Wednesday, October 28, 2009

New Frontier of Moral Hazard

I sent the letter below to the Wall Street Journal. Is there any sanity left in Washington? The funniest part (in a black humor sort of way) is that the White House reached this agreement wait for it...Barney Frank! I am reminded of de Gaulle's response to Nikita Khrushchev when the Soviet premier told him that the Russians would sign an agreement with Erich Honecker of East Germany to come to the East Germans' aid in attempting to kick the NATO allies out of West Berlin. De Gaulle told Khrushchev that he was not impressed with agreements among communists and that everyone knew that Honecker was his puppet.


----- Original Message -----
From: Patrick Barron
To: Wall Street Journal
Sent: Tuesday, October 27, 2009 4:24 PM
Subject: A New Frontier for Moral Hazard

Re: Big Financial Firms Would Bear Cost of Failed Rivals Under Proposal

"Under a deal hashed out between the Treasury Department and a key House Democrat, financial firms with more than $10 billion of assets would have to pay for the rescue or unwinding of a collapsed competitor..." This is a new frontier for moral hazard. At least there always was some hope that government might not want to answer to the public over bailing out big firms with taxpayer money, but now the government will force the failed firm's competitors to bail them out. So, where is there any discipline to conduct one's business in a fiduciarily sound manner, when one reaps all the rewards of success and...Oh, this is deliciously evil! gets to make one's competitors pay the cost of failure?

Patrick Barron
West Chester, PA

Monday, October 26, 2009

My Letter to the Wall Street Journal

I wrote the letter below in answer to the essay by Sanford Weill and Judah Kraushaar in today's Wall Street Journal. They are singing the government's tune--the banks did it and they need more supervision, higher capital requirements, etc., etc., all the statist solutions. But, since these so-called solutions will not prevent another crisis, the obvious conclusion for all those who believe in this nonsense is a complete government takeover of the financial markets. They want bankers working for the government in the same manner that they want everyone in healthcare working for the government.


From: Patrick Barron
To: Wall Street Journal
Sent: Monday, October 26, 2009 4:00 PM
Subject: Missing the Point

Re: Six Steps to Revitalize the Financial System, by Sanford I. Weill and Judah S. Kraushaar, 26Oct09

Dear Sirs:
As my friend, Professor Thorsten Polleit of the Frankfurt School of Management, is fond of saying, if you do not understand the cause of the problem, you will not propose the proper solution. Mssrs Weill and Kraushaar would have us believe that banks are inherently unstable beasts that must be kept on a short government leash lest they bring down the entire financial system. Thusly, they propose more financial regulation; specifically, greater transparency, a single streamlined and more vigorous regulatory agency (the Fed), more rules for the securities market, higher capital requirements, etc.,...the same "reforms" that other insiders assure us will prevent a similar crisis in the future. Nevertheless, an army of regulators empowered with new authorities and new analysis tools will not prevent another crisis, because the cause of the crisis lies deeper in our financial system. Our fractional reserve, fiat money, central banking system gives banks the ability to create money out of thin air. Our Federal Reserve Bank spurs them on by manipulating said reserves in order to create economic booms for the benefit of elected politicians. But it just doesn't work; the Fed simply creates one boom/bust business cycle after another, with each cycle creating more havoc than the last. Contrary to the implied system deficiencies embedded in Mssrs Weill and Krausahaar's recommendations, banking is as subject to Say's Law as any other business, meaning that banking ever tends toward equilibrium. In a free banking system, unhampered by government money and interest rate manipulation, poorly run banks go out of business and properly run ones survive. Absent socialization of risk by the FDIC, depositors would reward successful banks and punish unsuccessful ones as they do any other consumer product company--by rewarding or withholding their patronage. Those depositors who eschew risk can keep their money in a demand deposit account backed one hundred percent by gold. Those who desire to put some of their money to work would have the option of opening a savings account that was not backed by anything other than the banker's reputation and his capital. Now that is real banking, honest banking, stable banking! And there is no room for government in this free banking system other than to prosecute fraudulent bankers who fail to back their demand deposits one hundred percent by gold. The market takes care of everything else.

Patrick Barron

Friday, October 23, 2009

Avoiding Financial Collapse

Our current political leaders--and their sycophantic hangers-on such as New York Times columnist and recent Nobel laureate in economics Paul Krugman--do not care about tomorrow. They are concerned only with today. Yesterday provides no guidance to inform us of the likely consequences of today’s actions; furthermore, tomorrow never comes, so who cares? Thusly, our government piles debt upon debt with the promise of even more debt in order to bribe the people to remain quiet about the loss of their liberties.

The latest insult to our intelligence is the promise that replacing our current healthcare system with one run by the government will provide not only more access but cheaper access for all. One need only observe that if this were the case, why those of us who are satisfied with our current healthcare plans must sacrifice them in order for these unnamed others to receive better care. Is there something about our current, private care that deprives others of care? Of course not. If government wants to create a new, expanded welfare program, let them sell it to the public in a straight-forward manner as a new spending program that must be financed out of new taxes or cuts in other government programs. Since government is not willing to do this, we are left with the conclusion that providing a new welfare program is not the real purpose of the government’s healthcare proposal. The real purpose is to amass new, expanded powers for government to rule over us. The phony “crisis in healthcare” that must be solved through complete government control of the industry can be explained in no other way.

The Ticking Debt Bomb Will Cause the Dollar to Collapse

But this essay is not about the attempted government takeover of healthcare, but about how government will finance such an undertaking. In the preceding paragraph I said that government can increase taxes or cut current spending on some other program to finance its healthcare adventure. But government has a third, more stealthy way--it can create debt. And this is what government is doing on an unprecedented and unsustainable scale. Total U.S. debt as a percentage of GDP is close to 400% and rising rapidly. As Frankfurt economist Thorsten Polleit explains in his recent essay “An Unsustainable Path to Debt Expansion” (, even the most conservative upward trend will cause total economic collapse within a few decades. The cause of this collapse will be a loss of confidence by holders of dollars that debt can be repaid without continuous reductions in the purchasing power of the dollar.

Now, this sounds very academic, doesn’t it? Most folks’ eyes glaze over when one discusses things like monetary debasement, loss of money’s purchasing power, etc., as if these terms were of academic interest only. But what if you knew that that the dollar in your pocket would be as worthless as a Zimbabwean unit of currency within a few years? Would you seek to amass as many dollars as possible, even selling assets to obtain dollars? I doubt it. You would seek to get rid of dollars and dollar denominated assets in exchange for something that would not fall in value. Ludwig von Mises called this phenomenon the “flight into real value”. When the holders of dollars believe that currency debasement (fall in the value of the currency) will not stop but rather will accelerate, they will attempt to get rid of dollars as soon as practicable. Professor Polleit points out that since the dollar’s final break with gold in 1971 the relative debt burden of the U.S. in relation to our economy’s annual production has accelerated from well under 200% to almost 400%. Government’s promise to initiate new programs means that this trend cannot fall but will accelerate. Therefore, we must conclude that the dollar will collapse.

The Only Way to Prevent Collapse

There is only one way to avert total collapse of the dollar—cut government spending and end the dollar’s debasement. The former must precede the latter, because, as Professor Polleit explains, government will not default (technically) on its debt as will private companies. The government will repay its debt in a technical sense only--by paying debtors in debased dollars. But debasement will lead to the collapse of the division of labor society and bring economic chaos on the 1923 German model, which wiped out the middle class and created the psychological conditions for the rise of the national socialist (Nazi) totalitarian state.

Therefore, the only path open to averting collapse is the abolition of government programs and cabinet level departments whose insatiable appetite for spending drives government debt. Government wealth transfer programs are not debt obligations of government. No one holds Social Security debt as one would hold a corporate bond or even a government bond. The Social Security program is just a spending program and may be ended in an instant. This we must do before spending on Social Security, Medicare, Medicaid, the Prescription Drug program, and the new healthcare mandates drive the debt burden to the tipping point. Ending these programs is not the same as defaulting on government debt. It is simply ending tyranny, for it is only the coercive intervention of government that sustains them.

Workforce Deregulation Will Open Job Opportunities for All

At the same time, government must completely eliminate all regulation of the economy, especially the workforce. People who have retired on Social Security and can still add something to the economy must be allowed to do so. Those who have yet to retire on Social Security must be given as much time as possible to plan for a retirement without Social Security. Abandoning all coercive wealth transfers and prohibitions against willing labor, such as minimum wage laws, will reduce the cost of labor and restore full employment. Reducing all the regulatory burdens of government will increase the sanctity of property rights, spur capital accumulation, and cause prices to fall. All this will go a long way toward mitigating the pain that will be suffered by those who currently depend upon government's coercive transfers of wealth in their favor. Once government has slashed its spending on other worthless programs--such as those sponsored by almost all cabinet level bureaucracies other than defense, state, and treasury--it can abolish the Fed and convert the dollar to a private, commodity backed currency, which will prevent government from ever again embarking on such a spending binge. A commodity backed money immediately reveals the true cost of any government expenditure and illustrates for the people the unassailable fact that all government is a burden on the people and not some sort of economic stimulus. At this point the government’s role in the economy will be that as envisioned by our Founding Fathers, as policeman for protecting us against fraud, theft, and coercion. Once again government will be our servant and not our master.

Friday, October 16, 2009

Diminished Authority and Increased Fear

The U.S. government is engaged in a policy of increasing control over the economy, starting with the banking system and major industries first and proceeding, as it inevitably must, to total control. The unprecedented takeover within the past year of major banks and General Motors, once upon a time the world’s largest corporation, has been followed by the establishment of a “pay czar” (currently Treasury Department official Kenneth Feinberg) who makes arbitrary ex post facto decisions about the compensation packages of major corporation executives.

Ludwig von Mises explained in many of his books and articles that government intervention leads to an ever expanding need for further intervention. Take price controls, for example, of which executive pay is but one small element in that government dictates what business may pay for certain services, the services of its chief executive being merely the most visible and public of the services it purchases. The Wall Street Journal reported on Friday, October 16, 2009 that “Mr. Feinberg is reviewing pay for the 175 most highly compensated employees at the firms under his purview, and he has been wielding his power extensively. He recently persuaded Citigroup to unload its energy-trading unit to defuse a potential showdown over a $100 million pay package slated for a star trader.” So, first government tackles CEO compensation and then brow beats business to renege on its promise to give star employees the incentive pay that they had been promised. Apparently contracts, even if only implied contracts, have no standing when a government bureaucrat makes a decision.

Earlier in the article the Journal reported that Mr. Feinberg’s duties were making him highly unpopular: “Government officials have acknowledged privately and publicly that the pay czar is likely to upset both those who think his actions are too intrusive and those who think he hasn't done enough. Mr. Feinberg himself has said he'll need to move to Pluto when his job is over.” Is it not ever so when property rights have been violated? Those who fear the implications of the loss of the rule of law are matched in number by those who desire a complete breakdown in the rule of law and despise the half measures taken by those whom they perceive to be weak in the execution of their extraordinary powers. No one is happy and rightly so.

There is no logical stopping point once the process of economic control by government has begun. Ethically there is no more reason to refrain from setting the compensation package of the lowest position in a business than from refraining to rule upon the same thing for its CEO. Practicality reinforces this tendency. If the CEO’s compensation can come under government review, why not the compensation of his immediate subordinates, the senior vice presidents? And if the government reviews the compensation of the senior vice presidents, why not the vice presidents, as so forth on down the chain of command to the lowest position in the company?

Furthermore, the whole idea of a “pay czar” or any other kind of czar to rule over an important element of our economy suffers from a profound error in understanding how an economy operates. The genius of the free market is that it coordinates massive amounts of diffuse knowledge that no single person or committee could possibly comprehend even with the most sophisticated computers. And it does this coordination of diffusely held knowledge effortlessly, timely, and without coercion of any kind. This is why almost any conceivable good or service is readily available in a free market and why command economies suffer from shortages even of essentials. Command economies lack the coordination of diffuse knowledge that exists in a free market. It is important to note that it is the price system itself that is the medium by which local knowledge is diffused throughout the entire economy. And it is the price system which government action interrupts and perverts. It is as if our body could not differentiate between a hot surface and a cold one. We would not know that we had placed our hand on a hot burner until blisters appeared and the damage was done. The longer we hold our hand on the hot burner, the worse damage we do to our bodies. Likewise, the longer and more pervasive are government’s perversion of the price system, whether perverting the prices business pays its employees or some other price fixing intervention such as farm price supports, the more damage government does to the capital structure of the nation, reducing its ability to meet the real needs of its citizens.

Mr. Feinberg is right to be concerned about whether anyone will be satisfied with his pay reviews, for I saw something similar occur almost forty years ago in Britain, where I served in Uncle Sam’s armed forces during the Cold War. Britain had nationalized shipbuilding at the end of World War II. A number of separate and highly militant trade unions worked in the shipyards. One or more of these unions were constantly on strike, paralyzing shipbuilding because no union member from the other unions would cross another’s picket line. The reason for almost all the strikes was pay, of course. No one ever thought that his pay was just, especially in comparison with the pay of some other union worker in the shipyards. But instead of learning a new trade that was more highly regarded in the marketplace, the union members learned that they could get higher pay simply by going on strike. So union A would strike for higher wages and, since the government owned the shipyards and work would stop in all of the nation’s yards, they eventually would get it. But, this set off a series of similar strikes by the other unions to regain their “differentials”, meaning the pay difference that union A had established, either higher or lower, with all the other unions. So if union A got paid another fifty pence per hour, all the other unions would strike for the same or slightly greater increase. Then if the government eventually granted all the unions their increases as desired, union A would be dissatisfied because others had shared its sacrifices. So…you guessed it…union A would walk off the job again, and the vicious cycle would start all over again. Needless to say, Britain today is not the shipbuilding powerhouse that it once was.

The same dynamic will plague Mr. Feinberg and his staff. It may take a few years, but once labor learns how to play the game, it will constantly seek advantages through political power rather than through self-help, market oriented efforts. One group of workers will demand greater pay, setting off a cycle of work stoppages while all the other groups scramble to regain their relative position in the compensation hierarchy.

This slippery slope to total economic control is described so chillingly by German businessman Gunter Reimann in his 1939 book The Vampire Economy: Doing Business Under Fascism. Mind you, this book was written BEFORE the war, and yet Herr Reimann chillingly describes the chaos of Nazi control over prices and production a mere half-decade after the first Nazi price decrees. Corruption was rampant, because that was the only way business could obtain raw materials; petty (and not so petty) Nazi bureaucrats learned how to exploit their tremendously powerful positions in the ever more centrally controlled economy. Naturally, the Nazi government proscribed suitable punishments for those who did not abide by its price dictates and who engaged in bribery of public officials. Nevertheless, corruption increased because, as Herr Reimann explains, economic laws still existed and corruption was the only outlet left before bankruptcy. Thus, the citizen’s view of the government changed radically. Now anyone could become a criminal, from a top industrialist to a small shopkeeper, just because he did what was necessary to stay in business.

Herr Reimann makes the following revelation, which is not something that we in the Allied camp ever considered about the Nazi regime: “This has the effect of lowering the authority of the State; on the other hand, it also makes the State authorities more feared, for no businessman knows when he may be severely penalized.”

Increased fear and lowered authority—does this not describe the current state of government in America? On the one hand we fear the long arm of government at all levels. On the other hand, our regard for the state—what Reimann calls its authority—ever diminishes. This is the fertile ground for radicalism, something that we have never experienced in America to any great extent. But when its own overreaching causes economic chaos, government’s authority diminishes among all economic classes and radicalism becomes a possibility. This is not something we would wish to live through. Our Founding Fathers fought for the only radical change that we should ever desire. And they provided a system of republican government for the GRADUAL changes that the citizens may deem necessary over the years, decades, and centuries to come. But a weakening of the state’s authority, despite the increased fear that it engenders, increases the possibility of radicalism. Seldom in the history of the world has a more benign and liberal (in the classical sense) government emerged following radical change.

Friday, October 9, 2009

My Letter to National Review Magazine

Thursday, October 08, 2009

Re: “Pop Economics” by Kevin D. Williamson

Dear Sirs:

In “Pop Economics” (Oct 19, 2009 Edition) Kevin D. Williamson exposes as a lie the government’s self-serving rationale for further financial regulation—that greedy, overpaid, and irresponsible executives caused it all. Although he does not attempt to provide a complete and systematic explanation for the mess in which we find ourselves, Mr. Williamson and his colleague Stephen Spruiell like the moral hazard argument advanced by Jeffrey Friedman of the University of Texas that “Basel rules encouraged banks to load up” on assets that carried more risk than initially perceived.

Regulations account for some of the problem, to be sure, but the real, underlying cause was bank credit expansion not supported by real savings. Earlier in his essay Mr. Williamson made the perceptive observation that the bankers “all made similar bad decisions at the same time.” In his classic mid 1960’s book "America’s Great Depression", Murray N. Rothbard called what seemed to be inexplicably poor decision-making by America’s elite bankers as a “Cluster of Errors”. Mr. Williamson asks the same question as Rothbard and comes to the same conclusion—“they thought they were making good investments on behalf of their shareholders…” But what led them down the garden path? What can explain the suspension of Say’s Law--that markets tend toward equilibrium? These errors should have been self-correcting; poor investors lose their own and their clients money and are trusted no more.

Mr. Rothbard’s explanation, backed by meticulous statistical analysis grounded in Austrian School economic theory, is that inherent, fatal flaws in the not-two-decade old central banking system (the Fed), unleashed the boom/bust business cycle. Unfortunately, nothing has changed since 1929. The Fed still causes the speculative boom. And, although the malinvestment eventually reveals itself, government still tries to short circuit the bust and reflate the bubble. Hoover-FDR have been reincarnated in Bush-Obama.

The solution is obvious—take monetary control out of the hands of government and place it back into the hands of the market. In other words, end the Fed and return to whatever private money is accepted by market participants. Without a doubt, the market would return to the gold standard.

Patrick Barron
West Chester, PA

Monday, October 5, 2009


Economic prosperity depends upon social cooperation under the division of labor. The larger the pool of people who cooperate with one another by specializing in the production of one or a very few goods or services, the greater will be their individual productivity and the greater will be the total amount of goods and services available for man’s economic benefit. This fact is undeniable, both from an empirical and a logical perspective. Of course, the largest possible pool of people would encompass the entire world. We need only look around us to recognize the benefits of worldwide trade—coffee from the tropics, wool from Australia and New Zealand, electronic goods from Asia, manufactured goods from Europe, not to mention oil from the Middle East, to name just some of the most obvious examples.

Given the universal acceptance by economists that the division of labor accounts for all economic progress and that worldwide trade advances the division of labor, one would expect that mankind would be on a one-way escalator to higher and higher overall prosperity. But such is not the case. Even a supposedly free, capitalist country like the United States suffers almost routine, wrenching economic crises. Others seem on the road to permanent prosperity only to sink back into the Dark Ages, such as has occurred in many African nations since the spate of post WWII de-colonizations.

Statist apologists such as Nobel Laureate Paul Krugman blame the very foundation of our prosperity—capitalism--for these crises and demand that governments take a guiding role in important economic affairs. A frightened citizenry, constantly bombarded by this message, know that government has the power to redistribute wealth and, at least temporarily, protect vociferous, well organized, and high profile special interest groups. Such has been the case with the auto unions. They can deliver the make-or-break votes to key politicians and wage a well-financed publicity campaign to quiet dissenters. But one does not need to be a rocket scientist to understand that government cannot bail out everyone in society. If it could, there would be no crises in the first place. So either government interventions for the benefit of special interests is limited so that the real economy is able eventually to cure itself, or continued interventions will create what has been called a “vampire economy” marked by capital consumption. Then the plundered many will sink further and further into destitution until, eventually, the plunderers themselves will find fewer and fewer sources of capital to plunder and the entire economy will collapse. According to former Gorbachev economic advisor Yuri Maltsev, this was the scenario, carried out in the most brutal fashion, that caused the collapse of the former Soviet Union.

In contrast to capital consumption, capital accumulation proceeds from the above-mentioned process of social cooperation under the division of labor. But one must understand the policies that cause the two different outcomes. In other words, what policies aid and abet a division of labor society? It is that question to which we now turn and from which discussion will be revealed the twin pillars of civilization—money and the rule of law.

Money and the Division of Labor

In order to specialize, man must be able to exchange the goods and/or services that he produces above and beyond his own needs for goods and services produced above and beyond the individual needs of others. There are two ways to accomplish this exchange—direct exchange and indirect exchange. Direct exchange, also known as “barter”, requires a coincidence of wants; that is, A produces what B wants and B produces what A wants. The two agree to exchange. But direct exchange has limited usefulness. What if A does not desire the production of B, even if B desires the production of A, or vice versa? And how can one ever expect to produce something like a locomotive or a jumbo jet and exchange it for any ordinary necessity of everyday life such as bread? It is obvious that man would produce only simple goods and live a very limited economic existence indeed.

But, man discovered that some goods were always in high demand; therefore, he traded for them, secure in the knowledge that he could re-trade them for goods that he really desired. Thus was born, gradually over time, indirect exchange. All indirect exchange originated in some useful commodity, and over the centuries many commodities have performed the function of indirect exchange. But the precious metals, especially gold and silver, have always been used as indirect exchange, even when in competition with other commodities. The precious metals are rare, difficult to counterfeit, easily stored, impervious to the elements, divisible into small amounts for small transactions, etc. Now man would be able to extend the division of labor into more time consuming and capital intensive goods and services.

The Law and the Division of Labor

But it was not sufficient to discover indirect exchange only. In fact, indirect exchange made it easier to obtain the goods and services of others without exchanging anything at all. In other words, man could steal money or, worse yet, counterfeit money. Whereas, it would be difficult to hide thousands of dollars’ worth of some every day good, such as bread, and use it oneself or exchange it over a long period of time, money is ubiquitous and imperishable. That is, all money looks the same, is readily accepted everywhere, and does not lose its usefulness over time. Therefore, over the centuries, man adopted standards of civilized behavior and sanctions against those who failed to follow such standards. Thus arose a body of law, enforced by government’s criminal justice system, to make man secure in all his property, especially his money. Man had delegated his inherent, God-given right to self-defense to government to protect his life, liberty, and property. Without such laws and without powers delegated to government, man never would have been able to fully exploit the power of money to extend the division of labor to greater and greater levels of production. Civilization would have stalled at a very low level of existence, perhaps no greater than that of the indigenous tribes of North America.

Money and The Law Under Attack

Today both money and the law are under attack, boding ill for the future of civilization. Money no longer is based upon a useful commodity; it is fiat money and may be manufactured in unlimited amounts by the very man-made organization founded for its protection—government. Furthermore, government has become the prime tool by which certain groups in society obtain the production of others without freely trading a good oR service of their own. Whether by the name of “welfare economics”, “economic stimulus packages”, “trade tariffs and quotas”, or some other outrageous sophist claim, government dwarfs even organized crime as a group of bandits to be feared, for there is no legal basis for protecting oneself and one’s property from its predations. Furthermore, the third party beneficiaries give their wholehearted approval to government’s counterfeit money production and resource redistribution operations! Thus, we witness the sad spectacle of government, formed to protect money through enforcement of the law, becoming instead the agent for civilization’s destruction.