Month: October 2007

I’m pretty much an optimist when it comes to long term economic outlooks for the US. I assume that we will do what we need to do to be competitive in the world wide market. With any luck that will involve some things like implementing a flat tax, reducing the corporate tax, and going to a private social security plan. Yeah, I know, but I’m thinking really long term:-) Many countries have done these things, or are about to, especially eastern European countries.

In any case, Im pretty confidant that we will do what we need to in order to “Keep up with the Joneses.” I do have some worries though. No, it’s not about income disparity or environmental issues, it’s about monetary policy. There has not been a world wide monetary standard in a long time. All countries used to be on the gold standard, but I don’t think that there are any that do that now. It used to be that every denomination of currency was backed by a certain amount of gold (or silver). This means that the government could only print or circulate as much currency as it had in reserves. Today, we have what is called “Fiat” money, the government could print as much of it as it likes. The value of the currency is determined by simple(!) supply and demand. The more money the Fed puts into the system, the less any particular bill will be worth. The opposite is also true. The nice thing about the gold standard is that it restricted what the government could do with monetary policy. They couldn’t intentionally deflate the currency or even just screw it up. By having the currency backed by something, it limited the government’s impact and allowed the actual economy to do its thing.

Why does this matter? Since the entire world is using fiat money, it isn’t out of the realm of possibility to have a world wide currency crisis. If America’s dollar value really melts down, they are going to take a bunch of other countries with them. Many other countries have either pegged their currency to the dollar (like Yemen) or have just started to use US dollars as the local currency. Additionally, if the US dollar tanks, and I mean really tanks, we would no longer be able to afford the products from China or Europe. So their economies would feel it as well… We gotta hope that the Fed keeps their head and doesn’t allow that to happen…

There are a handful of practical issues with going back to the gold standard, not least of which is that the government doesn’t want to give up any control. Milton Freidman had some alternative ideas about stabilizing the currency. He suggested 100% reserve banking and an automatic, rules based mechanism (as opposed to using the discretion of the Federal Reserve) as possible remedies. I’m not really sure how they work, but he was pretty bright when it comes to things like this. In any case, I would eventually like to see some sort of stabilizing mechanism introduced. The recent weakness of the dollar brought this to my mind, I can only hope that our “leaders” get their financial act together before I really have to start worrying about monetary issues…

I just finished listening to the audiobook version of Mark Skousen’s “The Making of Modern Economics.” It was a good overview of the history of economic thought starting just a little before Adam Smith up to the late 90’s. This time period captures all of the really big events, “The Wealth of Nations,” Marxism, the marginal revolution, Keyensism, the Austrian school sorting things out (as usual), and culminating with Milton Freidman’s Moneterist revolution and getting back to Adam Smith’s ideas of freedom being the basis of economic prosperity.

The book has as it’s main theme the idea that Adam Smith got it basically right and throughout the years people have either added more understanding to his basic model (Mises, Hayek) or have taken us down what looked like a promising path but ended in failure (Marx, Keyenes). I think that this is basically right and history certainly seems to back that up. I knew quite a bit about a lot of the bigger names but this book filled in some of my gaps when it came to people like Shumpater, William Bates Clark, and Malthus.

For the non-economic minded among you (what?), I’ll give the you the punch line. If we hadn’t listened to Malthus (there is a limited amount of resources and we’re all doomed), and if the marginal revolution had come about a litte earlier, we could have saved millions of people. Marx had a lot to do with it, but his fatal flaw from a theory point of view was his labor theory of value (I’m ignoring the equally powerful, but much more involved Hayekian critique of central planning). Marx (among others at the time) thought that the value of any given thing could be found based on the cost of the labor that went into it. His whole theory sprang out from that. It wasn’t until the marginal utility theory came around to explain subjective value that economists could point out the problems with socialism in general and marxism in particular. But it was too late, Marxist ideas had taken hold and millions upon millions of people paid for it.

Marx is an obvious wrong turn in history, but Keynes may be more pernicious. Keynes was the economist that popularized the notion of government interference being the only way to get out of depressions. He assumed that capitalism was inherently unstable and used the great depression as evidence. His solutions flew in the face of traditional (classical) Adam Smith inspired economics. Deficit spending, massive government projects, and a hatred of saving were the outcomes of his theories. Keynes’ ideas took hold and basically ruled the roost for the next 40 years.

When you listen to Keynes, you end up with England in the 1970’s. High unemployment, low to no growth, and government debt spiraling out of control. Maggie Thatcher (with some help from Hayek) cleaned that place up… It wasn’t until Milton Freidman’s ideas came into popularity did things start to come around. He proved that the great depression was caused by incompetent monetary policy, not any inherent instability of capitalism, and used that as a springboard to dismantle Keynes’ theories.

Government incompetence and/or ignorance is another theme running through not only this book, but history in general. The great depression is a great example. The crash itself may very well have been a bubble popping, but the blame for the depression that followed can only be laid at the feet of the government. Milton Freidman showed that the Fed shrunk the amount of money in the economy by a third, thus plunging the country into depression. The Smoot-Haley tariffs caused an amazing amount of damage, and FDR’s directionless fiddling prolonged it for another 8 years or so. It wasn’t until the war ended did we pull out of it. If they had left well enough alone and not screwed with the money supply, the depression likely wouldn’t have lasted nearly as long…

With Milton Freidman’s contributions we may have seen the last bit of huge economic principles being introduced. There is still plenty of research into the finer points, but the big picture seems to have been pretty well explained. The hell of it is, Adam Smith pretty much did that way back in the 1700’s, it’s a shame that it took us this long to realize it…

Georgia is facing a problem with the current drought. They are running out of water and they don’t seem to be able to come up with a way to fix the problem. This article tells, at length, the problems, the purposed “solutions,” and the various groups involved in the fight. People are blaming the Corp of Engineers, a species of mussels that has some sort of protection, and too much growth in the area. I’ve got a much simpler explanation and a very simple remedy for their problem. Raise the price of water. The reason they are running out of water is that they have not been pricing it properly. There is a finite supply of fresh water, if it is underpriced, people will use too much of it. If you want to limit how much water is being used, if you want people to conserve water, if you want people to fix leaky toilets and water heaters, raise the price. Everyone will pay attention if their water bill doubles or triples, and I guarantee that water use will fall. Pass more “You can only water your lawns twice a week,” laws and I’m sure not much of anything will happen. If the price is allowed to “float,” with the supply of water, you’ll never have to worry about water shortages again.

This is assuming that all people face the same prices. Frequently, businesses like agriculture, gold courses, and others get special (low) prices. Of course they are the largest consumers of water as well… If you are worried about “the poor,” you can figure out a way not to charge them the extra amount. The key is to make sure that the largest percentage of water users feel the price increase. Viola, no more water shortages!