In Defense of GwBC: Conclusion

I am confident I have accomplished all I meant to accomplish with this series of posts, stimulated as they were by Gravelle's critique of my book, GwBC. In conclusion, I will speak to the notion, widespread today, and present in Gravelle's review, that a moderate and non-accelerating level of inflation is a good thing, in that it is predictable on the one hand and it accomodates the growing demand for money that comes with a growing population and economy on the other. This notion is presumably why Gravelle instructed me that only an "accelerating" rate of inflation should be considered "easy money."

This underlying idea is a fallacy. Price level unpredictability is one of the kinds of harm that inflation can do, but not the whole of it by any means. Yes, if every price and every wage reliably increases at, say, 2 percent a year every year: buyers, sellers, lenders, investors and so forth can all quickly become accustomed to this, draft contracts that presume it, etc. The predictability would be a positive thing, and the debasement of the currency would be merely a matter of form, not something that ought to bug anyone. That is what many economists (and Gravelle) seem to presume actually happens in real-world inflation when they write as if a “non-accelerating” rate is benign.

But in the real world, the average price levels measured by consumer prices indexes and so forth are just that, averages. If we know that the CPI has increased 2% over the last year we have no reason to believe that every good – even every good and service explicitly included in the CPI – even any respectably large number of those goods for that matter -- has increased by that benign-seeming amount. Nor do we know that there is some narrow range of possibility around 2% where most price changes comfortably reside. You can of course quickly get in over your head trying to wade a stream with an “average” depth of only half a foot.

A related point: new money infused into the economy doesn’t come into it all at once. It isn’t as if helicopters have dropped it evenly over the whole landscape, or as if we could all wake up one random morning with more money in our bank accounts than we had thought we had the day before.

No … money enters the economy because the Federal Reserve buys assets. If you’re one of the lucky few who get to sell assets to the Fed then, poof!, the new money suddenly appears in your bank account first. The new money in time radiates outward from the first recipients to those with whom they do business, and so forth, out to ‘the economy at large’ if we may. But the process is a sloppy one, and it does in the nature of things create winners and well as losers. It redistributes real wealth and creates perverse incentives, even if it is kept at a slow and non-accelerating rate over time.

A related fallacy is the notion that inflation is a good thing because a growing economy needs a growing money supply. Why? In a free market the prices will automatically adjust should the economy grow more rapidly than the money supply. Suppose the money supply is linked to gold, and privately held gold supplies are freely convertible into paper notes. If the supply of gold falls beneath demand, gold becomes more valuable. This means that gold in jewelry is converted into monetary use, and gold coins that had been hoarded, stashed away in a safe, are brought out and put back into circulation. Also, promising gold mining operations become more valuable and people line up to invest in mining technologies.

In the meantime, since gold is becoming more valuable, in such an economy, prices of all non-monetary goods are falling. We’ve just conjured up a deflationary scenario. A lot of energy has gone into persuading people that deflation is necessarily disastrous, but there is no evidence it needs to be.

My final thought in this connection is the eminently pragmatic one, that we shall all have to do a lot of new thinking, in matters economic and financial, in order to get ourselves out of the mess in which through the old thinking, still the mainstream thinking, we have gotten ourselves.

In Defense of Gambling with Borrowed Chips, Part IV

We now get to the core of our dispute. (“At last!“ you cry.) Lament not, for we have passed through some essential preliminaries.

What is core is that Gravelle takes issue with my recommendation that the U.S. abolish its central bank, the Federal Reserve.

She says (quite accurately) that the Federal Reserve existed for 20 years before the abandonment of the gold standard in 1933. The Fed was founded by an Act signed into law by President Woodrow Wilson on December 23, 1913.

I can’t agree with her about the “why” of that decision, though. She writes that the Fed was “needed in part to deal with the rigidity of the gold standard itself, which provided insufficient money, particularly around harvest time.”

No, the Fed wasn’t needed. It came into existence as a simple matter of coalition management. What was needed, politically, was the passage and enactment of something that could be called a “banking reform bill.” There were a lot of reasons for this, most of them terrible, the best of them only slightly muddled. But the vacuity of the Federal Reserve Act as any sort of genuine reform may be seen by the four distinct currents of thought that contributed to it.

There were some important voices at the time who wanted a private and centralized banking system. They found their champion in Nelson Aldrich. There were others who wanted a system that would be private but decentralized -- this was the guiding idea of Carter Glass, chairman of the House Banking Committee when Wilson entered the White House. There was another group who demanded a system both public and decentralized -- that would describe William Jennings Bryan, for example, who was Wilson’s Secretary of State, and whose interest in monetary/banking issues was a critical source of his own appeal to his own following. Finally, there was a faction that wanted a system both public and centralized, in effect an adjunct to the U.S. Treasury. Among these was William Gibbs McAdoo, who was Wilson’s Secretary of the Treasury.

[You can find an account of all of this in the biography, Woodrow Wilson (2010), by John Milton Cooper Jr., which I reviewed for The Federal Lawyer that spring. See especially pp. 219 et seq. of that book. ]

Along the two axes involved (private/public on one side, central/decentralized on the other), there were then four possibilities and for various mutually inconsistent reasons all four factions were unhappy about the banking system, all four wanted a change. Some change was almost certain to come about, and that change (when nominally led by a Wilson, a man with no firm settled convictions of his own on the subject, but a strong desire to please everyone, or at least everyone with a suitably progressive pedigree) was bound to be a jerry-rigged mess.

We have inherited that mess, and I for one am certain that it does us all much more harm than good.
It was merely a mess for the first twenty years of its existence. After 1933, it became something much worse than a mess. The Fed became a nexus of power in its own right, and the center of machinations against the soundness of the dollar. There are always such machinations -- and there are always constituencies for them. What has proven disastrous is that they have had this great institutional leverage.

Their leverage was somewhat diluted by the Bretton Woods accord of 1944, which brought a precious metal back into the system. That brings us to the relation of hard metals and gold in particular to the value of money, which is the fourth and final point I must contest with Ms Gravelle.

Before I do, though, allow me to say this: gold is not logically necessary for the existence of a sound currency. There are other ways of achieving that goal. For example, as I write, the Republic of Greece stilll has a sound currency. That currency is known as the euro, and it is sound because its quantity is outside of the control of any politicians or central bankers within Greece. Thus, the soundness of the currency (which is as it happens not backed by gold) is forcing the Greek political system to make difficult decisions -- decisions that ought to be made but that all participants there would plainly much rather avoid.

It  is possible that Greek politicians may in fact avoid those decisions by abandoning their sound currency, and re-creating the drachma, which they can then manipulate at will. If they succumb to that temptation, though, they will I am sure rue the day.

With that understood, allow me to agree: yes, the abolition of fiat currency means, in the U.S. context and as a practical matter, the re-introduction of some role for gold. This is the one of my policy prescriptions that I haven’t yet discussed, and I will come to it tomorrow.

In Defense of Gambling with Borrowed Chips, Part II

My recommendations, in Gambling with Borrowed Chips, are as follows:

1)      That  the U.S. government must repeal its legal tender laws, allowing Americans to find our own money.

2)      That there ought to be a simple and complete abolition of the Federal Reserve System

3)      That we must learn to let failures fail, without Greenspan or Bernanke “puts” and, finally,

4)      That “we need as a people to accept an important cultural change – we need to learn greater respect for the profession of accounting and for its independence.”

That’s the list as I presented it in my conclusion and as Gravelle considers it. In this blog, I propose to reverse the order. Starting with number 4 then, my reviewer plainly thinks this the runt of the litter. She isn’t “sure what Faille specifically proposes” in this line, so she won’t comment on it.

Well, perhaps in the PowerPoint sense I don’t “specifically propose” anything. It is hard to reduce a critical cultural shift to a list of specific proposals. It isn’t a matter for departmental white papers.  It is a matter of focus.

But I’ll dwell on this point today because recent newspaper accounts of JPMorgan and its billions of dollars lost on portfolio hedges tell a story that may assist with the needed cultural shift if anything can. These losses have stiffened the resolve of advocates of the “Volcker rule,” and of a stern construal thereof, and have at the same time confused those who have been trying to rejigger that rule to allow some flexibility, so this incident may end up having a lot to do with the future of investment banking in the US.  

JPM’s CEO, James Dimon, has said that "affiliated but asymmetric accounting" may have contributed.

Does this bore you, dear reader?  Are you saying, “oh, no, a discussion of accounting.” I suggest you resist the impulse to say that. That is all I “specifically propose” in such matters.

The problem in this case may have been that (a) derivatives on credit default swaps are marked to market – their value is constantly re-adjusted under existing accounting principles, but (b) the value of a bank’s outstanding loans are not marked to market – they are carried at original value, and adverse market condition are acknowledged through the creation of a reserve. If derivatives are used to hedge risks inherent in the loan portfolio then, as the “Heard on the Street” column in the Wall Street Journal has recently noted, the derivative can distort apparent earnings, and distort the bank’s own managerial processes.

I would certainly hope that bankers will correct this asymmetry by marking loans to market, and that the professional (private sector) bodies that maintain accounting standards will press toward this end. Prospects for that are not good at the moment, for reasons that were foreshadowed by the discussion in chapter eight of my book.  The leaders of the standards-setting bodies have been spineless and various politicians have introduced demagogy into accountancy issues over the years, cowing the spineless into indecision when the bases for sensible decisions were fairly clear.

If the politicians were to stand back, the accounting profession would hash out its own issues. And if the public were informed, if there was a general cultural acceptance of the importance of independent integral accounting standards, the leaders of that profession might exhibit the necessary backbone. Then we wouldn’t need a Volcker rule to do their work for them.

Ron Paul Got This Exactly Right

click

Two key paragraphs:

The Fed fails to grasp that an interest rate is a price—the price of time—and that attempting to manipulate that price is as destructive as any other government price control. It fails to see that the price of housing was artificially inflated through the Fed's monetary pumping during the early 2000s, and that the only way to restore soundness to the housing sector is to allow prices to return to sustainable market levels. Instead, the Fed's actions have had one aim—to keep prices elevated at bubble levels—thus ensuring that bad debt remains on the books and failing firms remain in business, albatrosses around the market's neck.

The Fed's quantitative easing programs increased the national debt by trillions of dollars. The debt is now so large that if the central bank begins to move away from its zero interest-rate policy, the rise in interest rates will result in the U.S. government having to pay hundreds of billions of dollars in additional interest on the national debt each year. Thus there is significant political pressure being placed on the Fed to keep interest rates low. The Fed has painted itself so far into a corner now that even if it wanted to raise interest rates, as a practical matter it might not be able to do so. But it will do something, we know, because the pressure to "just do something" often outweighs all other considerations.

I should add (since I used the word "exactly" in this entry's headline), that I do have one small nit to pick with the way Paul expresses himself here. Not with the substance of his exposition, which is perfect, but with the jots and tittles.

He defines interest rates briefly as "the price of time." They aren't the price of time. They are defined and measured by time, just as apartment rents are defined and measured by weeks, months, or years. But a rent isn't the price of time, it is the price of occupancy. Likewise, an interest rate is the price of credit, or of the use of the principal, for a specified period of time.

What Paul means is clear enough, and his brief use of the phrase "the price of time" probably does no harm, except ... that in the days of Savonarola and in the glare of Scholasticism one of the most common objections to the charging of interest, one of the reasons given for considering all interest as the sin of usury, was this notion that it is selling time and that time is of God. I would rather not have free-market advocates play into those bad old superstitions, or we'll end up throwing our vanities into a bonfire.

Still, Paul is making sound points. The Fed isn't wrong because of this chairman or that chairman. It isn't wrong in ways that new appointments or some tweaking of the mandating statutes could fix. It is wrong because it is a central bank, and what central banks do is in essence wrong. They are central planners, just as those who would run the auto industry from Washington (and who, these days, essentially do) are central planners.

The point should be not to improve the Fed but to close it down.

In this, perhaps, tea partiers and OWS types can come together.

Feldstein as Ruling Caste Sahib

On Monday of this week, the Wall Street Journal published an op-ed piece by Martin Feldstein, who as some of you will remember was chairman of the Council of Economic Advisers in the Reagan administration.   His essay has brought my anarcho-capitalist blood to a boil.

The gist of it is that the US dollar will lose value vis-a-vis other currencies in coming years, and this will be a good thing, because it will help our exporters. 

That line of thought in itself isn't surprising or especially infuriating.  Nor is the first of the reasons that Feldstein gives for this expectation.  He says that various "sovereign wealth funds and other international holders of large dollar balances" will diversify the currencies of their holdings, and this will have the effect of reducing the value of the dollar.  I can't argue with that.

The second reason he gives for this expected fall, though, is what lights a fire under my sanguinary kettle. He says the dollar will fall in value because the Fed will engineer such a fall, and that will be a good thing becauise the Fed can do so without setting off wage-price inflation.

"In the U.S., where only 7% of private workers are unionized, there is now little danger of an inflationary wage-price spiral.  The Fed can therefore counter the current economic weakness by promising to keep short rates at a near-zero level for an extended period of time," Feldstein writes.  Of course, if the Fed keeps rates near zero while the ECB raises its rates, then people will convert their dolars into euros to take advantage of the latter.  Which will help our exporters. Get it?

Why is this offensive?  It asks us to believe that inflation is only a problem if workers are organized and can fight back.  If workers aren't organized (as, in the US private sector, Feldstein rightly notes they aren't) then they can't fight back and demand increases as the value of their wages is being cheapened by ruling-class honchos like Feldstein and his policy making friends.  So, stick it to them!

Ah, it's all justified by creating more market opportunities for our exporters.  Evidently, it won't do much good for the people working for those exporters, because they are among those happily unorganized private sector workers who are going to get screwed.  So Feldstein means that a loss in the value of the dollar, and their wages, will end up helping the stockholders of our exporters.

Sorry, Sahib, but this makes me want to head to the ocean for some salt.

Gold Standard Links

There is talk -- not fever-swamp debate but serious discussion stimulated by the president of the World Bank --of bringing back the gold standard in some capacity.

Zoellick had a lot of sensible things to say as you can read here for yourself.

Robert Harding, writing for the FT, noted that gold "prices have risen from close to $200 a decade ago to almost $1,400 today. The rapid rise in recent years reflects fears that unconventional central bank policies – such as last week’s move by the US Federal Reserve to expand its balance sheet by another $600bn – could lead to inflation."

For some historical background, you might go here or here.

For the Austrian school's take on the significance of gold, go here.

For informed speculation on where the price of gold is headed, you might look to a Bloomberg story yesterday by Nicholas Larkin.

But back to Zoellick. Who the heck is he? Who was he before he was put in charge of the World Bank? Here'a the official bio.

Or you could listen to this fellow talking about the history of the institution.

And here are some final thoughts specifically on how a return to a gold standard might be accomplished.

2010: A Year of Living Dangerously

The Federal Open Market Committee, a body of the Federal Reserve, voted this week to keep the federal funds rate in the range betwen 0% and 0.25%.

Frankly, I believe this to be irresponsible. It is part of the bad old tradition of using the money supply to stimulate an economy by cheapening the currency. They also retained the "extended period" language. You can see the whole statement by clicking that link.

The first two sentences of the 3d graph are crucial: "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt."

This means full speed ahead for a policy of "quantitative easing," or the cheapening of the US dollar, and this in turn means increasing prices across the board are inevitable.

In the very short term, this is good news for some people. It is good news for businesses that have gone too far into debt, but whose debt is measured in nominal (non-inflation-adjusted) terms, because they'll be paying back that debt now in cheapened dollars, so in effect their debt is being reduced. It is good news, too, for some of hte unemployed. Some of those businesses, relieved of that debt, will be in a position to hire new employees. In simple terms, then, this policy will have and is having a stimulative effect, but it is like getting one's energy from a drug. The drug has effects on the body that go far deeper than the immediate rush, and even the rush won't be as great as some hope, because a body builds up tolerance over time, requiring ever-greater doses for the same effect.

Neal Lipschutz, managing editor of Dow Jones Newswires, expressed his disappointment immediately. "I continued to hope for the merest hint that zero rates can't go on forever. That would have been achieved by altering or eliminating the 'extended period' modifier for how long current policy would hold. But it stood unmolested."
Though Lipschutz didn't put it this bluntly, it does now appear that we are headed for 1970s-style stagflation.

The price of crude oil (which is globally set in terms of the US dollar) has been declining for the last month, from $80 to $70. Yet it began a climb immediately when markets learned that the FOMC was sticking with the near-zero rates and with the "extended period" description of their tenure.

In the House of Representatives

The House Financial Services Committee voted 43 to 26 Thursday in favor of a measure sponsored by Ron Paul (R-TX) that would expand Congressional oversight authority vis-a-vis the Federal Reserve.

As the Wall Street Journal rightly noted yesterday in a front page story, this vote was part of a general backlash of "populist anger that Wall Street was bailed out while the public was not." Actually, I think (and hope) that there was more to it than that, but I approve of the backlash, however defined, and so I'm inclined to be happy about this vote.

The problem with central banking isn't the opacity of the bank's operations vis-a-vis politicians or their constituents. The problem with central banking is ... central banking. As an institution, it is inherently misguided. Even if Paul's bill should pass, it will amount to little more than some additional work for the GAO in auditing the Fed. Still, one has to approve of the sentiment.

Greed is not always good, greed does not always work. And the way to limit the dysfunctional consequences of greed is through keeping money real.

Separately, the House this week has amended a bill under consideration designed to reduce the systemic risk that accompanies the failure of large financial institutions. Like, just for instance, Lehman Brothers. The bill at issue is the Financial Stability Improvement Act (FSIA or HR 3996). One of the themes of the bill is the creation of a sort of polluter-pays system for the unwinding of large banks. The cost of the orderly unwind is supposed to fall upon the shareholders and unsecured creditors of the bank, not the taxpayers.

The amendment adopted Wednesday, sponsored by Representatives Miller and Moore (Democrats from North Carolina and Kansas, respectively) is designed to ensure that even the secured creditors of such institutions take a hit. If you follow that link you'll find that this amendment takes up only a page and a half, so it would be easy enough to read through if it were not written in legalistic jargon. The gist of it is that secured creditors of a bank that fails and ends up in receivership will take a haircut, in that in the discretion of the Receiver up to 20% of the secureds claim could be turned into an unsecured claim "as necessary to satisfy any amounts owed to the United States or to the [polluter-pays Fund]."

An intense quarrel has broken out over this amendment in the financial blogosphere. Felix Salmon, for example, weighs in here.

Pragmatism Refreshed: Freedom Pursued

Is pragmatism an adequate and indeed an essential foundation for the advocates of liberty? I have long contended that this question needs a strong "yes" answer. As I explained in my September 12 blog entry, though, I am delighted that Frank van Dun has set forth his reasons for believing that I am wrong.

This is my reply to the case he has made, which was in turn a response to an editorial I wrote years ago for a now-defunct magazine called The Pragmatist.

Preliminaries

I am an anarcho-capitalist. I am no longer active within the Libertarian Party, but I wish the LP well, and I speak not merely of the anarcho-caps therein but of the minarchists as well. The advance of their ideas is infinitely to be preferred over the continued dominance of the "liberals" and "conservatives" in public debate.

My earlier essay on "The Necessity of Pragmatism," moved as concisely as I could manage through a theory of meaning, to the nature of truth and knowledge, and then on to ethics. I also said a few words at that time about restitution as the central principle of Justice. I will leave restitution out of this essay, but otherwise I will retrace and elaborate my steps, taking account as I go of van Dun's critique.

Van Dun agrees with me largely on meaning, so I will be very brief here. Pragmatists ask "what difference would it make" were one hypothesis rather than another true. If there is no practical difference, then pragmatists write off the dispute as an idle one. There is no difference anywhere that does not make a difference somewhere else. I will not press that point except to provide the curious with this link for the story of James' squirrel, a bit of philosophical exposition that van Dun and I both admire.

Van Dun disagrees with me about truth, but I think that this is largely because he conflates the old correspondence theory of truth with a more new-fangled thing called the disquotational (or deflationary) theory of truth. The two are not at all the same, as we can see from works in which advocates of the real correspondence view argue against deflation, and even from efforts to reconcile the two.

I think James' arguments retain their old force against the genuine correspondence theory. Jamesians can probably consent to the deflationary theory without loss of anything James wanted to save, though, because if "truth" is the uninteresting tautological property that deflationists say that it is, then the notion doesn't really do any work in epistemology or anywhere else. I'm happy to concede that the statement "snow is white" is true if and only if snow is white. If we say that this is a full account of truth, though, then we abstract from a lot of other considerations that show up in all of the older theories.

The gist of the older disputes remains, nonetheless. Giving up "truth" to the deflationists means that the 19th century disputes among coherentists, correspondence theorists and pragmatists will have to rage again over other labels, such as "reference," or "knowledge," or (fittest of all) "warrant." And pragmatism in particular can easily enough refit itself as what is nowadays called a theory of warrant, of when we are warranted in asserting or believing that snow is white or anything else.

I suspect that van Dun's real objection to my old essay, the heart of our quarrel, doesn't really become evident until deep into his essay, when he gets to historical questions. We come to that point when he quotes me thus: “Human history contains plenty of data from which we might draw the conclusion that liberty works and slavery fails.”

Human history

To this he takes exception on a number of grounds. He asks: “[Where] do we draw the line between ‘liberty’ and ‘slavery’?" I might interject: the line is easily drawn, because I mean by slavery here what the history books mean by it -- the ownership or control of a person as a chattel. His questions continue: "What is the point of asking whether it is liberty or slavery that works? Surely, no one holds that the abolition of the institution of slavery brings a libertarian society into existence. A person can be unfree without being a slave (or a prisoner) in the common meaning of the term.”

True enough. Allow me to get this riposte properly underway, then, with two examples of unfreedom that fall far short of slavery, that also conspicuously didn't work. I take examples from my own country's history. In the early 20th century a sophisticated political movement went to a good deal of trouble to secure an amendment to the U.S. Constitution in order to allow Congress to prohibit the manufacture, sale, or transportation of intoxicating liquors. Why? The motives were perfectly understandable (it is difficult to deny that the consumption of liquor has been tied up with a good deal of heartbreak and disaster in human life), and these motives seemed to participants in that political movement to justify a constraint upon human liberty, upon individual decisions about the use of their own property and about the contracts into which they would or would not enter.

That unfreedom, imposed on us from 1919 until 1933, quite plainly did not work.
It fell because it failed.

Secondly, let us consider the sort of unfreedom typified by centralized social planning represented by the creation of a Federal Reserve Board, and ultimately by the introduction of fiat money. I think it safe to say that the headlines of the last year and a half especially make it clear that this unfreedom, too, does not work. This example is of a new sort because in each of the preceding two examples -- chattel slavery and alcohol prohibition -- we are discussing an institution that is no more. In the case of the Federal Reserve, we have to deal with an ongoing failure. Nonetheless, that it is a failure -- and that it is an instance of unfreedom -- are both very clear to me, and I hope to Mr. van Dun.

Business cycles preceded fiat money. But such money, and the central bankers whose "fiat" it is, surely worsen these destructive waves, these macrocosmic outbreaks of manic-depressive disorder. By flooding the land with the ever-cheaper legal tender, the central bankers cajole the retail and investment bankers, who in turn cajole men and women of varying degrees of prudence, industry, and business sense to accept their loans, for residences and for businesses; for the execution of good plans or bad plans or no plans at all.

Thus houses are built to be sold to families with fictitious income on the expectation that the houses will keep rising in price and will "flip" so no one will be the wiser; malls are built where there is no reasonable expectation that anyone will shop; deserts are watered and made to bloom at enormous expense in regions few wish to inhabit; dotcoms boast of "new paradigms" when their only real achievement is cluttering up cyberspace with yet more harebrainedness.

We know what comes next. What else can come next? Mises put it well: "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." Either way, it is nasty, and the victims of the collapse are, insofar as they are victims thereof, unfree.

Slavery Fails

So why, if I acknowledge that not all unfreedom involves slavery, is it the case that when I say that freedom works, do I immediately couple that with "slavery fails"? The answer is simple: Slavery provides a neat textbook case, if you will, of the failures of unfreedom. It shows us for example that one important mark of the failure of unfree institutions is that they constrain the possibilities and deform the hopes even of those whom they seem to privilege.

Let us return to the issue of slavery, then. By the 1850s in the southern United states, it was clearly a dysfunctional pillar of a dysfunctional society. What did slavery do for the free laborers of the slave states? Hinton Helper was right about this, in his book on The Impending Crisis of the South (1857). Helper was wrong on much, but he was on firm ground in arguing that slavery undermined the economic development of the south. The great plantations that employed large numbers of slaves to tend usually just one out of just three agricultural staples suited to this arrangement also soaked up the risk capital than might otherwise have gone to entrepreneurs, manufacturers, or even more mixed-use varieties of farmer, thereby making a diversified and balanced economny impossible.

The LONDON DAILY NEWS, in its review of Hinton's book, described it as advocating "a thorough reform in the labor system and renovation of the capitalists." Alas, it was too late for the old South to renovate itself in this way. The region was straped into a kamikaze plane, about to dive bomb the aircraft carrier of the North.

Slavery, in short, fell not because of accidents of history, and not because it was inhumane toward its intended victims (though it surely was). It fell because it failed, even on its own terms.

Hinton's arguments against the slave system may be taken, then, as a paradigm of pragmatic arguments for liberty in general. Liberty works in directing capital toward a variety of fruitful products, and co-ordinating the activities of innumerable individuals pursuing innumerable courses of life. The slave system confused the movement of capital, and made such co-ordination impossible.

An Industrial Society

The economics of antebellum slavery in the US is a huge subject, but I will take it as established for my purposes here that slavery, as represented specifically by the slave states within the United States in the 1850s, did not work. This leaves us with another important question of van Dun: Where is the evidence that the experience of an industrial society with rapidly changing technologies, extended markets and a highly developed division of labour can be extrapolated to other types of societies?

First, I do happen to live in an industrial society with rapidly changing technologies, so I think it worth remarking that slavery failed here, and that other forms of unfreedom regularly fail to an extent that suggests the obvious generalization. They represent the problems that freedom does and will solve.

But, second: are there really any other types of "society" on this planet now? There is only the one, so far as I know. There are different governments, who strive to keep up the illusion that sovereignty is a valuable thing, and so pretend to represent not just arbitrary chunks of land and the people there but so many distinct "societies" or "nations." I don't buy it. Still, it all seems to be just the one, this industrial one with its rapidly changing technologies, where slavery as a central part of a society's structure is a thing of the past. And that one emphatically does not need an earthly sovereign.

Globalization is nothing new. It was well-established when Leonard Read wrote his classic exposition of the information value of prices, "I, Pencil." What did the pencil have to say for itself? My core, it said, comes from graphite mined in Ceylon mixed with clay from Mississippi to produce the mixture inaccurately called "lead." This lead is then treated with a hot mixture that includes candle wax from Mexico.
The rubber-like product that tops off the pencil so we users thereof can correct our mistakes is made by combining rape seed oil from the Dutch East Indies (this was published in 1958) with sulfur chloride. And so forth.

I submit that all these contributions to the existence of that single pencil are themselves drawn from a single society incorporating both Indonesia and the US State of Mississippi. What has changed since 1958 is not this singleness but our awareness thereof.

A couple of digressions

By way of digression, let us acknowledge the final point of Read's essay. His point was not so much geographic spread as overwhelming complexity. No person, no central planning commission -- and we might easily add on his behalf, no bank of computers -- could anticipate or ordain everything that goes into putting together a pencil, which on its face seems such a simple implement. Only the whole of society consisting of innumerable individuals whose activities are co-ordinated by prices can accomplish this in the efficient way that pencil users take for granted.

There is only one society and within this one, slavery is wrong. Does slavery no longer exist, then? Alas, we can not say that. A second and much more solemn digression is appropriate here. According to a study by the U.S. State Department, 600,000 to 800,000 men, women, and children are trafficked across international borders each year. Eighty percent of these are women, and about half are minors. Although most of the traffic is commercial sexual exploitation, manual labor is exacted from some such objects of traffic, too. There are likely millions of other victims who are trafficked within the borders of a single nation and thus don't show up in such statistics.

Everybody except the immediate beneficiaries (and they remain silent on their practices) has little trouble recognizing this as an evil and an atavistic practice. It is not something that works, nor anything that promises to work. It is simply on a continuum with the acts of battery and abduction with which it generally begins -- violent crime surviving because of the darker traits of human nature. Note indeed, that trafficking in human beings takes place largely for the benefit of a market, prostitution, that itself has been driven underground by misguided criminalization. Despite that, we have shaking ourselves into a better equilibrium than that in which such bondage was any essential part.

James' Moral Vision

Allow me now to move on to the most daunting portion of my exposition. I will try to convey the essence of William James' (and incidentally my own) moral vision. Not all value is moral value but moral value is the type on which van Dun and I seem to occupy distinct stands. I would ask him to try to grasp the Jamesian vision, and to note in doing so that it has both a conservative and a rebellious side -- the conservative respects and defends the social equilibrium that has developed, against the savage or the fraudulent and the threats each presents. But the rebellious side tells us that no equilibrium is final, and pushes forward toward something more inclusive, more tolerant...higher.

A thoroughly secular view can grasp both halves of this vision, as a logical matter. But depth in contemplation of the human predicament, James says, will lead an ethical philosopher to wonder what motivates and what sustains the rebels who challenge the existing order and upon whose efforts the pattern of moral progress depends. In one passage in The Moral Philosopher and the Moral Life, (MPML) James said that every one of "hundreds of ideals has its special champion already provided in the shape of some genius expressly born to feel it, and to fight to death in its behalf".

Expressly born? A champion already provided? Provided by whom? The most natural hypothesis is that champions -- saints, we may call them, to recall the lectures on sainthood and its uses in Varieties of Religious Experience -- they come to us and are sustained by what James near the end of MPML calls "a divine thinker with all-enveloping demands."

There are innumerable situations in which both sides are right. The conservative is right, as is the rebel. Mr. van Dun glances at this situation when he asks, "Does the fact that my liberty stands in the way of another's plans or hopes, provide him or any other with a sufficient reason to disregard it?" That is indeed a very good question. Given the adjective "sufficient" before the word "reason" in that question I can confidently offer an unequivocal answer: No. But this requires some explanation, and that in turn requires that we make the question a bit more concrete.

It is quite commonly the case that one person's liberty is in accord with the established systems of his day (in the 1850s, an Alabama white man may well have had plans or hopes that involved ownership of a slave) and the sort of conflict the question suggests comes about because other person's liberty will involve defiance of that order. A slave may plan his escape just as an aspiring owner approaches the site of the auction. With whose hopes and plans should the pragmatist side?

Victory and Defeat There Must Be

So we meet the conservative and the rebel in a rather stark form. There are reasons to lock out some interests and disdain some passions. The reasons always come down to this: those interests and passions are (a) inconsistent with the existing social equilibrium, and (b) we can not now see our way clear to a better one. But each passion has its champion, and the collective pressure of them helps make way (whether they as individuals wanted this or not is irrelevant) to a broader, more tolerant, equilibrium later. Here I quote James's MPML again. "Since victory and defeat there must be, the victory to be philosophically prayed for is that of the more inclusive side -- of the side which even in the hour of triumph will to some degree do justice to the ideals in which the vanquished party's interests lay."

Later, and adopting I would say a somewhat more Olympian tone, James writes, "The pure philosopher can only follow the windings of the spectacle, confident that the line of least resistance will always be towards the richer and the more inclusive arrangement, and that by one tack after another some approach to the kingdom of heaven is incessantly made."

James epistemology, then, leads to an ethic that has to unfold in history, and it conceives of history as progressive.

Let us move a bit further back to get a sense of how messy a process history is, even if conceived of as a moral progress. Consider the Puritans of Massachusetts Bay colony. They certainly felt locked out by the High Churchmen running the established religion in the mother country in the early 17th century. Some of their colleagues would in time rebel and help put a king to death. But the Puritans who show up in US history books are the ones who braved the ocean to create a "shining city on a hill."

Did their own rebelliousness entail tolerant attitudes on their part. Heck no! Neither Anne Hutchison nor Roger Williams thought so, at any rate. But the rebellions of the Puritans -- both the at-home King-killing ones and the emigrants -- helped contribute over time to greater tolerance in the English-speaking world. This business of rebellion and the emergence of ever more inclusive equilibria is a costly one, to be sure.

Every equilibrium has discontents, out of whose ranks come rebels. Every equilibrium also has its defenders, some of whom think that the status quo is wonderful; others of whom simply think that it is better than any of the other options on the table. So with this backdrop, we can confidently answer van Dun's question.

"Does the fact that my liberty stands in the way of another's plans or hopes, provide him or any other with a sufficient reason to disregard it?"

Remember that I said that "sufficient" is the crucial word there. If the question were whether it provides the "other" with a genuine reason to disregard it, I would have had to say "Yes." But that genuine reason is not a sufficient reason. There is history to consider. There is the question of which of our freedoms represents the more inclusive order. If he is the one proposing to break with an established equilibrium, there is the question whether his actions will help replace it with a better. The answer, then, is "No."

Infinite Regression

One of the classical arguments against pragmatism, either epistemological or ethical, is the claim of an infinite regression.

Truth, (or knowledge, or warrant, or successful reference) is understood by pragmatists to be that which works.

Works toward what end or by what standard? ask the critics. And if any end or standard is specified, they pounce. Does that end or standard work? If not, it is neither true nor good, according to pragmatism itself. Yet if the end or standard does work, it must do so according to some yet further end or standard, and so on forever. Surely nothing that requires such an endless loop can be an accurate account of how we do or should make our here and now decisions. So pragmatism stands defeated!

Although Van Dun makes no such argument explicit, I believe that some such notion operates between the lines of his essay, so I give it answer here.

The regression is not infinite because one can in principle imagine a world in which all desires are harmonized each with the others. That is not the world in which we live, but we may well see both history and ethics as a process of working toward that summit, and we may see freedom as the crucial means to that end -- the metabolism by which we can keep putting one foot in front of the other toward that eschatology.

Physics

But then there is the argument from the Second Law of Thermodynamics, or from contemporary cosmological theory, that the world will not end happily -- that it will all end in a heat death, as detached particles move endlessly far away from each other and all meaning is lost. Won't that make a mockery out of the goals humans had pursued so assiduously during our span in this cosmos?

Not at all. All such scientific premises represent the latest word, hardly the last word. A century from now, some revived form of the old Steady State cosmology may be regnant and the second law may itself have been defeated by some real-life version of Maxwell's demon, brought us by nanotechnology. Indeed, who knows but that in some Big Picture the destiny of the human race is to reverse the flow of energy into heat and save the cosmos from the contemplated death? All the better, then, do we have a good reason to set each other free from one another's tampering.

And with that stunningly speculative flourish I had better conclude, for fear that anything else I might say in this post will be an anti-climax.

The Banking Industry Stress Test

The Federal Reserve yesterday made public a portentiously titled document about its ongoing examination of all those troubled investment banks you've been reading about.

The Fed's paper is called "The Supervisory Capital Assessment Program: Design and Implementation."

Read it for yourself here.

Or take my word for this concise summary. The Fed and other regulators have been looking over the records of the banks with an eye to determining whether they could survive the next bad thing that might happen to them, "a recession that is longer and more severe than the consensus expectation."

The idea, apparently, is that if the Fed does this stress testing and then triumphantly proclaims that the US banks are now in great shape, able to handle whatever economic reality may throw at them over the next two years, potential equity investors and counter-parties will cheer up and the engines of commerce will start to hum again.

There is a lot that is dubious in that reasoning. But I have to say, I find the name of the program funny. Supervisory Capital Assessment Program? SCAP? Why not make it the Supervisory Capital Recovery Assessment Program? Oh ... sorry ... I just realized they are no doubt saving that name for an assessment of the US auto industry.

Anyway, there was a neat public argument over this program on CNBC yesterday morning, puitting Rick Santelli against Steve Liesman. Rick Santelli, you may remember, helped inspire the whole "tea party" thing with a much-viewed soliloquy on mortgages, bail-outs, etc.

The clip to which I'm about to link you starts in a rather pedestrian way. Santelli gives his usual morning report from the trading pits. Feel free to skip forward to about 3:15, when things get more interesting. The pundits in the studio are talking about the saying "most people think they're above average" and what it may mean in terms of the upcoming stress test announcements.

Then at about 4:15, Santelli jumps back into the discussion, and it gets hot between Steve and Rick, with each accusing the other of not understanding how the banking system works.

Interesting question from Liesman. "You are a local official on the banks of the Mississippi, deciding how high the levy should be. How great of a disaster do you want to prepare for, a 100-year flood? a 500-year flood?"

The point of course has to do with how stress tests should work (what is a "worst case scenario" exactly?) and how banking capital reserves should be set.

Rick gives a good philosophical answer to that question, but Steve thinks it misses the point, and wants to try to get Rick to think inside the box, if you will, of the existing social/political/regulatory system. "Reality not your imagination," as he puts it. Then things go amusingly down hill into shouting match territory.

A stress test for the vascular system of both men, perhaps?

Top Financial Stories 2008

I generally ask myself at this time of year what were the biggest stories of the past twelve months, in business/financial news.

By "stories," I don't mean themes, such as "Bear market in bank stocks" or "volatile crude oil prices." I mean stories, such as one might have seen in a particular newspaper on some specific day.

Of course, I choose the ones I do largely because they illustrate an important theme. But the theme itself isn't the story.

Further, I don't rank them, as in a top ten list. Usually, on this blog last year at this time and at my blog-city home for two years before that, I've simply given one "top" story from each of the twelve months of the year now ending.

This year has been so wild, though, especially its second half, that I haven't been able to stick to the one-a-month presentation. I've ended up with a list of 18 big stories, two per month starting with July.

All that understood, here we go!

January. Frenchman Jerome Kerviel loses 4.9 billion euros for Societe Generale. $7 billion. The story started off the year with a bang. Kerviel leap-frogged past Nick Leeson as the all-time most rogue-ish "rogue trader."

February. A jury in Hartford, Conn. convicts a former AIG exec of skullduggery.

The executive in question was Christian Milton, once AIG's vice-president for re-insurance. He was convicted of an effort to inflate AIG's loss reserve numbers.

March. The Federal Reserve backs a JPMorgan takeover of Bear Stearns. At one point, [i.e. the morning of March 17] the price was actually $2 a share for Bear's stock, although less than a week prior -- at the close of trading Monday afternoon, March 10, the market valuation had been $70.08 a share. It was hard not to think JP Morgan was making off with ill-gotten gains somnehow. In fact, the purchase price didn't stay down at $2. To resolve some problem in the documentation, it was eventually raised to $10. Bully. Still, the value-evaporation was breaktaking.

April. Food price increases cause riots, political crises, worldwide.

There would be a lot to discuss under this heading, were that my goal in this entry. Instead, I'll just ask about the use of foodstuffs as a surrogate for gasoline: what impact did that have in triggering the price increases or the result?

May. Yahoo successful in warding off acquisition attempt by MS.

A victory for Jerry Yang, the founder of Yahoo!, who remains its guiding spirit and has preserved its independence.

June. Voters in Ireland reject the Lisbon treaty, thus slowing Euro unity..

The world continues to wrestle with the whole idea of "sovereignty," in terms of nation-states or of broader or smaller units.

Hereafter we award two biggest-story prizes per month.

July. (a) Israel, of Bayou and Bear Mountain infamy, turns himself in.

The whole Bayou funds meltdown had more than a touch of the bizaare to it. Israel's effort to simulate a suicide on the Bear Mountain Bridge, the failure of authorities to discover a body in the Hudson, and his re-appearance and surrender just added the garnish to that meal of oddities.

(b) Crude oil prices peak near $150 barrel, head down.

Why did it get that high? Why has each barrel lost close to three quarters of that value in the months since? Which one is the anamoly, prices above $140 or around $40? which one will be the norm going forward? Reviewing this year just leaves me full of questions.

August. (a) Second circuit court hears arguments in CSX/TCI dispute.

This is fascinating litigation about proxy votes and the working of the equity swaps market. These aren't issues that will go away anytime soon.

(b) CME, Nymex agree to consolidation -- part of the much broader trend of the consolidation of exchanges worldwide.

September. (a) Bankruptcy of Lehman Brothers, all heck breaks loose re: bank stocks or, for that mnatter, US equities generally.
(b) SEC emergency order bans any short selling of bank stocks .

These two points rather adequately explain themselves. I'll only add that the ban later expired unlamented. Various restrictions of short-selling remain, but a simple ban on it is akin to a ban on pessimism. It is idiotic.

October. (a) Bush and 'leadership' put a TARP over troubles.
The acronym "TARP" stood for the "Troubled Assets Relief Plan," the keystone of the Emergency Economic Stabilization Act of 2008, which became law on OPctober 3, after a turtuous legislative process that re-defined the Presidential campaign to Senator McCain's disadvantage. That isn't all it has redefined.

(b) Waxman hearings excoriate the credit rating agencies I'll just leave a link to my contemporaneous explanation of this hearing and its bovine idiom.

November. (a) Geithner an early cabinet choice of President Elect.
The Republicans during the campaign had sought to tag Sen. Obama a "socialist" (while a President and Treasury Secy of their party were nationalizing industries -- how odd!) Anyway, the Prez-elect's choice of Timothy Geithner as his own Treasuiry Secretary should have re-assured anyone who needed re-assurance on this front.
(b) Paulson completes the bait-and-switch with the TARP.
The outgoing Treasury boss has advertised the TARP as a fund for purchasing troubled assets. Hence, the name. Those purchases were meant to stabilize, without taking over, the banking system. But by one month out, Paulson was acknowledging that the real use of the money would be to make "equity infusions." In other words, takeovers.

December. (a) Bernard Madoff is arrested Dec. 11, one day after his sons had apparently revealed his pyramid scheme to the authorities.

You can't really call Madoff a "rogue trader" in the manner of Kerviel, the rogue with whom the year began. A rogue is a trader who gets a firm in trouble by going behind the back of his bosses there. Madoff was the guy with his name on the door. Call him a "rogue principal" if you like. Still, his fall gives a nice sense of symmetry to the year.

(b) Dec. 16, Federal Reserve lowers federal funds rate to a range between 0% and 0.25%, record territory. Three days later, the Bank of Japan followed suit, lowering its benchmark rate to 0.10%.

Wow. Funds rates are dropping like crude oil prices.

Whew. I'm sooo happy this year is over.

Anarcho-Capitalism

An acquaintance who doesn't cotton to my theorizing about anarcho-capitalism put his objections thus: "How can money arise without a government? You're back to stuff with intrinsic value like precious metals but that puts power into the hands of those with mines or anyone who has enough power to corner the market."

To which I answered thusly.

Money can arise without government because humans are intelligent creatures who can easily recognize the utility of a medium of exchange.

As for going back to precious metals, that's possible. But why are precious metals "precious"? What is their "intrinsic value"? Use in jewelry? That's a big leap.

The value of gold comes from certain physical facts. First, there's only a limited amount of it in the world.

Second, it is a chemical element -- so it is neither created nor destroyed except by very unusual processes (is gold fissionable? -- probably not).

Third, gold is malleable enough so that numbers can be printed on it easily, yet sufficiently solid so that a coin can keep its shape.

There might be a more psychological point here, one that I believe John Maynard Keynes suggested. Perhaps to our symbol-hungry minds, silver reminds us of the moon and yellow/gold reminds us of the sun, and since these two heavenly bodies are of primordial importance, so are the metals.

Government doesn't have to exist in order to inform people of such facts. They operate whether or not they are broadcast, and they keep gold valuable as a medium of exchange.

Of course other media may also come about. I'm told that unopened packs of cigarettes are frequently exchanged under battlefield conditions. The intrinsic value of a cigarette, the pleasure of smoking, may be the original inducement to their value -- just as the decorative use of gold as jewelry might have originally suggested its value as a medium of exchange -- but once they start circulating they can be sought after simply because they ARE such a medium, and continue to circulate for a long time before anyone breaks the seal, reconverting the packet into a consumer good.

But suppose the precious metals were generally accepted as a unit of exchnage. You worry about this because it "puts power into the hands of those with mines...."

So someone will have a mine, even in the absense of government? Are you acknowledging that private property in real estate -- and in the sort of expensive capital tools used to dig and retrieve gold -- would survive anarchy? [This is btw the sort of contention that my acquaintance, earlier in the exchange, had denied]. If not, you are contradicting yourself here. If no one will "have a mine" then no one will have the power you say you're worried about.

"...or has enough power to corner the market."

Precisely what I'm worried about. The Federal Reserve Board has cornered the market in federal reserve notes. Shouldn't we rebel? Or work to undermine the conditions that cause people to think this is "necessary"?

A Smart Guy, But....

There's no doubt Federal Reserve chairman Ben Bernanke is a smart guy. In fact, on the scale of Bush administration appointees he's off the charts.

He was the chairman of the economics department at Princeton University, and the editor of the American Economic Review, to name just two dandy resume brighteners in his bio.

But you have to wonder, in view of recent events, whether this isn't the sort of brightness that can hurt more than it helps in real-world applications.

Jim Cramer was right in a bit of his now-famous televised meltdown. Bernanke doesn't have any idea. But Cramer was right in the wrong way. Cramer was demanding, with veins popping in forehead and all, that the Fed bail out the big Wall Street institutions with a discount rate cut. To prove that he did have a clue. Bernanke agreed with the scary guy and did exactly that, proving the contrary.

The business cycle is always a credit cycle. When credit is too easy, an upswing becomesd an unsustainable bubble. The only rational thing to do about a bubble is to pop it, and accept the consequences. Instead, the easy thing to do is to work to preserve and continue expanding the bubble, which is the course Bernanke has taken.

That always means that the popping will be worse when it does come. And it will.

Bernanke once gave a speech speculating about the use of a helicopter to drop dollar bills and save the economy. He seems to be trying to do that:

http://prudentinvestor.blogspot.com/2005/10/ben-helicopter-bernanke-could-land-at.html