The issues underlying financial "reform" are incredibly complex. Yet, it is utterly banal, average people, with average (or less) knowledge of the subject who will pass laws to force financial practitioners to act in a certain way. Imagine a quack who could pass a law telling a dentist how to pull a tooth. Financial "reform" will be equally painful, although the pain will be spread over decades and be much harder to detect. If one needs a visualization of how regulation is simply force that negates the mind, think of that dentist and the quack-regulator.
The other consequence of the complexity of the financial mess is that it becomes nearly impossible to fight financial "reform" except at the philosophical level. Philosophically, the broad case for capitalism is made by Ayn Rand's philosophy of Objectivism. It validates reason and individual rights, the base of capitalism. However, the battle must also be fought at the level of economics, and on that level the issues are simply too complex to fight something as "real-time" as this bill.
At the level of economics, unraveling the mess means understanding how a history of financial intervention dating back to our country's founding has cumulated into the current mess. We have the consequences of the state laws against branch banking, the government's ossification of the gold standard after the Civil War, the establishment of the Federal Reserve Bank, the 1930s laws (Glass-Steagall, the SEC), government-sponsored securitization of mortgage finance (Fannie Mae and Freddie Mac, also beginning in the 1930s), Regulation Q, laws against corporate takeovers, the final abandonment of the gold standard in the late 1960s, laws that restrict the trading of derivatives on exchanges, etc.
The consequences of each of these laws can be traced, sometimes through spans of time longer than a century, all the way up to the present day. Each of them was involved in the current crisis (and each was passed in response to bad consequences stemming from the prior laws). The solution requires the repeal of all of them, and the establishment of free, private banking in a form that has never existed in this country.
This is the type of case that must be made on economic terms and is the proper context for the congressional hearings on financial reform. However, very few people can present such a case. Certainly, none of them have appeared in these hearings.
Bottom line: The quacks are going to tell those of us in finance how to practice our craft. Finance is the "brains" of capitalism. It allocates capital to where it can create the most wealth. Our economy's brain is about to take another bullet.
Thursday, April 29, 2010
The issues underlying financial "reform" are incredibly complex. Yet, it is utterly banal, average people, with average (or less) knowledge of the subject who will pass laws to force financial practitioners to act in a certain way. Imagine a quack who could pass a law telling a dentist how to pull a tooth. Financial "reform" will be equally painful, although the pain will be spread over decades and be much harder to detect. If one needs a visualization of how regulation is simply force that negates the mind, think of that dentist and the quack-regulator.
Saturday, February 06, 2010
Healthcare is not a right. It is a good and service to be bought voluntarily from willing providers, like anything else. Do I tell my barber that a haircut is my right, and then force him to provide me with the haircut of my choice at the price that I dictate to him? That is what socialized medicine does to doctors.
If it is my right to that haircut, what has happened to the right of the barber to offer his service on terms agreeable to him? And if his rights are violated -- if he is reduced to the status of an unwilling servant -- imagine how lousy my haircuts will look, as he rushes them along to provide them at the price set by government.
Now consider that this same scenario plays out right now with a far more vital service, one upon which all of our lives depend. Today about 50% of medical costs are paid for by the government under terms set by government. We have 50%-socialized medicine in the United States. The problems we have are due to this high level of socialism that already exists.
The solution is not to drink the whole bottle of poison and condemn all of us, doctors and their patients, to life-shortening medical "care" by rights-less doctors and their disgruntled, sick patients.
The solution is freedom. It has never really been tried. Abolish government funding of medical care. Eliminate the rules that bind insurance companies and doctors from offering the care that customers want. Respect the rights of doctors and their patients to freely contract with each other for medical services.
Healthcare is not a right, and our lives depend on acknowledging this fact.
Say "no" to any scheme to further entrench socialized medicine.
I just posted this here on a website that is soliciting solutions for the problems in healthcare. Register your vote.
Friday, October 09, 2009
by Raymond C. Niles
(This introduction was originally posted at the "Principles in Practice" website where a free version of Mr. Niles' article originally in The Objective Standard, "Net Neutrality: Toward a Stupid Internet," has been made available.)
The chairman of the FCC recently called for applying “net neutrality” to the wireless spectrum. Such a measure would dramatically extend the reach of proposed “net neutrality” rules, which were originally slated to govern the delivery of Internet content via wire—cable and DSL lines—but not via wireless signals. The expanded rules would govern the delivery of Internet content to cell phones, iPhones, Kindles, and other wireless devices. The advocates of net neutrality claim they are seeking to preserve a “free” and “open” Internet and to prohibit the “unfair” policies of Internet service providers that favor some content over others. According to them, to preserve this openness and freedom, the FCC must be granted vastly greater powers to coercively determine the business practices of Internet service providers.
That claim, however, is a sham.
An “open” and “free” Internet cannot be achieved by means of further FCC regulations. Extending FCC controls to the wireless spectrum would not “open” anything or free anyone; rather it would further violate the rights of Americans to produce and trade according to their own judgment and thus thwart this vital new realm of life-serving technology. It would unleash a torrent of government control over every aspect of the Internet, granting the government power to dictate how content is to be delivered and at what price, making it less profitable for Internet service providers to invest in costly infrastructure, and thereby quashing their incentive to innovate.
To the extent that “net neutrality” is implemented, the result will be a slower, less robust Internet—a “stupid” Internet, as one of the chief advocates of this pernicious idea aptly describes it. For an elaboration on how “net neutrality” violates the rights of Internet service providers and users alike, and why it is a bad idea for the wired Internet and by implication the wireless spectrum, read my article “Net Neutrality: Toward a Stupid Internet.”
Wednesday, October 07, 2009
The Federal Reserve recently announced that it would establish rules governing the pay of employees at essentially all bank and financial corporations in the United States. This goes well beyond just targeting CEOs at banks who received federal bailout money last year. According to the New York Times, the proposed rules would apply to 5,000 bank holding companies and state-chartered banks. And it would apply to traders, loan officers and other employees, not just top bank executives.
Ostensibly, the purpose of the rules is to reduce “systemic risk.” Allegedly, by having government regulators determine the pay of bankers, those bankers will no longer have the incentive to make risky loans to individuals and corporations.
Such a policy evades the fundamental cause of that risky behavior, namely government policies that fostered artificially cheap credit and mandated risky loans. The Fed itself is the author of these policies. It flooded the economy with cheap credit and 1% interest rates in 2003-2004, which fed the orgy of subprime borrowing. The Fed also enforced the Community Reinvestment Act that forced bankers to meet quantitative targets of loans to uncreditworthy borrowers. Moreover, Fannie Mae and Freddie Mac, two government-sponsored enterprises, guaranteed mortgages against default, thus ensuring that bankers would have no incentive to monitor credit risk.
The government’s subsidies, guarantees against default, and promiscuously cheap credit created an atmosphere in which private bankers were rewarded for taking excessive risks, and made to look like suckers if they prudently restrained themselves.
Yet the government blames the bankers for this mess and now wants to control their pay.
Over the past year we have seen Barney Frank (October 2008) call for a moratorium on Wall Street bonuses and President Obama (February 2009) call for limiting the bonuses of CEOs to $500,000. At the time, I warned that when government arrogates such a power to itself, do not assume that it will be confined to a few Wall Street executives. Now we see the Fed claim for itself the power to control the pay of tens of thousands of employees at every banking institution across the land.
Government fostered the financial crisis by violating the rights of private citizens through its reckless policy of subsidy and cheap credit. Now it proposes to “solve” the problem by further violating rights, including the right of employer and employee to voluntarily agree on the terms of employment.
The end game of this dangerous grab for power should be obvious. The government will not stop until it has taken complete control of the commanding heights of the economy. And it has already largely succeeded. With its progressive takeover of banking, government is now assuming control of the most important sector of the economy. The banks are fundamental in economic importance because their lending and capital raising decisions directly affect the growth of all other industries. Now the government, through its control of banking, will decide whether a particular company or industry is to receive credit, and succeed or fail.
Do not doubt that the government will use this power. Recently, for example, the Wall Street Journal reported that former Vice President Al Gore used his influence to steer two $500 million federal loans to cronies planning to make expensive “environmentally friendly” cars. Imagine what Al Gore or others will be able to do when the Fed controls the salaries of thousands of private bankers. To whom will they be able to direct loans, and for what type of quid pro quo?
Statist governments operate under a rule. They always seek to control the commanding heights of the economy. Statists know that if they control the key industry upon which all others depend, they can control all industries. Our government is seizing the commanding heights of our economy right before our eyes.
Sunday, June 14, 2009
Some weeks ago a reader of my blog posted the story of his father-in-law, who received treatment under Canada's system of socialized medicine. With his permission, I reproduce his story below. As President Obama this week begins his congressional push for further socializing medicine in America, consider the story of his father-in-law, and think about what socialized medicine will mean for you. Consider the "human face of socialized medicine." My response to him follows his story.
"I was born in Canada and have taken Canada’s socialized health care system for granted all my life that it was good - until we needed it.
My father in law, a Filipino immigrant, wasn’t feeling well so we took him in for a check up. We waited for a few more months until the testing could be arranged, and then more waiting since there were, “complications.” He had a lung cancer and we would have to wait for “6 to 8 months” before scheduling treatment.
I think he knew he was going to die and took charge. After a few months of constantly coughing, we tried to pester the doctors to speed up the waiting time. He tried his own remedies to alleviate his worsening condition like drinking Ginger soup but he could delay no longer. He and his wife decided to go back to the Philippines for treatment. The doctors there had immediately started treating him with radiation but it was already too late. He had developed a fast growing form of lung cancer and died a few weeks later.
The doctors seemed concerned but wouldn’t change the waiting times due to limited available machines and Canada’s administrative central control in this field.
The fact the Canadian health care system pretends to be based on equality hides the fact it is a socialist experiment that destroys human life and can never be sufficient enough to heal life when needed. The carrot in Canada’s healthcare system is the so called “affordability for everyone” promise, but it is an inherently bad way to go due to its built in socialization. Lives are constantly lost. Ted Harlson (Toronto, Canada)"
Galileo Blogs' response to Mr. Harlson:
Your story saddened and angered me. It is criminal that your father-in-law had to die because of socialized medicine.
Socialized medicine harms everyone, doctors, patients, and their families. It is deadly to human health, as your story illustrates. Socialized medicine kills.
The alternative is to recognize that doctors have the right to freely charge for their services, just as patients have the right to freely select their doctors. No one has a "right" to medical care. That care must be paid for, and when government is the payer, it means rationing care and killing off the "excess" patients that "the system" cannot afford.
No one worries about there being a shortage of cars. People do not wait in line to buy cars, clothing, or houses. That is because those markets are largely free. Each party voluntarily deals with the other. The result is an abundance of these goods willingly bought and sold in the marketplace, at times and in quantities, and at quality levels that both parties mutually and voluntarily agree on.
Recall the long lines in the Soviet Union for bread, shoes, and toilet paper. That was because their entire economy was socialized. Those Soviet-style lines have now come to medical care, because it too has become socialized in Canada and, soon I fear, the United States. Your father-in-law died waiting in one of those lines.
Please take your grief and fight back by denouncing this injustice, as you have by sharing your story.
Please accept my condolences and best wishes.
Wednesday, May 13, 2009
The European antitrust regulator has just announced it will fine Intel Corporation $1.44 billion (1.06 billion euros) because it "harmed millions of European consumers by deliberately acting to keep competitors out of the market for computer chips for many years." It did this, essentially, by discounting the price it sold chips to stores that agreed to sell computers containing them in bulk through exclusive agreements.
We've been down this path before. The railroads that served Standard Oil charged him a lower rate because Rockefeller could guarantee large, steady shipments of oil, which the railroads could ship more cheaply. For providing the railroads with product in a way that reduced their costs, and being charged less for providing that, Rockefeller was prosecuted.
In the same manner, a retail store that can guarantee large, steady sales of computers containing Intel chips is more valuable to Intel than a store that buys some of its chips and some of its competitor's chips. Intel can afford to provide a discount.
Those never-to-be-denied European customers benefit from this by getting cheaper Intel chips, yet they were supposedly harmed according to the European antitrust commissioner.
But also evaded by the European antitrust commissioner is that a market for computer chips would not exist at all if Intel did not invent, develop, and constantly innovate the chips that become the brains of computers. Because of Intel's work, each year the chips are faster and smarter. Each computer sold with those chips can do more -- faster processing of material from the Internet, simultaneous handling of video and audio, and numerous other tasks -- because of the relentless intellectual effort of Intel's scientists and engineers.
That is part of what the never-to-be-denied European consumers and all others who buy Intel chips are getting.
To steal $1.44 billion from Intel is to demand that these scientists and engineers work for free. It is to steal the fruit of their effort, which we all benefit from by voluntarily buying their products that they create. As their property created by their minds, they have the right to set the terms under which we gladly buy these products, which we buy because of the great benefits they offer us.
Into all this steps the punishing European antitrust commissioner. She violates Intel's property rights and the rights of Intel's customers to do business with Intel on mutually agreed-upon terms. And by so doing, she ensures that Intel has $1.44 billion less in which to reward the efforts of those scientists and engineers who create the marvelous Intel chips.
If our computers are a little slower than they could be and our freedoms more diminished, thank Neelie Kroes, the European antitrust commissioner, and the legions of apologist economists who rationalize the pernicious doctrine of antitrust that gives her this power.
Thursday, April 16, 2009
I joined thousands of other protesters yesterday at the "Tea Party" protest at City Hall Park in downtown New York. My sign read on one side, "Reason & Capitalism. No Creeping Socialism!" On the other, it read, "Ayn Rand Is Right." I saw many signs referring to Atlas Shrugged and Ayn Rand. One Objectivist joined me with his sign that read, "Who Is John Galt?"
We found a strategic spot right alongside Broadway. Many busloads and carloads of commuters got to see "Ayn Rand Is Right" and "Who Is John Galt?" on their way home from work. One person asked us who John Galt was. We told him that if he wants to understand what is wrong with the world and what should be done about it, read Atlas Shrugged. He said he would.
I was pleased overall by the event. It was remarkably secular. There were few references to God and the conservative Republicans only showed themselves in a tentative manner. (I think they know how responsible the Bush-era Big Government and Religious Right Republicans are for the crisis we're in.)
Overall, the impression I had was one of a true grassroots protest. People were angry at the violation of our rights. People expressed it in terms of outrage over spending and taxation.
The speakers weren't very good overall, but they were sincere and angry.
This is the first protest I have ever gone to. I have always thought that the battle of ideas is won through conventionally intellectual pursuits: writing and teaching.
But there is a time to speak out in the form of a protest. This was one of those times.
I hope we see more Tea Parties.
Thank you, Rick "Sam Adams" Santelli for issuing the clarion call that was heard around the country.
Saturday, March 14, 2009
What is bankruptcy?
Bankruptcy is the financial state that occurs when a person or business can no longer repay its debts. In the legal sense, bankruptcy begins when a court recognizes that the financial state of bankruptcy exists. The bankruptcy court takes charge of the bankrupt entity and disposes of its assets or reorganizes it to pay off as much of the debts as possible.
A bankruptcy proceeding recovers money for the creditor, but both parties benefit.
The purpose of a bankruptcy proceeding is to facilitate the maximum recovery of the money owed to the creditor. But it also benefits the debtor. After the debtor pays off what he can, his remaining debt is extinguished. This is not a “get of jail free” card; the debtor, whether a person or business, must face the damage to its reputation and a greater difficulty in obtaining credit for a long time into the future. Rather, it is an acknowledgement that the debtor simply cannot repay his debt. For both parties, bankruptcy offers timely resolution to an otherwise unsolvable dilemma. The creditor regains a portion of the money owed, and the debtor, relieved from the burden of a debt he cannot pay, can move on with his life.
Bankruptcy is economically valuable.
In economic terms, a speedy and fair process of bankruptcy allows both assets and people to resume being productive as quickly as possible. The creditor regains cash that it can redeploy as it sees fit. If it is a bank, it has regained funds that it can loan out again to more productive businesses or creditworthy individuals. The creditor can also redeploy the assets of the bankrupt entity into the hands of a more capable manager.
Take the financial malaise of General Motors as an example. Although effectively bankrupt, there has been no legal recognition of this fact (as of this writing in March 2009). As a result, its factories and workers continue to be tied up inefficiently making mediocre cars. General Motors is a drag on the American economy.
Bankruptcy would free General Motors’ factories and employees to be more productive. Once a court legally acknowledges General Motors’ bankruptcy, it could allow General Motors’ new owners, its creditors, to appoint a more competent manager. Or the creditors could sell the plants to a superior car manufacturer, such as Toyota. Either way, after reorganization under bankruptcy, the plants would be used to make cheaper, more attractive cars that customers want to buy.
The creditors may also choose to shut down some or all of the plants and sell them for scrap. But recycling the old plants into new steel that becomes the girders of modern, efficient factories is a better use for those plants if they are obsolete. No party is in a better position to make these judgments than General Motors’ creditors, who have their financial self-interest at stake.
While General Motors is just a single, albeit enormous, example, speedy and fair bankruptcies end the bleeding of money-losing operations across the economy, and re-direct inefficiently utilized assets and capital to more productive activities. In sum, bankruptcy facilitates economic recovery. A failure to permit bankruptcy prolongs stagnation.
Some fallacies about bankruptcy
Bankruptcy always means shutting down a business. This is not true. Creditors, in consultation with the bankruptcy court, decide whether to shut down and liquidate, or to operate under new management. Creditors have every incentive to make the decision that maximizes their pay-out over time, not just the amount of cash that can be had right now.
Bankruptcy is bad for employees. Considered in full context, bankruptcy is good for employees. An economy with speedy and fair bankruptcy procedures is one where healthy, growing companies predominate. Healthy companies can pay employees more because their labor is worth more to them. Therefore, employees benefit from bankruptcy, even if someone occasionally faces dislocation or the uncertainty of working for new management. But, even if employees dislike such occasional dislocation, there is no alternative to bankruptcy if their employer is not financially viable.
Bankruptcy allows deadbeats to avoid meeting honest obligations. When bankruptcy laws are properly drafted and applied, this is the exception rather than the rule. Bankruptcy laws are designed to protect the rights of all parties, not to unfairly favor debtor or creditor. Bankruptcy acknowledges a fact, that the debtor cannot repay all his debts, and it facilitates the repayment of all debts that can be repaid.
Government should stop bankruptcies. During financial panics, governments sometimes try to prevent bankruptcies by putting moratoriums on them, subsidizing bankrupt entities, or changing the laws governing bankruptcy to favor debtors. Such interventions are both unjust and impractical. They are unjust because they deny the legitimate right of the creditors to collect what they are owed. The money they are owed is their property, and they have the right to collect it, to the extent it is reasonably possible. Such interventions are unjust and impractical because they attempt to deny reality. “Stiffing” the creditors or forcing innocent third parties to bail out the bankrupt entity through subsidies does not change the fact that the bankrupt entity cannot repay its debts.
Bankruptcy is moral.
Bankruptcy is just, if resolved through a fair and speedy judicial process. A bankruptcy proceeding acknowledges the actual state of affairs that exists, that the bankrupt entity cannot repay its debts. It resolves this dilemma for the maximum benefit of the creditor, but in so doing allows both parties – debtors and creditors – to resolve this matter with finality, and move on with their lives. Bankruptcy only involves the parties to the debt obligation. It does not require that innocent, third parties be forced to subsidize or bail out creditors or debtors. In doing so, it respects the rights of all concerned.
A just process of bankruptcy is also economically practical. Bankruptcy removes assets from those who have mismanaged them, and puts them into the hands of those who are most capable of putting them to productive and financially responsible use. The institution of bankruptcy is an essential part of a prosperous and just capitalist society.
First published at The One Minute Case and Capitalism Magazine.
Wednesday, February 11, 2009
Paul Hsieh has an interesting commentary on President Obama's embrace of something called "libertarian paternalism." Obama appointed Cass Sunstein, who authored this concept, as a senior regulatory official in his administration. The concept says that government should "nudge" us with coercive measures to do "good things" such as eating better foods, saving for retirement, encouraging our children to do their homework, etc.
The nudges involve handing back our tax money to us in the form of credits or deductions, or even paying us for performance, again using the tax money already taken from us. The "nudge" may also be more direct, such as New York City's ban on the use of trans fats in restaurants.
All of this is for our "good." But who determines this good? Answer: Cass Sunstein or sundry other regulatory officials who make it their life's work determining what is good for me, or even President Obama himself. Accepted in this premise is that the judgment of these individuals must forcefully supplant my own judgment about my own life. I am not permitted to make my own decisions on topics that these officials have determined are worthy of their attention.
These nudges come at the expense of my personal liberty. A society where people are nudged about is one where individual rights are absent. That is the society we are being nudged to accept.
As Mr. Sunstein and his cohort of regulators, led by the regulator-in-chief, President Obama, prescribe and proscribe in the minutest detail how we are to live our lives, don't be fooled by confusing phrases such as "libertarian paternalism," or by the broad smile of President Obama as he appoints Mr. Sunstein to take on his duties. "Libertarian" is seemingly based on "liberty"; "paternalism" derives from the Latin word for "father." There is nothing "fatherly" in government ordering adult Americans about; we are not children. Moreover, liberty cannot exist where government is telling us what to do. These terms are meant to confuse. In such confusion, government power is rationalized and expanded. It is a tactic that has been used by dictators throughout history.
In George Orwell's fictional 1984, the dictator "Big Brother" said, "Freedom is slavery." In the same oxymoronic manner, "Liberty is paternalism."
Don't be fooled.
Wednesday, February 04, 2009
[See update to this post below.]
“There will be a time for [Wall Street executives] to make profits and there will be a time for them to get bonuses. Now is not that time.” So said President Obama on January 29 to reporters (source: “The Kudlow Report,” CNBC).
So we receive President Obama’s declaration that Wall Street bonuses must be cut. According to him, now is not the time for those bonuses, although he allows that there will be a time – determined by him – when bonuses will again become acceptable.
When Obama arrogates to himself the authority to determine whether, when, and in what amount payments shall be made by an employer to an employee, do not think that such power will only be used to lighten the wallets of Wall Street executives. Such a power demanded today becomes one that will be used in the future to cut the wage or bonus that any American is paid, if doing so should please the Presidency.
If you doubt that, consider that at several times in history the American government fixed the wages of nearly all Americans. It happened during World War II and it happened again in the early 1970s. It is neither a Democratic nor a Republican issue, with the former happening under Democratic President Roosevelt and the latter under Republican President Nixon.
It needs to be said, because Americans have become so used to having their liberties encroached: a man’s ownership of his labor is parcel of the ownership of his own life. If he cannot freely contract with an employer to offer his labor at voluntary, mutually agreed upon terms, then his life is no longer his own. Instead of being a free agent offering his services at a voluntary, mutually agreed upon rate to a willing employer, he becomes a serf, whose labor and life is controlled by his lord and master.
That is the meaning of Obama’s attack on Wall Street bonuses. Attacking the private right of employer and employee to voluntarily agree on salaries and bonuses is an attack on the freedom of both parties. In calling for Wall Street executives to be treated like serfs, President Obama is setting the precedent that will make all of us serfs in the future.
Do not be fooled by the issue of government bailouts. Government had no right to hand out that money. It does not belong to government; it belongs to each one of us. Moreover, this crisis would have ended on its own without any government “rescues.” Recessions always end through the economic adjustments of all participants in the economy. It happens on its own, without a “rescue” or despite it. The current recession is no exception and will end, despite Presidents Bush and Obama’s profligate showering of trillions of dollars of taxpayer money on the problem.
However, government committing a wrong by handing out bailout money does not give it the right to compound its wrong by using that as a justification for further violating the rights of employers and employees. Government should not be handing out bailouts, nor should it be telling employers whether they can pay bonuses.
No one, including President Obama, has the right to forcefully tear apart the private employment relationship between employer and employee. When a private individual does it, it is considered fraud or theft. When the President does it, he takes on the scary personage of a dictator.
2/4/09 UPDATE: President Obama now says companies that have been given (or forced to take) bailout money must cap the pay of their senior executives to $500,000 salary plus $500,000 bonus. For the morality of that, see above. In terms of its effect, government will get the quality of executives that it pays for. Guess who runs Wall Street now?
We could see this coming. See my October 27, 2008 post, "The Man Paying the Bill Gets to Determine Who's for Dinner."
This post is re-posted. It was originally posted at www.simplycapitalism.com on February 1, 2009. Also published at www.capmag.com on February 4, 2009.
Saturday, January 24, 2009
I commend to you a new review of a great work of art, Dae Jang Geum. The author of the review contends that it is a "work of Romantic art of the top rank, well worth the attention of anyone who values Romantic art." I agree. Read his review to judge his argument. Better yet, watch the series. (See my review of Dae Jang Geum here.)
Thursday, January 08, 2009
When I was an economics undergraduate in the 1980s, I learned an astonishing “joke” among economists: “Torture the data and nature will repent.” My professor, a Chicago School economist who studied under Milton Friedman, used the joke to illustrate how a clever economist armed with the tools of statistics can “torture” the data to reach any conclusion he wished. My professor was an “empiricist” economist.
The other type of economists I encountered taught my classes in Keynesian macroeconomic theory. They spun intricate, mathematical theories divorced from the real world. They were the “theorists.”
Both approaches resulted in “conclusions” that, if they had anything to do with reality, it was only by smuggling in a better approach. Otherwise, the questions asked and answered by these economists were as relevant to human life as the questions debated by a group of peasants standing around a well in the Middle Ages or by a group of scholastic monks peering down at them from their monastery up the hill.
Now we have an article entitled “International bright young things” (The Economist, 12/30/08), which highlights the best and brightest new economists, as selected by their mentors.
One who calls herself a “randomista” uses randomized trials to answer economic questions. She recently demonstrated that “mothers in the Indian state of Rajasthan are three times as likely to have their children vaccinated if they are rewarded with a kilogram of [lentil beans].” The article wonderingly asks, “[who knew] such a modest incentive (worth less than 50 cents) [would] make such a big difference?”
Another has “proven” that regressive inheritance subsidies [that means subsidies for those who receive inheritances] would “take the edge off…the uncertainty” that results from the “biggest roll of the dice in life [which is] the family you are born into.”
Yet another “shows” that government must provide enough unemployment benefits so that “[t]he unemployed decide that an unhurried job search is worth the extra cost of depleting [their additional funds].”
Armed with rigorous tools of statistics and mathematics, and powerful computers, these economists are spinning their wheels answering questions about… nothing.
But they are missing the most powerful tool, the one that will give them the proper method and purpose for their efforts. Without that tool, these practitioners of a vital science have become seekers of unimportant curiosities at best and diminutive statist nostrums at worst.
That tool is a rational philosophy. Every scientist is guided by a philosophy that tells him what is the proper subject of study and how that knowledge can be gained. Today's economists are sorely in need of a rational philosophy, one that will point them to subjects that are more than a handful of lentil beans in importance, and to research methods that are more effective at discovering enduring principles than the randomista's spin of the wheel.
A philosophy like that exists. See Ayn Rand and her philosophy of reason called Objectivism.
I originally posted a version of this piece on the Harry Binswanger List forum.
Tuesday, December 30, 2008
I enjoy many good blogs, many of which are represented on the "My Reading" list that appears on the right side of this blog page. However, I want to draw attention to a great new one I discovered, "Heroes of Capitalism." Each day this blog features a businessman who improved our lives. Actually, the last part of that sentence is redundant because a successful businessman in a capitalist economy always improves our lives by creating goods that we value and purchase from him in trade.
The businessmen cited so far range from the well-known (Henry Ford and Steve Jobs) to the obscure (James Wright and Peter Hodgson, developers of "Silly Putty"), but all of them are benefactors to man. We can all thank them and have already done so, simply by purchasing and using their products, but this website goes further by publicly acknowledging their achievements.
Men like this need to be recognized. They are the "human face" of capitalism, the social system that frees them, and all of us, to produce. If I stop to think about it, nearly every second of my life I am using one of their products and my life has been made healthier, happier, longer, and full of great enjoyable things as a result.
Thank you, businessmen, and thank you to the producers of "Heroes of Capitalism" for bringing their good work to the attention of the world.
Saturday, November 15, 2008
Bush Is No Champion of the Free Market
November 14, 2008. Reprinted with permission from the Ayn Rand Institute.
Washington, D.C.—In a recent speech on the financial crisis, President Bush said, “If you seek economic growth, if you seek opportunity, if you seek social justice and human dignity, the free market system is the way to go.”
According to Yaron Brook, executive director of the Ayn Rand Center for Individual Rights, “It’s true that free markets are the source of economic prosperity and individual liberty—but President Bush, while he may pay lip service to free markets, has been a consistent opponent of them.
“Did Bush abolish the countless regulations and controls strangling businessmen? No. But he did sign into law Sarbanes-Oxley—the largest expansion of business regulation in decades. Did Bush consistently push for free trade? No. But he did give us a new steel tariff. Did Bush attempt to roll back America’s massive welfare state? No. But he did pass the prescription drug benefit, the largest new entitlement program since Lyndon Johnson’s Great Society. Did Bush curtail government spending? Far from it. Bush presided over an unprecedented increase in the federal budget: from $1 trillion at the time he took office to more than $3 trillion today. This is to say nothing of Bush’s response to the financial crisis. He has completely evaded his administration’s responsibility for the Fed and housing policies that created the housing bubble. Instead, he has led the chorus blaming the market and calling for unprecedented handouts, bailouts, and nationalizations as the cure.
“If Bush is a friend of the free market, who needs enemies? By praising the free market while systematically undermining it, Bush has done more to discredit capitalism than any open critic could. Like a con artist who undercuts the reputation of Mercedes by selling lemon look-alikes, Bush has now led people to associate his failed policies with capitalism. That association needs to be erased. We must make it clear: Bush is no friend of free markets.”
Thursday, November 06, 2008
I did not vote for Obama, but I am glad he got elected given the alternative. Yet, I fear we are becoming an Obama-Nation that is most assuredly an abomination. The Obama-Nation part is the insane cult of personality surrounding Obama, such as the Soviet-ish look of his posters, complete with Communist Red coloring.
I went to sleep early on election night but was awakened throughout the night and into the morning by the continuous sound of screaming. Throngs of Obama supporters screamed and swarmed through the streets of New York into the early hours of the morning. I cannot believe that people can scream continuously for so long. The screams gave me nightmares and in those nightmares I saw Obama's face surrounded by a red halo.
What is happening to America that people lose themselves and worship their Dear Leader? American individualism was notably absent during that election night. People became part of a great collective, and they pined for the man, their leader, who will deliver them from their fearful lives.
I will fight for American individualism, the land where each of us is free by right from our neighbors, and the government does no more than protect that right. America is far away from that now. The fight will be long and hard.
Monday, October 27, 2008
In this case, it is Rep. Barney Frank. Of Wall Street bonuses, he says, "There should be a moratorium on bonuses." Just who is Barney Frank to tell private American businesses how much to pay their employees?
Well, he is the spokesman for their new minority owner, the federal government. As Chairman of the House Financial Services Committee, he gets to tell these companies what to do. So does any other politically ambitious petty bureaucrat and tyrant who wants to loudly score political points at these companies' -- and the American economy's -- expense.
What unleashed these ignorant clown-bullies on America's leading corporations is their partial nationalization orchestrated by President Bush, Treasury Secretary Paulson, and endorsed by Republicans and Democrats in Congress.
The real price of the $250 billion partial nationalization of America's leading financial firms will be much larger than just this dollar amount. We are only seeing the first signs of it now. Barney Frank and his minions are just fashioning the bibs to their bellies. Their feasting on America's leading banks and investment banks -- starting with Goldman Sachs, Morgan Stanley, JP Morgan, and Citibank -- has just begun.
Barney Frank claims to pay the bill for this dinner, but it is all of us who will pick up the tab. How much will it cost, not just in money, but in terms of our freedom?
Saturday, October 25, 2008
The article below is reprinted with permission from the Ayn Rand Institute. My comments follow.
Greenspan Has No Free Market Philosophy
October 24, 2008.
Washington, D.C. --Opponents of the free market are giddy at Alan Greenspan's declaration that the financial crisis has exposed a "flaw" in his "free market ideology." Greenspan says he is "in a state of shocked disbelief" because he "looked to the self-interest of lending institutions to protect shareholder's equity"--and it didn't.
But according to Dr. Yaron Brook, executive director of the Ayn Rand Center for Individual Rights, “any belief Greenspan ever had in truly free markets was abandoned long ago. While Greenspan long ago wrote in favor of a truly free market in banking, including the gold standard that such markets always adopt, he then proceeded to work for two decades as leader and chief advocate of the Federal Reserve, which continually inflates the money supply and manipulates interest rates. Advocates of free banking understand that when the government inflates the currency, it artificially increases prices and causes booms in certain sectors of the economy, followed by inevitable busts. But not only did Greenspan lead the inflation behind the dot-com bubble and the real estate boom, he blamed the market for their treacherous collapses. Greenspan should have recognized that what he wrote in 1966 of the boom preceding the 1929 crash applied here: ‘The excess credit which the Fed pumped into the economy spilled over into the stock market--triggering a fantastic speculative boom.’ Instead, he superficially blamed ‘infectious greed.’
“Should it be any shock that Greenspan now blames the free market for today's meltdown--rather than the Fed's policies, which fueled an inflationary housing boom, which rewarded reckless lenders and borrowers from Wall Street to Main Street? Greenspan didn't mention the word ‘inflation’ once in his testimony.
“Whatever Greenspan's economic philosophy is, it is not anything resembling a free market.”
Galileo Blogs comments:
I agree with this editorial. Greenspan's testimony on Thursday and his track record in government, particularly as Federal Reserve chief, reveal that he has abandoned a proper economic understanding of capitalism, if he ever had one to begin with. It is difficult to imagine that the man who wrote an article in the 1960s advocating gold-backed money issued by private banks entitled, "Gold and Economic Freedom," in Capitalism: The Unknown Ideal is the same man who flooded our economy with cheap money (such as 1% interest rates), and then failed to acknowledge that such cheap money is the root cause of both the Internet and the housing bubbles.
Instead, he humbly sat before a Congressional witch-hunt committee and joined the chorus in declaring that "self-interest" is the cause of the economic meltdown. What explains Greenspan's meltdown? That is what I will explore here.
Greenspan's congressional testimony and the statements in his recent autobiography show that that it is unlikely that the man who penned the article, "Gold and Economic Freedom," ever properly grasped the principles of capitalism and the moral principles that underlie it, or else he abandoned those principles long ago.
In his autobiography, Greenspan made two interesting revelations. First was the ostensive reason he gave for abandoning the edifice of Objectivism, the philosophy developed by Ayn Rand, which he also advocated in the 1960s. His reason was that he could not understand how capitalism could be financed through voluntary means, i.e., without coercive taxation. The second revelation is Greenspan's declaration that everyone is motivated by a desire for the admiration of others. I will show how both of these views of Greenspan shed light on the collapse of his legacy which reached its apotheosis in the excoriation he faced on Thursday at the House hearings on the financial crisis. To start, I will sketch some elements of Objectivism.
Objectivism is the only philosophy that provides a proper moral foundation for capitalism. That foundation consists of the morality of rational self-interest, which is based on a scientific examination of the requirements of man's survival. Underlying the approach is a commitment to reason, the method of using logic and the evidence provided by our senses to learn what is true. Reason requires the ability to think in principles. (I recommend Ayn Rand's books, The Virtue of Selfishness and Capitalism: The Unknown Ideal, for further explanation. In particular, I recommend the articles in those books entitled, "The Objectivist Ethics," "Man's Rights," "What is Capitalism?", "The Nature of Government," and for the discussion that follows below, "Government Financing in a Free Society.")
The method of thinking in principles is what Mr. Greenspan apparently failed to properly learn. A principle, once properly understood, applies to all instances of a phenomenon. A key principle in Objectivism is the right to property. Properly understood, this means that any person who trades for or creates wealth, gets to keep it. No one, including government, has the right to violate the rights of a property owner by using force against him to take or harm his property or person.
Because government cannot use force against its citizens, this means that it is immoral for government to forcefully expropriate property through taxation, regulation, or any other means. No society truly respects the rights of its citizens if its government employs coercive taxation.
This argument begs the question that apparently tormented Greenspan of how government can possibly finance its expenses through a voluntary means. Ayn Rand answered this question in her short essay entitled, "Government Financing in a Free Society." Ayn Rand makes the case that a government can be practically financed through voluntary means, but only if government had already been shrunk down to its legitimate functions. This means that government would only be spending money on the legitimate functions required to protect individual rights, namely the police, the courts, and the armed forces.
In the context of today's government, this means abandoning all forms of "income transfers" and welfare spending, including Social Security, food stamps, agricultural and business subsidies, "pork barrel spending," and so on. All of these programs entail violating the rights of some individuals as their property is stolen from them and then transferred to other individuals. This widespread government theft that must stop before a system of voluntary financing could even be contemplated.
The reason is not that hard to understand, and partially involves simple arithmetic. Government spending today consumes between 40% and 50% of gross domestic product. Such a heavy burden can only be financed through the expropriatory process of taxation. No voluntary system could work, nor would anyone be willing to make it work, if nearly half of his income went to fund every chiseler, con-artist, widow, orphan, sick person, and corrupt businessman around him. But if all such spending were eliminated, government expenditures would be an order of magnitude less expensive. They would probably consume just 1%-3% of gross domestic product. However, this state of affairs could only happen after a successful revolution in thinking has taken place over the span of decades, just as the original American Revolution did not happen until many decades after the first ideas underlying it were advocated.
This is the state of affairs that must exist for voluntary financing to work. Ayn Rand made this eminently clear in her article. Greenspan was part of a circle of students of Ayn Rand's in the 1960s. He spoke to her often and could have questioned her if any part of her argument was unclear.
Yet in his autobiography he blithely dismisses the edifice of Objectivism because of this single issue. His dismissal is off-handed. Unspoken but implied in his dismissal are the words, "But of course, how silly is it that anyone can take such an idea seriously." Well, anyone who has studied Ayn Rand's writings, seen or heard her speeches, or were so fortunate as to have known her in person, knows just how seriously Ayn Rand took all of her ideas.
Instead, what Greenspan reveals by his comment is that he did not take her ideas seriously, or perhaps more accurately, he did not take her ideas properly. By properly, I mean that he did not fully understand Objectivism as an integrated system of principles. The methodological essence of Objectivism (or any true body of thought), is that it is a statement of principles. Proper principles are validated by reference to facts and to each other.
Bearing that in mind, the issue of government financing is one of the last principles, i.e., the one furthest removed in time from all other aspects of her philosophy. It is almost an act of science fiction imagining at this point in time to demand that every last detail of a system of voluntary financing of government be worked out now before every other aspect of laissez-faire capitalism has been validated and put into practice.
The point is not that such a system of financing is impractical. It is practical. The philosophic case for it has been made, and the essence of its practicality is clear. For details read Ayn Rand's article, but I will just mention two points. First, with government properly confined to its legitimate roles, it would require very little money to be financed, compared with either the gargantuan level of today's government spending, or compared to the enormous productive potential of a future laissez-faire capitalist economy that would finance it. A future laissez-faire economy would be many times wealthier and more productive than today's hampered mixed-economy, and could easily provide the small amounts required to operate government's legitimate functions.
Second, Ayn Rand proposes at least one effective mechanism that would easily fund such a relatively small burden. That method is a simple fee paid for government enforcement of contracts. It would be calculated as a small percentage of the value of contracts. Enforcement of contracts is a core function provided by government in its role as protector of property rights. Such a voluntary fee, paid by those who want government to enforce their contracts, could fund all of government, including the courts and jails, and even a military.
Case made on this issue of the far future; today it is time to focus on more immediate issues such as the case for capitalism and against government intervention, which includes government manipulation of money (as discussed in Greenspan's article, "Gold and Economic Freedom") and all other interventions.
But Greenspan in his autobiography stated that he was unsatisfied with Ayn Rand's argument for voluntary financing of government, and this is the reason why he abandoned Objectivism.
Taking him at his word, this is a failure to properly understand and think in principles. If Greenspan were convinced of all the prior and more fundamental arguments for reason, and then for rational self-interest, and then how rational self-interest forms the moral base for capitalism, and then how capitalism is the only moral and practical social-economic system for man -- if he were convinced of all that, then how could he abandon it because he had reservations about Ayn Rand's thoughts regarding the voluntary financing of government, an issue that is last in this hierarchy of principles?
If Greenspan properly thought in principles, and properly understood the principles of capitalism, he would never have committed such an incredible thinking error.
Greenspan's failure to think in principles is revealed by the other comment he made in his autobiography. He said that everyone is essentially motivated by a desire for admiration by other people. Again, if he understood The Fountainhead and Atlas Shrugged, he knew that this idea is exactly what Ayn Rand denounces. Ayn Rand makes it clear that a person should be motivated solely by his evaluation of what is in his rational self-interest. Therefore, a person must have integrity for his principles. Therefore, the only admiration a person may value is that from people he himself admires, i.e., people who share his values.
But in his autobiography Greenspan states that one seeks the admiration of others, implying that the admiration of "the public" is a good thing. From which members of the public does he want his admiration, from the congressmen who grilled him at Thursday's hearing, such as Representative Henry Waxman? These are the same men who unbelievably denounced "deregulation" as the cause of the current economic crisis (which was actually caused by regulation), and who have demanded (and enacted) caps on the salaries of executives as part of the solution because "greed" and "selfishness," according to them, are the true causes of this crisis. Are these the people from whom Greenspan seeks admiration? Or is it from magazine editors, such as the Newsweek editors who placed him on the cover of their magazine as a member of "The Committee to Save the World"? Or, is it from Bob Woodward, the author of the glowing biography that calls him Maestro? Are these people, all of whom have always thought capitalism and self-interest are dirty words, the ones he wants admiration from?
Ayn Rand has colorful characters such as Peter Keating and Ellsworth Toohey in The Fountainhead, and James Taggart in Atlas Shrugged, and many others, who demonstrate in negation that a person must be of self-made soul. Just where is the soul of Greenspan?
In the final analysis, I believe that Greenspan never did properly think in principles. As a result, he allowed flawed ideas to gradually creep into his thinking so that the young man who circulated with Ayn Rand and wrote his brilliant economic essays in the book, Capitalism: The Unknown Ideal, never really grasped those ideas, and eventually allowed their opposite to germinate in his mind. The particular name of Greenspan's failure to think in principles is pragmatism.
The result of Greenspan's pragmatism was the sad spectacle of this seemingly broken 82 year old man knuckling under to the ignorant Congressional bullies. These are the same bullies who used their podium to hound many great, and not-so-great, captains of industry. They are the same bullies who hounded yesterday the man who could have been their defender. He is the man who either sold his soul, or never properly built it, and therefore gave it away in the pursuit of admiration from those who read Newsweek and vote for Representative Waxman. Yesterday, he sat crucified by these same people.
If I display contempt for Greenspan, it is only because I am jealous of someone who had such an unparalleled opportunity to learn from the great thinker Ayn Rand, and who squandered it and ultimately did worse. He sat at the foot of the congressional inquisitors and agreed with them that "self-interest" is the cause of the current crisis. In that moment, one can almost envision him holding a tattered newspaper in the rain, with a dirty boot print stamped over the face of someone he once claimed to have admired. However, instead of that being Gail Wynand holding the newspaper image of Howard Roark in the movie version of The Fountainhead, it is someone else kneeling in the rain holding a tattered newspaper. A different face appears on the front page.
One must never sell his soul, but to avoid doing that, one must build it on a foundation of properly understood principles.
Monday, October 20, 2008
Enjoy this compendium of 20 of the world's tallest buildings under construction or planned for completion over the next few years.
My favorites are these:
(1) The Burj Dubai. At half a mile in height, it bears an uncanny resemblance to Frank Lloyd Wright's "The Illinois" proposal for a mile-high skyscraper. I have a print of Frank Lloyd Wright's superb drawing for this never-built skyscraper hanging in my study.
(2) Chicago's The Spire. I heard that work on this 2,000 foot tall residential skyscraper has been temporarily suspended due to the weakened economy. I can accept that setback, but not the regulatory one that nearly knocked this building out. I look forward to the resumption of economic growth eventually propelling the Spire skyward over Chicago.
(3) This is my favorite building, Marina 101. It evokes the rugged, honest skyscrapers of Louis Sullivan in my favorite city of skyscrapers, Chicago. Bracketed by the tall buildings around it and the warmth of the ocean and marina in front of it, it stands as a tall sentinel protecting its surroundings.
The two ugliest buildings are appropriately located in Moscow and Mecca, Saudi Arabia.
In the classic shape of an ancient mausoleum, or a pedestal for human sacrifices, this new Moscow pyramid promises to rise in the capital of the new Soviet state which, in its old and new incarnation, has caused the deaths of so many people.
In the spiritual heart of the land of nihilistic belief will rise this concoction, which could only have been inspired by that great fictional architecture firm of Francon & Keating in the novel The Fountainhead.
Although some of the grandest buildings are rising in the Middle East, the semi-capitalist leaders of the world economy including America, Hong Kong, South Korea (and arguably China) are also building some of the world's tallest new buildings. I cheer them higher!
Saturday, October 04, 2008
A jury in Nevada convicted O.J. Simpson yesterday of armed robbery. In a poetic reminder of O.J.’s horrendous crime long ago, the verdict came in 13 years to the day that O.J. Simpson was acquitted of murdering his ex-wife, Nicole Brown Simpson, and her friend, Ron Goldman. Although overwhelming evidence confirmed O.J. Simpson’s guilt in those murders, including blood in his car and O.J.’s confessional statements, a largely black jury acquitted him.
The acquittal was unjust and shocking; the reaction to the acquittal was equally shocking. In New York City people feared racial riots before the verdict. Fearful, huddled groups of commuters stood in long bus lines in the middle of the afternoon to escape the city. Because most of the buses were scheduled for end-of-work pick-ups, there were not enough of them. People had to wait in long lines standing on the streets for hours fearing for their physical safety at every moment.
After the verdict, groups of blacks were dancing in the streets, while whites were perplexed and dismayed. Suddenly, people who had seen each other just moments before as individuals to be judged by their own, individual characters, saw each other instead as members of a racial collective. On that day, what mattered was not who you were, but the color of your skin.
That day also provided shocking evidence of how much damage the vital principle of individualism has suffered in this country. Groups of people saw justice in racial terms. For many blacks (and many whites), the essential fact in the O.J. Simpson trial was that blacks had been enslaved and persecuted in the past. Therefore, acquitting O.J. was a justifiable act of revenge for all those years of persecution.
Lost in this illogic is that O.J. Simpson is a single man, and Nicole Brown Simpson and Ron Goldman were single individuals. It was O.J. who murdered them and Simpson and Goldman who were his victims. By appealing to the false standard of “group justice,” justice was denied for each of these individuals. “Group justice” meant that O.J. Simpson would not be punished for his crime.
Collectivist thinking is not just the province of racism. Marxist collectivists also deny our individuality and see our identity solely in terms of belonging to the class of “the rich” or “the poor.” Thus, it is okay to “soak” the rich to “give” money to the poor. Isn’t that the essence of the government’s subsidy of “poor” homeowners over the years that led to our current financial crisis?
As we think not just about this financial crisis but about all matters of justice, remember that the essential unit is the individual. On that basis, I applaud yesterday’s verdict in the O.J. case and commend the prosecutor, judge, and jury. Although O.J. has not been punished for the crime he committed nearly 15 years ago, he is going to jail and that is where he belongs. Yesterday, the primacy of individual justice was affirmed. In that sense, this verdict reverses the grave injustice committed 13 years ago.
Wednesday, September 24, 2008
As for the denunciations of greed by John McCain, Wall Street trader Jim Cramer, and so many others, it is just so... un-American! America was founded on the principle of "life, liberty, and the pursuit of happiness." That means that each of us is free to live good, happy, and prosperous lives, to the extent of our abilities. It is no skin off anyone else's back if you or I make a lot of money. In fact, it helps other people because it means I am producing goods and services that other people want to buy.
Well, Congress wants to cap that, literally, by capping the salaries of Wall Street executives. Where does it end?
Thursday, September 18, 2008
I originally wrote this for the website "The One Minute Case" here. Given that short sellers are once again a scapegoat for a declining stock market, I have decided to re-publish it:
What is stock shorting?
Stock shorting is a method of profiting from a decline in a stock’s price. It is the opposite of investing long, where the investor profits from a rise in the stock’s price. “Going long” or hoping for a gain in the stock’s price is the more familiar method of investing. However, “going short” and profiting from a decline in a stock’s price is an equally valid method of investing.
How does stock shorting work?
Shorting a stock is a little more complicated than going long where a stock is simply bought and then sold later for either a gain or loss. Shorting stock first involves borrowing it from an existing owner. The short seller pays a fee to the owner to borrow his shares. Upon borrowing it, the stock is immediately sold and the proceeds are kept in the short seller’s brokerage account. When the short seller wants to close out his position (or the shares’ owner wants them back), he buys equivalent stock in the marketplace and returns the shares he borrowed back to the owner.
If the stock has fallen in value, he makes a profit that is the difference between the price at which he borrowed the stock and the price at which he bought it back. Conversely, if the stock has risen in value, he suffers a loss since he has to buy back the stock at a higher price than he borrowed it for.
Short sellers fulfill a crucial and productive role in financial markets:
Short sellers bring to light valuable information about poorly run companies.
Short sellers have a strong incentive to uncover poorly run companies. If a short seller successfully discovers ahead of others that a company is destroying value through incompetence, bad luck or even criminal activity, he profits by shorting the stock and publicizing the information. Short sellers are similar to good investigative journalists. They make more money if they can “scoop” others with information that will drive the stock down.
It is this aspect of short selling that many company managers, regulators and others find discomforting. Yet these same managers and regulators have no problem when an investor uncovers a successful company. Why should they be opposed to someone who does the opposite, and uncovers the overvalued, incompetent, lazy or even fraudulently managed companies?
Short sellers help capital go to the best companies.
By taking financial capital away from poorly run companies, short sellers free up money that can go to the best-run companies. Short sellers are the other half of the value-creating process of financial markets whereby capital is continually re-directed to those who can put it to the most valuable use. The existence of short sellers means that capital will more quickly flee the poorly run companies and thereby become available that much faster for the better-run companies. The profit that a short seller makes is his reward for aggressively uncovering the poorly run companies.
Short selling is challenging.
Short selling is not for everyone for the simple reason that stocks generally tend to go up. During the 20th century, stocks gained 9% a year on average, although there was significant yearly variation. Stocks do not decline in value across the board for long periods of time. Because of this, short sellers must time their moves well, and attempt to short at the top of a stock’s move and then close out the position when it has hit bottom. If the short seller mis-times his moves, he will lose money. Such precision in timing is less important for long investors because stocks generally go up.
It is a misconception that short sellers can unfairly cause stock prices to go down.
This is the most common misconception about short sellers. However, short selling is only likely to be successful if companies truly have problems. If a seller shorts a strong or improving company, he will lose money. It is a misconception to think that short sellers (or long investors) can cause stock prices to deviate for meaningful time periods from their true values.
The only power a short or long investor has comes from being right. When he is right, he is rewarded for helping to bring true information to the marketplace. When he is wrong, his wealth is dissipated and his ability to invest further is diminished. If he is wrong often enough, all of his wealth will be dissipated and his ability to influence stocks will be nullified.
Conclusion: Short selling is moral and should be permitted.
Short selling creates value by making the capital markets work more efficiently. Short sellers help bring negative information about companies to the market. By doing so, short sellers provide liquidity to the market and help capital to flow away from the worst companies and toward the best companies. Without short sellers, markets would be less liquid and more volatile. Long investors would have more difficulty buying and selling their positions, and the lack of liquidity would make it more difficult for companies to raise funds in public offerings.
To restrict short selling not only harms the efficiency of the markets, but it violates the right of stock owners to freely dispose of their shares as they see fit. Because their shares belong to them, it is their property, they have the right to do what they want with them, including loan out their shares to short sellers. Conversely, short sellers have the right to borrow those shares.
A proper understanding of short selling demonstrates the valuable and productive role it plays in the financial markets.
Added "buying and" to last sentence, third paragraph from bottom. It now reads: "Long investors would have more difficulty buying and selling their positions, and the lack of liquidity would make it more difficult for companies to raise funds in public offerings." For the reason, see my answer to J. Henry's question in the comments below.
Monday, September 08, 2008
The weekend nationalization of Fannie Mae and Freddie Mac is nothing new. From their creation in the 1930s, these entities were government controlled. Whether government controlled them outright or had partially privatized them, government always called the shots. Government set terms on what types of mortgages they could offer, to whom, and in what amount. Most importantly, government provided a widely understood “implicit” guarantee of the debt issued by these entities. Unlike other financial institutions, Fannie Mae and Freddie Mac could issue debt (which was then lent out to mortgage borrowers) with the backing of the U.S. Treasury and Federal Reserve. That gave Fannie and Freddie an edge over private banks in making mortgage loans, by design. Reportedly, 50% of all outstanding mortgages are guaranteed by Fannie and Freddie, and as much as 75% of all new mortgages in recent years were issued by these agencies.
The government’s purpose in forming these entities was to make mortgages more widely available. Absent Fannie and Freddie, the other way to get mortgages has always been from private, profit-seeking banks, banks that had to safeguard their credit by striving to lend their money only to creditworthy borrowers. The only way Fannie and Freddie could out-compete these banks was by doing the one thing its government backing enabled it to do: lend to less creditworthy borrowers. This is a case of the bad credit driving out the good credit. In the space of 70 years, millions of uncreditworthy borrowers got mortgages as these government agencies pushed out the more prudent private banks and gained the largest market share in the mortgage market.
Now the loans are being called. The credit and stock markets are calling these loans en masse. The sheer weight of thousands of deadbeat borrowers has created a crisis that even the implicit guarantee of Fannie and Freddie’s debt by the U.S. government cannot ameliorate. So, this weekend the implicit guarantee has been made explicit.
That should make it fully clear to everyone, if it wasn’t during the past 70 years of the “implicit” guarantee. The lender to all these deadbeat borrowers, borrowers who didn’t qualify to get loans from private banks, is you, me, and everyone else in this country. We are all on the hook for the bad loans to our neighbors. That is socialism, and now it has been made explicit.
Sunday, September 07, 2008
It is nearly impossible to know what a politician will do in office. I blame pragmatism for that difficulty. Nearly every politician succumbs to pragmatism, and pragmatism means that his ideas are divorced from his actions. Ideas are floating, unreal constructs to him, and actions are taken in response to range-of-the-moment considerations. As a result, any politician who proclaims certain ideals will not take those ideals seriously when he is in office. Instead, when he arrives in office, he responds to the day-to-day pressures that buffet him.
The question then becomes, what kind of pressures buffet him? When Jimmy Carter was president in the 1970s, an intellectual rebellion against regulation had arisen, led by figures such as Milton Friedman. Given the country’s economic malaise that Carter’s and his predecessors’ policies had produced and the need to “do something” new, Carter acquiesced to the de-regulationary proposals of Alfred Kahn and others. As a result, it was under Jimmy Carter’s administration, a left-wing Democrat, that airlines, trucking, and railroads were deregulated in the United States.
Consider also the example of Bill Clinton. Faced with the “swing to the Right” embodied in the 1994 elections, Bill Clinton, a conventional left-winger, relented and inaugurated partial welfare reform that reduced the future growth of welfare spending by billions of dollars.
Then consider the examples of Bush Sr. & Jr. Each Bush claimed to be for free markets. We “read the lips” of Bush Sr. on “no new taxes.” We also heard the claims of Bush Jr. to be for free markets. Yet Bush Sr. raised taxes when he was confronted by the pressure of Democrats and fellow Republicans complaining about a large budget deficit. For his part, despite his avowed “free market” stance, Bush Jr. could not resist the cries for protection from steel producers, most of whom, undoubtedly, donated large amounts of money to his election campaign. Therefore, he raised steel tariffs.
The examples I have cited show that party affiliation is a poor predictor of what a candidate will do in office. Also, his stated views have little bearing on what he will do. Rather, because of pragmatism, each candidate responded in a range-of-the-moment fashion to the general pressures around him. Carter and Clinton, although ostensibly anti-business Democrats, partially reduced regulation and the growth rate of welfare. Bush Sr. & Bush Jr., two ostensibly free market Republicans, presided over tax increases and protectionist policies, among other statist measures.
All four presidents were pragmatically responding to the “pressures of the day,” not the dictates of party or conscience.
I suggest that we try to understand what will be the “pressures of the day” tomorrow that will bear on McBama, when he is elected. I posit that those pressures will determine the policies, not the man. Moreover, I will venture that there are two sets of strong pressures that will influence him: (1) environmentalism, and (2) fear of intransigence vis-à-vis Islam. Thus, the next President, whoever he may be, will continue to enact alternative energy and anti-carbon policies, and will continue to take half-measures against the Islamists. I do not think it matters which man is President.
Note: This post first appeared as a response to Burgess Laughlin's comment on my prior post.
Friday, September 05, 2008
These words championed on Republican banners during John McCain’s acceptance speech last night mark a dangerous inversion of the moral principles America was founded upon. Consider the principles as stated in the Declaration of Independence:
We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed.Man has certain inalienable rights, and to secure these rights governments are instituted among men. The individual is paramount in the Founders’ vision. The individual’s right to pursue his own happiness and the rights to life, liberty and property, which are his means of achieving it, is the purpose of government. Governments exist solely as the means to secure these rights.
McCain and the new Republican principles reverse that order. For them, it is country first. Service to the state is the ideal. John McCain himself represents that ideal, the patriotic soldier who re-discovered this principle while being tortured for six years in a Hanoi dungeon. In that dungeon, he says that he learned to stop saying “me first,” and learned to say “country first.”
McCain’s new discovery is actually very old. From his earliest days, man has been sacrificing himself to the state. Whether it was embodied in the tribe and king, or the shaman and witch doctor, or the collective, man’s fate was to suffer for others, until the first free country ever clearly enunciated a different moral principle.
The American Revolution was fought to overturn the principle of individual subservience to the state, to overturn the tyranny of kings and their ilk. In America, men could proudly claim their own happiness first. Their patriotism was based on the knowledge that the government existed to protect them from the tyranny of the state and the forceful violations of their rights by their fellow men.
McCain’s old vision is not patriotic, properly understood. Carried to its logical extreme, it will reduce our status to the level of serfs. Man will return to his traditional relationship with the state, that of subservience. Men will be put back in the dungeon.
While McCain himself does not represent that sort of tyrant yet in degree, he does represent it in principle. One of McCain’s heroes is Teddy Roosevelt. Teddy Roosevelt gave us “authoritarianism lite.” Like McCain, he bashed big business. Roosevelt busted up the big trusts, including Big Oil, which McCain also despises. Roosevelt was also an environmentalist, championing the establishment of the massive Parks system.
Expect more of the same from McCain and the new-old Republican Party, for now. For a vision of our longer-term future, study the history of every society that proclaimed the state first. The party of the state is not the ally of each of us who wants to pursue his own happiness. With country first, the individual is subservient.
Tuesday, August 19, 2008
A group of 100 college presidents called the Amethyst Initiative has publicly declared its support for lowering the drinking age to 18. I agree with its statement and objective.
The legal principle of "age of majority" establishes when a child legally assumes the responsibilities and obligations of adulthood. Although children vary in their rates of maturation -- some children at 12 are more mature than others at 17 -- the law must establish a general norm at which children are recognized as adults. That age is 18 in the United States. At 18, a child legally becomes an adult and can enter into legally binding contracts governing property, money, and their bodies. Despite this legal recognition of responsibility to enter into contracts, be subject to criminal laws, and to have complete freedom to use their own bodies as they choose, our government infantilizes young adults by banning the drinking of alcohol.
In comparison to the awesome, legally-recognized freedom that comes with adulthood, the drinking of alcohol is a minor matter. To ban it is to insult the very concept of adulthood.
The signers of the Amethyst Initiative observe that the young 18-20 year-old adults routinely violate the 21-years drinking age. Young adults sense the contradiction that they have a legally-sanctioned freedom of action in every matter except one trivial area, the drinking of alcohol. On college campuses, they seek to violate this law, as they should.
The 21-years drinking age should be abolished. It is a contradiction to recognize the greater part of the freedom of adulthood and to deny adults the minor part of that freedom. The ban on under-21 drinking has done that; it infantilizes adulthood. Legally permit the drinking of alcohol and recognize that adults are responsible for their own lives.
Minor edit 8/20/08: Changed to "recognize" from "bestow" second sentence, last paragraph.
Thursday, June 19, 2008
I am pleased to announce that the above-entitled article, written by (non-pseudonymous) me, has been published by The Objective Standard.
The article addresses what went wrong with the electric grid, and traces its problems to a critical failure to secure a vital asset in the earliest days of the industry. That failure, apparent even before Thomas Edison threw the switch to light up America's first commercial electric grid in Lower Manhattan in 1882, haunts the industry to this day. What is that vital asset? Why and how must it be secured? If it is, what kind of future becomes possible?
My answer is here.
Monday, June 09, 2008
A stockbroker friend of mine sent me this chart showing the ratio between the Dow Jones Industrial Average (and its equivalent predecessor index) and the price of gold. Notice the greater amplitude of variation in this ratio after Congress established the Federal Reserve Bank in 1913 and severed the connection between gold and money. After 1913, money could be created in arbitrary fashion by the Federal Reserve Bank. Further sundering the connection between gold and money in the 1930s, FDR's New Deal Congress outlawed the private ownership of gold, and clauses in private contracts that called for payment in gold. Finally, Richard Nixon's Congress severed the last vestige of the gold standard in the late 1960s and early 1970s by suspending the U.S. government's promise to pay in gold to settle international claims.
These moves to unmoor the dollar from gold coincided with the stock market swinging to higher highs and lower lows relative to gold. I interpret the chart as showing the effect of monetary inflation in the 1920s, 1960s, and 1990s, and then the impact of recession/Depression in the 1930s and price inflation combined with recession in the 1970s.
When the stock market was relatively high and gold low, in the 1920s, 1960s, and 1990s, the economy genuinely boomed, but that boom was artificially enhanced by easy money. That is why the ratio soared to higher highs than existed in the pre-1913 gold standard era. The result of that monetary inflation was an economic bust, as the dislocations caused by that monetary inflation harmed the economy. Inevitably, the excess money showed up in price inflation, especially evident during the 1970s "stagflation" when both recession and inflation cursed the nation.
Does this chart tell us anything about the future? The author of the chart would have us believe that we are headed for a 1930s or 1970s style economic catastrophe, as shown by the "Target Zone" marked on the chart. Certainly, the precursors for such a catastrophe have been established, and we are seeing the first signs of economic malaise of the 1970s variety. We had monetary inflation in the 1990s and 2000s, which is now manifesting itself in price inflation and incipient recession.
What is your interpretation of the historical meaning of the graph? What do the highs and lows of the various eras mean? Do you agree with my interpretation? What is your thought of the future? Are we headed to a low Dow/high gold ratio that we last saw in the 1930s and 1970s, or will such an economic disaster be averted? In other words, will our economy muddle along for awhile, or must we endure a true economic disaster before the economy improves?
I will offer my opinion later in the comments section.
Tuesday, June 03, 2008
Congress is blaming speculators for the barreling rise in the price of oil, as of this writing $126 per barrel.
In late 1998, oil dipped briefly below $10 per barrel. Where were the speculators then? Interestingly, at that time the U.S. dollar had been appreciating for about 4 years. It had appreciated roughly 25% by then from its bottom in 1995. The dollar is not the only factor*, but it is a significant one that explains the oil price. A good deal of today's gain in the price of oil, denominated in dollars, reflects the depreciation of the dollar.
Speculators are agents that transmit fact-based expectations about future supply and consumption trends into present prices. As such, they facilitate economizing between present and future supply/consumption. If the expectation is that future consumption will be high and supplies will be constrained -- or that nominal demand expressed in dollars will be high due to dollar depreciation -- then speculators will bid up the price of oil today. That is happening now.
The opposite happened in the late 1990s, at least with regard to the purchasing power of the dollar. Expectations were that its purchasing power would strengthen relative to the world's currencies. Therefore, speculators bid down the price of oil.
In regard to the general point of whether speculators can manipulate the market, they cannot alter the long-term or fundamental course of markets. Market prices incorporate such fundamental information. If a speculator positioned himself (incorrectly) against the long-term trend, he would be bankrupted very quickly. For example, if a speculator in the mid-1990s incorrectly bet that oil would go up, he would have lost his shirt.
Blaming the speculators is a lot like blaming the gas gauge for showing that your tank is empty, except that the "speculator gas gauge" is even smarter. It accounts not just for the amount of gas in your tank right now, but also for the nearness of a gas station down the road. The "speculator gas gauge" will adjust to reflect the ease with which you can fill up your tank in the future, thus encouraging you to either consume more gas or less right now, depending on those facts.
The speculator's role is very valuable. If the government restricts it, it will make the markets work less efficiently. Ultimately, this will mean less oil availability because it will become more costly to finance oil production and refining. Capital will demand a higher premium to invest in the oil industry if financial liquidity and quality market information about future demand/supply are reduced because speculation has been diminished by law.
*The key fundamental factors keeping oil prices high in real terms (not just nominal terms, which is affected by the value of the U.S. dollar) are restrictions on Western drilling and the nationalization and cartelization of oil over the past 60 years. These two factors have diminished supply by taking it out of the hands of entrepreneurial oil companies and concentrating it in the hands of a smaller number of unproductive, state-run operations.
On the demand side, large new demand from China would act to keep prices high but in the absence of the supply constraints, prices would not have to rise as much as we are seeing, or could even fall. Consider that oil prices in the United States fell for decades during most of the late 19th and 20th centuries even while U.S. economic growth and oil consumption during much of that time grew at a rate comparable to China's growth rate today.
Saturday, May 31, 2008
A friend of mine recently renovated his apartment in New York. It was a gut job; the contractor peeled off the walls and removed the floors. After peeling off the surface layer, what did my friend find underneath? He found improperly braced sub-floors; no fire-stopping had been installed between his apartment and his neighbors; support columns were not covered with flame-resistant material; and insulation wasn’t put in around the windows, to name just a few deficiencies.
In the building he lives in, substandard pipes broke in the winter and flooded his apartment. Exterior wall coatings were improperly applied and leaked. Parapets were reinforced with interior-grade (not exterior-grade) wallboard and rotted.
There is an understandable explanation for how this happened. The developer of his building, a conversion of an existing 100 year old commercial building to residential use, went bankrupt during the recession of the early 1990s. He went bankrupt midway through the work on my friend’s building. So, in the midst of a recession and an awful real estate market, an unwilling bank had to take over and finish the job. They did a lousy job.
In a capitalist marketplace, there are bad actors. This developer clearly wasn’t a top-notch developer. He lacked the financial depth and customer base to survive the recession and went bankrupt. Good riddance. Capitalism continually cleanses out bad actors. He is not building anymore or, if he is, he is operating on the fringes.
But the question remains, where were the city inspectors during all this? Many of the conditions my friend discovered during his renovation and undoubtedly many, many more that are still hidden from view, are subject to the thousands of pages of city, state, and federal rules that govern construction. Many of the conditions my friend discovered are explicitly governed by laws designed to promote fire safety. The installation of fire-retardant material that can slow a fire’s spread between apartments, and fire-proofing support columns so that they don’t buckle under the heat of fire (as the columns of the World Trade Center buckled), are clearly within an inspector’s purview. Inspectors, by law, must regularly visit construction sites. Why didn’t they catch these potentially life-endangering failures?
My friend got a clue as to the answer. City inspectors also regularly visit renovation jobsites in New York. One day, as I happened to be in his apartment, a city electrical inspector showed up. A fat, slovenly, surly, disrespectful, and barely literate thing showed up at the door. As the new floors had just been laid down and polished, the project supervisor politely asked him if he could take off his shoes. “No, I don’t do that,” the inspector said. So, he asked, could he wear “booties” that workers wear so they don’t harm finished floors? Same answer.
So, while the slob thudded his way through the apartment to the nearly finished kitchen, he said, “You need a new outlet there.” That was that. I kept my mouth shut, because I knew that if I said anything, it would only anger the inspector and that would not help my friend who was trying to get his renovation done, on time and under budget. I almost spoke up because when I looked around the kitchen, I saw, literally, dozens of outlets. Underneath the cabinets, my friend had installed strips of outlets, spaced one foot apart. There were dozens of outlets in the kitchen, way more than could be needed to meet the minimal requirements of some construction code.
But I kept my mouth shut. So did my friend, and so did the project supervisor. All of us undoubtedly had the same thought on our minds. Keep our mouths shut, put up with this jerk, and wait for him to leave so that the real work could get done.
Now, when I think about the construction cranes that have recently fallen over in New York, I think of that city inspector. A representative of an industry association on television said that the problem is not that there are an insufficient number of inspections. The problem is that the inspectors need more training. Really? Does more training address the root of the problem?
When the city inspector left my friend’s apartment, I asked the project supervisor if he would ever hire a man like that city inspector to work as an electrician. He said that, as a rule, people who become inspectors are the bottom of the barrel. They are the unemployables that private industry would never hire. They become city inspectors because that is the only place they can get work. In fact, one employee his company had to fire became an inspector. Now he must deal with that fired, disgruntled ex-employee, who has the enforcement apparatus of the state to back up his incomprehensible (and possibly vindictive) demands. (Undoubtedly, there are some good inspectors out there, but the failure to demand good work inherent in government employment ensures that they are few and far between.)
When I think about my friend’s apartment renovation, I ask myself what is it that ensures quality and competent work. Is it the presence of city inspectors, or is it something else?
Then I consider how my friend chose his contractor. He interviewed many contractors, he got recommendations and checked references and, most importantly, he visited their work. The work of the contractor he chose spoke clearly. The way the floor boards were tightly joined together, the walls were perfectly smooth and properly finished off, the way all the details matched in a beautiful whole, and the politeness and quiet competence of the men and women he spoke with gave him the answer he needed. His careful effort in selecting the best contractor for the job paid off. The result is a beautifully renovated apartment.
My friend’s rational self-interest is what led to that good outcome. Because he wanted to live in a nice apartment, he selected a good contractor. Then it was the contractor’s good judgment that created a quality product. The pre-renovation apartment he moved into, built in the early 1990s, had been inspected, like all buildings in the city. Those inspections did not prevent a bankrupt developer and a desperate bank from doing a pitiable job finishing the building.
No, it was the lack of self-interest on the part of the developer who went bankrupt that led to his actions. If he had cared for himself more, he would have run his company better, and would have survived the recession. In contrast, consider the firm that my friend chose for his renovation work. It is over 20 years old. It has survived two recessions and it has never laid off an employee. Work comes to them in good times and bad because they are good at what they do.
Capitalism is the system that rewards contractors like the one my friend chose. It is the system that unleashes self-interest to flourish. By the same token, capitalism is ruthless at weeding out the incompetent and the immoral, like the sloppy developer who went bankrupt after doing such a poor job with the building conversion in the early 1990s.
An entire army of city inspectors will never ensure safety. Yes, it will “gum up the works” by wasting the time and energies of good people like the contractors who did such a marvelous job on my friend’s apartment, but it will never ensure safety.
So what will make sure that we live in safe buildings and those disasters like the cranes toppling over in New York City are rare occurrences? More city inspectors are not the answer. There is only one answer, and no one (at least nearly no one) is talking about it.