Category Archives: Economics

BBC Roundtable Discussion on Europe’s Banking Crisis

May 27, 2010 – 1:04 pm

Its always interesting to hear some great thinkers discuss issues in this format. This meeting brought together Jeffery Sachs, Gillian Tett, and Hugh Hendry.

I believe Hugh gets it right: Europe needs to let the banks that made bad decisions fail.

Towards the end, though, Hugh discusses imposing stricter legislation on banking dividends, and this is where I think he misses the mark: If banks are allowed to fail, they are not going to arbitrarily raise their dividends to boost their stock price, something that only makes sense if you are going to get a bailout.

By Jud Stephenson | Also posted in Asides | Tagged , , , | Comments (0)

How Property Rights Saved Chile And Destroyed Haiti [Updated]

February 27, 2010 – 5:17 pm

The Destruction

Rarely do I really sit down and watch “the news”, preferring, instead to find my news online and research topics I find of interest. However, when I do watch television, I prefer to watch Fox News for apolitical news stories. Today, though, in the aftermath of the 8.8 magnitude earthquake in Chile, many of the pundits are pointing to stricter building codes leading to death tolls in Chile that are orders of magnitude less than an earthquake in Haiti, which itself was rated 500x less than the Chilean earthquake today. Oddly though, that there is almost no mention of property rights and economic freedom, the true cause of better buildings and lower death tolls.

Chile Earthquake

Four weeks ago, I had the privilege of sitting in a lecture by Mark Thorton where he proposed the idea of property rights as a prediction of destruction caused by a natural disaster. The idea being that the systematic destruction of property rights discourages investment in infrastructure and building quality. When describing the sheer lack of property rights, he told this story:

A farmer in Haiti, wanting to provide a source of income for his family in the future, planted a coconut seed in the hopes of nuturing it to bear fruit (a task that takes 7 years to complete). He planted the seed on his land and before he could rise the next morning, someone had dug up the coconut and eaten it.

If that story doesn’t provide enough visualization, according to The Heritage Foundation Property Rights Index, Haiti’s score is an abysmal 10 (right on par with Cuba). Haiti also scored very low for government corruption and investment freedom, particularly for the restriction of investment in infrastructure and overall financial freedom.

Putting the pieces together, we see an all too vivid painting of disaster waiting to happen. The systematic destruction of property rights (aka socialism) and the tough investment atmosphere discourages entrepreneurial endevers to bring the infrastructure up to par, add the pronounced government corruption on top and the picture starts becoming sharper. With this in mind, lets look at the earthquake that happened today, in Chile, keeping in mind that the Chilean earthquake was 500x stronger than its counterpart in Haiti.

The statistics are shocking: A projected death toll of ~240 and destruction that doesn’t even come close to the death toll of 230,000 and the absolute destruction of nearly all standing building in the Haitian earthquake.

Haiti Damage

The critics will be quick to point to building codes as providing a minimal standard for which contractors will work by, although, as seen in a few places around the internet, and as common sense should dictate, building codes are not always followed or enforced. Rather, it is wealth, or more specifically, the investment of wealth, that inherently leads to better safety features being incorporated into building design. If people are unable to invest in a structure without the townspeople destroying it, there will be no investment at all, as seen with Haiti. Stricter building codes in Hait will only lead to a higher cost of entry for entrepreneurs, discouraging what little investment exists to the point of extinction.

Free Market Alternative

To see what the free market can come up with without government imposed building codes, we should look no further than Dubai, where there is no unified building code. Despite this, we see buildings being created that implement safety features beyond the norm. Why is this? The ability to reliably invest in ones own property without fear of its destruction allows the construction of building with safety features that pay off only in the long run. Logically, if a building will only have a life of 1 year or less before rebels destroy it, earthquake proofing and fire safety become less of an issue than speed and low cost.

Critics will claim that the push for an extra buck will drive down quality, though, they give no credit to intelligent consumers who have the ability to choose buildings which are safer, over those that are not. When building codes are in place, a successfully built building has an untold promise: “I have been certified safe by the government”. When there are no governmental codes, the market becomes uncannily efficient at its own methods of “certification”, a case in point would be Underwriters Laboratories, a private firm that tests and certifies a myriad of things to meet their specification of safety.

Mark Thornton comments on the UL in his piece “What Keeps Us Safe”:

The Lab was the first to set standards for certifying the safety of pilots and planes before the government intervened. It set the standards for building materials, fire-fighting equipment, air conditioners, and household chemicals. It employs safecrackers and pyrotechnicians to test safes, and a variety of unique machines and devices to test thousands of other products each year. It has been testing multicolored Christmas lights since 1905, and entered the building-code business right after the San Francisco earthquake of 1906.

Its effectiveness in determining safety standards (even for brand-new products) and maintaining them over time has generated an interesting result. Many government regulations, especially at the state level, merely mimic the building codes and insurance requirements of the Lab.

There are already private companies that stringently test and develop their own building codes. Governmental bureaucracy only adds additional cost to the the construction of a building and discourages 3rd-party certification, stifling new and innovative methods for testing and certifying safety.

Impressed at Chile’s resilience to a 8.8 magnitude earthquake? So am I. Yet, their resilience is no poster-child for government superiority in construction. It is their superior enforcement of property rights that leads to greater investment in ones own property, and as a side effect of greater investment, greater safety. This assumption can be taken one step further by suggesting that the best action for Haiti relief would be aid with a stipulation for stricter protection of property rights and deregulation of investment, which in turn, would put Haiti on the road to long term wealth. To quote Thornton: “[T]he market discovers new and effective solutions to the problems of everyday life, reduces the risks all around us, and does so without resorting to the coercion and inefficiency of government.”

The thoughts and prayers of The Austrian go out to the families and victims of the Chile earthquake. It is our hope that education about the perversion of property rights and their effects on the magnitude of destruction caused by natural disasters will gain a footing in todays society and shape it, for the better, for tomorrows future.

Update: I should have known that the first released numbers were governmental propaganda. The “dust-settled” death toll in Chile is ~720. The same points, though, are still very applicable.

By Jud Stephenson | Tagged , , , | Comments Off

Instinctive Economics

February 6, 2010 – 4:11 pm

The subject of greed and profit has always been a very politically polarizing topic, with the left seeing profit as inherently evil and the right, while not perfect, seeing profit as a more acceptable showcase of success. From the Austrian perspective, profit is the side effect of providing a good or service that has more marginal benefits than marginal costs. It is also referred to as interest in some papers, being the interest on funds invested in the company.

Bank Bailout Protesters

The subject of profits and greed has been something of a front page topic in the fallout of the housing bubble and the associated bailouts and zero-interest funds being lent to banks unable to escape with their balance sheets in tact. Upon closer inspection, it becomes obvious why people are upset about the money that banks are making and especially the bonuses that bank executives are taking home. Ironically, as with most economic problems, people have a tendency to cry out to the government to fix a problem without realizing what is driving their misplaced anger against “profit”.

To get to the bottom if the situation, I will refer back to my introduction, a definition of “profit”. If you look at the government banking equation of bailouts + write-downs = profits, you can clearly see why people are upset: the banks aren’t making real profit, only ending the financial quarters with excess dollars and not giving anyone a service that yields marginal benefit.

It sparks the interest when an economist can talk to “common people” who have never heard about marginal benefit, yet still understand instinctively how profit is to be acquired. They fall short in their understanding how profit can be acquired without providing net marginal benefits and they wrongly stereotype excess profits as greed, often calling for government taxing and intervention to bring profit to a more acceptable level.

Psychologically, I can believe that a company has the ability to make too much money relative to the marginal benefits they provide to consumers. Economically though, I cannot believe that companies can make excessive profits, as profits are by definition the product of providing a good or service that provides a marginal gain to consumers. Both of these thoughts can be rationalized when one entity is added to the equation, government intervention into markets.

Protesting against bank bailouts

In every case, without fail, where there is an outcry of “excessive profits”, one can look no further than the acts of government intervention that cause “profits without cause” or those which were had without providing a beneficial service that seemed to warrant a specific quantity of profits. Drug companies “shameful” profits: a byproduct of extensive regulation by the FDA, Record bank profits: the direct effects of giving them billions of zero-interest dollars, and the list can continue into the auto industry and the fact that a great opportunity to change the way we think about cars was squashed by the government “saving” and industry which has failed miserably for decades.

The fact of the matter is, it is impossible under a pure market driven economy to make profits without being a net benefit for the community. In that case, the more profits, the better off society as a whole will be. When you fail to provide anything of value to society, people quit buying and profits dwindle. Barring government intervention, failure to change as profits decline will end up in bankruptcy and a new opportunity arises for other, more agile companies to step in and provide what that company couldn’t. The market works, but people are sometimes unable to see the forest for the trees.

By Jud Stephenson | Tagged , , , | Comments Off

Nelson, Obama, and Health Reform

December 21, 2009 – 2:40 pm

Ben Nelson

Out of Touch

President Obama is in an interesting position. For the fifth straight week, between 38% and 41% of Americans oppose health care reform. However, as we found out last night when the Senate voted on ending debate over the bill at 1 am EST, a whopping 60% of our elected representatives favor the current health care bill, which will increase government control over medical decisions more than ever before. Obama’s position? Well, he believes the bill falls short of complete reform but is willing to sign it in order to have a political win under his belt.

Being a shameless proponent of a single payer system, Obama now finds his position on health care, a hotly debated issue in the campaign, much farther left than the American public. Just to his right sit the majority of Democrats whose constituents who do not trust the government to run one-fifth of the economy. Farther right of this group sits the majority of Americans; the 57% of Americans who believe that doing nothing is preferable to passing the current bill. Obama finds his policy at least two degrees separated from the wishes of the majority of Americans. If this was a pure democracy (which I am certainly not advocating) a popular vote would render this bill obsolete. How, then, can an unpopular bill be virtually assured of becoming law? Nothing a little political maneuvering can’t fix.

Reid to the rescue

In the words of Harry Reid, “A number of states are treated differently from other states, [...] that’s what this legislation is all about: compromise.” Mr. Reid is referring to one state in particular that will be treated differently from all others: Nebraska. In fact, the citizens of Nebraska, the state of Senator Ben Nelson, will be treated very differently from their American counterparts in the other forty-nine. Sen. Nelson was the last Democrat in the Senate to sign on, apparently holding out in order to be satisfied that no taxpayer funds will pay for abortions. Well, the liberal establishment just could not give that one up, and it is reported that Reid and Obama virtually met daily with Nelson until a “compromise” was worked out. Reid was able to offer Senator Nelson extra Medicaid money and other kickbacks for the taxpayers in Nebraska, for Nelson to become less dogmatic about abortion and support the bill. In case you are wondering if I am questioning the integrity of the senator from Nebraska — I am.

The public choice school, which combines political science with economics, has long criticized the way legislation gets passed. Government Failure, by Gordon Tullock, Arthur Seldon, and Gordon Brady addresses the issue of vote trading and logrolling. The Nelson kickback is a prime example of how Senators are willing to drop their moral convictions when offered a package of goodies by the political elite intended to buy votes. There’s only one problem: that package has to come from other taxpayers. The government has nothing of its own; it must take from someone else. The citizens of other states are, in essence, subsidizing the sweetheart deal Senator Nelson negotiated for his constituents. To add insult to injury, Harry Reid parades around preaching the beauty of senatorial compromise. Logrolling is an old trick, but the fanfare surrounding it is relatively new in American politics.

Where Is The Austrian School?

Austrian economics has a lot to say about healthcare. Don’t believe me? Here is a wonderful lecture I heard this summer entitled “Health Economics”, where Walter Block seeks to show how socialized medicine cannot work and how free markets are a better solution.

I fully intended to wake up this morning and write about the correlation between central banking and war, but I could not overlook the hullabaloo from our friends in Washington. I can only hope that this article will be an eye-opener for our readers, and possibly serve as a call to action for those who are weary about government control in the private sector.

By Chandler Waits | Comments (0)

The Dictator of the Free World

December 17, 2009 – 1:04 am

Ben Bernanke Photo courtesy of (Time)

Today, Time Magazine announced their “Person of the Year”, bestowing the award on none other than Ben Bernanke, the chairman of the Federal Reserve. This, though, does bring up the question that not many people think about:

How is it that Ben Bernanke, the chairman of a private entity set up congress to keep our monetary supply in check, was able to garner enough power and clout to become the person of the year?

Simply put, in the years following the creation of the federal reserve by congress, each successive Federal Reserve chairman has bestowed upon themselves more power than the last, all, essentially unchecked by congress who currently has no authority over the Fed. Ron Paul was on hand this morning with “Morning Joe” to give his reaction to the award.

Ron goes on to say that “[Bernanke] is more powerful than the President himself” and if Bernanke wanted to make a trillion dollars out of thin air, he could; Something that neither the President, congress, or any other government organization could do, even if they wanted. On a radio show this morning, the author of the article in Time was quoted as saying:

“Many people don’t understand what the Fed does how much the Fed effects [their] lives. Mr. Bernanke essentially dictates the price they pay for a loaf of bread.”

This seemingly unlimited power held by the Federal Reserve has come into question recently by Ron Paul in an interview with the Financial Services Committee.

End[ing] The Fed, is the only way to curb the boom-bust business cycle caused by mal-investment, stemming from loose credit policies handed down by the current dictator of the free world, Ben Bernanke.

By Jud Stephenson | Comments (0)

Did Capitalism cause the crisis?

December 15, 2009 – 10:07 pm

Is capitalism in peril?

Is capitalism, as Keynes and his few but loyal followers suggest, subject to an inherent instability? Did the “deregulation” of the Bush years cause the bubble that was toxic enough to jeopardize the global economy? Jeffrey Friedman, who recently wrote The Causes of the Financial Crisis, seeks to answer these questions in an article appearing in the journal of the American Enterprise Institute, a neoconservative think tank. In the article, Friedman makes a compelling case that deregulation did not cause the banking crisis that began in the U.S. with the Lehman Brothers fallout. To the contrary, he says, it was too much regulation, specifically The Recourse Rule which

“Required [banks] to hold 80 percent more capital against commercial loans, 80 percent more capital against corporate bonds, and 60 percent more capital against individual mortgages than they had to hold against asset-backed securities, including mortgage-backed securities rated AA or AAA. The Rule thus created a 60-80 percent incentive to buy highly rated MBS [Mortgage Backed Securities] for any bank that wanted to reduce its capital reserves.”

Given that capital reserves exist in order to insure banks against uncertainty in the marketplace, this rule encourage banks to be overleveraged. This, he argues, is what caused the systemic risk to the American banking system and was piled on an already disastrous subprime crisis. He continues

“And without the Recourse Rule, there is no reason that American banks that were trying to leverage up would have converged on mortgage-backed bonds. No other group of investors—not hedge funds, not pension funds, not mutual funds—were, as a whole, so overinvested in mortgage-backed bonds. But then, only banks were subject to the Recourse Rule”

Thus, Friedman showed it was a combination loose monetary policy (artificially low interest rates) and overregulation (The Recourse Rule) that helped to cause the current depression. He goes on to criticize both the left and the right for their treatment of this topic and asserts that competition is the distinguishing characteristic of capitalism. “Since regulators’ and citizens’ ideas are imposed on the whole system at once, they can’t be put to the competitive test,” he says.

Overall, it was refreshing to read an article from a neoconservative think tank where Austrian theory was implicit in the entire article. Furthermore, Friedman identified the ultimate culprit, Washington.

By Chandler Waits | Comments (0)

Uncontested Fallacies At The New York Times

December 11, 2009 – 5:04 pm

This is Chandler Waits’ first post on The Austrian. Chandler is working on his undergraduate degree in Economics and Spanish from Auburn University.

Waking Up To Smell The Roses

This morning I had the good fortune of reading an op-ed by New York Times columnist Bob Herbert. The title reads “Safety Nets for the Rich.” The author, Bob Herbert, seemed intent on revealing his political prejudices from the beginning just in case we did not realize what newspaper he was working for. I decided to read the article to look for economic fallacies, and it did not take me long to realize Bob knows little to nothing about economics.

He starts his article with a critique of the bailouts of Wall Street and big banks, and he correctly recognizes that “Money given to the rich won’t trickle down to the poor.” Wow, this guy’s Austrian! Not so fast. He then goes on to imply that he predicted the economic collapse in December of 2007 that, of course, was caused by the greedy bastards on Wall Street.

“The gamblers and con artists of the financial sector, the very same clowns who did so much to bring the economy down in the first place, are howling self-righteously over the prospect of regulations aimed at curbing the worst aspects of their excessively risky behavior and preventing them from causing yet another economic meltdown.”

He continues later with the second big point of the article: “We cannot continue transferring the nation’s wealth to those at the apex of the economic pyramid — which is what we have been doing for the past three decades or so — while hoping that someday, maybe, the benefits of that transfer will trickle down in the form of steady employment and improved living standards for the many millions of families struggling to make it from day to day.”

Why It Wasn’t Wall Street

To be clear, Herbert understands that the principle of privatizing gains and socializing losses is not a desirable policy because it rewards bad business decisions and creates moral hazard. His rationale to support this claim is damaging, however, because to accept his claims would inevitably lead to more recessions and more bailouts.

Two points: First, it is economically ignorant to claim that Wall Street greed caused this crisis. Just like one should not criticize the bailouts without ignoring Washington’s role, one cannot look at the housing bubble without seeing a direct relationship to failed government policies. Herbert does both. He calls it the risky behavior of the “gamblers and con artists of the financial sector.” But why was their behavior risky?

Those trained in Austrian economics know that problems arose when Greenspan lowered interest rates in 2001 under market equilibrium levels causing massive overinvestment, particularly in the housing sector. Many other factors contributed to this “risky behavior” from the financial sector including: The Community Reinvestment Act, Equal Credit Opportunity Act, Fannie Mae and Freddie Mac. But Herbert does not point a finger at our friends in Washington who sat back creating laws that forced lenders to relax lending practices so we could have our “homeowner society.”

Friedman Fights Back

My second point comes in reaction to his comments regarding transferring wealth from the deserving poor to the greedy rich. Many mistakenly believe that those who advocate for the free market are not at all concerned with the distribution of wealth. On the contrary, it is precisely because of our concern for the poor that we call for economic liberty and capitalism. I think Milton Friedman said it best when he responded to a question from Phil Donahue about greed:

“In the only cases where the masses have escaped from the grinding poverty you’re talking about, the only cases in recorded history, are where they have had capitalism and largely free trade.”

Here is the video:

Clearly, Herbert seeks to explain economic phenomena through a prejudiced lens that tells him someone can only get rich at the expense of someone else. He would do well to listen to Adam Smith who taught us that individuals pursuing their own self-interest can make a mutually beneficial transaction that, if free from political influence and taxation, will benefit society as a whole.

By Chandler Waits | Comments (0)