OUR WONDERFUL GOVERNMENT MINDS
INTRODUCTION
Over the past century or so,
academics have presented mankind with spectacular scientific advancements in
just about all fields of study...except one. Armed with a mastery of
mathematics and physics, scientists sent a spacecraft hundreds of millions of
miles to parachute to the surface of one of Saturn’s moons. But the
practitioners of the “dismal” science of economics can’t point to a similar
record of achievement. If NASA engineers had evidenced the same level of
forecasting skill as our top economists, the Galileo mission would have had a
very different outcome. Not only would the satellite have missed its orbit of
Saturn, but in all likelihood the rocket would have turned downward on
lift-off, bored though the Earth’s crust, and exploded somewhere deep in the
magma.
In 2007 when the world was
staring into the teeth of the biggest economic catastrophe in three
generations, very few economists had any idea that there was any trouble
lurking on the horizon. Three years into the mess, economists now offer
remedies that strike most people as frankly ridiculous. We are told that we
must go deeper into debt to fix our debt crisis, and that we must spend in
order prosper. The reason their vision was so poor then, and their solutions so
counterintuitive now, is that few have any idea how their science actually
works. The disconnect results from the nearly universal acceptance of
the theories of John Maynard Keynes, a very smart early-twentieth century
English academic who developed some very stupid ideas about what makes
economies grow. Essentially Keynes managed to pull off one the neatest tricks
imaginable: he made something simple seem to be hopelessly complex.
In Keynes’s time, physicists
were first grappling with the concept of quantum mechanics, which, among other
things, imagined a cosmos governed by two entirely different sets of physical
laws: one for very small particles, like protons and electrons, and another for
everything else. Perhaps sensing that the boring study of economics needed a
fresh shot in the arm, Keynes proposed a similar world view in which one set of
economic laws came in to play at the micro level (concerning the realm of
individuals and families) and another set at the macro level (concerning
nations and governments). Keynes’s work came at the tail end of the most
expansive economic period in the history of the world. Economically speaking,
the nineteenth an early-twentieth-century produced unprecedented growth of
productive capacity and living standards in the Western world. The epicenter of
this boom was the freewheeling capitalism of the United States, a country unique in
its preference for individual rights and limited government.
But the decentralizing
elements inherent in free market capitalism threatened the rigid power
structures still in place throughout much of the world, horrified by the
prospect of people liberated to run their own lives. In addition, capitalistic
expansion did come with some visible extremes of wealth and poverty, causing
some social scientists and progressives to seek what they believed was a more
equitable alternative to free market capitalism. In his quest to bring the
guidance of modern science to the seemingly unfair marketplace, Keynes
unwittingly gave cover to central authorities and social utopian masterminds
who believed that economic activity needed to be planned from above. At
the core of his view was the idea that governments could smooth out the
volatility of free markets by expanding the supply of money and running large
budget deficits when times were tough. When they first burst onto the
scene in the 1920s and 1930s, the disciples of Keynes (called Keynesians), came
into conflict with the “Austrian
School” which followed
the views of economists such as Ludwig von Mises. The Austrians argued that
recessions are necessary to compensate for unwise decisions made during the booms
that always precede the busts. Austrians believe that the booms are created in
the first place by the false signals sent to businesses when government’s
“stimulate” economies with low interest rates. So whereas the Keynesians
look to mitigate the busts, Austrians look to prevent artificial booms.
In the economic showdown
that followed, the Keynesians had a key advantage. Because it offers the hope
of pain-free solutions, Keynesianism was an instant hit with politicians. By
promising to increase employment and boost growth without raising taxes or
cutting government services, the policies advocated by Keynes were the economic
equivalent of miracle weight-loss programs that required no dieting or
exercise. While irrational, such hopes are nevertheless soothing, and are a
definite attraction on the campaign trail. Keynesianism permits
governments to pretend that they have the power to raise living standards with
the whir of a printing press. As a consequence of their pro-government
bias, Keynesians were much more likely than Austrians to receive the highest
government economic appointments. Universities that produced finance ministers
and Treasury secretaries obviously acquired more prestige than universities
that could not. Inevitably economics departments began to favor professors who
supported those ideas. Austrians were increasingly relegated to the margins.
Similarly, large financial institutions, the other major employers of
economists, have an equal affinity for Keynesian dogma. Large banks and
investment firms are more profitable in the Keynesian environment of easy money
and loose credit.
The belief that government
policy should backstop investments also helps financial firms pry open the
pocketbooks of skittish investors. As a result, they are more likely to hire
those economists who support such a worldview. With such glaring advantages
over their stuffy rivals, a self-fulfilling mutual admiration society soon
produced a corps of top economists inbred with a loyalty to Keynesian
principles. These analysts take it as gospel that Keynesian policies
were responsible for ending the Great Depression. Many have argued that without
the stimuli provided by government (including expenditures necessary to wage
the Second World War), we would never have recovered from the economic abyss.
Absent from this analysis is the fact that the Depression was the longest and
most severe downturn in modern history and the first that was ever dealt with
using the full range of Keynesian policy tools.
Whether these interventions
were the cause or the cure of the Depression is apparently a debate that no
serious “economist” ever thought was worth having. With Keynesians in
firm control of economics departments, financial ministries, and investment
banks, it’s as if we have entrusted astrologers instead of astronomers to
calculate orbital velocities of celestial bodies. (Yes, the satellite crashed
into an asteroid, but it is an unexpected encounter that could lead to enticing
possibilities!) The tragi-comic aspect of the situation is that no
matter how often these economists completely flub their missions, no matter how
many rockets explode on the launchpad, no one of consequence ever questions
their models.
Most ordinary people have
come to justifiably feel that economists don’t know what they are talking
about. But most assume that they are clueless because the field itself is so
vast, murky, and illogical that true predictive power is beyond even the best
and most educated minds. But what if I told you that the economic
duality proposed by the Keynesians doesn’t exist? What if economics is much
simpler than that? What if what is good for the goose is good for the gander?
What if it were equally impossible for a family, or a nation, to spend its way
to prosperity? Many people who are familiar with my accurate forecasting
of the economic crash of 2008 like to credit my intelligence as the source of
my vision. I can assure you that I am no smarter than most of the economists
who couldn’t see an asset bubble if it spent a month in their living room. What
I do have is a solid and fundamental understanding of the basic principles of
economics. I have that advantage because as a child my father provided
me with the basic tool kit I needed to cut through the economic clutter.
The tools came to me in the
form of stories, allegories, and thought experiments. One of those stories
serves as the basis for this book. Irwin Schiff has become a figure of
some renown and is most associated with the national movement to resist the
federal income tax. For more than 35 years he has challenged, often
obsessively, the methods of the Internal Revenue Service while maintaining that
the income tax is enforced in violation of the Constitution’s three taxing
clauses, the 16th Amendment, and the revenue laws themselves. He has written
many books on the subject and has openly challenged the federal government in
court. For these activities, he continues to pay a heavy personal price. At 82
he remains incarcerated in federal prison. But before he turned his
attention to taxes, Irwin Schiff made a name for himself as an economist.
He was born in 1928 in New Haven, Connecticut,
the eighth child of a lower-middle-class immigrant family. His father was a
union man, and his entire extended family enthusiastically supported Roosevelt’s New Deal. When he entered the University of Connecticut in 1946 to study economics,
nothing in his background or temperament would have led anyone to believe that
he would reject the dominant orthodoxy, and to instead embrace the economic
views espoused by the out-of-fashion Austrians...but he did. Irwin
always had the power of original thinking, which, combined with a rather
outsized belief in himself, perhaps led him to sense that the lessons he was
learning did not fully mesh with reality. Digging deeper into the full spectrum
of economic theory, Irwin came across books by libertarian thinkers like Henry
Hazlitt and Henry Grady Weaver. Although his conversion was gradual (taking the
full decade of the 1950’s to complete), he eventually emerged as a full-blooded
believer in sound money, limited government, low taxes, and personal
responsibility. By 1964, Irwin enthusiastically supported Barry Goldwater for
president.
At the 1944 Bretton Woods (New Hampshire) Monetary Conference, the United States
persuaded the 44 Allied nations of the world to back their currencies with
dollars instead of with gold. Since the United States
pledged to exchange an ounce of gold for every 35 dollars, and it owned 80
percent of the world's gold, the arrangement was widely accepted.
However, 40 years of
monetary inflation brought about by Keynesian money managers at the Federal Reserve
caused the pegged price of gold to be severely undervalued. This mismatch led to what became known as the
"gold drain," a mass run by foreign governments, led by France in 1965,
to redeem U.S. Federal Reserve Notes for gold.
Given the opportunity to buy gold at the old 1932 price, foreign
governments were quickly depleting U.S. reserves.
In 1968, President Lyndon
Johnson's economic advisors argued that the gold drain resulted not from the
attraction of bargain basement prices, but because foreign governments feared
that U.S.
gold reserves were insufficient to provide backing for domestically held notes and to redeem foreign notes. To dispel this anxiety, the president's
monetary "experts" advised him to remove the required 25 percent gold
backing from domestic dollars so that reserves would be available for foreign
dollar holders--a license to counterfeit money.
The dollars could now be printed at will because there was no actual
gold needed to back them up! Presumably,
this added "protection" would assuage concerns of foreign governments
and would stop the gold hemorrhage.
These economic geniuses could not conceive that a profit motive could be
a factor--that actually getting something for nothing might motivate human
beings. Irwin, then a young business
owner in New Haven, Connecticut, correctly surmised our
government's reasoning was absurd.
Irwin sent a letter to Texas
Senator John Tower, who was then a member of the committee reviewing this gold
issue, explaining that the United States faced two choices: (1) force down the
general price structure to bring it in line with the 1932 price of gold, or (2)
raise the price of gold to bring it in line with 1968 prices. In other words, to adjust for 40 years of
Keynesian inflation, America
now had to either deflate prices or to devalue the dollar.
Although Irwin argued that while
deflation (lowering prices of goods) would be the most responsible course,
since it would restore lost purchasing power of the dollar, he understood that
economists erroneously viewed falling prices as a catastrophe and that
governments have a natural preference for inflation. Given these biases, he argued that
authorities could at least acknowledge prior debasement and officially devalue
the dollar against gold. In such a
scenario, he felt that gold would have to be priced at $105 per ounce.
He also feared a much more
likely, and dangerous, third option: that the government would do nothing
(which was precisely what it chose to do).
Then as now, the choice was between facing the music or deferring the
problem to future generations. They
deferred, and we are the future generation.
Tower was so impressed with
the basic logic of Irwin's arguments that he invited him to address the entire
committee. At the hearings, all the
highly placed monetary experts from the Federal Reserve, the Treasury
Department, and Congress testified that removing gold backing would strengthen
the dollar, cause the price of gold to fall, and usher in an age of prosperity!
In his testimony, Irwin
asserted that the removal of gold backing from U.S. currency would cause gold
prices to soar. But more importantly, he
warned that a currency devoid of any intrinsic value would lead to massive
inflation and unsustainable government debt.
This minority opinion was completely ignored, and gold backing was
removed.
Contrary to everything the
economists had predicted, the availability of additional gold reserves failed
to stop the outflows of gold--the world kept flocking to buy $105 worth of gold
for only $35! Finally, in 1971,
President Richard Nixon closed the window, which severed the dollar's last link
to gold. At that point, the global
economic system became completely based on worthless money! Over the next decade, the United States
experienced the nastiest outbreak of inflation in our history and gold headed
towards $800 per ounce.
In 1972, Irwin set out to
write his first major attack on how Keynesian economics was putting the United States
on an unsustainable economic course. His
book The Biggest Con: How the Government
Is Fleecing You, enjoyed widespread critical acclaim and decent sales. Among the many anecdotes the book contained
was a story about three men on an island who fished with their hands.
The story had its genesis as
a simple time killer on family car trips.
When caught in traffic, Irwin attempted to entertain his two young sons
with the basic lessons of economics (any boy's idea of a perfect afternoon). To do this he almost always resorted to funny
stories. This one became known as
"The Fish Story."
The allegory served as a
centerpiece of a chapter in The Biggest
Con. About eight years later, after
so many readers had commented to him about how much they loved the story, he
decided to develop an entire illustrated book around it. How An Economy Grows and Why It Doesn't was first published in 1979
and went on to achieve quasi-cult status among devotees of Austrian economics.
Thirty years later, as I
watched the United States' economy head off a cliff, and as I watched our
government repeating and redoubling the same mistakes of the past, my brother
and I thought it would be an ideal time to revise and to update "The Fish
Story" for a new generation.
Certainly, there has never
been a greater need for a dose of economic clarity, and the story is the best
tool we know of to give people a better understanding of what makes our economy
tick.
This version is in many ways
more ambitious than the one Irwin drafted 30 years ago. Our scope is wider, and our attempt to
incorporate the historical sequence is deeper.
In fact, the story would best be described as a riff on the original.
We hope that this book can
appeal to the kinds of people who typically go numb when they hear economists
drone on about concepts that seem to have nothing to do with reality. We intend to show that the model proposed by
the Keynesians, whereby governments can spend without consequence in the belief
that worthless (counterfeit) money can be an effective economic lubricant, is
both false and dangerous.
The bad news is that when
you take off the rose-colored glasses that all of our economists have forgotten
that they are wearing, you can see clearly that our nation is confronting
serious problems that we are currently making much worse, not better. The good news is that if we allow ourselves
some clarity, then we can at least make an attempt to solve the problems
sensibly.
And while the subject matter
is deadly serious, we approached the project with the kind of humor that is
absolutely vital in times of stress--just as Irwin would have wanted it.
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