When an economic crisis hits, everybody from the Fed chairman to the man on the street knows that the Fed must print more money and reduce interest rates and that the government must spend more money and go deeper into debt. This is seen as necessary to “fill the gap” left by the private sector.
This approach is entirely wrong. In fact, it is highly counterproductive.
Murray Rothbard’s number one rule in an economic crisis is for the government not to interfere with the market’s adjustment process, or, in Wall Street terms, “the correction.” The more government intervenes in the economic crisis, the longer and the more grueling it will be. It can even perpetuate the depression as it did during the Great Depression.
However, the government has been intervening in most economic crises for the last century. This approach started shortly after the founding of the Federal Reserve in 1913. If printing money can paper over a problem, it seems like an easy, straightforward solution to politicians.
The United States had economic crises during the previous century. Two big ones were caused by the First and Second Banks of the United States. The ones after the War Between the States were quickly resolved because the national government could do precious little to intervene.
Even after the Fed was born, intervention was not the rule. During the depression of 1920–21 the Fed raised interest rates in the same way it did in the early 1980s. President Harding also balanced the budget. Both times it was grueling, but the economy quickly recovered, with full employment, rising wages, and a growing stock market.
What are the interventions that Rothbard wrote about that hamper market adjustment? In his America’s Great Depression (1963, pp. 19–23) we find the following:
First, government can attempt to delay or prevent bankruptcy or foreclosure by lending money or establishing moratoriums on rents and mortgage payments. This keeps prices up and prevents necessary adjustments.
Second, the Fed can adopt an easy money policy of inflation. This keeps prices up and interest rates down, whereas economic recovery is based on lower prices and higher interest rates.
Third, efforts during a depression to keep wages higher than market rates when prices are falling means that real wage rates rise. The result is massive unemployment.
Fourth, policies to keep prices up also raise the cost of living and can result in surpluses of goods with no buyers.
Fifth, efforts to stimulate consumption discourage saving, a prime ingredient of recovery. Food stamps and taxes on wealth, capital, and profits encourage consumption and discourage savings. Because government spending is entirely consumption, its budget should be slashed permanently.
Sixth, policies to subsidize unemployment, such as unemployment insurance, only increase unemployment and discourage people from searching for jobs or accepting lower-paying ones.
In summary, Rothbard’s approach for dealing with an economic crisis suggests that government should not prevent prices and wages from falling or stand in the way of bankruptcies. The road to recovery involves higher interest rates and price deflation. This leads to a painful but effective and historically tested process that is fully opposed by mainstream economists.
To show you the common sense of this deflationary approach, consider what is typical in an economic crisis. During a hypothetical economic crisis, we might see the following:
The price of capital falls drastically. Thing like stocks, real estate, and land fall by up to 90 percent. The Dow and NASDAQ lost around 50 percent after the housing bubble. The Dow lost more than 90 percent of its value during the Great Depression.
The prices of basic commodities, like energy, grains, and metals, fall significantly, sometimes by more than 50 percent, as did gasoline after the housing bubble.
The price of labor falls noticeably, with the prices of highly skilled labor falling by more than 50 percent in some cases and those of manual labor falling even further. After the dot-com bubble burst, computer programmers could not find work and often opted to retrain for other occupations.
The prices of consumer goods fall somewhat, but although luxury goods prices might fall by 20 percent or more, the declines in the prices of necessities is minimal, because the demand for goods like toothpaste and soap is largely unaffected while the demand for others, such as rice and potatoes, often increases.
The obvious implication of these changes in relative prices is that entrepreneurial people should buy up the cheap capital goods, commodities, and labor to produce consumer goods or hire the abundant skilled workers to produce innovative consumer goods to sell for profits.
Mainstream, especially Keynesian, economists use the metaphor of a black hole to describe an economy experiencing deflation as utter destruction. I have dubbed this fear apoplithorismosphobia. As shown above, Austrian economists see deflation as part of a necessary cleansing process, and they use the metaphor of the shock absorber to describe the impact of deflation. The historical record supports the Austrian view of deflation.1Joseph T. Salerno, “Deflation and Depression: Where’s the Link?,” Mises Daily, Aug. 6, 2004, https://mises.org/library/deflation-and-depression-wheres-link; Pavel Ryska, “Deflation and Economic Growth: The Great Depression as the Great Outlier,” Quarterly Journal of Austrian Economics 20, no. 2 (2017): 113–45; Greg Kaza, “Deflation and Economic Growth,” Quarterly Journal of Austrian Economics 9, no. 2 (2006): 95–97.
In terms of silver linings, it’s worth noting that Microsoft and Google were small companies when they started in the late 1970s and the late 1990s, respectively, but that both greatly expanded in and after the subsequent economic crises. Microsoft did so in the depression of the early 1980s, and Google did so in the aftermath of the collapse of the tech-stock bubble in the early 2000s.
Still, there is great skepticism that the U.S. government would ever sit on the sidelines and not pursue the interventionist, big government agenda. True enough, but there is actually a silver lining here too. If the government continues to pursue this failed approach, things will only get worse and we could end up in a hyperinflation:
The value of the U.S. dollar has already fallen immensely and is currently only strong vis-à-vis other fiat monies. It has suffered an official inflation rate of 2,500 percent since the Fed began operations. The M1 money supply—what we think of as money—has increased from around $250 billion when the United States was taken off the gold standard in 1971 to $5 trillion today, up from $4 trillion just a couple of months ago! That is an increase of 1,900 percent. The M3 money supply, which includes all forms of money, increased from $685 billion in August 1971 to over $16 trillion today, an increase of 2,200 percent.
If the federal government continues to run massive deficits and the Fed continues to monetize government debt, interest rates will increase and foreigners and their central banks, who are large holders of both our currency and our debt, will lose confidence. If they decrease their demand for our government debt, it will start us down the road to hyperinflation and possibly a totalitarian form of government.
The silver lining here is that proponents of the free market would likely get what they have long wanted through the political process: a return to the gold standard, the repeal of Social Security and welfare, an end to the warfare and surveillance states, and a return to a decentralized form of federalist government.
On February 10 the stock markets were at all-time highs, with the Dow 30 at almost 30,000. The unemployment rate was at an all-time low and interest rates around most of the world were at all-time lows.
With interest rates near zero for an entire decade, the value of stocks, bonds, real estate, land, and virtually any asset was artificially inflated. As a result, total household net worth doubled, increasing from $60 trillion to $120 trillion!
People were saying that things were too good to be true. Everything from giggling about personal finances at the gym to people embarking on unlikely business projects, and business owners being shocked when told it would not last, and even record-breaking skyscrapers. Things were too good to be true.
Now the popular refrain is that the coronavirus caused the economy to collapse. The government shut down the economy, putting people out of work. so there has been less consumption. Whole industries have been shuttered. The unemployment rate has skyrocketed, increasing by more than 10 percent in the last couple of weeks.
It is easy to see how politicians, the media, and even real people see this coronavirus situation as causing the economic collapse. A caused B. This in turn created the supposed need for trillions of dollars in subsidies, bailouts, and unemployment benefits. Plus the Federal Reserve would have to inject many more trillions of dollars to bail out every aspect of the financial industry including junk bonds and student loans.
All of this is false in the sense that A did not cause B. A, the coronavirus, did not cause B, the economic crisis; it merely triggered it, causing it to occur earlier than it would have. It may have also accelerated the collapse, and will likely deepen the trough of the crisis in business cycle terms.
In other words, the economy was weak, not strong. The fundamentals were weak, not strong. Balance sheets were weak, not strong.
This weakness could be clearly seen when President Trump began to publicly attack Federal Reserve chairman Jerome Powell for raising interest rates by 2 percent, which he rightly thought would hurt the stock market and his reelection chances.
The stock market thrived when interest rates were negative when adjusted for price inflation. However, when Powell pushed the inflation-adjusted rate to near zero, stock markets stalled and all political hell broke loose.
Let’s get back to the economic fundaments prior to the coronavirus. We are all consumers, so, starting with the consumer we find that, as a whole, consumers had a great deal of debt and not much in the way of savings.
There was certainly an effort to increase savings after the housing bubble crisis. The personal savings rate, which had fallen to 2 percent before the previous crisis (the housing bubble), had now risen to 7 percent but was still well below the 10+ percent that was normal when we on the gold standard.
The main villains behind a depressed savings rate are inflation and taxation on interest income. One-third of American households have zero savings and 60 percent have less than $1000. In effect, the Fed and the Treasury have needlessly put millions of households at risk.
Consumer debt is now more than double the amount prior to the last crisis, student loans are now more than $1.6 trillion, and the combined consumer credit of households and nonprofits is over $4 trillion. And, of course, this debt is not evenly distributed across the population, as some people have enormous debts relative to their ability to pay and some have none.
Before the virus, the labor market was also a mess despite a record low unemployment rate. There were millions of jobs that were going unfilled and millions of college graduates who could not get jobs in their desired fields, but who were instead working as waiters and bartenders and living at home. One of the biggest villains here is student loans, which encourage too many teens into college and put them on unproductive career paths.
The other big factor distorting the labor market is the Fed and its monetary policy. The unpreceded decade-long zero interest rate policy has caused a massive business cycle. Here, by artificially causing malinvestments, the Fed changed what types of jobs are in high demand and distorted income distribution as well.
In general, the Fed’s interest policy has increased the demand for very highly skilled workers such as electrical engineers, biochemists, and patent attorneys with graduate degrees. The increased demand for these types of labor has increased wages and distorted the distribution of incomes.
These types of workers are necessary to produce such things as new iPhones, software platforms, computer chips, and pharmaceuticals, all of which require a significant amount of work by patent attorneys.
Another way to view the distortions in the labor market is to take note of the number of job openings. In December 2019 the number of openings was 7.3 million, the highest number since it began to be counted in 2000. One of the reasons I suspected an economic crisis was around the corner was that this number stopped climbing and began to fall noticeably, before it recently plummeted.
Meanwhile, the unemployment rate for recent college graduates had been 41 percent and about one-third of all college graduates are underemployed, meaning that their job does not require a college degree. Remember, total student loan debt has skyrocketed to $1.6 trillion. These are all signs of a badly distorted labor market.
The too much debt/too little savings distortion can also apply to businesses and corporations, especially financial institutions. Some corporations have plenty of cash, such as Apple. It was so flush with cash that they started giving dividends to their shareholders.
But more telling is the problem of corporations using cash to buy back shares in their own company instead of investing in productivity. Another was the recent wave of mergers and acquisitions. Apparently, the Fed’s zero interest rate policy has driven the marginal return of capital so close to zero that corporations have resorted to these types of financial manipulations in an attempt to increase profits.
In summary, despite stellar numbers in the stock market and an all-time low unemployment rate, the US economy was already headed for an economic crisis. Prior to this economic crisis, we could clearly see that many consumers could barely pay their bills and had virtually no savings to rely on. The labor market was also badly distorted, with highly skilled markets booming, a record number of job openings, and massive numbers of recent college students unemployed or underemployed. Finally, the corporate market was also distorted, with firms using atypical financial manipulations such as share buybacks and mergers to increase profits. The viral pandemic merely triggered or revealed what was ultimately going to happen.
This article was originally featured on Mises.org and is reprinted with permission.
Beltway libertarian economists are today hailing the Fed’s efforts to cure the economic crisis or are even suggesting they intervene to a greater extent to quell fears in markets. That is like saying we need to spread the coronavirus to more people to stop the pandemic.
The Fed created the economic crisis with its more than a decade–long campaign of ultralow interest rates and quantitative easing policy that injected massive liquidity into financial markets. This unprecedented monetary policy caused companies to become more leveraged and to embark upon capital spending programs on a massive scale.
This made an economic crisis inevitable. The coronavirus is simply the match that lit the fuse. It’s just a trigger of the crisis. Just before the event, the stock market was at all-time highs and unemployment was at all-time lows. Things were literally too good to be true!
Then the Fed announced an emergency rate cut on March 3, and it is widely expected to reduce its rate to zero in the near future. Most people, even economists, were left shaking their heads. Why cut rates when the economy is doing so great? How can rate cuts do anything about a medical problem or a supply chain disruption?
The truth is that “monetary policy,” that is, inflation, cannot solve such problems. The truth is that the Fed is trying to doctor the stock and bond markets. So far it has not worked and could even be said to be backfiring.
It is the Fed money supply inflation and ultralow interest rates that caused the inevitable crisis in the first place. It also has helped enable trillion-dollar deficits and an exploding national debt. It has encouraged companies to issue more bonds, and a big chunk of marginal investment grade bonds (BBB) will soon be headed for junk bond status. It has also encouraged individual investors not to save or invest in safe assets and to put their money into riskier stocks because they cannot earn interest from banks or dividends from safe companies. Any economist should see all these effects as bad for the economy.
Zero Hedge reports “China’s Skyscraper Boom Comes Crashing Down Amid Developer Default,” noting reports that construction work was recently halted on the nation’s potentially tallest skyscraper, after the developer defaulted on a payment to the construction company.
They then invoked the Skyscraper Index which they describe: “The index is simple; the world’s tallest buildings are often constructed or completed at economic turning points, right before or just as the downturn gets underway.” The Skyscraper Curse is the economic crises that ensues with every new world record.
The book is actually two short books, the first one on the Skyscraper Curse, which explains the theory and history of the Skyscraper Index. The second half demonstrates that Austrian economists also have a remarkable record of predicting economic crises, but one that is not based on the Skyscraper Index. Rather, it is Austrian economics and the Austrian Business Cycle theory that shows how sustained artificially low interest rates are a precondition for both record setting skyscrapers and the Skyscraper Curse.
The theory is that artificially low interest rates induce more borrowing for longer term investment projects such as research and development on new technologies, pharmaceutical drug projects, and of course long-term real estate projects, like skyscrapers. My book provides a detailed analysis of how low rates impact skyscrapers, but the most important point is that skyscrapers are just a good example of what is going on throughout much of the economy.
The article is correct that there is a great deal of building super tall skyscrapers in China, but is unclear if the stalled construction would have set a new record in China and certainly it would not set a world record. If it would have set a new Chinese record, then it would still indicate an economic crisis is coming to China soon.
No matter, the stalled Jeddah Tower in Saudi Arabia was set to become a new world record skyscraper, originally expected to be completed in 2020, which is when we can expect the next Curse to begin.
The fundamental case for an economic crisis in the near future should be obvious. Central banks around the world have implemented ultra-low interest rate policies. In fact, a large portion of government bonds are now being financed at negative nominal rates, which is unprecedented. Many people manning Wall Street, hedge funds, and banks have never experienced a Federal Funds rate of 3%, which was the norm the previous half century.
Debt levels are at historic highs whether it is government debt, business debt, or individual debt. Debt levels tend to rise with low interest rates and expending economies, i.e. the artificial boom phase of the economy, only to become the most painful aspect in the economic crisis, i.e. government austerity budgets, corporate restructuring and bankruptcy, and bankruptcy, foreclosure, and unemployment for individuals.
Anecdotally, I am seeing buildings built taller, more spending on research and development, and newer companies poaching employees and customers from older companies.
The crisis usually begins when we see more stories about unexpected higher costs and lower revenues. While nothing about the next crisis is obvious to all—it never is–the stock markets will render their judgements.
Scott Sumner recently penned an article suggesting that the Federal Reserve needs to modernize its approach to monetary policy, a sentiment shared by many economists and policymakers. The Fed certainly has made a series of changes and adjustments to increase its transparency and its credibility after President Nixon took the world off of the Bretton Woods era gold standard in 1971.
However, in Sumner’s case, he is asking for a modernization of the monetary policy schedule. The Fed’s monetary policymaking body—the Federal Open Market Committee—meets approximately every 6 weeks, takes a vote and then issues its policy guideline for the Federal funds rate, i.e., the FFR, over the next 6 weeks.
Sumner advocates a system that would have all voting members of the committee emailing the chairman their desired rate on a daily basis. He would then choose the median rate for the Fed to target on that day. The FFR and all the rates based on it could change on a day-to-day basis.
Sumner thinks this is a superior approach because daily change happens in all markets, so it looks like a more market-oriented data series denominated in tiny increments of 1/100 of 1%. Compare this to the clunky stair-step approach we have today where rates change in 25/100 of 1% increments on an irregular basis.
The second reason for this reform is that the Fed committee can make mistakes as it did in 1937, according to Sumner, leading to a severe recession. The 1937 Fed was reluctant to reverse course because they would be admitting their mistake in such an obvious way of lowering the FFR in an abrupt manner. With Sumner’s reform the admission of failure and guilt would be far less obvious to the general public.
However, the underlying question is whether you want the FFR to adjust quickly or correctly. It seems clear that Sumner and many economists, including myself, think that the Fed is regularly making mistakes. Market determination is both quick, regular, and tends to be more correct than bureaucratic determination. However, in order to get a more market oriented monetary policy, it is necessary to rethink the artificial construct of targeting the FFR.
The current approach involves reading the tea leaves of aggregated data. How fast is GDP growing? What is the state of the labor market? How rapidly is price inflation rising? However, it is not always clear what the raw data implies. Sometimes declining GDP is a good thing, such as after World War II. Sometimes a declining labor participation rate is a good thing, as when more Americans are enjoying their retirement.
Then there is the issue of the revision of those statistics. GDP, a flawed measurement of the economy is released three times over the four months following the end of the three month period it intends to measure. How are open market committee members suppose to make daily projections based on that kind of process?
If we scrapped the current system, then it would be bankers that are going to determine the FFR based on their daily decisions to borrow or lend in the Federal Funds Market, where banks borrow from other banks on a short term basis to meet their reserve requirements.
Bankers would be basing their decisions on the anticipated and actual amount of business that walks through the door on a daily basis. Are deposits rising or falling? Are applications for loans rising or falling. Are people going for longer or shorter term loans? Are customers depositing money in short-term deposits or longer term CDs? All of this information is readily available to bankers.
The Fed is driving the economy by looking out the rear view mirror and is bound to make mistakes. Bankers will also make mistakes, but not only can they adjust very quickly, but they have the information to make more correct decisions and to make the necessary adjustments. Their ability to stabilize the market should only improve over time with experience.
With these market-determined interest rates there would be more stability in assets such as real estate and stock markets, avoiding the booms and busts of central-bank-fueled business cycles. This would offer Americans greater stability and confidence in their savings, something that is all the more important given concerns about solvency of social security. Economic growth would be natural, not artificial.
The goal of policy reform should not be to make quick daily decisions that look like market data. The goal should be to make correct decisions that are market data.
Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.
Over the last couple of weeks we have been bombarded by news coverage of the US government handling of foreigners illegally crossing the southern border and having their children separated from parents by our government. At first I tried to avoid subjecting myself to this circus, but I have been paying close attention for about a week.
I describe it as a circus because of the hysteria involved. Everyone from the Know- Nothing wing of the Trump party to the ultra-PC progressives, and the libertarians, and even the First Lady Melania Trump have jumped on the emotional roller coaster. The story is all the rage on talk shows and even reporters for NPR, remarkably, have shown audible signs of emotion.
Despite my diligence in reluctantly following this story, without exception there has been no coverage of the reason why these people from Central American are risking their lives during a treacherous journey. They leave all to get to a country where they face our hostile president and government and they don’t even speak the local language. While Mexicans have been crossing into America at least since the US annexed Texas in 1845 and stole the northern half of Mexico in 1848, Central American immigration to the US is a relatively new phenomenon.
If we knew what was causing this new phenomenon of the highly risky immigration we might be able to stop it and end all the hysteria. Yet, the media does not appear to be interested in discovering the cause of this effect. Maybe they are not bright enough to recognize that most effects have causes?
Central American Violence
The direct cause of this migration is violence in their home countries. The level of violence has risen dramatically in this century. According to UN statistics, the Central American country of El Salvador had the highest murder rate in the world with a recorded 83 murders per 100,000 inhabitants in 2016. Its neighbor to the north, Honduras, had the second worst rate at 57. Tiny Belize had the 7th worst rate. Guatemala was 15. th
On a recent excursion into the otherwise tranquil and picturesque country of Costa Rica, I learned that violence and murder were the country’s main problems. The murder rate there is 12, which is slightly worse than Uganda!
Looking at 20 countries with the highest murder rates, 17 are below our southern border in Central America, the Caribbean, and South America. Those facts should give us a strong hint as to what is causing the exodus from Central American countries.
America’s War on Drugs
A big factor here is our own War on Drugs. The production of illegal drugs occurs in large amounts in South and Central America. The US government has used its military and other resources to stop the shipment of these drugs via planes and boats so the smugglers use the jungles and deserts of Central America as a pipeline to the US.
In addition, the drug cartels and kingpins use the tiny Central American countries, where state security services are lightly armed, as their base of operations and for warehousing their drugs, money and weapons.
The cartels use violence and the threat of violence to intimidate the local population and governments. They do not require control over entire countries, but only a small conduit. As a result, the violence is highly concentrated in the areas they wish to have power over. In these places, life outside of the cartels is intolerable. This is the same reason for the hysteria in previous years about children without guardians making the treacherous journey from their homes in Central America to the US on their own.
If you care as much about the immigrant children in US detention centers as much as I do, then you should care at least as much about their frightened, terrorized cousins back in their home country.
Some of you might harbor the idea that a building a wall would stop illegal immigration. It won’t. Others might think that immigration is an inherently evil thing. It is not.
We have it in our power to end this travesty by ending the War on Drugs — which subsidizes and pressures Central American and South American governments into maintaining prohibition. This, in turn, enriches the cartels.
Ending the War on Drugs would go a long way to bring down high rates of violence and murder. Life in Central America would then return to some state of normalcy. With this, there would also be a big increase in foreign investment which would create jobs in those countries. In fact, this would also be a huge spur for immigration into Central America from North America and Europe creating even more service and construction jobs.
Meanwhile, trust your free market instincts and don’t trust the political process and the mainstream media for answers.
Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.
Timothy Hsiao recently made the rather startling case that libertarians should support the War on Drugs by claiming that recreational drug use undermines a critical precondition for freedom, namely, the ability to think clearly and to choose wisely. Hsiao notes that:
Accordingly, since the government has a responsibility to protect personal freedom, it must also protect and promote a culture that is conducive to clear thinking and discourages impaired thinking. The government, therefore, has a responsibility to restrict activities that impair, destroy, or otherwise undermine clear thinking.
There are many types of libertarianism. They range from the strong version, which is grounded in the non-aggression principle and prohibits any coercion by government, to the weak or impaired version where government can use force to foster particular freedoms and activities. Hsiao’s argument obviously rests on a weak version of libertarianism.
The argument that alcohol and drugs alter our ability to think clearly and therefore need to be restricted is not new. In fact, it can likely be traced back thousands of years, and was a common argument in the modern American movement to prohibit alcohol during the 19th century and during the War on Drugs of the 20th century. Recall, for instance, the “Reefer Madness” hysteria of the 1930s, when the use of cannabis (marijuana) was said to cause insanity, violence, rape, and murder, and acts of superhuman strength.
The larger point here is that Hsiao’s use of libertarianism shows just how popular libertarian thinking has become. In fact, demographically speaking libertarianism and libertarian-conservativism seem to be the wave of the future. However, drug and alcohol prohibition is a policy usually connected to the ideology of progressivism and even fascism.
For the sake of argument, let us grant Professor Hsiao his own version of libertarianism. Let us also grant that alcohol, marijuana, cocaine, heroin and many other drugs impair clarity of thought, choice, and action. Finally, let us further grant that certain drugs are so powerful and addictive that they can take over individuals’ lives and lead to improper actions, violence, accidents, and overdose deaths.
The Opioid Crisis is a painful reminder of these abnormalities. Here we have thousands of Americans becoming new addicts and thousands dying from drug overdoses each month. Furthermore, the crisis involves “normal” Americans, who would never otherwise consider trying heroin, becoming heroin addicts and overdosing.
Professor Hsiao does not discuss this crisis, but surely it is the best evidence for his case that certain drug use impairs individuals in a way that undercuts their self-interest by short circuiting their ability to reason and act rationally. However, this crisis is mostly about the changes in pain prescription guidelines rather than prohibition.
Two Pragmatic Objections to the Drug War
The two objections that I wish to raise to his libertarian case for drug prohibition are pragmatic, not libertarian per se. In fact, I firmly believe, like Professor Hsiao, that society must somehow impose itself on individuals to induce improved clarity of thought and individual responsibility.
The first objection raises the question of whether or not drug prohibition works to achieve its goal. This objection is not a cost-benefit issue, so that achieving even a small fraction of the goal at a high cost is enough to successfully counter this objection.
In my second objection, I ask the questions: What is the general reason why we have such a large problem with alcohol and drugs and what is the best response for dealing with these problems?
Drug Prohibition Does Not Work
Alcohol and drug prohibition creates more problems than it solves. During alcohol prohibition, circa 1920–1933, beer and wine were virtually non-existent on the black market while spirits of very high potency and high levels of impurities flooded the market. Crime and corruption were rampant. The murder rate nearly doubled. Bribery of public officials was endemic and respect for the rule of law plummeted. It is true that teetotalers and many moderate drinkers did obey the law. However, they were not part of the problem alcohol prohibition was designed to address.
The same is similarly true of the War on Drugs. The Reefer Madness hysteria is now widely considered hokey propaganda, much like the more recent “This is your brain on drugs” campaign. When President Nixon started his War on Drugs, the government measurement of the potency of cannabis was a mere 0.4%. Twelve years later it was ten times as high. The potency has continued to increase and the reason is prohibition itself, not consumer demand. The Iron Law of Prohibition states that prohibition increases drug potency and makes the product more dangerous.
That does not matter much with cannabis because consumers can always use a lower quantity. However, with so much legal pressure on cannabis, drug cartels have increasingly turned to cocaine, heroin, and methamphetamine as the drugs of their choice. The potency of these drugs makes it easier to smuggle a far greater number of doses in a given container compared to bulky cannabis.
The Gateway Theory of drugs has been thoroughly discredited, but the history of the War on Drugs has mimicked the theory because over time law enforcement effort and legal penalties have increased and consequently drugs have become more potent and dangerous to consume.
The War on Drugs has also spread crime, corruption, and violence. The US has the world’s largest prisoner population and highest rate of incarceration. The most salient factor in this is the War on Drugs. America is also home to the largest gang population in the world, largely financed by selling illegal drugs. Our War on Drugs has caused failed states in Central America and is a leading vehicle for financing terrorism.
Why Drug Abuse?
To help solve a problem, it helps to know what is causing the problem. Inner city minorities, war veterans, people with mental illnesses and young males have much higher rates of alcohol and illegal drug use and abuse. What all these groups have in common is that they tend to be marginalized in society and to experience a general condition of hopelessness and anxiety for their future.
We can also see this marginalization and hopelessness in the general population. In the US there are haves and have nots. As an economist I see the group of the “haves” as having a special advantage through government. Think of all the professions that require a government license rather than a good reputation or some form of professional certification to succeed. Think of all the government contractors. Think of all the people employed through government and unions. All these people hold a privileged position in society. They generally work less for greater pay and fringe benefits and have greater job security compared to the “have nots” or unprivileged population. These advantages are typically secured through access to government backing or at least tacit appeal to government coercion.
The unprivileged population has no such advantages. They participate in tight labor markets that do not have restrictions on entry. Therefore, they have a hard time getting and keeping jobs which ultimately pay less and have fewer fringe benefits compared to the privileged groups. They also have a far lower level of job security and rates of employment. Not surprisingly, a great deal of alcohol and illegal drug use and abuse occurs in this group, which can keep the unprivileged people stuck in their dead-end jobs. Alcohol and drugs help them cope with their marginalization and hopelessness. Unlike the privileged, this group also is far less likely to have health insurance which might pay for addiction treatment services. It is government interference, and not drugs themselves, which is the indispensable element in this cycle of despair.
An important solution to this situation would therefore be to eliminate government privileges and allow everyone to compete on a level playing field. Attacking drugs is bound to fail to alleviate societal problems, because the drugs are not the root cause of those problems. If Professor Hsiao’s recommendations were followed, one could anticipate the government becoming even more powerful, which would actually harm, and not help, the very people whom Professer Hsiao seeks to help.
Just as Professor Hsiao’s arguments are not novel, neither are mine. Even Milton Friedman, who structured his entire body of thought on a weak version of libertarianism, openly opposed the War on Drugs for over 34 years and he did so for the pragmatic reason that prohibition did not work, but the marketplace did. Moving from prohibition to legalization does not just make the drugs cheaper; it changes everything for the better.
Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.
[This article originally appeared in The Free Market, April 1998; Volume 16, Number 4.]
British Prime Minister Tony Blair apologized for doing “too little” in response to the Irish Potato Famine of the 19th century that killed one million people and brought about the emigration of millions more. But in fact, the English government was guilty of doing too much.
Blair’s statement draws attention to the question of what caused the famine. Up to now, the popular theory is that the Irish were promiscuous, slothful, and excessively dependent on the potato. As a result they died by the hundreds of thousands when a blight appeared and ruined their food source, in the midst of one of the fastest economic growth periods in human history.
Was the Potato Famine an ecological accident, as historians usually say? Like most famines, it had little to do with declines in food production as such. Adam Smith was right that “bad seasons” cause “dearth,” but “the violence of well-intentioned governments” can convert “dearth into famine.”
In fact, the most glaring cause of the famine was not a plant disease, but England’s long-running political hegemony over Ireland. The English conquered Ireland, several times, and took ownership of vast agricultural territory. Large chunks of land were given to Englishmen.
These landowners in turn hired farmers to manage their holdings. The managers then rented small plots to the local population in return for labor and cash crops. Competition for land resulted in high rents and smaller plots, thereby squeezing the Irish to subsistence and providing a large financial drain on the economy.
Land tenancy can be efficient, but the Irish had no rights to the land they worked or to any improvements they might make. Only in areas dominated by Protestants did tenant farmers have any rights over their capital improvements. With the landlords largely residing in England, there was no one to conduct systematic capital improvements.
The Irish suffered from many famines under English rule. Like a boxer with both arms tied behind his back, the Irish could only stand and absorb blow after blow. It took the “many circumstances” of English policy to create the knockout punch and ultimate answer to the Irish question.
Free-market economist J.B. Say was quick to note that the system of absentee landlords was deplorable. He accurately diagnosed this cause and grimly predicted the disastrous results that did follow. He sadly relayed the suggestion of a member of Parliament that the seas swallow up the Island of Erin for a period long enough to destroy everything on it.
The Malthusian law of population is sometimes used to explain away English guilt. Here the Irish were viewed as a promiscuous bunch that married young and had too many children. Malthus himself considered the Irish situation as hopeless. The Irish then paid for their sins via the starvation and disease that the famine wrought.
Were the Irish such a promiscuous bunch? The population of Ireland was high and the island had become densely populated after union with Great Britain in 1801. Part of this population growth can be attributed to basic economic development as population was also increasing rapidly in England and elsewhere in Europe.
In fact, the Irish population was only growing slightly faster than the English population and was starting from a much smaller base. But why was it growing faster? The answer lies in the fact that England had placed Ireland in an unusual position as the breadbasket for the Industrial Revolution.
The British Corn Laws were designed to protect local grain farmers from foreign competition. In 1801, these laws were extended to Ireland. The laws not only kept prices high; they protected against falling prices in years of plenty. The main beneficiaries of this protectionism were the English absentee landlords of Ireland, not the Irish.
The Irish people were able to grow large quantities of nutritious potatoes that they fed their families and animals. Landlords benefited from the fact that the potato did not deplete the soil and allowed a larger percentage of the estate to be devoted to grain crops for export to England.
Higher prices encouraged the cultivation of new lands and the more intense use of existing farmlands. A primary input into this increased production was the Irish peasant who was in most cases nothing more than a landless serf. Likewise, the population growth rate did slow in response to reduced levels of protectionism in the decade prior to the Famine.
This artificial stimulus to the Irish population was secure with English landlords in control of Parliament. However, English manufacturers and laborers supported free trade and grew as a political force. With the agitation of the Anti-Corn Law League, the Whigs and Tories agreed in 1845 to reduce protectionist tariffs and the Corn Laws altogether by 1849. The price of wheat plummeted in 1847 (“corn” being British for grains, especially wheat, the prime grain protected under the Corn Laws), falling to a 67-year low.
Repeal drastically impacted the capital value of farmland in Ireland and reduced the demand for labor as Irish lands converted from grain production to pasture. It should be clear that while free trade did bring about these changes, the blame for both stimulating prefamine population growth and the subsequent depopulation (the Irish population did not recover until 1951 and net emigration did not end until 1996) rests with English protectionism and the Corn Laws.
These price shocks made a population decline inevitable. As emigration became a viable option, many Irish decided to take the long and dangerous journey to the New World rather than the ferryboat to the factories of England.
Let us now take a look at the so-called laissez-faire approach that the English applied to the famine and for which Tony Blair apologized. This is important because it forms the backbone of the case that the free market cannot address famine and crisis (also that the IMF and FEMA are all the more necessary today).
Far from allowing the market to work, England launched a massive program of government intervention, consisting mainly of building workhouses, most completed just prior to the onset of the Famine.
Earlier, the Irish Poor Inquiry had rejected the workhouse as a solution to poverty. In the report, Archbishop Whately — attacked today for his free-market stand — argued that the solution to poverty is investment and charity, but these “radical” findings were rejected by the English who threw out the report and appointed George Nicholls to write a new one.
The workhouses, an early version of New Deal make-work programs, only made the problem of poverty worse. A system of extensive public works required heavy taxation on the local economy. The English officials directed money away from projects that would increase productivity and agricultural output into useless road building.
Most of these roads began nowhere and ended nowhere. Worse yet, the policy established by Sir Charles Trevelyan to pay below-market wages, which you can well imagine were pretty low, meant that workers earned less in food than the caloric energy they typically expended in working on the roads.
The British government opened soup kitchens in 1847 and these were somewhat successful because they mimicked private charity and provided nutrition without requiring caloric exertion or significant tax increases. But the kitchens were quickly ended. Next came a return of the workhouses, but again they could not solve the problem of poverty and hunger. In the summer of 1847, the government raised taxes, a truly callous act.
In addition to the fundamental failure of the government programs, workhouses, public works, and soup kitchens tended to concentrate the people into larger groups and tighter quarters. This allowed the main killer of the Famine — disease — to do its evil work.
Fewer Irish people had died in the numerous past famines; indeed, the potato blight did not severely afflict most of Europe. What was different in Ireland in the 1840s? The Irish Poor Law crowded out private charity. In previous famines, the Irish and English people had provided extensive charity. But why donate when the taxpayer was taking care of the situation? The English people were heavily taxed to pay for massive welfare programs. The Irish taxpayer was in no position to provide additional charity.
Reports concerning English policy towards genuine charity are hard to ignore. One account had the people of Massachusetts sending a ship of grain to Ireland that English authorities placed in storage claiming that it would disturb trade. Another report has the British government appealing to the Sultan of Turkey to reduce his donation from £10,000 to £1,000 in order not to embarrass Queen Victoria who had only pledged £1,000 to relief.
Other factors played a role. The Bank Act of 1844 precipitated a financial crisis created by a contraction of money as a more restrictive credit policy replaced a loose one. Taken together these factors support John Mitchel’s accusation that “the Almighty sent the potato blight but the English created the Famine.”
Did the English create the Famine on purpose? This was after all an age of revolution, and the Irish were suspected of plotting yet another revolt. The “Irish Question” was of major importance and many Englishmen agreed with Trevelyan that God had sent the blight and Famine.
Ultimately, the question of blame is not as important as the question of cause. Even more importantly, the Famine is a source of great economic errors, such as the claim that famines are the fault of the market and free trade, and that starvation results from laissez-faire policy. Even Karl Marx was heavily influenced by events happening in Ireland as he wrote in London.
Ireland was swept away by the economic forces that emanated from one of the most powerful and aggressive states the world had ever known. It suffered not from a fungus (which English scientists insisted was just excessive dampness) but from conquest, theft, bondage, protectionism, government welfare, public works, and inflation.
As an American, I am hardly one to consider Mr. Blair’s apology. However, if the apology had been for causing the Famine and for the welfare policies that made it so deadly, it would have much more to recommend it.
Prime Minister Shinzo Abe of Japan has announced plans to request that Japan’s corporate leaders increase salaries and wages at an upcoming meeting of government, business, and nonprofit leaders in preparation for the spring labor negotiation period, or shunto. That would be the fourth straight year that Mr. Abe has proposed higher wages to strengthen Japan’s beleaguered economy.
The idea that higher wages can lead to economic recovery has become a core principle of what has come to be called Abenomics. But does the idea pave the road to another great depression?
The two main principles of Abenomics are a very loose monetary policy and a stimulative fiscal policy involving large government budget deficits. Japan has also raised its consumption tax. This policy agenda has been in place since the Tokyo stock market bubble broke in 1989.
Not surprisingly, this policy approach has failed to fix the problems in the Japanese economy. The policy probably looks familiar because it is also the standing policy in the US and most eurozone nations. It should also be familiar because it is really nothing new, but simply old-fashioned Keynesian economics with a new label.
This approach has resulted in the once vaunted Japanese economy of the 1980s becoming the world’s worst debtor nation. Its ratio of national government debt to the size of its economy, or GDP, is now close to 250 percent. Most countries that approach or exceed a ratio of 100 percent are considered to be economic basket cases. The last calculation for the US was 104 percent and growing.
Let us take a closer look at this idea of politically motivated increases in salaries and wages.
How would politically driven increases in salaries and wages lead to economic recovery? This notion has its foundation built on the observation that in growing economies workers generally experience higher wages, or at least increases in the purchasing power of their wages. Therefore, the idea is that higher wages will lead to economic growth.
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