffer at least a 15-20% correction. At that point, incremental rotation into silver would be sensible, with a more aggressive response should equity markets suffer a substantial 30%+ decline.
Turning to the platinum group metals, palladium is unusually expensive due to Russian supply concerns. While this is entirely reasonable due to the Ukraine crisis, the fact is that near-substitute platinum is much cheaper. And the on-again, off-again strikes at the large platinum mines in South Africa could escalate in a heartbeat, providing ample justification for platinum prices to catch up to palladium. Alternatively, should the Ukraine crisis de-escalate meaningfully, palladium is highly exposed to a sharp downward correction, and I would recommend a strong underweight/short position at present.
(1) Perhaps one reason why many fail to appreciate the essential role that speculators play in a market economy is that mainstream, neo-Keynesian economics treats speculation as mere ‘animal spirits’, to borrow their classic depiction by Keynes himself.
(2) This report can be accessed here.
Matt Ridley, in The Times [paywall restricted], considers the political relevance of the values of 19th century Liberals, including Richard Cobden.
Surely wanting government to stay out of the economy should go with wanting government to stay out of society too. They went together in the 19th century, after all. Radical liberals who campaigned against war, colonialism, slavery, politicial patronage and the established church were usually furiously free-market libertarians on economics: people such as Richard Cobden, Harriet Martineau, Herbert Spencer or WE Gladstone.
Cobden, said one of his biographers, “believed in individual liberty and enterprise, in free markets, freedom of opinion and freedom of trade.” But he also was an implacable pacifist and refused a barontcy from a monarch he disapproved of. Nobody would have dreamed of calling him a rightwinger.
Mr Ridley also suggests that these values would be useful for politicians to build a coalition around: people who want the government out of “the boardroom and the bedroom.” That is not a cause that the Cobden Centre has any business getting involved in. But it is nice to see someone noticing the relevance of Cobden’s ideas.