Archive for January 2013

Evidence on Industrial Policy

Industrial policies (IPs) include such varying practices as production subsidies, export subsidies, and import protection, and are commonly used by countries to promote targeted sectors. However, such policies can have significant impacts on sectors other than those targeted by the IPs, particularly when the target sector produces goods that are key inputs to downstream sectors. Surprisingly, there has been little systematic analysis of how IPs in targeted sectors affect other sectors of the economy. Using a new hand-collected database of steel-sector IP use in major steel-producing countries from 1975 through 2000, this paper examines whether steel-sector IPs have a significant impact on the export competitiveness of the country’s other manufacturing sectors, particularly those that are significant downstream users of steel. I find that a one-standard-deviation increase in IP presence leads to a 3.6% decline in export competitiveness for an average downstream manufacturing sector. But this effect can be as high as 50% decline for sectors that use steel as an input most intensively. These general negative effects of IPs are primarily due to export subsidies and non-tariff barriers, particularly in less-developed countries.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at

What’s really key for the price formation of gold?

Gold Switzerland interviews Robert Blumen. It include an interesting discussion on China, socialist calculation, as well as the gold market.

Are Profits Evil?

The late philanthropist Jeremy S. Davis made possible this seminar on economics for high school students, featuring lectures by Robert P. Murphy and Peter G. Klein. Presented in Houston, Texas, on 25 January 2013.

The Social Functions of Property by Robert P. Murphy

Big Business: Friend or Foe by Peter G. Klein

Deflation in Japan?

The topic of deflation has risen to new heights in Japan because the new Prime Minister has promised to fight deflation and to set new minimum inflation targets for the Bank of Japan.
In this article Frank Shostak shows why Japan should not try to fight inflation. Instead they should fight their apoplithorsismosphobia.

Let the banks fail

So says the President of Iceland. He also said that the financial sector, even a successful one, is like a parasite on the economy drawing out vital resources for the innovative productive sectors.

Surrendering to the Boom Bacillus

Doing some research the other day, I came across a 1926 article from Harper’s Monthly on the Florida real estate boom and how the journalist covering the story eventually succumbed to the boom mentality.  (Sorry, there’s no link.)  Here’s a short excerpt (from Gertrude Mathews Shelby, “Florida Frenzy,” Harper’s Monthly, January 1926, p. 177):

…I then was offered by a reputable firm a great bargain in a [Fort Lauderdale] city lot for $1000, an unusually low price.  Well-located $3000 fifty-foot lots are rather scarce.  This bonanza turned out to be hole, a rockpit–and I reflected on the credulous millions who buy lots from plats without ever visiting the land!

But to set against this experience I had one of exactly the opposite sort which left me with a sharp sense of personal loss.  An unimportant-looking lot several blocks from the center of Fort Lauderdale (whose population is fifteen thousand) on Las Olas Boulevard had been offered me about a week before at $60,000.  I didn’t consider it.  It now resold for $75,000.

“It doesn’t matter what the price is, if your location is where the buying is lively,” I was told.  “You get in and get out on the binder, or earnest money.  If you had paid down $2500 you would have had thirty days after the abstract was satisfactorily completed and the title was approved before the first payment was due.  You turn around quickly and sell your purchase-contract for a lump sum, or advance the price per acre as much as the market dictates.  Arrange terms so that your resale will bring in sufficient cash to meet the first payment, to pay the usual commission, and if possible to double your outlay, or better.  In addition you will have paper profits which figure perhaps several hundred per cent–even a thousand–on the amount you put into the pot.  The next man assumes your obligation.  You ride on his money.  He passes the buck to somebody else if he can.”

“But what happens if I can’t resell?”

“”You’re out of luck unless you are prepared to dig up the required amount for your first payment.  You don’t get your binder back.  But it’s not so hazardous as it sounds, with the market in this condition.”

Imagine how I felt two weeks later when the same lot resold for $95,000.  By risking $2500 with faith that I could have made $35,000 clear, enough to live on for some years.  Terror of an insecure old age suddenly assumed exaggerated proportions.  Right then and there I surrendered to the boom bacillus.  I would gamble outright.  The illusion of investment vanished….

Only two years later and a year before Black Tuesday, Joseph Kennedy would liquidate much of his investment portfolio and warn that “only a fool holds out for the top dollar.”  He later invested in Florida real estate at depressed, post-boom prices.

Shelby’s story reminded me of the boom mentality that pervaded the country in the 2000s, especially Florida and especially again in my hometown of Naples, where so-called investors driven by the “greater fool theory” were day-trading houses at one point.  Lost in most of the popular writings from the 1920s is any understanding of the role played by an activist Fed in expanding credit, lowering interest rates below market rates by its control of the discount rate, inflating the dollar in an explicit strategy to allow the British pound to find its pre-war exchange rate, and the general reinterpretation of the Fed’s implied mandate in the Federal Reserve Act to increase the money supply to ensure funds flowed to “legitimate business,” whether or not the economic was experiencing a panic, and even if this resulted in the bubbling land boom in Florida.

As people tended not to make those connections in the past, so they don’t today, following several years of massive and unprecedented increases in bank reserves engineered by the Bernanke Fed and optimistic news reports that the housing market is recovering.  Are happy times and land booms are here again?  As Clarence Darrow once said: “History repeats itself, and that’s one of the things that’s wrong with history.”

Mencken on the Economists

Today is the 57th anniversary of  the death of H. L. Mencken, perhaps the greatest of American writers. Murray Rothbard called him the “joyous libertarian” (a term that describes Rothbard as well). Rothbard wrote that “American Kultur . . . was incapable of understanding H. L. Mencken. . . . It is difficult for Americans to understand a merger of high-spirited wit and devotion to principle; one is either a humorist, gently or acidly spoofing the foibles of one’s age, or else one is a serious and solemn thinker. That a man of ebullient wit can be, in a sense, all the more devoted to positive ideas and principles is understood by very few; almost always, he is set down as a pure cynic and nihilist.” Mencken was no nihilist, but a “serene and confident individualist, dedicated to competence and excellence and deeply devoted to liberty.”

To honor Mencken, I direct you to one of his  typically funny essays, “The Dismal Science,” about the economists of his day. A few excerpts:

One of [my poisons], following hard after theology, is political economy. What! Political economy, that dismal science? Well, why not? Its dismalness is largely a delusion, due to the fact that its chief ornaments, at least in our own day, are university professors. The professor must be an obscurantist or he is nothing; he has a special and unmatchable talent for dullness; his central aim is not to expose the truth clearly, but to exhibit his profundity, his esotericity—in brief, to stagger sophomores and other professors. The notion that German is a gnarled and unintelligible language arises out of the circumstance that it is so much written by professors. . . .

[There is no] inherent reason why even the most technical divisions of its subject should have gathered cobwebs with the passing of the years. Taxation, for example, is eternally lively; it concerns nine-tenths of us more directly than either smallpox or golf, and has just as much drama in it; moreover, it has been mellowed and made gay by as many gaudy, preposterous theories. As for foreign exchange, it is almost as romantic as young love, and quite as resistant to formulae. . . .

Political economy, in so far as it is a science at all, was not pumped up and embellished by any such academic clients and ticket-of-leave men. It was put on its legs by inquirers who were not only safe from all dousing in the campus pump, but who were also free from the mental timorousness and conformity which go inevitably with school-teaching—in brief, by men of the world, accustomed to its free air, its hospitality to originality and plain speaking.

The Negative Consequences of Near Zero Interest Rates

John B. Taylor is always worth the time to read when he comments on monetary policy.

Today’s WSJ critique of Fed policy, John Taylor: Fed Policy Is a Drag on the Economy, is no exception.

Some highlights:

While borrowers like near-zero interest rates, there is little incentive for lenders to extend credit at that rate.

“More broadly, the Fed’s excursion into fiscal policy and credit allocation raises questions about its institutional independence and accountability. This reduces public confidence in the central bank.” [This last may be the one good thing in the fed’s misguided policy response to the slow recovery.]

Jeffrey Rogers Hummel in the Independent Review, provides the details. See “Ben Bernanke versus Milton Friedman: The Federal Reserve’s Emergence as the U.S. Economy’s Central Planner.” Keep in mind this was written before the Fed began QE Infinity and its purchase of 75% plus of newly issued Federal debt.

At the very least, the policy creates a great deal of uncertainty.

The low rates also make it possible for banks to roll over rather than write off bad loans, locking up unproductive assets.

As such the response postpones necessary adjustments to malinvestments of the previous boom(s) also prolongong a return to prosperity and sustainable growth. .

For another interesting discussion on the adverse effect of low rates on recovery see part three in Steve H. Hanke’s GlobeAsia column “Rethinking Conventional Wisdom: A Monetary Tour d’Horizon for 2013

Here’s Another Reason Why The Government’s Budget Deficit Figures Are Phony Baloney

There is so much in the government’s official deficit figures  that is phony it is hard to say what is real.

But we should add at least $89 billion to the official deficit figure. To see why, we need a bit of background.

The US government deficit is supposed to be running at around $1.2 trillion. But the government gets there by using accounting methods that would put private business executives in jail for fraud. The real deficit by different estimates should be multiples higher. This is already widely known.

It is also increasingly understood that the Fed is covering the deficit by creating new money out of thin air and using it to buy the government’s bonds. What is not generally understood is that the Fed then posts “income” from the newly purchased bonds, uses some of it to cover its own expenses, which are not subject to Congressional oversight, and then remits the rest to the Treasury. The Treasury in turn can use this phony income to reduce the deficit.

Consider what has happened here. The government sells a bond to itself by selling it to the Fed. The Fed then “charges” the government interest. The interest is actually paid by borrowing more from the Fed, but nevertheless is booked as real Treasury income and used to “reduce” the deficit.

A Bloomberg article mentions in passing that the Fed sent $88.9 billion of this phony income to the Treasury in 2012. That is another $89 billion that should really be added to the deficit.

To put this $89 billion in perspective, it is much larger than the $62 billion per year in expected tax revenue from the new taxes on the rich ( those making over $400,000 a year) that were enacted in January with the “fiscal cliff” legislation.

Help Us Make “The Free Market” Even Better

Now in its 31st year, the Mises Institute’s monthly newsletter, The Free Market, is expanding into a longer, more diverse publication with more articles and interviews, plus Institute Alumni news, and the latest news from our Donors, Members, and Faculty.

We’re now seeking submissions of various sorts including featured articles, movie reviews, book reviews, and one-to-four-panel comics.

Over the past three decades, authors like Ron Paul, Walter Block, Tom Woods and Robert Higgs have written for the pages of The Free Market.  Through the 1980s and until his death, The Free Market was home to some of Murray Rothbard’s most entertaining and informative new articles, and many of them now appear in the compilation Making Economic Sense. You can be part of this tradition.

Please send submissions to editor Ryan McMaken at Articles should contain fewer than 1,000 words and should not have footnotes or endnotes. Short book and film reviews under 750 words are very welcome.

We’re also interested in finding out more about what our Donors, Members, and Alumni are doing. Donors, Members, Alumni, and Faculty are invited to write us with your news, successes, photos, and (scholarly and non-scholarly) publications at If you’ve been part of Mises University, our Fellowship Program, a Rothbard Graduate Seminar, or one of our High-School Seminars, brag to us about your many successes at Please include what program you attended, and when.

The French Roots of the Scottish Enlightenment

Gavin Kennedy offers a nice review of Alexander Brodie’s 2012 book, Agreeable Connexions: Scottish Enlightenment links with France. Hayek, of course, locates the roots of classical liberalism in the 18th-century Scottish philosophers such as Ferguson, Smith, and Hume, while Rothbard, influenced by Hayek’s student Marjorie Grice-Hutchinson, among others, emphasized the contributions of the Scholastics, particularly the 16th-century School of Salamanca. Writes Gavin:

Brodie’s thesis is that what became known as the Scottish Enlightenment has its roots in a long history of connections between Scottish intellectuals from the medieval period onwards, primarily with their French opposite numbers, despite their different theological traditions, particularly after the Reformation (largely inspired from Luther’s Germany).

Lots of interesting details about the rich interactions among Scottish and French academics and universities and the development of a shared intellectual legacy.

NBER’s Golden Dilemma

NBER has just published a paper, “The Golden Dilemma.” by Claude B. Erb and Campbell R. Harvey. The paper examines several issues regarding the use of gold in financial portfolios. It finds that many of the arguments for owning gold are questionable. For example they find that gold is not a good inflation hedge in the short run (several years) because it does not correlate well with the Consumer Price Index. However, they find that it is good to have during hyperinflation.
NBER Working Paper No. 18706


While gold objects have existed for thousands of years, gold’s role in diversified portfolios is not well
understood. We critically examine popular stories such as ‘gold is an inflation hedge’. We show that
gold may be an effective hedge if the investment horizon is measured in centuries. Over practical investment
horizons, gold is an unreliable inflation hedge. We also explore valuation. The real price of gold is
currently high compared to history. In the past, when the real price of gold was above average, subsequent
real gold returns have been below average consistent with mean reversion. On the demand side, we
focus on the official gold holdings of many countries. If prominent emerging markets increase their
gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold
may rise even further from today’s elevated levels. In the end, investors face a golden dilemma: 1)
embrace a view that ‘those who cannot remember the past are condemned to repeat it’ and the purchasing
power of gold is likely to revert to its mean or 2) embrace a view that the emergence of new markets
represent a structural change and ‘this time is different’.

Charts and conclusions here

Is Violence a Disease?

A few years ago an economist colleague of mine debated a professor from our university’s school of public health on gun violence and gun control. My colleague walked through the empirical evidence on the effects of gun control laws on crime, accidental injury, and other social ills, citing well-known studies by economists and legal scholars such as John Lott, John Donahue, Gary Kleck, Ian Ayres, etc. As Circle Bastiat readers probably know, the empirical social science evidence, while not conclusive, clearly suggests that stronger gun control leads to increased rates of gun violence.  The public health professor — an MD who also teaches in the medical school — ignored these issues entirely, instead telling emotional stories about ER patients he’d treated for gunshot wounds and how everything must be done to stop this “epidemic” of gun violence.

The two speakers were, of course, talking totally past each other. One approached gun control from a simple, “rational actor,” cost-benefit approach. Gun control laws may make it slightly more difficult for bad people to get guns and for good people to do bad things, accidentally or in the heat of the moment, with a deadly object. But gun control also makes it more difficult for good people to acquire and use guns defensively, to deter crime. The net effect is ambiguous, but the existing empirical evidence strongly suggests that the latter effect outweighs the former. (Of course, I’m ignoring for the moment the relevant normative, political, and Constitutional issues.) The other speaker did not see gun violence, and violence more generally, as the result of purposeful human action. Rather, he saw violence as a disease, like the flu or cancer, which — while affected in some ways by people’s preferences, beliefs, and choices — is basically an epidemiological problem.

Indeed, the epidemiological approach to gun control is gaining adherents. “Is It Time to Treat Violence Like a Contagious Disease?” asks Wired in its latest issue. MSNBC breathlessly reports a claim that the National Rifle Association “suppressed” an important study, “rigorously conducted by ten credentialed experts” and “appearing in the prestigious New England Journal of Medicine,” showing that owning a gun makes a person less safe, rather than more safe. But these studies, conducted by public health professionals rather than empirical social scientists, are typically marred by basic methodological flaws such as sampling on the dependent variable, failure to account for endogeneity and unobserved heterogeneity, and other problems that would flunk a first-year econometrics grad student. Jacob Sullum offers a nice summary of some of this literature. Sullum focuses on researcher bias (e.g., selective citation of the existing literature), but also discusses some of the most infamous gaffes, such as a 2009 paper in the American Journal of Public Health showing that gun owners were more likely to be shot than “similar” people not owning guns, but matching only on age, gender, and race, ignoring the fact that people who are more likely to be the victim of gun violence are more likely to own firearms — i.e., that the causation is reversed. (This is a typical problem of what econometricians call “identification,” for which there are several generally accepted remedies, all apparently unknown to the public health research community.)

My sense is that the basic problem is the disease model of violence. Medical professionals are used to running controlled experiments, using clinical trials, and are unaware of how to perform empirical social science research outside a laboratory setting, so they apply the epidemiological model to issues like gun control, not recognizing that the decision to engage in violent acts, like crime more generally, is a form of purposeful human action. It’s time for journalists and politicians to recognize that the disease model is fundamentally flawed, and to turn to the best available research by economists, legal scholars, and other social scientists trained in how to do this kind of work.

(NB: I’m not suggesting that the mainstream law-and-economics research on crime, based on neoclassical economics, is free from problems. Ignoring time preference. See Samuel Cameron’s thoughtful essay.)

Money Really Does Matter

A very good discussion on why money matters: “Fed’s policies expose mainstream fallacies”

Dr Frank Shostak, at:

The conclusion:

Contrary to mainstream thinking the aggressive policies of the Fed have highlighted the destructive nature of loose monetary policy – hence money supply matters more than ever.

The Great Moderation: Where was the Inflation?

Robert Higgs in “Monetary Policy and Heightened Price Volatility in Raw Materials Markets” provides a very good companion piece to Mark Thornton’s “Where Is the Inflation?

A highlight:

As anyone who ponders the movements of the PPI from the late 1940s to the present can see, things are currently far from placid on the price front. In the markets for raw materials, the past decade has been the exact opposite of a “great moderation,” and these wild swings have occasioned tremendous difficulties and required wrenching adjustments by many different kinds of producers. Yet scarcely have they made one adjustment when another one cries out for their attention. Such a violently variable, impossible-to-forecast price environment has necessarily brought about a greater volume of business mistakes and a heightened reluctance to embark on new enterprises and to make new long-term investments in existing firms. For such paralyzing uncertainty, we have policy makers at the Fed and in the federal government to thank.

While policy during the great moderation did not lead to, at least by Fed standards, significant increases in core inflation, it did prevent or retard what should have been benign productivity driven declines in prices, and set the stage for back to back boom-bust cycles (Garrison (2009).

Current policy, while not currently generating significant changes in officially measure inflation, has retarded recovery in several significant ways. As noted by Higgs above, the current mondustrtrial policy, has increased policy uncertainty, which is slightly less comprehensive than Higgs’s regime uncertainty, but as argued extensively by John B. Taylor’s is a significant source of slow recovery. From an Austrian prospective, the policy has also significantly retarded the necessary deleveraging and it is possible that the Fed commitment to a 2% measured inflation target has impeded necessary wage and price adjustments.

The Fed and the Dirty Dozen

Dallas Federal Reserve President Richard Fisher in a recent speech called for an end of the “too big to fail doctrine.” He identified the dozen largest US banks (which represent almost 70% of all banking assets) as a continuing threat to the American public. He basically admitted that all the layers of bank regulation, including Dodd-Frank, are both overly complex and unlikely to succeed in preventing future bank bailouts. His plan calls the elimination of federal protection for all bank activity that is not explicitly apart of traditional commercial banking.

Our proposal is simple and easy to understand. It can be accomplished with minimal statutory modification and implemented with as little government intervention as possible. It calls first for rolling back the federal safety net to apply only to basic, traditional commercial banking. Second, it calls for clarifying, through simple, understandable disclosures, that the federal safety net applies only to the commercial bank and its customers and never ever to the customers of any other affiliated subsidiary or the holding company. The shadow banking activities of financial institutions must not receive taxpayer support.

Fisher’s plan does not directly reduce the size of the mega banks, it reduces taxpayer liability for the non-traditional “shadow” banking.

Systemic Appraisal Optimism and ABC Theory

Paper by Robert C. B. Miller

ABSTRACT: Austrian business cycle theory (ABCT) has focused on the
effect of interest rates set below the natural rate, leading to unwarranted attempts by businessmen to make more elaborate roundabout structures than can be completed by the available foregone consumption. This distorting effect is the main theme of the Austrian capital-based theory of the trade cycle.

But interest rates pushed below the natural rate can have another serious damaging effect. They can distort the appreciation of risk. Austrian economists have claimed that interest rates include a risk premium in addition to valuing future over present consumption. It follows that interest rates below the natural rate can create an unwarranted bullishness that leads to systemic “appraisal optimism.” Error prone “marginal entrepreneurs” receive resources which would not have been available to them in ordinary circumstances.

A “GDP Fetish”: Corners not craters

Corners not craters: A “GDP Fetish”

In today’s WSJ the ever insightful David Henderson reviews Keynesian Alan Blinder’s new book on the financial crisis After the Music Stopped.

A highlight:

Mr. Blinder is a strong believer in the ability of government regulation to solve problems and even prevent them in the first place. He sees the private sector as mainly to blame for the housing and financial crises and criticizes “laissez-faire” economic policies adopted by the Clinton and Bush administrations that supposedly contributed. But I do not think that term means what he thinks it means. Laissez-faire has traditionally meant that the government keeps its hands off the economy and allows for economic freedom. But at times, Mr. Blinder applies the term to cases in which the government, once its hands were already all over the economy, didn’t take the additional steps he favored.

His conclusion:

Mr. Blinder is a Keynesian, that is, someone who believes that the federal government should use fiscal policy—changing taxes and government spending—to stabilize the aggregate demand for goods and services. He therefore favored the stimulus policy that President Obama adopted his second month in office. Mr. Obama had the government increase spending in order to create more demand for goods. But Mr. Blinder is relatively unconcerned about whether the money was spent on valuable items. He has what I call the “GDP fetish”—the belief that increases in GDP are good whether or not they represent increased production of things that people actually value. If the government spends $100 billion digging holes and then filling them back up, then GDP can rise by $100 billion or more even if the $100 billion is totally wasted. Some stimulus projects, in fact, are little better than hole-digging. One example I noted on a recent visit to Detroit is the tearing up of sidewalk corners to make them wheelchair-friendly, even though the sidewalks themselves have so many craters that people in wheelchairs use the roads instead. With his faith in government intervention, Mr. Blinder sees the corners but not the craters.

The whole review, but perhaps not the book, is worth a read.

Congratulations to Dr. Malavika Nair!

Malavika Nair, a former Mises Fellow and Ph.D. student of Austrian economist Ben Powell at Suffolk University, will be taking a position at Troy University in Fall 2013. There she will be joining the Economics Division and the Johnson Center for Political Economy as a tenure track faculty member. The Johnson Center features a distinguished group of young Austrian and free market faculty including its executive director Scott Beaulier, Daniel Smith, George Crowley, and Malavika’s husband G.P. Manish.

Trillion Dollar Coins and Alien Invasions

Professor Salerno, the great thing about Paul Krugman is that he’s a walking reductio ad absurdum.  Critics of Keynesianism don’t even need to point out, “Well Dr. Krugman, by the same logic, you could also say…”  He saves critics the trouble, because he’s already there. He performs the logical reductio himself, and promulgates the resulting absurdities as pearls of Keynesian wisdom.