Your Teacher Said What?! (7 page)

On the other hand, returning to a gold standard, or something like it, isn't really all that attractive either. Though requiring the government to have a given amount of gold for all the money in circulation prevents
inflation
(by definition, you can't have more dollars around than you have gold) and reduces uncertainty, it also creates the risk of
deflation
whenever the economy grows faster than the gold supply. According to the U. S. Geologic Survey, the total amount of gold that has ever been mined is “only” about 142,000 metric tons,
⁹
which, at a price of $1,200 an ounce—what it was trading for as of July 2010—would be a bit less than $5 trillion; and the Federal Reserve calculates that nearly $9 trillion is currently in circulation in the United States alone.

Some pretty sane economists—and a
whole
lot of libertarians—still think that it might be worthwhile to return to some kind of “hard” currency. I'm not one of them, though I'm sympathetic to anything that takes control of the economy out of the hands of a bunch of bureaucrats. It might be a more stable world if the dollar were tied to something like gold (though the argument that paper has no “intrinsic value” isn't very persuasive either; what's gold good for, anyway, other than filling teeth and making jewelry?), but I'll take my chances on letting the marketplace set the prices of most things, including the folding money in my pocket.

Hayek, Friedrich A.
Political philosopher and economist (1899– 1992) who made basic contributions to the study of free-market capitalism, price signals, and monetary theory. Author of, most famously,
The Road to Serfdom
. Winner of the Nobel Memorial Prize in Economic Sciences in 1974.

From the 1920s, when the Austrian-born Hayek was hired to work at the London School of Economics by Ludwig von Mises (another member of the free-market pantheon), until his death, he was collectivism's fiercest enemy. Part of his hostility to the enthusiasm for state control of the economy, which has been such a durable part of the European mind-set, was Hayek's belief that it led directly to totalitarianism, which, given the history of Europe since the 1930s, is supported by an awful lot of evidence.

But he didn't just oppose it on political grounds. Collective decisions about economic issues require some kind of overall authority, and while they do a lousy job, they have always had a lot of appeal to Progressives. And some, but by no means all, ten-year-olds.

 

“Blake?”

“Yes, Dad?”

“When you have a bake sale at school, who decides that the brownies should be fifty cents apiece?”

“The person who made the brownies, I guess.”

“If you sold all the brownies, and people asked for more, does that mean that fifty cents was the right price?”

“I guess.”

“And if you didn't sell any?”

“Maybe they liked chocolate cookies more.”

“Would you think the person might have picked the wrong price?”

Blake gave me a wordless what-a-stupid-question look. “Of course.”

“Would you still want the person to set the price next time?”

“Nope. I'd want to set the price myself.”

The idea that efficient exchange demands price signals seems pretty obvious, but there's still a ten-year-old inside most people who doesn't trust a system without someone running it. Hayek's great insight was that even without anyone at the controls, a price-signaling system (as we'll see in chapter 4, he called it “catallaxy,” though no one else does) actually spontaneously organizes itself.

Of course, such a system depends on private property, freely traded, which is one reason that he was one of Ronald Reagan's favorite economists.

Higgs effect.
Noun. Sometimes known as the Higgs ratchet effect. The phenomenon that transforms temporary economic crises into permanent government involvement in the economy, to no good effect.

The experience described by libertarian economist Robert Higgs in his 1987 book
Crisis and Leviathan
was really just the latest in a series of cautionary tales that dates back to James Madison, who warned against “the old trick of turning every contingency into a resource for accumulating force in government.” The “ratchet” of his effect refers to the reliable fact that, even though every crisis—the Great Depression or the recession of 2008—eventually ends, and the enthusiasm for state intervention may recede, it never returns to the level it occupied before the crisis. Consider, for example, the Export-Import Bank of the United States, which was created in 1934 to combat the worst effects of the Great Depression by providing loan guarantees to banks that agreed to lend to buyers of American exports.

Partly because it costs the American taxpayer nothing, covering its costs by charging fees to foreign borrowers, the Ex-Im Bank has a lot of supporters. None of them is bigger than the aircraft manufacturer Boeing, which accounted for 40 percent of Ex-Im Bank's business in 2009. This is not a misprint; a government agency established to fight an economic crisis seventy-five years ago now exists in large part as an ongoing subsidy for a single company. The distortions of this sort of cronyism are hard to miss: by some estimates, an oversupply of nearly 10 percent in commercial airplanes. (This is nothing compared to the record of Freddie Mac and Fannie Mae; see chapter 10). The only certain thing about emergencies is that, over time, every one of them increases government involvement in the economy.

For people who actually think government knows best—you know, the people who never want to “waste” a crisis—this is a good thing. For free markets, however, it's like increasing Blake's allowance; once we give her a raise, we find it next to impossible to take it back.

Income tax.
Noun. The part of the earnings of people and businesses that are levied (this is another word for “taken”) by local, state, and national governments.

Income taxes can be
flat
—where everyone pays the same percentage of their income—
progressive
, where the more you earn the higher the percentage you pay, or
regressive
, where the more you earn the lower the percentage you pay. This sounds simple, but it isn't. In fact, the federal law that defines what income can be taxed and at what rates is now more than 55,000 pages long. This is not a misprint. Once upon a time, before the tax code crossed the four-million-word mark, the government assumed that people owned 100 percent of their income, and levied—okay, took—what was needed to run itself. Recently, we've started assuming that the government owns 100 percent of your income and, after it gets done running itself, allows you to keep the part left over. The two definitions are equal mathematically, but not in any other way. The notion that all income begins as a possession of the government is why some people call activity that
isn't
taxed a “tax subsidy.” This is like one kid stealing some of another kid's candy and calling the rest a “dessert subsidy.”

There is a whole lot more justification for a
negative income tax
, a favorite of
Milton Friedman
,
in which people earning less than a specified amount receive a subsidy, than for a positive one. Taking care of the poor by simply giving them money is definitely better than the constellation of antipoverty programs currently littering federal and state government. Two reasons: First, it returns some level of personal responsibility to people who are, either through bad luck or just a lack of effort, unable to support themselves. Second, it eliminates thousands of useless jobs for people who supervise, plan, evaluate, and manage anti-poverty programs, leaving everything to the (relatively) simple Internal Revenue Service. Of course, this may have the effect of making all those social workers, consultants, and community organizers eligible for the negative income tax themselves . . .

Inflation
and
deflation.
Nouns. Inflation is an increase in the price of a good or service over time; deflation is a decrease. Popularly, the terms are used to describe increases and decreases in the overall package of goods and services purchased by a typical family: a rise or fall in the Consumer Price Index.

Inflation—which
Milton Friedman
called “taxation without legislation”—basically comes in two flavors: an increase in the amount of money in circulation (or, back in the days when
gold
and silver coins were used as money, the addition of cheaper, or base, metal, which is where the term “debasement” of the currency comes from) or just an overall increase in prices. Generally, the first definition is reserved for something that economists call “monetary inflation.”

The other sort of inflation (or deflation) is calculated in a dizzying number of ways, but in general the price of a package of goods and services on one date is compared with the same package a year later to come up with an annual inflation rate. There are huge problems with this over any really long period of time, since the “package” itself changes (even the wealthiest family today spends a lot more on, for example, Internet service and a lot less on servants than it did fifty years ago), and even components of the package aren't really comparable: A gallon of gasoline costs five times as much as it did when I got my first driver's license, but the car I fill up today gets twice as many miles per gallon.

Inflation doesn't “tax” everyone the same way. People who borrow money in an inflationary economy tend to do pretty well, since they repay their loans with money that is worth a lot less than it was the day they borrowed it; lenders, on the other hand, get burned. The belief that house prices would continue to inflate more rapidly than the economy at large persuaded millions of borrowers
and
lenders to buy property at very high prices, convinced that they could sell it at an even higher price (this is sometimes known as the “greater fool” phenomenon). However, since deflation is usually a sign of enormous financial stress (and
hyper
inflation—when the value of currency can fall so far that you need to carry banknotes to the grocery store in a wheelbarrow—is even worse), it's generally a good idea to have some inflation.

However, the idea that inflation is the price for full employment, so beloved of Progressives and followers of
Keynes
, died during the 1970s, when the world was able simultaneously to have high levels of both inflation and unemployment, forever after known as “stagflation.”

Innovation.
Noun. The successful application of a new idea.

One of the biggest errors made by the first generation of economists, such as
Adam Smith
, David Ricardo, and others, was the belief that free markets would eventually drive profits down to zero and wages to subsistence level, as competition eliminated the ability of both producers and workers to charge more than their most aggressive competitor; the technical term is the “disappearance of monopoly pricing power.”

Well, profits haven't vanished, and average wages have increased several hundredfold since Smith's day. The reason, in a nutshell, is innovation—and it is just as much a part of the free market as the “invisible hand.” The new ideas that are the raw material of innovation have been appearing at an ever-increasing rate ever since the law started recognizing a property right not just in tangible things such as land and gold but in intangible things such as inventions and copyrights. Steam engines, telephones, automobiles, and computers aren't just responsible for a big chunk of the wealth of the modern world; they also create a world different enough from the perfect competition envisioned by classical economists that firms can enjoy—temporarily—enough monopoly pricing power that they can both generate big profits (Apple's iPhone, anyone?) and pay very high wages, indeed.

And even if the power is temporary, who cares? That's really what
creative destruction
is all about. Societies that recognize a property right in ideas never run short of them, or of the innovation needed to make them successful.

Interest.
Noun. The price paid for borrowing anything, usually money; by extension, the amount earned on a deposit account that is used by someone else as borrowed money. The difference between the amount paid on deposits and that earned by lending is the bulk of a bank's
profit
.

As mentioned above (in the entry for
credit
), Blake's idea of a reasonable interest rate is a little high, but everyone has a different view of what is a worthwhile rate. Once upon a time, government-insured certificates of deposit in banks were paying more than 15 percent interest; in 2010 that number has been less than 2 percent. The amount of return expected from lending money, either directly to borrowers or indirectly through bank deposits, is a function of the alternatives foregone. When stocks are booming, banks need to pay high interest rates to entice investors to take their money out of the market and put it in the bank. So do governments and businesses when they issue bonds that also pay a fixed rate of interest. One of the most reliable signs of trouble is when the interest rate paid on the safest imaginable investments is extremely low; in 1933, the worst year of the Depression, U.S. Treasury bills were paying a rate of 0.14 percent annually.

Keynes, John Maynard.
British economist (1883–1946) and architect of the Bretton Woods 1944 system of fixed exchange rates among nations, pegged to the U.S. dollar. Author of numerous books and articles, most notably the 1936
General Theory of Employment, Interest, and Money
, which introduced the set of concepts known as “Keynesianism” to the world.

Like everyone who lived through the
Great Depression
, Keynes was changed forever by it. Unlike most everyone else, he thought he had found a solution to it (or at least its frighteningly high unemployment rate) in the economic philosophy that became known as Keynesianism, whose most basic idea was that full employment demands government expenditures. Keynes was no Marxist, much less a socialist, but the source of his ideas still seems to be a kind of scorn for the idea that people can make economically rational decisions; “animal spirits,” in his words, drive most business decisions and are not only disreputable but also unreliable.