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The Circle Bastiat

A builder works on a new single-family home in North Andover, Mass. U.S. Mortgage-backed securities are an unexpected and smart way to invest in a still-depressed housing market, according to some. (Elise Amendola/AP)

How to invest in the housing market. Really.

By Douglas FrenchGuest blogger / 02.21.12

The New York Times reports that Greg Lippmann, made a star by author Michael Lewis in The Big Short, for making millions on the housing collapse, is now taking the other side of the bet and buying mortgage backed securities.

On the surface one wonders what he’s thinking. As Azam Ahmed writes,

Take one security, JPALT 2006-S1 1A11, which was built from Alt-A loans, or mortgages that required little documentation verifying a borrower’s income.

On the surface, the numbers are not encouraging: of the 799 mortgages underpinning the bond, many in foreclosure-heavy California and Florida, about 21 percent are more than 60 days late on payments.

The annual default rate is about 7 percent, and of the homes sold out of foreclosure, investors take a 54 percent hit, according to data from Bloomberg. On average, about 5 percent of the homeowners refinanced their mortgages before they were due over the last 12 months.

However, JPALT 2006-S1 1A11 is trading for 70 cents on the dollar, making the security a compelling buy. An investor can still make more than 5.4 percent even if defaults increase, according to Ahmed. And even a slight improvement in the default rate would send returns as high as 8.7 percent.

“Price is a wonderful thing,” said Chris Flanagan, an analyst with Bank of America Merrill Lynch. What was “toxic” at 100 cents on the dollar is compelling at 70 cents.

When prices are allowed to adjust, markets clear. Imagine, if wages were allowed to fall or banks and the GSEs were allowed to fail.

Secretary of State Hillary Rodham Clinton speaks during a news conference at the State Department in Washington, Friday, Feb. 17, 2012, with EU High Representative Catherine Ashton. Clinton has expressed interest in a job at the world bank once her Secretary of State gig is up. (Jacquelyn Martin/AP/File)

Hillary Clinton's new job: At the world bank?

By Ryan McMakenGuest blogger / 02.20.12

Within minutes of Robert Zoellick’s announcement that he will leave the world bank being made public, Hillary Clinton announced that she was interested in the job. The World Bank has long been a favored retirement village for American warhawks. Considering the fact that World Bank is ostensibly about making loans to developing counties for capital improvements, it’s significant that three of the 11 World Bank presidents (Robert McNamara, Paul Wolfowitz and John McCloy) have come from the U.S. Department of Defense/War. Now Clinton, while not at the DOD, but very much the architect of the American war on Libya, wants the job. I suppose that after years of bombing developing countries into rubble, people like Clinton and Wolfowitz and McNamara think it might be fun to assuage their consciences by lending money to developing countries.

Whether such loans actually help matters for these countries if hardly clear. Given that the World Bank was founded by Keynesians at Bretton Woods, one might be somewhat skeptical of the economics and politics put forward as the justification for the scheme. On the other hand, we do know that the World Bank is a mechanism for exercising political control over the debtor nations. So it’s really just the same old story, and it’s fitting that agitators for wars of conquest find a home at the world bank. To paraphrase Carl von Clausewitz, perhaps the World Bank is war by other means.

A lone joggers runs past apartment blocks in Sesena in the Toledo Provence near Madrid, Spain. Only a 45-minute drive from downtown Madrid, towering vacant apartment blocks loom over empty streets and weed-filled lots. Apartments galore are for sale and rent, and prices are plunging. (Paul White/AP)

Spanish real estate bust leads to ghost towns

By Ryan McMakenGuest blogger / 02.17.12

The real estate bust in Spain has produced a variety of apartment communities and similar properties that have turned into ghost towns as real estate demand has evaporated. See the link for photos. In a town called Sesena:

More than 13,000 apartments were supposed to go up to create a mini-city for 30,000 people just 45 minutes outside of Madrid. But only 5,100 were built, many are uninhabited and regular Spaniards who bought them as investments are now competing to offload them for huge losses.

In Sesena and other ghost developments around Spain, some banks are already trying to unload finished apartments at discounts of up to 50 percent of their original prices.

Any discussion of misallocation of resources on a massive scale would be incomplete without a remembrance of Muang Thong Thani, the small city of condo towers built near Bangkok in Thailand right before the Asian debt crisis of 1997. The towers were built to house approximately 150,000 people, although it’s unclear if those building have filled up, even fourteen years later. It’s difficult to tell if the web site has been updated since 2007, but it presently states that “The vast majority of these condos, shops, and office buildings have never been occupied since their completion in 1995-97.”

The Commanding Heights documentary (see below) has an interesting section on Muang Thong Thani and on how loose monetary policy in Europe and the US helped to ruin the Thai economy. (Although the video doesn’t quite put it that way.) It offers some insight into the psychology of real estate booms and how middle class investors are encouraged to invest in doomed real estate by easy money policies.

Also, Mark Thornton noticed last week that the world’s tallest building is now a distressed property.

Meanwhile, here in the U.S., foreclosure activity may be ramping up following the conclusion (for the most part) of negotiations with loan servicers and the feds and state attorneys general over a massive legal settlement. The conclusion of negotiations signals that the processing of foreclosures, which has slowed significantly during the past year as banks dealt with the controversy, may now be speeding up. Considering that, according to the Mortgage Bankers Association, more than 14 percent of all first-lien mortgage loans in Florida are now sitting in foreclosure (to name the worst one), it looks like they will have plenty of loans to deal with. The Houston Chronicle reports, however, that the taxpayers may be footing much of the bill for the financial hit the banks will be taking.

Also this week: Housing starts up. Well, they’re up compared to banner years 2009 and 2010.

Temeka Williams, right, of Detroit, uses her bridge card tokens for a purchase from Elizabeth and Gary Lauber from Sweet Delights at the Farmer's Market in Detroit in this file photo. Galles argues that proponents of the federal food stamp program exaggerate its benefits. (Carlos Osorio/AP/File)

Why the food stamp program is a fraud

By Gary GallesGuest blogger / 02.16.12

The Los Angeles Times has given me a case of déjà vu. It recently (February 6) ran an opinion piece titled "Food stamp fight," by history professors Lisa Levenstein and Jennifer Mittelstadt, that had a distinctly familiar ring to it.

Their justification included several arguments for why "food stamps are essential" to America. They claimed that food stamps are necessary to relieve hunger, which benefits the country because hungry people are not productive. They claimed that "In 2009, they pumped $50 billion into the economy;" and cited a USDA publication’s claims that "Every $5 in new food stamp benefits generates a total of $9.20 in community spending," and that each "$1 billion of retail food demand by food stamp recipients generates 3,300 farm jobs."

While those claims may be new to Times readers, they are actually golden oldie misrepresentations that seem to never die. For example,   at a food stamp hearing held in 1975, Senator Hubert Humphrey asserted that:

The food stamp program plays a very critical role in enabling millions of low-income families have a better diet. It plays a very important role in the support of American Agriculture. It also plays a very important role in keeping the economy from sliding into a deeper recession.

Humphrey supported his claims by citing a Department of Agriculture study of the impact of food stamps in Texas 40 years ago, which he described as follows:

The study found that $63.9 million in bonus food stamps provided in Texas that year generated $232 in new business in Texas and appeared to generate at least $89 million in business elsewhere in the United States. In addition, the $63.9 million provided in bonus food stamps created 5031 jobs. Translated nationwide, this could mean that the food stamp program is now responsible for $27 billion in business in the United States each year and 425,000 jobs…Furthermore, consider how much money we would have to spend to support those 425,000 workers and their dependents if they did not have the jobs that the food stamp program has apparently generated."

Unfortunately, however long the pedigree of repetition such defenses of the food stamp program (now called SNAP, for Supplemental Nutrition Assistance Program) have, they simply reiterate the same basic misunderstandings when it comes to food consumption, nutrition, agriculture, and its effects on income and job creation.

The food stamp defense uses the magnitude of food stamp benefits to dramatically overstate the increase in food consumption. The reason is that food stamps are equivalent to cash for almost all recipients, because virtually everyone would purchase more food than their food stamp allotments, even if they were given cash. So, for the vast majority, food stamps simply replace money that would have been spent on food anyway, freeing that money to spend however they choose.

Other than higher administrative costs, the result is the same as giving them money.

Even for the few families for which food stamps might raise food expenditures compared to cash, their nutrition effects are misrepresented. Studies find little difference between the nutritional adequacy of the diets of low- and high-income families, so that the problem is vastly overstated. Added food spending also often fails to improve nutrition, as less nutritious but more convenient pre-prepared food is substituted for healthier home-prepared food. Further, obesity is a more common problem among low-income families today than lack of food. Therefore, trying to force recipients to consume more food than they would otherwise by giving food aid instead of cash would, to the extent it was successful, do little to improve nutrition, but would worsen obesity problems. That doesn’t seem very "essential" to Americans’ well-being.

The effects on agriculture are similarly overstated. Food stamp proponents count the billions in food stamp benefits as equal to the increase in demand for agricultural products. But since food stamps are like cash for almost all recipients, they add no more to food purchases than do cash benefits. Since less than 20 percent of an increase in income goes to added food spending, the effects is less than one-fifth what is claimed. Further, it ignores the fact that those taxed to pay for the benefits will consume less food as a result of their reduced after-tax incomes, which further reduces the effect on the agricultural sector. In addition, after retailing, processing and transportation, less than half of food spending makes it to farmers, and most of that goes to cover the cost of producing the crops. Properly understood, the effects on agriculture go from muscular to minuscule.

In addition, to the extent food stamps increase agricultural production, they do so only at the expense of reducing the demand in other industries. The result is to redistribute output and income from other areas — a transfer rather than a benefit to society. And to the extent food stamps increase food consumption compared to giving recipients money, they do so at the expense of other goods recipients judge to be even more important, or they would use cash to buy added food anyway.

The economic stimulus claims reflect the same problem. What is counted as increased aggregate demand are really just transfers from taxpayers to recipients (and to a smaller extent, from other industries to agriculture). The taxes others must pay reduce their demands for goods and services just as the benefits add to them. But those negative effects are simply ignored, turning an essentially nonexistent benefit into an apparently sizable one.

The misrepresentation of economic stimulus effects is further exaggerated by using multiplier effects. It is true that when one person gets more money, they spend more, increasing demands and income elsewhere. But the same process occurs in the opposite direction as those with reduced after-tax incomes from financing the benefits spend less, decreasing demands and income elsewhere. The same process works in both directions, with little net effect, but the adverse effects are simply ignored. And with such blinders in place, insignificant effects can be presented as major benefits.

Even if the argument is made that the government is borrowing money rather than taxing to raise it, the argument doesn’t change. Deficits represent future taxes, with future negative effects, but looking only at the present disguises an attempt to transfer resources from the future to the present as if it was solely a stimulus.

If the assertion that income is stimulated wasn’t misrepresented enough, more piling on occurs when promoters claim that it also increase jobs. Just as the stimulus and multiplier effects are erroneously counted only on the plus sign, so are the jobs. The net effect is essentially zero. Further, jobs and income are not separate benefits; they are two ways of counting the same thing. It is the income from a steady job that is the benefit, not the job, but counting them as if they were each separate benefits is simply double counting. Worse, jobs, which are actually the burdens people bear in earning their incomes, are counted as if they were actually benefits. (When I ask my students whether they could have the same lifetime income with a job or without, they all choose "without.")

In addition to these massive exaggerations of food stamps’ benefits, there is a substantial negative effect supporters suppress. Food stamp benefits are reduced by 30 cents for each dollar of net income a recipient earns. As a result, the program acts as an added income tax rate facing recipients (paid in reduced benefits rather than increased income taxes). That, in turn reduces their incentives to earn, and their consequently reduced earnings (which make recipients look poorer in official statistics, because the food stamp benefits are not counted but the reduced market earnings are), makes recipients more dependent on government as a result (which Levenstein and Mittelstadt dismiss, in a truly impressive display of ignorance of the subject, as reprising "the false charges once leveled at welfare."

For years, food stamps, along with so many other "I’m from the government and I’m here to help" (which, if memory serves, Ronald Reagan called the "the nine most frightening words in the English language") programs, have been systematically promoted by reiterating multiple false claims — claims that have never been true — over and over. But its defenders’ rhetoric, no matter how often it plays in re-runs, remains very far from the reality. And while those who administer the food stamp program occasionally change policies to combat food stamp fraud (like going to electronic debit cards instead of paper food stamps), its systematic misrepresentation to the public is the greatest food stamp fraud.

The President of the European Central Bank, Mario Draghi, laughs during a press conference in Frankfurt, Germany in this file photo. The European Central Bank left its benchmark interest rate unchanged at a record low 1 percent on Thursday while it waits to see whether the economy needs more help as the 17 countries that use the euro struggle with a debt crisis and likely recession. (Thomas Lohnes/AP/File)

Why do European central bankers sound like Austrian economists?

By Kel KellyGuest blogger / 02.13.12

Last week I attended a workshop at the ECB on Global Liquidity. Global Liquidity of course refers to money flowing throughout the world as a result of western central bank money printing—especially Fed printing. I thought it might be beneficial to highlight some insights gained.

1. Attended mostly by central bankers, the group of 40-50 people seemed to be in agreement that their—and particularly the Fed’s—monetary policy is a key driver of financial asset prices, including commodities and real estate.

I learned that while there is no consensus among central bankers that increased bank credit is the sole driver of higher asset prices (though I’m told many say that it is, and one economist I spoke with said that it was), there is a consensus that it is the sole driver of inflation in the long run. The short-run drivers are rather insignificant. One that I agree with is changes in the supply of imports. As a booklet I bought states: “Inflation is ultimately a monetary phenomenon.”

Why central bankers agree that rising consumer prices are ultimately a monetary phenomenon, but believe rising asset prices are only a partial monetary phenomenon is beyond me.

Just to be clear, I asked one central banker about the theory that unions can drive up prices. He said that they could—if there was an increase in money. He was spot on.

An very interesting insight came about when he said that I sounded like a monetarist. I said that I was actually more aligned with Austrians. He immediately replied that the school is not much different than monetarists with respect to what we had been discussing. Of course he was right, but it impressed me that he was that intimately familiar with Austrian views. After all, one Italian central banker I spoke with a few years ago asked: “what is an Austrian?”

2. The group also discussed that monetary policy has both a supporting and a destabilizing effect on the economy and financial system (we, of course would argue that it is the sole driver of asset prices and of GDP and consumption in the long run). One PPT presentation by an economist from the Bank for International Settlements, regarding the financial crises concluded: “Who to blame? Model says the Fed.” I agree with him. But it’s shocking that they actually state/admit this.

Another statement was “the central bank can create distortions.” Again, to us they are—absent acts of nature—the only ones creating distortions, but that they accept their influence as matter of fact is surprising to say the least.

3. The group kept commenting that it was increased credit driving leverage. They agree that it is leverage driving asset prices. As one person said “increased leverage has to come from somewhere” (i.e., you cannot create new leverage without creating more money/credit). (They defined leverage as total bank assets over bank equity and as equity of banks times leverage). Interestingly, several people discussed that the leverage of banks is inversely related to the VIX.

4. There is a whole area of research related to the following information that I too have previously learned the importance of: the transmission channel of money flow into consumer prices (i.e., bank loans) is a completely different transmission channel of money flow into asset prices. For asset prices, money flow is originated in the interbank market (money market) with the large banks and hits the hedge funds/brokerage houses/institutional investors in the form of “non-monetary bank liabilities such as money market papers, certificates of deposit, commercial papers, structured notes, or bonds, which [are bank credit but] not recognized as the common medium of exchange.”

As part of this, there is a large debate about which side of bank balance sheets are responsible for rising prices: the asset or liability side. This is known as the money view vs. the credit view. The money view is the liabilities view that argues that the creation of money in the form of bank deposits pushes prices higher. The credit view is the asset view (or loanable funds theory) that argues that the creation of credit in the form of bank loans is responsible for rising prices. They noted that credit has grown much more rapidly than money over the last 25 years.

This explains why both GDP growth and consumer prices have had low growth rates while asset prices of boomed (asset inflation has been high). It also explains why performance of the financial market is unrelated to the performance of the real economy (money can flow into asset prices without flowing very much into consumer prices, causing GDP to stay low).

5. Though there was some debate on this, it was said several times that “the U.S. is the global provider of liquidity.” I thought that Europe and parts of Asia were also providers, by way of coordinated monetary policy. But somehow the US is supposed to be the driver. Perhaps they simply mean that the Fed initiates policy first, and that other central banks follow in the footsteps of the Fed unofficially so as to keep their currencies aligned. By intentionally keeping their currencies at parity, they suck in capital flows pushing their asset prices higher. Thus, US liquidity evolves into global liquidity.

6. One paper argued that Europe is as large of a driver of US asset prices, but it’s not registered on the radar screen as such because the Eurodollars they use are held in the names of US banks, and thus show up as US assets. If this is the case, European banks affect our asset prices much more than previously expected.

7. I was surprised at how their language was so similar to that of Austrians, since mainstream economists usually cloak their points with obscure, “roundabout” language. These monetary economists spoke regularly of the central bank creating money, and kept noting that it was only possible in a fractional reserve system. They even used the term “Ex nihilo” as Austrians do. They also spoke of misallocation of capital, distortions, and booms and busts. Interestingly, one paper presented distinguished between “aggregate demand” and “aggregate real demand” differentiating between aggregate demand caused by money printing and true aggregate demand in the real economy (which, of course, can rise only with more production).

8. Though they know that they are aware causing rising prices, boom and bust asset movements, and financial crises, they still support fractional reserve banking and credit creation. They really, truly believe that economies need new credit in order to grow. That, is their originating flaw.

The main takeaway is that it is very surprising how aligned with Austrians these monetary economists are. I think this is so because these people focus in such a detailed fashion on money and prices that they cannot avoid the real facts. Within the scope of their daily work, they are not political propagandists; they are merely seeking—as are Austrians—to understand how things really work. It’s just too bad they don’t advocate different policy actions based on their conclusions.

Shoppers walked out of Bloomingdale's at the Mall of America in Bloomington, Minn. Malls across the country are facing a rash of store closings, resulting in unprecedented vacancy levels. (Carlos Gonzalez/AP/The Star Tribune/File)

The decline of the shopping mall

By Ryan McMackenGuest blogger / 02.08.12

According to Bloomberg, banks are beginning to push short sales consistently for the first time since foreclosures began to pile up back in 2008. Prices really began to fall before the financial crisis, as early as mid-2007 in some places, but banks have long placed numerous obstacles in the way of homeowners who tried to sell their homes for what they were actually worth in the marketplace. Those of us who have worked with real estate agents who do short sales have heard nothing but complaints for years about how banks will stall and prevent short sales in a variety of ways. The result is that the property then goes into foreclosure and ends up selling for far, far less as an REO property post-foreclosure.

Why would banks do this? Well, banks have for years just assumed that home prices would turn around “any day now.” Their army of PhD economists, who ran their little computer models to tell them what would happen, told them to just avoid facing the reality of home prices for just a little while longer, and then everything would be OK. After nothing but declines since 2008, some banks are coming to terms with reality.

The article mentions CoreLogic’s home price index as ongoing proof of price declines, and we could also point to Case-Shiller in which the composite index has declined year over year fro the past 14 months or so, ever since the tax credit ended. In other words, government meddling did nothing but postpone the inevitable.

The New York Times reports on vacant malls across the American landscape. Thanks to declining retailers:

The result is near-record vacancy rates at malls of all kinds, both the big enclosed ones and the sprawling strips. Sears Holdings is closing up to 120 stores, Gap Inc. 200 stores and Talbots 110. Abercrombie & Fitch closed 50 stores last year, Hot Topic, almost the same number. Chains that have filed for bankruptcy in recent years, like Blockbuster, Anchor Blue, Circuit City and Borders, have left hundreds of stores lying vacant in malls across the country.

The political side of this is that these malls were cash cows for state and local governments and now that revenue is drying up. It’s not just that people are buying less stuff, it’s also that a lot of it has moved online, so the stakes are very high for governments seeking to tax internet sales.

Meanwhile, while single-family and retail real estate remains in the dumper, multifamily loan originations spiked 64% in 2011. The multifamily industry is just making up for lost time after almost a decade of misallocation of resources toward single-family mortgages in response to Fannie, Freddie and the Fed pushing homeownership like there’s no tomorrow. Multifamily production and demand suffered from about 2003 through 2009, thanks to government and GSE edicts on mortgages.

Republican presidential candidate Rep. Ron Paul listens to a question at a news conference after a speech at a campaign event in Las Vegas February 1, 2012. (Rick Wilking/Reuters)

Ron Paul's Fed chairman

By Douglas FrenchGuest blogger / 02.03.12

As president, Ron Paul would select Jim Grant as chairman of the Federal Reserve. A president Newt Gingrich would appoint Grant to a gold standard commission. “Unfortunately, I haven’t heard from Mr. Romney yet,” joked Grant when MarketWatch’s Brett Arends called on him in his offices down on Wall Street. “I’m sitting by the phone, I’m ready.”

Arend’s discussion with Grant produces many great points from Wall Street’s foremost wordsmith, including:

“The anachronism is today’s system,” he says. We have a “command and control, top down” system whereby the Federal Reserve imposes an interest rate on society. The Fed, in other words, tells us what the price of money should be. It is, Grant says, oddly at odds with the modern age. “We live in a world of collaborative social networks” of the Internet and Facebook, of Wikipedia instead of the old World Book, and so on. And yet when it comes to the price of money, we wait for a committee that sits in private to tell us what it should be."

Republican presidential candidate, Rep. Ron Paul, R-Texas speaks to members of the group Hispanics in Politics, Wednesday, Feb. 1, 2012, in Las Vegas. (Julie Jacobson/AP/File)

Is Ron Paul's gold standard idea dangerous?

By Douglas FrenchGuest blogger / 02.02.12

With the campaign carnival stopping in Nevada this week for Saturday’s Republican caucus, the Las Vegas Sun’s J. Patrick Coolican takes Ron Paul to task for Paul’s call to end the Fed and return to gold. Coolican writes:

To start with, inflation is not a problem right now. The Fed has effectively controlled inflation since Paul Volcker, who was appointed by President Jimmy Carter, began to rein in inflation 30 years ago. (Most important, inflation rates have been stable and predictable, which allows for economic planning by firms and households.)

Let’s see, Tall Paul left the Fed in 1987. Using even the establishment’s numbers via “The Inflation Calculator” what cost a $1.00 in 1987 cost $1.89 in 2010. So the value of the dollar has been cut in half just since 1987 using the most conservative numbers. What’s stable and predictable about cutting the value of the dollar in half?

Coolican doesn’t understand what all the fuss is about concerning the tripling the Fed’s balance sheet (he writes that “the Fed has tripled the money supply” since 2008 which isn’t right M-2 is up 29%). He says prices have increased 1.5% per year. What’s the problem?

Even according to the government CPI increased 3% over the past 12 months. If one calculates CPI the old fashioned way as John Williams does on, price inflation is running at more than a 10% clip.

Coolican then enlists the services of UNR economist Elliott Parker, who says monetary matters were a mess before the steady hand of the Fed came to be in 1913. “It’s an absurd argument because before the Fed prices were unstable in the short term, and long term there was a long period of deflation,” says Parker.

Look at any historical long-term chart of the CPI and it’s a flat line until heading skyward starting in 1971. And what’s so bad about falling prices for a long period of time. That’s how we all become better off is when goods and services become more affordable through technological improvements.

The long depression Parker talks about (1870s to 1900) was actually a period of great prosperity. This period of the classical gold standard was marked by gently falling prices leading to increased productivity, raised living standards, and the first glimpses of globalization.

Jim Grant of Grant’s Interest Rate Observer writes, “you can look far and wide without finding a decade so ebullient, prosperous and — in so many ways —so modern as that of the 1880s.”

While prices fell, the US economy prospered. Industry expanded; the railroads expanded; physical output, net national product, and real per capita income all roared ahead. For the decade from 1869 to 1879, the real national product grew 6.8% per year and real-product-per-capita growth was described by Murray Rothbard, in his History of Money and Banking in the United States: The Colonial Era to World War II as “phenomenal” at 4.5% per year.

And no there was no Fed back then to bail out Wall Street, so malinvestment was liquidated quickly and in turn the economy recovered quickly. So while Coolican says, “The world would have collapsed without aggressive action by the Federal Reserve.” The financial world needed to collapse and hasn’t been allowed to as the Fed continues to prop it up. Thus, the pain continues.

Coolican and Parker think falling prices create less incentive to produce. But they leave out the cost side. As costs fall through innovation, profit margins remain. All inflation does is hide inefficient producers. As for the worry of wages falling, it’s not the amount of your wages, but how much will your wages buy.

But the hundreds of years of evidence supporting gold money doesn’t convince Parker. He says, “But there is no evidence that getting rid of the Fed and replacing it with private banking along the lines of a gold standard would help the economy at all. None. In fact, the idea scares the hell out of me.”

Another reminder of the quality economics training that students are receiving at our nation’s universities.

In this file photo, a man walks past a collage of copies of Chinese RMB, U.S. dollar and other foreign bills at a money exchange store in Hong Kong. Galles argues that the free market system is unfairly blamed for people behaving unethically. (Kin Cheung/AP/File)

The free market doesn't make people poor. People do.

By Gary GallesGuest blogger / 01.30.12

I am a believer in the power of liberty — voluntary relationships — to bring out the best in individuals and, therefore, society. But that well-founded belief makes it painful to see markets (willing exchange) blamed for virtually everything someone can think to object to, in favor of coercion of some by others via government, inspired by some utopian vision that cannot actually be achieved by that coercion.

The question then becomes why unattainable utopian visions seem to be so much more attractive and inspirational to so many people than liberty, which can achieve the best society actually attainable, and how the spell that leads to ever-increasing statism can be broken.

Leonard Read, one of America’s most prolific defenders of liberty in the 20th century, considered that question. And in his 1969 Let Freedom Reign, he offered a useful two-part answer in his chapters, “Free Market Disciplines” and “The Bloom Pre-Exists in the Seed.”

In “Free Market Disciplines”, Read showed that liberty’s failure to gain more adherents than utopian statism can be, in part, traced to the fact that it is the ends envisioned, rather than the means involved, that often motivate people. And since unlike utopian visions, freedom, including free markets — an “amoral servant” — cannot be proven to have no objectionable results to anyone, liberty can be saddled with an inspirational deficit. However, attributing disliked results to markets misplaces the blame. Therefore, restricting voluntary arrangements (beyond preventing the use of force and fraud on others) cannot solve the real problem, yet it hobbles the market’s ability to coordinate people’s cooperative and productive plans, causing harm in the misguided attempt to accomplish good:

[T]he free market is the only mechanism that can sensibly, logically, intelligently discipline production and consumption. For it is only when the market is free that economic calculation is possible. Free pricing is the key.

[But] it is necessary to recognize the limitations of the free market. The market is a mechanism, and thus it is wholly lacking in moral and spiritual suasion…it embodies no coercive force whatsoever.

[Quoting W.H. Pitt]: “[T]he market, with its function for the economizing of time and effort, is servant alike to the good, the compassionate, and the perceptive as well as to the evil, the inconsiderate, and the oblivious.”

Given a society of freely choosing individuals, the market is that which exists as a consequence — it is a mechanism that is otherwise non-definitive. It is the procession of economic events that occur when authoritarianism…is absent.

In a word, the free market is individual desire speaking in exchange terms … When the desires of people are depraved, a free market will accommodate the depravity. And it will accommodate excellence with equal alacrity. It is "servant alike to good … and evil.”

It is because the free market serves evil as well as good that many people think they can rid society of evil by slaying this faithful, amoral servant. This is comparable to… breaking the mirror so that we won’t have to see the reflection of what we really are.

The market is but a response to — a mirror of — our desires.

Instead of cursing evil, stay out of the market for it; the evil will cease to the extent we cease patronizing it. Trying to rid ourselves of trash by running to government for morality laws is like trying to minimize the effects of inflation by wage, price, and other controls. Both destroy the market, that is, the reflection of ourselves…attempts not to see ourselves as we are…

To slay this faithful, amoral servant is to blindfold, deceive, and hoodwink ourselves…denying the market is to erase the best point of reference man can have.

The market is a mechanism and is neither wise nor moral…The market is an obstacle course; before I can pursue my bent or aptitude or obsession, I must gain an adequate, voluntary approval or assent…My own aspirations, regardless of how determined, or lofty, or depraved, do not control the verdict. What these others…will put up in willing exchange for my offering spells my success or failure, allows me to pursue my bent or not.

Eventually, in a free society, the junk goes to the junk heap and achievements are rewarded.

I believe that anyone should follow his star; but let him do so with his own resources or with such resources as others will voluntarily supply. This is to say that I believe in the market, a tough, disciplinary mechanism.

[An] individual, in the free market, considers how much of his own property he is willing to put on the line…the free market gives short shrift to projects that are at or near the bottom of individual preferences.

Read saw that defenders of liberty must face the fact that markets enable people to do whatever they want better — i.e., that it is an amoral servant. It cannot be relied upon with certainty to only do good and inspirational things. But whenever they enable doing ill, they only reflect what some desire. If we reformed ourselves, markets could do no harm. And Read had great faith such improvements were possible, that “Eventually, in a free society, the junk goes to the junk heap and achievements are rewarded.” In contrast, coercively “reforming” ourselves by law does not eliminate the cause of such harm and so does little to actually stop it, but the restrictions on markets adopted in the process throw out the amoral servant to doing greater good than can be accomplished via any other mechanism.

Read proceeded to address the crucial distinction between the “inspirational” utopian ends and the means that such ends necessarily entail in “The Bloom Pre-Exists in the Seed.”

Intended ends may be the vision that inspires people, so much so that they ignore whether the means are morally defensible. That is, the utopian ends envisioned can be chimeras of self-delusion that can be used to justify immoral means. And if the collectivism to be imposed requires immoral means, one cannot assert the result is a moral system:

[Many] people expect to achieve lofty goals without any thought of the means they use to attain them…[but] a hard look at means and ends is appropriate.

Ends, goals, aims are but the hope for things to come, in a word, aspirations. They are not a part of the reality…from which may safely be taken the standards for right conduct. They are no more to be trusted as benchmarks than are day dreams or flights of fancy. Many of the most monstrous deeds in human history have been perpetrated in the name of doing good — in pursuit of some “noble” goal. They illustrate the fallacy that the end justifies the means.

Examine carefully the means employed, judging them in terms of right and wrong, and the end will take care of itself.


An individualist…looks upon society as the upshot, outcome, effect, recapitulation incidental to what is valued above all else, namely, each distinctive individual human being.

[Quoting Hayek]: “[W]e differ not so much on ultimate values, but on the effective means of achieving them.” Thus, if we would find the distinction between collectivism and individualism…examine the actions — means — that are implicit in achieving the goals.

[There are] opposed means implicit in the pursuit of collectivism or of individualism…So, for us to understand…we must discover what is implicit in the collectivistic as well as in the individualistic approach.

Implicit in the collectivistic approach…is the masterminding of the people who make up society…The control of the individual’s life is from without…

The collectivistic view holds that society is the prime concern…The individual does not fit himself into place but, instead…is assigned that niche or role which the political priests believe will best serve whatever societal pattern they have formulated…These coercive actions…are implicit in and must logically follow from the beehive way of looking at humanity.

Implicit in this beehive view is that men exist who are competent to form the ways and shape the lives of human beings by the millions…that there are those who not only can rightly decide what is best for all of us but who can prescribe the details as to how the best that is in us can be realized.

Any conscientious collectivist, if he could see beyond his utopian goals and thus properly evaluate the authoritarian means his system of thought demands, would likely defect…

However lofty the goals, if the means be depraved, the result must reflect that depravity. Therefore, the eventual outcome of the collectivistic way of life may be accurately predicted by anyone who understands the means which must be employed.

People who call themselves individualists rarely reflect on the means implicit in their philosophy. Individualists thus overlook the merits of their means to the good life just as the collectivists overlook the shortcomings of their way. When only ends are envisioned and means ignored, there can be no reliable estimate as to whether the consequences will be good or bad.

When the individual replaces the beehive as the ultimate goal…the means implicit in achieving such a goal must be radically different.

Either I will concentrate on me and my welfare or on others and their welfare…mind my own business or mind other peoples’ business.

In view of the obstacles to the relatively simple task of self-realization, reflect on the utter absurdity of my…undertaking to manage the lives of millions.

Attention to self is not a disregard for others. On the contrary, each individual best promotes his own self-interest by peaceful, social cooperation as in the free market. Indeed, the more I make of myself the more are others served by my existence…The way to assume “social responsibility” is for the individual to rise…as far as possible.

If we concede…that man has a right to his life, it follows that he has a right to sustain life, the sustenance being the fruits of one’s own labor. Private ownership is as sacred as life itself.

Private ownership lies at the very root of individual liberty. Without it there can be no freedom; with it freedom is secure…It is senseless to talk about freedom if the right of private ownership be denied.

Can we pronounce a moral judgment on these means implicit in the individualistic goal…to the pursuit of self-perfection and the right of owning what one produces? … These means serve as a powerful thrust toward the individual’s material, intellectual, moral, and spiritual emergence — and that is right! Others — those who comprise society — are the secondary beneficiaries of individual growth. If we would help others, let us first help ourselves by those means which qualify as righteous.

Visionary or utopian ends may inspire people to pursue what turn out to be statist failures, sacrificing liberty for innumerable “good causes.” Read argued powerfully that we should instead focus on the means (voluntary versus coercive) rather than stated goals or ends that can often be achieved only in someone’s imagination. And since the means utilized by statist “solutions” are immoral, such systems are morally inferior to voluntary arrangements, not morally superior.

Leonard Read recognized that liberty — voluntary arrangements that spring up, once one’s rights to oneself and one’s production are protected — provides the means of achieving what is actually achievable in advancing society. As we develop ourselves, we each have more to offer others, accomplishing the goals of statist utopias, without immoral acts, that they themselves cannot, despite their immoral acts. And what freedom has historically accomplished, beyond anyone’s ability to envision, extended to further as-yet-unknowable possibilities (beyond the fact that it will benefit those who voluntarily participate) was at the heart of his inspirational vision.

To follow in Leonard Read’s path toward increasing liberty, we too also develop our ability to “see” the unseen (and often unimagined) good that can only be accomplished by freeing people’s ability to peacefully create and innovate. To complement that skill, we must also be able to “see” and articulate the inherent failings of the coercive and immoral means employed toward utopian goals, which are unachievable despite such means. With such binocular vision, liberty can be recognized as far more inspirational than any statist alternative. If that is the vision we hope others to catch, that is the vision we need to better articulate, as Read argued over and over again.

A Chinese national flag flies in front of private apartment blocks in Hong Kong in this file photo. Some are warning that China's inevitable housing bust could have a global effect. (Tyrone Siu/Reuters/File)

Beware of China's housing bubble

By Mark ThorntonGuest blogger / 01.29.12

The housing bubble was a global rather than US event. The bubble outlasted the US experience in several other countries such as Australia and Canada which are experiencing some weakness. However, the one I’ve worried about is in China. Keep your eye on this one.


The Chinese government’s announcement last week that growth for 2011 slowed only slightly to a still impressive 9.2% was greeted enthusiastically by the world’s stock markets. Investors also remain buoyant on China’s future. They appear to be buying the official line that the gigantic property price bubble is gradually and smoothly deflating, posing little risk to an engine that’s so crucial to the future of global trade.

But the math tells a different story. The housing frenzy has driven prices so high, so fast, that a crash on the scale of the real estate collapse in Japan in the 1990s is a virtual certainty. And China’s already exaggerated official growth rate could take a pounding, all the way to the zone of the unthinkable, into the low single-digits.

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