April 18, 2014

Review: “A Free-Market Monetary System” and “A Pretense of Knowledge” by Friedrich A. Hayak

English: GFDL picture of F.A. Hayek to replace...

Friedrich A. Hayak. Image via Wikipedia

I recently read the short brochure “A Free-Market Monetary System,” a compilation of Friedrich A. Hayak’s 1974 Nobel Prize speech “A Pretense of Knowledge” and a short essay on proposing a free-market monetary system (hence, the name, see?). Both are short, and neither waste any time proposing radical changes to what was then, and indeed what is still, the status quo in monetary and economic policy.

Both the essay and the speech are worth reading.

In “A Free Market Monetary System,” Hayek warns that as long as central banks are in control of the money supply, we can expect to see the economic highs and lows that we have come to expect, better known as “bubbles”  and “recessions.” Both are part of the market corrections that result when markets try to correct for artificial highs created by monetary policy in the control of a central bank.

Hayek’s recommendation?  Let private enterprises issue their own money for circulation.

I am more convinced than ever that if we ever again are going to have decent money, it will not come from government: it will be issued by private enterprise, because providing the public with good money which ic can trust and use can not only be an extremely profitable business; it imposes on the issuer a discipline to which the government has never been and cannot be subject.

Get it? Rather than “Dollars,” we would buy, and spend, money that might be called something else. Nike “Swooshes,” perhaps, or American Express “credits.” The point is that business does not have a monopoly on money the way that government–i.e. central banks–does and therefore has a greater incentive to protect the integrity of that money from inflation and against other currencies by good policies. If it doesn’t, people won’t use it and it’s value will drop. (Can you hear the invisible hand clapping?)

“It is a business which competing enterprise can maintain only if it gives the public as good a money as anybody else,” said Hayek.  Meanwhile, central banks have no such limits or restraints. Just ask Ben Bernanke.

Bernanke in Congress

Bernanke in Congress (Photo credit: Talk Radio News Service)

Could it work? Would the government ever give up its control of the money supply?

Ha! Good one. Have you ever known the government to willingly give up any power?

For an interesting look at how an economy where private enterprise issues its own money, check out the speculative novel “The Unincorporated Man” by  Dani Kollin and Eytan Kollin.


The second part of the brochure is the text of  “A Pretense of Knowledge.”  Hayek’s speech upon receiving the Nobel Prize for economics in 1974 (he shared the prize with Gunnar Myrdal for their work in “the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena”) was a thunderhead of a critique of policies recommended by economists and implemented by governments that had, in his words, “made a mess of things.”  He attributed the failure of economists to guide public policy more successfully to a “propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences[...]” That attempt, he said, “in our field may lead to outright error.”  Economics is not an exact science, and the application of “habits of thought to fields different from those in which they have been formed” lead to a “‘scientistic’ attitude” that the unknowable is knowable.

Economies involve an “organized complexity” that is too deep for economic researchers to obtain.  Speaking of wages and prices as an example, Hayek argues that “the determination of [prices and wages] will enter the effects of particular information possessed by every one of the participants in the market process–a sum of facts which in their totality cannot be known to the scientific observer, or to any other single brain.”  What he is saying is that while my wife at the grocery store may know enough to decide whether one can of salsa is better priced than another–based on a list of criteria only she knows, including flavor, cost relative to other salsas, cost relative to other stores and whether it is worth driving to those other stores to get the salsa, as well as how much my daughters are fussing in the shopping cart to hurry, whether we need salsa at all, and so on–the observer, the economist or market researcher or whoever is watching, can never know all that goes into her mind.

Says Hayek:

It is indeed the source of the superiority of the market order, and the reason why, when it is not suppressed by the powers of government, it regularly displaces other types of order, that in the resulting allocation of resources more of the knowledge of particular facts will be utilized which exists only dispersed among uncounted persons, than any one person can possess.

Only the market–the composite of my wife, and the hundreds of thousands (or millions) of shoppers out there can determine what the market value–the price–of the salsa should be.

Chevy Volts coming off of the production line. Image via jalopnik.com

This is why governments mess things up when they try to intervene. Whether it is propping up failing auto companies (go google “GM volt january 2012 sales” to find out that the company bailed out by Washington, D.C. sold a measly 603 Volts last month) or promoting and subsidizing “green” energy companies (for this only, google “Solyndra scandal” where even the New York Times admits that the government took risks that the market would not take. I wonder why the market wouldn’t risk it?), when government tries to pick winners better than the market, it inevitably fails or produces less success than the a free market.

This isn’t to say that economics is entirely unable to offer predictive power. Quite the contrary. It just can’t do so with the same ability as the “hard sciences,” such as physics, or chemistry.

Often all that we shall be able to predict will be some abstract characteristic of the pattern that will appear–relations between kinds of elements about which individually we know very little.[...] The danger of which i want to warn is precisely the belief that in order to have a claim to be accepted as scientific it is necessary to achieve more. This way lies charlatanism and worse. To act on the belief that that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which we do not possess, is likely to make us do much harm.

As I have said on this blog before, neither the Members of Congress making laws, the President and his Executive Branch (proposing, executing, and, also, making laws), nor judges in their black robes know enough to out think the decisions of millions or billions of people that make up a market.

But in the social field the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims.

We may not always understand why the market chooses what it does, but in large part the market chooses, through spontaneity, that which helps man get what he wants.

In other words, Hayeks’ message to economists and policy makers is simple: get out of the way and let the market choose. It’s much smarter than you are.


You can read the brochure here for free. Download it and read from your mobile device, including Kindle or iPad (or you can pay $4.99 to Amazon for a Kindle version or $6.00 for a paperback. Go figure).

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Need a primer in Austrian economics? [video clip]

You’ve been watching the debates (except for that one at 7 AM on Sunday morning), and you keep hearing references to Austrian economics. They keep mentioning names like Hayek, Friedman, and Mises .  What’s with all these German sounding names, you say. And why is Ron Paul staying up to read an economics textbook while the rest of these bozos are watching college football?  (ok, maybe Friedman is more Chicago style, but his name sounds German, too, and Paul does ascribe to certain aspects of Friedman philosophy, as well).

I know, and you know, who Keynes is (because we “are all Keynesians, now,” right? Wrong…but I digress, as usual), but who are these other guys?

Friedrich Hayek

Two of them are Nobel prize winners (Hayek and Friedman), and all are the fathers of Ron Paul’s political philosophy. If that’s not substantial enough for you to spend at least five minutes figuring out who the Austrian economists are, as well as what they believe, then I don’t know what is.

To help us out, we have Peter Boettke, an economist himself at George Mason University. He recently spoke to The Browser and, in addition to providing a brief explanation of the Austrian school of economics, recommended a few books that could get you started on your way to understanding Austrian economics better. Here’s how he describes the way Austrian economists view the world:

Classical economists, Austrian economists, and New Institutional economists reside in the box that starts with a complex problem situation but nevertheless gets you social order. The way you do that is not based on the behavioural assumptions of the actors, but on the institutional assumptions underlying them, ie things like the political, legal and cultural context within which individuals engage and exchange. If that context is the right context, then even in the most difficult of situations, individuals can generate social order. They can cope with their ignorance, they can take care of uncertainty. When the market goes astray, it’s not because there is something wrong with the market mechanism, it’s because the rules under which the market mechanism operates have got distorted.

That last word is very interesting. I think if we were to go back and check out what Ron Paul’s been talking about during the campaign, I think we would find out that his complaints about the government spending, healthcare reform, entitlements, and perhaps even defense spending and American projection of power abroad, often root from his views that government is interfering in the natural workings of the market. In other words, distortions.

Check out the rest of his analysis. It’s interesting and compares the Austrians to Marxists and Keynesians. It’s well worth the read.

So what books does he recommend?

  • Human Action by Ludwig von Mises. “[...] when the government distorts the monetary unit, through the manipulation of money and credit, it can generate boom-and-bust cycles. So rather than the business cycle being inherent to capitalism, it’s a consequence of distortions caused by the manipulation of money and credit.”
  • Individualism and Economic Order by Friedrich Hayek. “Hayek’s writings set off a research programme to study how it is that information gets communicated within a complex system, and a variety of different people have picked up on that, and worked with that idea and taken it in directions that even Hayek couldn’t have envisioned.”
  • Calculation and Coordination  by Peter Boettke. “What I’m doing is trying to get the history right and then get the political economy analytics right, and then trying to use both of those to explain that from that original history it was logical that we ended up with the system that we ended up with, rather than the system that we wanted to end up with.”
  • The Invisible Hook by Peter Leeson. “I think The Invisible Hook does a fascinating job of communicating to people the enjoyment of just thinking through a problem like an economist.”
  • After War by Christopher Coyne. “What he found was that in US-led efforts, basically somewhere between two-thirds and three-quarters of the efforts failed to meet even that minimum standard.”

I’ve not read any of these, yet, but I’m looking into them. I could certainly use an expanded understanding of our economy. Which will you pick up this week? Are there others that you recommend?

Round Two: Keynes v. Hayek

If you remember Round One (“Fear the Boom and the Bust“), then you won’t want to miss Round Two.

[Read more...]

Federal budget outraces CPI by four times

Did you know that federal spending has increased  faster than consumer prices?

Four times faster?

From 2000 to 2010, federal spending has increased 106% while prices (according to the Consumer Price Index) have only increased 26%. In other words, while the cost of stuff has risen only 26%, the government is spending roughly four times more than if it had increased spending to match increased costs.

To be sure, a few things have happened in the last ten years that have affected the increase in federal spending faster than consumer prices. There was 9/11 and wars in Iraq and Afghanistan. There was a recession, and there still is a recession.  But even so, shouldn’t federal spending increases match consumer price increases, at least somewhat?

Mandatory Spending or Discretionary Spending?

Right now, a lot of the debate over the size of the federal budget  centers around “discretionary” versus “mandatory” spending. As one economist (Arnold Kling) points out, budget items in the later group aren’t so mandatory as they may seem.

The data indicate that it is not very difficult to increase Federal government spending, in spite of the large portion that is mandatory. Why not? Some hypotheses:

1. We tend to see discretionary increases in “mandatory” spending. As in the prescription drug benefit. Note that at the time the prescription drug benefit was enacted, nobody said, “You know, on the whole, the elderly are doing fine. We want to provide prescription drugs as an in-kind benefit, but maybe we should cut back on other transfers to the elderly in order to maintain generational balance.”

2. The government’s “cost of living” goes up much faster than the CPI. For example, with Medicare and Medicaid, outlays are tied to health care costs, and we all know that health care costs are rising faster than inflation.

Check out the rest of his analysis here. Noting that, with the exception of “net interest,” every major category in the federal budget has seen an increase in spending greater than the consumer price index, Kling argues that if we cut spending back to 2000 levels–without touching defense, Medicare, or Social Securitywe could slash $500 billion from the federal budget.

That’s a healthy chunk of change, and a simple idea. Roll spending back to 2000 levels, and then start looking at entitlement reform for other budget constraints and deficit reduction.

Here’s his data:

Spending, in billions, vs. Consumer Price Index

Spending Category 2000 level 2010 level Percentage increase
Consumer Price Index 174 219 26 %
Total Federal Outlays 1789 3721 108 %
Defense 294 719 144 %
International 17 51 197 %
Health 154 372 141 %
Medicare 197 457 132 %
Income Security 254 686 170 %
Social Security 409 721 76 %
Net Interest 223 188 -16 %
Other 240 526 119 %

Get it? Prices have risen only 26%, and federal spending should have risen about the same, even accounting for defense, Social Security, and Medicare. But it hasn’t. Federal spending has increased far faster.

Kling puts in a last word:

Or maybe the answer to the paradox is that when it comes to the Federal Budget, spending is discretionary when somebody proposes an increase in its rate of growth but mandatory when somebody proposes a decrease in its rate of growth.

Are politicians really just “the slaves of some defunct economist“?

The Federal budget is a curious thing. It alone in the world of finance and spending–from individual home budgets, corporate coffers, Wall Street, and state budgets–is controlled by persons whose primary interest is not responsibility, but reelection, and who spend based on good ideas for benefits, not the realities of economics.

Few things secure reelection like bringing home the bacon or signing a revolutionary new program. Yet the law of unintended consequences is stronger than all the political clout or well-meaning programs in the world.

So it is: well-meaning Congressmen (and Congresswomen), Senators, and Presidents head off to the marbled halls of Washington, D.C. to make plans and pass laws that their constituents will love back home, solve society’s problems, and make world a better place.

Then, the plans hit the real world, and little do  politicians know what results will really happen.

As I’ve quoted before, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

The road to hell, or rather, bottomless debt, is paved with good intentions. So, perhaps, is the road to Washington, no matter how little men “really know about what they imagine they can design.”

Recommended reading for more: The Road To Serfdom, by F.A. Hayak.

Cover of "The Road to Serfdom: Fiftieth A...

Cover via Amazon

(h/t Library of Economics and Liberty)

Fear the Boom and the Bust

Really, a little too short a summary, but if you’re not willing to work your way through a few good books, it’s better than nothing…and way more entertaining.

A few instructional tidbits from the clip:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

John Maynard Keynes


“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”

Friedrich von Hayek

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