the freeman

VOLUME 60, NO 1 JANUARY/FEBRUARY 2010

Features8 The Green-Economy Mirage by Andrew P. Morriss

13 How Dense Can They Get? The Fallacy of Alternative Fuels by Richard W. Fulmer

14 Freedom in America: Is the Glass Half-full or Half-empty? by George Leef

19 Walmart’s Bottom Line by Art Carden

24 The Long and Short of Short Selling by Warren C. Gibson

30 Deflation:The Good, the Bad, and the Ugly by Steven Horwitz

37 “We Want to be Regulated” by Bruce Yandle

Columns4 Ideas and Consequences ~ Principled Parties by Lawrence W. Reed

17 Thoughts on Freedom ~ On Trade and Currency Manipulation

by Donald J. Boudreaux

28 Peripatetics ~ Frustrating Michael Moore by Sheldon Richman

35 Our Economic Past ~ Dangerous Historical Myths by Stephen Davies

39 Give Me a Break! ~ Transfer Machine by John Stossel

47 The Pursuit of Happiness ~ The Balance-of-Payments Deficit: Not to Worry

by David R. Henderson

Departments2 Perspective ~ Getting in Deeper by Sheldon Richman

6 Medical Markets Can’t Work? It Just Ain’t So! by Theodore Levy

Book Reviews

41 A Failure of Capitalism:The Crisis of ’08 and the Descent into Depression

by Richard A. Posner Reviewed by Chidem Kurdas

42 Unsanctioned Voice: Garet Garrett, Journalist of the Old Right

by Bruce Ramsey Reviewed by Brian Doherty

43 The Legal Foundations of Free Markets

edited by Stephen F. Copp Reviewed by George Leef

44 Unmasking the Sacred Lies

by Paul A. Cleveland Reviewed by Joseph G. LehmanPage 42

Page 19

Page 35

In what the Wall Street Journal calls “a watershedmoment for government intervention in the privatesector,” the Federal Reserve announced in October

that it will regulate executive compensation at all banksso they will not have incentives to take on too muchrisk.

Meanwhile, the Obama administration said it wouldcut by half (on average) the compensation of the high-est-paid people at the seven companies still on taxpayerlife support: AIG, Bank of America, Citigroup, GeneralMotors, Chrysler, GMAC, and Chrysler Financial.

So here’s the puzzle: Is such government intrusioninto the compensation process a good or bad thing?

Before answering, let’s remember that the taxpayershave been compelled to rescue lots of companies, bank-ing and otherwise, over the last two years.The people’sexposure is immense. Neil Barofsky, special inspectorgeneral for Treasury’s financial sector rescue, says enor-mous surprise bailout costs will befall the country inaddition to the $159 billion the Congressional BudgetOffice projects TARP will lose. Barofsky was referringto the cost of government borrowing and the potentialcost of rewarding risky behavior.

Besides that, the Fed has been buying up billions ofdollars in “toxic” (that is, worthless) mortgage-backedand other paper with money created from thin air.Thenew money threatens to ignite a monster price inflationwhen the banks begin to lend it.The impending dissi-pation of the people’s wealth at the hands of theFed(eral Bureau of Counterfeiting) is another cost ofthe bipartisan government bailout of corporate finance.It’ll be a massive tax on the middle and working classes.

Well, then, shouldn’t the government have some-thing to say about what goes on in those companies onthe dole, executive pay in particular?

It’s tempting to say yes, but I think the best answer isno. I’m not totally comfortable with that answer, but itseems better than the alternative.

First off, we must reject the propaganda that theTreasury and the Fed are acting as the taxpayers’ agentsby taking control of corporate compensation. Nothingcan be further from the truth. They are the taxpayers’adversaries and are only looking out for themselves.

2T H E F R E E M A N : I d e a s o n L i b e r t y

Getting in DeeperPerspective

Published byThe Foundation for Economic Education

Irvington-on-Hudson, NY 10533Phone: (914) 591-7230; E-mail: [email protected]

www.fee.org

President Lawrence W. ReedEditor Sheldon Richman

Managing Editor Michael NolanBook Review Editor George C. Leef

ColumnistsCharles Baird David R. Henderson

Donald J. Boudreaux Robert HiggsStephen Davies John Stossel

Burton W. Folsom, Jr. Thomas SzaszWalter E.Williams

Contributing EditorsPeter J. Boettke Dwight R. Lee

James Bovard Wendy McElroyThomas J. DiLorenzo Tibor Machan

Joseph S. Fulda Andrew P. MorrissBettina Bien Greaves James L. Payne

Steven Horwitz William H. PetersonJohn Hospers Jane S. Shaw

Raymond J. Keating Richard H.TimberlakeDaniel B. Klein Lawrence H.White

Foundation for Economic Education

Board of Trustees, 2009–2010Wayne Olson, Chairman

Lloyd Buchanan Walter LeCroyWilliam Dunn Frayda Levy

Jeff Giesea Kris MaurenEthelmae Humphreys Roger Ream

Edward M. Kopko Donald Smith

The Foundation for Economic Education (FEE) is anonpolitical, nonprofit educational champion ofindividual liberty, private property, the free market,

and constitutionally limited government.The Freeman is published monthly, except for combined

January-February and July-August issues. Views expressed by the authors do not necessarily reflect those of FEE’s officers and trustees. To receive a sample copy, or to have The Freemancome regularly to your door, call 800-960-4333, or e-mail [email protected].

The Freeman is available on microfilm from University MicrofilmInternational, 300 North Zeeb Road,Ann Arbor, MI 48106.

Copyright © 2009 Foundation for Economic Education,except for graphics material licensed under Creative CommonsAgreement. Permission granted to reprint any article from this issue, with appropriate credit, except “Transfer Machine.”

Cover: Bill Liao [flickr]

3 J A N U A RY / F E B R U A RY 2 0 1 0

P E R S P E C T I V E : G e t t i n g i n D e e p e r

After all, they are the ones that exposed the taxpayers tothese huge liabilities in the first place.

Moreover, it’s not really the taxpayers’ money thepoliticians are looking out for. In real terms, it’s nowtheir money by virtue of legal plunder.The Bush admin-istration tried to sell the public on the bailout by sug-gesting that the toxic assets (or bank shares) acquired bythe government might one day be resold at a profit forthe taxpayers. But if the assets do sell for more than thegovernment paid, will taxes be cut to reflect the profit?Fat chance. Politicians tend to spend every penny theycan get their hands on—and then some. It is they whowould profit, not the taxpayers.They ain’t us.

Another reason to oppose government conditionson bailout money is that they are likely to make thingsworse. I seriously doubt whether anyone at the Fed orTreasury is qualified to design compensation packagesthat would encourage just the right amount of risk,not too much or too little.

A third reason to reject this government interven-tion is that it will serve as a justification for furtherintervention. Pay czar Kenneth Feinberg already says hehopes the pay scheme will become a model for the restof Wall Street.

My final reason for saying no to the pay czar andbank regulators is that I want to make sure that suchbailouts never happen again. Maybe the people will beless likely to acquiesce the next time if they see the cur-rent corporate rescue for the plunder it is.

We can’t change the past. The bailouts happened.Now we have to deal with the consequences. Weshould concentrate on stripping government of thepower to bail out companies in the future. We shouldalso begin to fully separate State and banking. A goodstart would be to abolish government deposit insur-ance, which only lulls depositors into a false sense ofsecurity and creates the very systemic risk the regula-tors say they want to avoid.

* * *

“Green jobs” are the magic words promising tobestow prosperity and environmental bliss throughcostless government manipulation. Do you need morereason to be skeptical? Andrew Morriss performs thedebunking. Richard Fulmer adds an insight on theshortcomings of alternative energy sources.

In the mixed economy, is freedom’s glass half full or half empty? George Leef shows that this is morethan a philosophical question.

Walmart inspires hisses and hosannas. Which aremore deserved? Art Carden sorts it all out.

These days it’s especially popular to scapegoat any-one engaged in complex financial transactions notreadily understood by laymen. Example: short sellers.They’re accused of manipulating the stock market forpersonal profit, so the government has its eye on them.Warren Gibson comes to the defense of this valuableyet unappreciated group.

The government’s money managers are willing torisk inflation to avoid deflation. Good idea? StevenHorwitz distinguishes good deflation from bad.

One of the great pieces of American folklore is thatbusinessmen don’t like regulation. Bruce Yandle sets therecord straight.

Here’s what our columnists have come up with thistime around. Lawrence Reed declares himself a Loco-foco. Donald Boudreaux won’t let Chinese currencymanipulation keep him up at night. Stephen Daviesdemonstrates the power of historical myth. John Stossellooks at the tax system and doesn’t like what he sees.David Henderson says don’t fear the trade deficit. AndTheodore Levy, encountering the claim that marketsfor medical care cannot work, remonstrates, “It JustAin’t So!”

Volumes about the alleged failure of the market, acrusty old individualist, the law, and American publicpolicy undergo scrutiny by our reviewers.

—Sheldon [email protected]

B Y L AW R E N C E W. R E E D

Principled Parties

Ideas and Consequences

Imagine a political movement that says it’s commit-ted to “equal rights”—and means it. Not justequality in a few cherry-picked rights but all

human rights, including the most maligned, propertyrights. Imagine a movement whose raison d’être is tooppose any and all special privileges from governmentfor anybody.

When it comes to political parties, most of them inrecent American history like to at least say they’re forequal rights. If we’ve learned anythingfrom politics, though, surely the first les-son is this:What the major parties say anddo are two different things.

In American history no such group hasever been as colorful and as thorough inits understanding of equal rights as onethat flashed briefly across the political skiesin the 1830s and ’40s. They were called“Locofocos.” If I had been around backthen, I would have proudly joined theirillustrious ranks.

The Locofocos were a faction of theDemocratic Party of President AndrewJackson, concentrated mostly in the North-east and New York in particular, but with notoriety andinfluence well beyond the region. Formally called the“Equal Rights Party,” they derived their better knownsobriquet from a peculiar event on October 29, 1835.

Turn On The Lights, The Party’s Starting

Democrats in New York City were scrapping overhow far to extend Jackson’s war against the feder-

ally chartered national bank at a convention controlledby the city’s dominant political machine, TammanyHall. (He had killed the bank in 1832 by vetoing itsrenewal.) When the more conservative officialdom ofthe convention expelled the radical William Leggett,editor of the Evening Post, they faced a full-scale revolt

by a sizable and boisterous rump. The conservativeswalked out, plunging the meeting room into darknessas they left by turning off the gas lights. The radicalscontinued to meet by the light of candles they lit withmatches called “loco focos” (Spanish for “crazy lights”).

With the Tammany conservatives gone and theroom once again illuminated, the Locofocos passed aplethora of resolutions. They condemned the nationalbank as an unconstitutional tool of special interests and

an engine of paper-money inflation.Theyassailed all monopolies, by which theymeant firms that received some sort ofprivilege or immunity granted by state orfederal governments. They endorsed a“strict construction” of the Constitutionand demanded an end to all laws “whichdirectly or indirectly infringe the freeexercise of equal rights.” They saw them-selves as the true heirs of Jefferson,unabashed advocates of laissez faire and ofminimal government confined to securingequal rights for all and dispensing specialprivileges for none.

Three months later, in January 1836,the Locofocos held a convention to devise a platformand endorse candidates to run against the Tammanymachine for city office in April. They still consideredthemselves Democrats, hoping to steer the party of Jef-ferson and Jackson to a radical reaffirmation of its prin-cipled roots rather than bolt and form a distinctopposition party. “We utterly disclaim any intention ordesign of instituting any new party, but declare our-selves the original Democratic party,” they announced.

The “Declaration of Principles” the Locofocos passedat that January gathering is a stirring appeal to thebedrock concept of rights, as evidenced by these excerpts:


Lawrence Reed ([email protected]) is the president of FEE.

William Leggett’s expulsion from aDemocratic Party meeting sparkedthe formation of a new factionfirmly dedicated to equal rights.commons.wikimedia.org

The true foundation of Republican Government isthe equal rights of every citizen, in his person andproperty, and in their management.The rightful power of all legislation is to declare andenforce only our natural rights and duties, and to takenone of them from us. No man has a natural right tocommit aggression on the equal rights of another;and this is all the law should enforce on him.The idea is quite unfounded that on entering intosociety, we give up any natural right.

The convention pronounced “Hostility to any andall monopolies by legislation,”“unqualified and uncom-promising hostility to paper money as a circulatingmedium, because gold and silver are the only safe andconstitutional currency,” and “Hostil-ity to the dangerous and unconstitu-tional creation of vested rights bylegislation.”

These days Congress and the legis-latures of our 50 states routinelybestow advantages on this or thatgroup at the expense of those whomthe same laws disadvantage—fromaffirmative action to business subsi-dies. The Locofoco condemnation ofsuch special privilege couldn’t beclearer: “We ask that our legislatorswill legislate for the whole people andnot for favored portions of our fel-low-citizens, thereby creating distinct aristocratic littlecommunities within the great community. It is by suchpartial and unjust legislation that the productive classesof society are . . . not equally protected and respected asthe other classes of mankind.”

William Leggett, the man whose expulsion from theOctober gathering by the regular Democrats of Tam-many Hall sparked the Locofocos into being, was theintellectual linchpin of the whole movement. After ashort stint editing a literary magazine called The Critic,he was hired as assistant to famed poet and editorWilliam Cullen Bryant at the New York Evening Post in1829. Declaring “no taste” for politics at first, hequickly became enamored of Bryant’s philosophy of

liberty. He emerged as an eloquent agitator in the pagesof the Post, especially in 1834 when he took full chargeof its editorial pages while Bryant vacationed inEurope. He struck a chord with the politically uncon-nected and with many working men and women hithard by the inflation of the national bank.

In the state of New York at the time, profit-makingcorporations could not come into being except by spe-cial dispensation from the legislature.This meant, as his-torian Richard Hofstadter explained in a 1943 article,that “men whose capital or influence was too small towin charters from the lawmakers were barred fromsuch profitable lines of corporate enterprise as bridges,railroads, turnpikes and ferries, as well as banks.”

Leggett railed against such privilege: “The bargain-ing and trucking away of charteredprivileges is the whole business ofour lawmakers.” His remedy was “afair field and no favor,” free marketcompetition unfettered by favor-granting politicians. He and hisLocofoco followers were not anti-wealth or antibank, but they werevociferously opposed to any unequalapplication of the law.To Leggett andthe Locofocos, the goddess of justicereally was blindfolded!

The Locofocos won some localelections in the late 1830s andexerted enough influence to see

many of their ideas embraced by no less than MartinVan Buren when he ran successfully for president in 1836. By the middle of Van Buren’s single term, theLocofoco notions of equal rights and an evenhandedpolicy of a small federal government were reestablishedas core Democratic Party principles.There they wouldpersist through the last great Democratic president,Grover Cleveland, in the 1880s and 1890s. Sadly, thoseessentially libertarian roots have long since been aban-doned by the party of Jefferson and Jackson.

If you’re unhappy that today’s political parties givelip service to equal rights as they busy themselves carv-ing yours up and passing out the pieces, don’t blameme. I’m a Locofoco.


P r i n c i p l e d P a r t i e s

Leggett and theLocofocos were notantiwealth or antibank, but theywere vociferouslyopposed to anyunequal application of the law.

Dr. Darshak Sanghavi, an academic pediatriccardiologist who (like all physicians) finan-cially benefits from the cartelization of medi-

cine, explains in Slate, the online magazine, that healthcare markets can’t work because of the informationasymmetry between physician and patient (“Talk to theInvisible Hand,” www.tinyurl.com/y948v3o). So weneed the cartel.This is not particularly surprising; mostphysicians think that. But it ain’t so.

Through several examples Sanghavi attempts todemonstrate that a medical market with the cus-tomer/patient in charge just doesn’t make sense. Withthe U.S. government now paying half of all medicalbills and consumers paying only 10 percent out ofpocket, it is not surprising that Sang-havi can show that marginal efforts tomove toward a market without mak-ing any fundamental changes in thesystem do not always work, but let’slook at his examples:

In 2004 President Clinton devel-oped chest pain, was diagnosed withcoronary artery disease (CAD) andtreated with coronary artery bypass grafting (CABG).Sanghavi notes that Clinton, savvy though we knowhim to be, did not study New York state’s database ofhospital- and surgeon-specific death rates from heartsurgery. Had he done so, he might have thought twiceabout having the surgery at Columbia-Presbyterian inNew York City, which the database lists as having “thehighest death rate of any of the 35 hospitals doingbypass surgery.” Sanghavi sees this as evidence that evensavvy consumers cannot deal with the complexities ofthe medical marketplace. But is it?

First, in a true medical marketplace, hospitals mightfind it profitable to advertise the results of the database,something they have little incentive to do now, whenpatients remain rationally ignorant of the quality ofhospitals not covered by their employer-chosen insur-ance. More important, the database in the form devel-oped by New York state is crude. Are you better offgoing to a cardiac surgeon who does 50 CABGs peryear, restricting his surgery to only otherwise healthypatients with mild CAD, and has a 1 percent complica-tion rate, or are you better off going to a cardiac sur-geon who does 500 CABGs per year, takes patientsrefused surgery elsewhere because they’re viewed as“too risky,” and who has a 2 percent complication rate

overall (but among otherwise healthypatients with mild CAD has a compli-cation rate of 0.4 percent—thoughthis breakdown is not in the raw dataoffered by the New York database)?

How can one obtain such detailedanalysis of the data? One can do whatClinton did: Go with the recom-mendation of the cardiologists he

entrusted with his care. In a true medical marketplacehe’d have even more options: Businesses would developthat analyzed such data and provided their analysis for afee (or perhaps it would be available for free on theInternet, paid for by ads, like Google searches).

Sanghavi questions whether it helps for consumersto “have skin in the game”—that is, pay some healthcare costs directly so they no longer treat it as essen-tially a free good, overusing it and driving up costs. He

Medical Markets Can’t Work?It Just Ain’t So!


B Y T H E O D O R E L E V Y

Theodore Levy ([email protected]) is a physician practicing in the southwest.

Most doctors thinkthat we need acartelized health care system.


acknowledges that the famous RAND Health Insur-ance Study (1982) showed that when patients paid 25percent of costs, overall medical spending dropped 20percent.

But Sanghavi is concerned. He notes that consumers“cut back equally on highly effective and largely point-less treatments.” He fails to say this means that underthe highly regulated system he defends, where medicalexperts are in charge of determining what is neededwithout worrying about patient cost concerns, “largelypointless treatments” are still available. Of the RANDresults Sanghavi notes with a concern that can only befelt by physicians: “The cost savings came from mostlyavoiding doctors altogether.” But most people who seedoctors have transitory complaints that resolve on theirown, caused by problems or pathologies that are neverdetermined, no matter the expense ofthe workup (headache and back painbeing the two most common com-plaints). So it is good that “the costsavings came from mostly avoidingdoctors altogether.”

Most important, the RAND studyshowed, though Sanghavi didn’t men-tion it, that with few exceptions, see-ing doctors less often and spending 20percent less overall “had no adverseeffects on participant health.”

Of course, if we had a competitive market in healthcare, with all its implications for easier access to infor-mation, broader advertising of various options, directprice competition, easier access to medications, andmore, I would expect that consumers might better dis-tinguish “highly effective” from “largely worthless”medical practices. They seem to make good choicesnow when given the opportunity, in areas like Lasikand plastic surgery.

For Sanghavi, “The usual rules of the marketplaceseem not to apply to health care” because doctorsapparently know more about medicine than patientsdo. So doctors control the interaction. So regulationsare needed. So the argument goes.

But this argument proves too much. Informationasymmetry is the norm not the exception. Car dealersknow more about cars than consumers do. The guysbehind the Genius Bar know lots more about comput-ers than Apple customers do. Are consumers alwaysbeing ripped off? Sanghavi the pediatric cardiologistclaims—correctly, I’m sure—that no parents ever ques-tioned him when he ordered a special type of colorDoppler cardiac ultrasound on their child. But heunfortunately seems to believe a medical marketplace iseverything we have now—all the regulatory burdens,supply restrictions, informational prohibitions—exceptpatients will pay more out of pocket. He ignores vari-ous other innovations that may help consumers getwhat they need despite information asymmetry. Forexample, competing cardiologists trying to simplify

matters for patients might offer flatfees, including labs and imaging, sothe consumer could compare physi-cian costs more easily and not need to know whether a specific lab orultrasound was “needed.” Alterna-tively, consumers could go on theweb and use the services of MedicalCost Advocate (www.medicalcostad-vocate.com). Such services would bemore commonplace in a truly freemarket in health care.

Some say that health care is different, and if by thatthey mean the health care market has been artificiallyrestricted, segmented, regulated, and distorted by gov-ernment interventions dating back more than a cen-tury, they are right. Only the educational and financialindustries come close in the degree of governmentregulation, which doesn’t speak well of regulation’ssuccess. But if they mean health care is more compli-cated than anything else offered in the marketplace orthat health concerns don’t respond to supply anddemand or that medical services can only be providedwhen medical cartels battle government payers whileinsulating patients from the true costs of care . . . it justain’t so.

M e d i c a l M a r k e t s C a n ’ t W o r k ? I T J U S T A I N ’ T S O !

Informationasymmetry is thenorm not theexception.Areconsumers alwaysbeing ripped off?

If you got an email offering you the chance to investin a business that would create new profitableindustries, employ millions of people, reduce

energy consumption without reducing quality of life,and improve environmental quality, would you be skep-tical? And if the email went on to claim that the tech-nologies to do all this exist now and could save existingbusinesses billions ofdollars in just a fewyears by reducing wasteand energy use, wouldyou wonder why noone was already imple-menting all these “com-mon sense” ideas? If theemail went on to prom-ise that you could dothis all at no risk byinvesting borrowedmoney, you’d likely bereaching for the deletekey.

If we substitute “thefederal government” or“the United NationsEnvironment Programme” or “the European Union”for “you” and change the email to a proposed law, how-ever, we discover that politicians from Washington toBrussels are embracing measures to “green” the econ-omy and create “green jobs” with an almost religiousfervor, despite weak empirical support for these pro-posals. The Obama administration included billions ofspending and tax incentives for green initiatives in itsbudget, and last spring’s “stimulus” bill poured $62 bil-

lion in transfers plus $20 billion in tax cuts into “greeninitiatives.”

Unfortunately, the rhetoric about “greening theeconomy” or creating “green jobs” is just political win-dow-dressing for some of the same central-planningmeasures proposed by the left for years. Behind thatrhetoric are proposals built around government subsi-

dies for favored tech-nologies, measures tolimit trade, and a greatdeal of wishful thinkingabout alternative energymeasures not quiteready for prime time.

What Counts as Green?

The first problem in untangling the

claims made by green-economy proponents is determining whatcounts as a “green” jobor technology. Manytimes no definition atall is provided; even

when the term is defined, different groups pick quitedifferent definitions. For example, the U.S. Conferenceof Mayors’ report Current and Potential Green Jobs in theU.S. Economy defines a green job as

B Y A N D R E W P. M O R R I S S

The Green-Economy Mirage


Andrew Morriss ([email protected]) is H. Ross and HelenWorkman Professor of Law and Business at the University of Illinois,Urbana-Champaign. For more of his work on green jobs see “Green JobsMyths” at www.tinyurl.com/cpe8ut and “The Illusion of Green Jobs” atwww.tinyurl.com/yfyro9b.

any activity that generates electricity using renew-able or nuclear fuels, agriculture jobs supplying corn or soy for transportation fuels, manufacturingjobs producing goods used in renewable power generation, equipment dealers and wholesalers specializing in renewable energy or energy-effi-ciency products, construction and installation ofenergy and pollution management systems, govern-ment administration of environmental programs,and supporting jobs in the engineering, legal,research and consulting fields.

Interestingly, the mayors count jobs in existingnuclear power plants but not in new ones.

In contrast the United Nations Environment Pro-gramme’s Green Jobs: Towards Decent Work in a Sustain-able, Low-Carbon World excludes all nuclear jobs, butincludes all jobs said to “contributesubstantially to preserving or restoringenvironmental quality.”

If we take politics into account wecan explain these definitions. TheConference of Mayors is concernedwith building a coalition for spendingto benefit its members. Those mayorswith nuclear power plants in theircities want to claim credit for greeningtheir economy through nuclear plants(which also pay lots of local taxes).The U.N. report, onthe other hand, was aimed at gaining support from aninternational environmental movement that detestsnuclear power, which explains why it didn’t count anynuclear jobs.

Neither applies any objective criteria to the problemof defining which industries will gain and which willlose. For example, both define as “green” any jobsrelated to nonfossil-fuel technology, even if these energysources (such as wood) release as much carbon dioxideper BTU of energy generated as fossil-fuel sources—ormore. (Wood is much less efficient in terms of carbonemissions than either natural gas or gasoline on a per-BTU basis.) Moreover, burning many renewable fuelsproduces considerable particulate pollution, both insidehomes and outside—a serious problem particularly forwomen and children in developing countries.

Green-economy proponents also disagree abouthow green hydroelectric plants are. Many who advo-cate government spending on alternative energy alsowant to dismantle existing hydro projects to restorerivers and improve fish habitats. (And many of thosedams were built with subsidies by the Bureau of Recla-mation and Army Corps of Engineers and would haveflunked any serious cost-benefit analysis.) But smallhydro, their preferred alternative, is by definition“small.” As a result, it would take quite a few smallhydro plants to produce sufficient energy to replaceeven a single large dam or coal-fired power plant. Notsurprisingly, there is no evidence of a large-scale build-ing boom in small hydro projects or even a seriouseffort to identify where such projects might be located.

Even more interestingly, both definitions are expan-sive enough to include “supporting jobs in the

engineering, legal, research, and con-sulting fields.” Indeed, the Confer-ence of Mayors found that the toptwo U.S. jurisdictions for currentgreen jobs are New York City andWashington, D.C., suggesting thatthe investment in green technologyso far is producing a lot of consult-ants, lawyers, and lobbyists ratherthan engineers or factory workers.Another estimate found more secre-

taries, management analysts, bookkeepers, and janitorsamong “green jobs” than environmental scientists.

Defining terms is essential to a rational policydebate; without clarity we end up with a divisionbetween favored and disfavored technologies driven byinterest groups rather than by either market forces orlogical thinking. Unfortunately, so far the green-econ-omy literature has mostly produced lists of “technolo-gies we like” and “technologies we don’t like” based onpolitics. We certainly shouldn’t be spending billions ofdollars promoting what we can’t define.

Where Do Estimates Come From?

Even if we don’t quite know what a green economylooks like, its advocates assure us there will be lots

of jobs and other benefits from converting to it. Notsurprisingly, most green-economy proposals predict


T h e G r e e n - E c o n o m y M i r a g e

The investment ingreen technology sofar is producing a lotof consultants,lawyers, and lobbyists.

huge benefits at low cost, making them politicallyappealing. Jobs will appear in economically depressedareas, and energy efficiency will soar, saving firms, con-sumers, and governments billions. Unfortunately thesebenefits are largely due to inappropriate economicforecasting methods. In particular, most estimates areproduced via “input-output analysis,” the same tech-nique used to produce outlandish claims for the bene-fits of municipal stadium projects.

In an input-output analysis a vast matrix is calcu-lated from economic data as they exist today, tracingconnections between firms in different industries. Forexample, an automobile plant uses steel, aluminum,plastic, batteries, paint, tires, and other materials to pro-duce cars with a particular amount of labor per carunder current technology. If wethought that the plant would beginproducing more cars, the input-out-put matrix could be used to calculatehow much more steel, aluminum, andother inputs would be demanded bythe car industry and how many moreworkers would be hired to work in it.

There is a role for such calculationsin industry forecasts (predicting steeldemand from auto production helpssteel plants decide about investing innew capacity, for example). But usingthem to predict the impact of govern-ment programs to green the economyis problematic because the methodrests on two assumptions that green proposals violate:constant prices and constant technology.

By definition, efforts to change energy technologyare going to change technology and prices. The rela-tionships in an input-output matrix based on using coalto generate electricity and gasoline to fuel cars simplyaren’t applicable to an economy where substantialamounts of energy come from high-cost sources likewind and solar and the cars are hybrids or run onethanol.

Worse, the green-economy predictions rest onextremely optimistic estimates of the impact of spend-ing on new technologies. Almost no advocates of thesepolicies deduct the jobs lost from replacing existing

technologies with the new, green ones. Refinery work-ers, coal miners, fossil-fuel power plant workers, andmany others will all lose their jobs if the proposed shiftto nonfossil fuels takes place. Some of those workersmay find jobs insulating public buildings or boltingtogether windmills, but many will not. Because all thatpublic spending to produce these new technologiescomes from taxes (whether today or in the future), itreduces private spending and so eliminates the jobs thatwould have been created by the higher private spend-ing displaced by the taxes.

Any estimates of major changes are likely to beimprecise even if all these factors are taken into accountbecause of the considerable uncertainty surroundingthese relationships. Ignoring all the downsides, as

green-economy proponents do, sug-gests that they are less interested inaccurate predictions than in creatingpolitical pressure for policies regard-less of their impact.

Labor Productivity

Even if we set aside these technicalissues, however, there are still

some serious problems with green-economy plans. Perhaps most impor-tant, the literature mistakenly glorifieslow-productivity jobs on groundsthat more employment is better. Forexample, the UN Environment Pro-gramme criticizes modern agricul-

ture because “labor is extruded from all points in thesystem,” argues wind and solar are better technologiesbecause producing each BTU of energy requires morelabor than in fossil-fuel industries, and argues that thesteel industry has evolved to use too little labor.

To see why this is a problem, let’s consider ethanol.Although even many environmentalists now recognizeethanol’s problems, it was the darling of alternative-energy proponents for many years, and hundreds ofmillions of dollars in subsidies have produced a sub-stantial corn-based ethanol industry in the UnitedStates. (Despite these subsidies, the fuel remainsuncompetitive with gasoline at current gas prices.)Corn-based ethanol requires more labor to produce


A n d r e w P. M o r r i s s

Ignoring alldownsides, as green-economy proponentsdo, suggests that theyare interested increating politicalpressure for policiesregardless of theirimpact.

than gasoline does, largely because growing and pro-cessing corn is more labor-intensive than pumping andrefining oil.As a result, green-economy advocates scoreethanol higher than gasoline since each BTU ofenergy in ethanol takes more labor to make than aBTU of gasoline.

But lower labor productivity is a bad thing not abenefit. Not only does more labor mean higher costs,but higher-productivity jobs (generally those thatinvolve working with greater amounts of capital) canpay higher wages precisely because they are more pro-ductive. Low-productivity jobs are low-paying jobsbecause employers cannot afford to pay their employeesmore than the employees generate. If more labor werethe metric, we’d all be better off using quills and parch-ment in place of computers.

Rejecting Trade

The advocates for greening theeconomy reject more than basic

labor economics. They also believethat a green economy is one with rel-atively little trade. The literatureemphasizes buying locally producedgoods over those from other areas,both to save the transportation costsand to promote self-sufficiency. Notsurprisingly, the UN Environment Programme criti-cizes Walmart for its global supply chain:

Companies like Wal-Mart (with its policy of globalsourcing and especially its policy of searching forcheap products, with potential negative impacts forlabor and the environment) are major drivers andsymptoms of [increased global trade]. . . . Ultimatelya more sustainable economic system will have to bebased on shorter distances and thus reduced trans-portation needs. This is not so much a technicalchallenge as a fundamental systemic challenge.

To be fair, the benefits of trade are sometimes hardto understand. Nobel Prize-winner Paul Samuelsonsaid the theory of comparative advantage was a contribution of economic theory that was both“nonobvious and nontrivial,” and generations of Econ

101 instructors have proved his point by struggling toget students to understand it. But the libertarian casefor trade is remarkably simple and clear: Voluntaryexchanges must make people better off or theywouldn’t occur, so a world with more voluntaryexchange is preferable to one with less. Even the per-son most confused by trade theory can understandthat autarky (producing everything locally) is a recipefor disaster by examining the record of Albania undercommunist dictator Enver Hoxha or North Koreatoday, two examples of societies where the rulersreject virtually all trade.

Moreover, the idea of locally grown food (a keycomponent of the green economy) is hard to accept forthose of us living far enough north to lack a year-roundgrowing season. From my home in rural Illinois, I can

see miles of soybean and corn fields. Iam delighted that my neighbors cantrade their corn and soybeans to peo-ple living elsewhere and that peoplein countries from France to Hon-duras to Israel to New Zealand sendagricultural products here in return. Ican buy French wine, Honduranbananas, Israeli citrus, and NewZealand lamb in my local grocerystore because of trade, enriching both

the variety and healthfulness of my diet. Even if it didn’t make us better off, the freedom to trade wouldbe an important liberty. Since it does, it is indispensableto the vastly better lives we live today compared to ourancestors.

Ignoring Incentives

Those advocating for a green economy often appearto believe that no one will undertake any measures

to improve environmental quality or conserve resourceswithout a government program to show them the way.We know this is false because we have over a hundredyears of experience with market incentives for bothproviding environmental quality and reducing resourceuse.

Studies of income levels and environmental qualityhave found what is termed the “environmental Kuznetscurve,” a U-shaped relationship between national



Advocates forgreening theeconomy believe thata green economy isone with little trade.

income and environmental quality. As very poor coun-tries begin to develop, environmental quality often fallsas energy production and use increase, factories appear,and people begin to consume more. But once percapita gross domestic product (GDP) reaches about$5,000, people can afford to spend more on improvingthe environment. Not surprisingly they do, and envi-ronmental quality improves after that point with respectto most pollutants for which we have data. In short,richer is greener.

Environmental quality also improves because marketincentives spur firms to reduce energy and resourceuse. Any firm that cuts itsenergy use can devote thesavings to undercutting its competitors’ prices.This has happened on aneconomy-wide basis. Forexample, from the 1970sto 2000, energy use perdollar of real GDP fell by 36 percent as firmseconomized on energywithout reducing output.Each unit of energy inputyielded four times asmuch useful heat, movedpeople 550 times farther,provided 50 times moreillumination, and produced 12 times as much electricityin 2000 compared to 1900—a stunning success story.Major energy-using industries like steel, aluminum, andpaper have all become more energy- and resource-effi-cient, while consumer goods like refrigerators havebecome larger, more feature-rich, and cheaper to oper-ate. It doesn’t take a government program to makefirms more efficient, but it does take a market economy.

According to its proponents, the green economywill run on biofuels, wind, and solar power, ushering ina new age of clean energy. Unfortunately, this is mostlywishful thinking. The Department of Energy (DOE)

says wind currently contributes less than 0.6 percent oftotal U.S. energy production. (Usually green-energyadvocates note that it contributes 7 percent of renewableelectricity generation, ignoring the less flattering totalenergy numbers.) Moreover, wind is both expensive andunreliable, as wind turbines produce energy only whenthe wind blows. Plus the massive wind farms green-energy advocates envision would require building whatDOE estimates are $60 billion of new transmissionlines (which many environmentalists oppose) and off-shore wind farms like the Cape Wind project (blockedfor years by the late Sen.Ted Kennedy, who objected to

its impact on the viewfrom his sailboat). Thereare also important ques-tions about wind turbines’effects on bird popula-tions and the impact of“shadow flicker” from theturbine blades on neigh-bors. Similarly, solar power(mostly solar thermal andhot-water production)currently produces only0.05 percent of U.S.energy consumption andis projected by DOE torise to just 0.13 percent by2030. Solar panel arrays

take a great deal of land, usually in sensitive desert envi-ronments where endangered-species issues have alreadyblocked some proposed photovoltaic sites. And bothsolar and wind power require expensive backup plantsfor when weather conditions aren’t right (such as atnight and on days without wind).

None of these problems are insurmountable, and it isquite possible (and perhaps likely) that as the prices ofnatural gas and oil rise in the future, an entrepreneurialinventor will find ways to make these technologiesviable.The problem is that they are not viable today andwill not become so in an environment of subsidies.


A n d r e w P. M o r r i s s

Zero emissions! Zero risk! Zero-point-zero-six percent of total energy produc-tion! Act now!Chuck Coker



B Y R I C H A R D W. F U L M E R

When it comes to power, energy density is the key.Solar power, wind power, and ethanol are soexpensive because they are derived from very dif-

fuse energy sources. It takes a lot of energy collectors such assolar cells, wind turbines, or corn stalks covering many squaremiles to produce the same amount of power that traditionalcoal, natural gas, or nuclear plants can on just a few acres.

Each of these alternative energy sources is based onmature technology. Agriculture and fermentation have theirroots in prehistory; windmills date back at least to 65 B.C.;the photovoltaic effect was discovered in 1839.Yet nowherein the world are these technologies serving as primaryenergy sources without significant government subsidies.While incremental improvements can be expected, it wouldtake an order-of-magnitude increase in productivity forthem to become viable. As old and as well-researched as thetechnologies are, such improvements are possible butunlikely.As significant future energy sources, these technolo-gies are dead ends, which is why the government, and notthe private sector, is funding them.

Industry is more than willing to risk research dollars ontechnologies that show real promise, but it is not willing toflush shareholder money down a rat hole. Politicians, however,operate from different incentives.When a crisis, real or imag-ined, makes headlines, they want voters to see them “doingsomething” about it, and they must move quickly becauseelection cycles and constituent attention spans are short.Funding long-term research in promising technologies does-n’t meet politicians’ needs. Solar panels, wind turbines, andethanol refineries are all current technology and can beerected quickly with fanfare and photo ops. By the time thesealternative power sources prove to be financial and, possibly,environmental busts, the politicians will have been reelectedand voters’ attention will have shifted to the next crisis.

Another benefit of subsidizing “shovel ready” solutions isthat existing technologies have existing supporters who canprovide campaign funds. Such supporters, however, consti-tute a well-financed status quo that will make governmentfunding, once started, difficult to end. For example, eventhough corn-based ethanol has driven up food and fuelprices, increased auto emissions, raised atmospheric carbondioxide concentrations (by causing additional acreage to betilled), and possibly resulted in net energy losses, the govern-ment is still subsidizing the industry and still requiring thatthe fuel be added to gasoline.

Wind energy, for its part, has been “just a few years away”from being economically competitive with conventionalpower for at least the last 25 years, and this will not change

any time soon.The Energy Information Agency predicts thatin 2016 wind power will still be 49 percent to 77 percentmore expensive than electricity from either coal or naturalgas. Furthermore, because wind turbines work only whenthe wind blows, wind farms cannot replace conventionalplants. Backup power from conventional sources, usually gasturbines, must be ready to come on line the moment thewind fails. Despite these fundamental problems, subsidiescontinue to flow thanks to an entrenched lobby.

By contrast, consider the significant oil-industry invest-ments in researching biofuels made from algae. Unlikeethanol, biofuels are chemically similar to fuel made frompetroleum and, like petroleum-based fuels, have a signifi-cantly higher energy content than ethanol. Biofuels can alsobe handled by current fuel distribution systems and can beburned in today’s vehicles.

Algae can be grown in brackish water on desert land and,with today’s technology, can produce over 2,000 gallons offuel per acre each year. This compares favorably with theapproximately 250 gallons of ethanol that can be producedfrom an acre of corn—a ratio of 8 to 1. Accounting for thedifferences in BTU content, the ratio jumps to over 12 to 1.It may even be possible to boost productivity to 100,000 gal-lons per acre per year, raising algae’s potential to over 600times that of corn-based ethanol!

Biofuels are carbon-neutral because the carbon dioxidereleased when they are burned is extracted from the atmos-phere by the algae. Unlike burning petroleum-based fuels,then, burning biofuels will not result in a net increase inatmospheric CO2 levels.

With algae’s vast potential, it is easy to understand whyprivate industry is interested and why no government subsi-dies are needed to encourage investment. Moreover, if algae-based fuels do not prove viable, the companies nowresearching them will have no “status quo” problems withending their investments and shifting scarce resources tomore promising technologies—where “promise” is measuredin density.

Richard Fulmer ([email protected]) is a senior fellow withthe Institute for Energy Research and coauthor (with Robert L. Bradley,Jr.) of Energy:The Master Resource. This article originally appeared at www.thefreemanonline.org.

How Dense Can They Get? The Fallacy of Alternative FuelsSource Gallons of fuel BTUs Million

per acre per per acreper yr1 gallon2 per year

Algae 2,000 128,520 257Corn 250 84,262 21Sugar Cane 450 84,262 38

Source: 1. http://tinyurl.com/y8u6vzm 2. http://tinyurl.com/yerpqh6

It is an age-old question of perception. Show a per-son a glass with some liquid in it and ask,“Is it half-full or half-empty?”

The importance of the answer depends on the inter-ests of the person asking the question. If you owned arestaurant and wanted to skimp on the wine, you wouldrather your customers focused on what they are gettingand not on what they aren’t. You won’t get many com-plaints if your patrons think that half aglass of wine is normal.

We are facing exactly that problemin America with respect to freedom.“Half-empty” people notice that a lotof freedom is missing. They are awarethat they’re prevented by force of lawfrom doing many things they wouldlike to do, and compelled by force oflaw to do many others that they wouldprefer not to do. Most of those peoplealso know that in the past there werefar fewer restrictions on freedom thantoday; they sense that with each passingyear, the glasses contain less and lesswine.

Looking on the Bright Sidealf-full” people, in contrast, rarely think aboutthe government’s innumerable laws and taxes as

deprivations of their freedom.They focus on what free-dom they still have and regard it as enough.

Just as restaurateurs prefer customers who see half-full glasses and are content with that, so rulers prefercitizens who are content with whatever freedom theychoose to permit. For that reason, crafty rulers—and

the form of government doesn’t matter—try to condi-tion the people to think that they are enjoying the bestpossible state of affairs. Rulers want the people tobelieve that all the state’s numerous mandates, prohibi-tions, and confiscations are actually good; they’re donenot to take away freedom but only to improve society.If you can get your citizens to look at things that way,they will be as docile as sheep.

A survey by George Mason Univer-sity economics professor Daniel Kleinhelped me (a half-empty person) to seewhat’s going on. Klein had written crit-ically about minimum-wage legislation,mentioning that such laws not only haveadverse economic consequences but alsoabridge freedom—namely, freedom ofcontract. Imposing a minimum wagecommands employers: Either pay eachemployee at least the legal minimum orelse face prosecution.To Klein’s surprisea number of economists responded thatthey did not think that law has anyimportant impact on freedom. Kleinsubsequently conducted a poll askingeconomists if they felt that minimum-wage laws were an attack on freedom.A

majority of those who responded said that theyregarded them as having little or no impact on free-dom.

So here is a government mandate—do this or you’llbe punished—yet a majority of economists see no loss

H“

B Y G E O R G E L E E F

Freedom in America: Is the Glass Half-full or Half-empty?


George Leef ([email protected]) is book review editor of The Freeman.

Focusing on the liberties we still have,instead of on those we’ve lost, soundsnicer and certainly pleases our rulers.commons.wikimedia.org

of freedom. An obvious explanation is that the mini-mum wage simply has no effect on professors. Theydon’t hire low-wage workers and therefore feel no stingfrom the law. But even when people are directlyaffected by government actions that restrict their free-dom, they’re apt to shrug it off as “just one of thosethings.”They still have a lot of other freedoms, after all.Why get upset over the part of the glass that’s empty?Enjoy the part that’s full.

Most people view taxation like that. For working,successful Americans, federal, state, and local taxestake about half their income. If it weren’t for thoseexactions, they would be able to spend, invest, anddonate to charities much more than they now can.True, the tax system is cleverly designed to hide theimpact of taxes through anotherpiece of coercion—withholding.Nevertheless, intelligent peopleknow that a great deal of theirmoney is confiscated by the govern-ment. Few complain. In fact, manysupport political candidates whohave pledged to increase their taxes.How do we explain that? The “half-full” mentality does it. The glass may be down to 49 percent, but that’senough.

Freedom of contract gives us another illustration.Government has steadily whittled away at it over thelast several decades but few people seem to care. Theminimum wage is just one aspect of the attack on free-dom of contract; there are many others. Employers maynot “discriminate” when hiring workers, meaning thatthey are subject to legal action by the government ifthey allegedly decline to hire an applicant because ofhis race or some other immutable characteristic (“for-bidden grounds,” as legal scholar Richard Epstein puts it). Do Americans regard “affirmative action” laws as an abridgement of freedom? Mostly, no. It’s not justthat most of us don’t hire any workers, but also thatfreedom to choose with whom to contract has beentarred with the pejorative “discrimination,” and there-fore laws taking away that freedom are actuallyapplauded. Why should people be free to do somethingthat’s bad?

Medicine is another part of life where our freedomhas been trimmed.We are not allowed, for example, topurchase any medicine that hasn’t been approved by theFood and Drug Administration. A concerted effort tooverturn that law on constitutional grounds failedrecently.This can be a matter of life and death for a fewpeople, but the court held that the government wasdoing nothing wrong in making it illegal for sick peo-ple to use unapproved medicines.There was almost noprotest. Apparently, Americans are so used to govern-ment agencies regulating their lives that freedom todecide which medicines to take is now in that unob-served empty part of the glass.

Too Much Freedom?

If a law or regulation seems to takeaway some freedom,“half-full” peo-

ple think, “It’s not that we’re now lessfree but that we had too much freedombefore.The government is giving us abetter balance.”

Let’s look at a few more examples.The government punishes merchantsif they increase prices “too much” fol-lowing a natural disaster (“price goug-ing”). Hardly any Americans objectthat this deprives merchants (not to

mention consumers) of freedom.The government dictates that only certain kinds of

light bulbs may be used in the future. Americans offerhardly a peep of protest.

The government makes it illegal to drive a car unlessthe driver and passengers are buckled in. Are any of the politicians who supported the law voted out ofoffice? No.

The government forces banks to make mortgageloans to people who would not qualify for one underprudent lending standards. No complaints about thatattack on freedom, although some Americans are nowunhappy that it helped catalyze the mortgage crisis.

The government requires people to buy officialstamps for all documents to make them legal. Do thepeople care? Well, this one’s a trick. It’s the Stamp Act,imposed in 1765 by the British government. The lawsent a great many Americans into the streets to protest


F r e e d o m i n A m e r i c a : I s t h e G l a s s H a l f - f u l l o r H a l f - e m p t y ?

Many people supportpolitical candidateswho have promisedto increase theirtaxes. How do weexplain that?

and threaten the officials charged with enforcing thelaw. Most Americans were not “half-full” people backthen. If a similar law were passed today, people wouldmeekly obey, saying to themselves, “Well, the govern-ment needs more money for all the good things itdoes.”

Skeptics may be thinking, “Okay, some peripheralbits of freedom may have been whittled away over theyears, but the government wouldnever deprive the people of any reallyimportant aspect of freedom.” Putaside the riposte that what one personthinks peripheral may be extremelyimportant to another. I think that the“glass half-full” view most peopleapparently have puts all of our free-dom at risk. Could we lose, say, free-dom of the press the way we have lostother, “peripheral” freedoms? I thinkso. Here’s a hypothetical case to make my point.

Suppose that a new law were proposed, the“National Truth and Civility in Publishing Act.” Itwould establish a federal agency with authority to pun-ish anyone who published a book, magazine, newspa-per, blog, or anything else that was adjudged to beeither false or potentially harmful to the feelings of areader.Would Americans tolerate a law like that? It tearsthe heart out of the First Amendment. But I think most

Americans would be assuaged if the political spin doc-tors said,“Look, people are still free to write what theywant. The law merely tells them that they need to gettheir facts straight and not write in a way that could bedemeaning or offensive. The government has a com-pelling interest in promoting truthful and respectfulwriting, doesn’t it? What good ever comes from lies ordisrespectful writing? Freedom of the press has never

been absolute and we are merelyrefining it a little to make life better.”

“Half-full” people would probablyfall for that since they focus on thefreedom that’s left, not that which hasbeen taken away.They’d never give athought to the consequences of put-ting federal officials in a position toharass those who write what the gov-ernment does not want the public toread.With a law like that in place, the

baseline concept of what freedom means would adjustdownward again. No, the freedoms protected by theFirst Amendment are not secure. Nothing is if peopleonly look at the freedom that’s left, not that which isbeing taken away.

Frédéric Bastiat taught that people’s thinking is usu-ally influenced by what they see, not what they do notsee. His point is at the root of the slow death of free-dom in America.


G e o r g e L e e f

Nothing is secure ifpeople only look atthe freedom that’sleft, not that which isbeing taken away.

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B Y D O N A L D J . B O U D R E A U X

On Trade and Currency Manipulation

Thoughts on Freedom

Explaining that American imports fromChina reflect nothing more sinister than the voluntarychoices of American consumers does not satisfy simple-minded protectionists. It is sufficient that these importstake business away from some American producers. Inthe minds of simple-minded protectionists, interna-tional trade is harmful whenever itcauses domestic business to lose mar-ket share to foreign rivals.

Not all protectionists, though, arethis simple-minded. Some of themunderstand that resources have alter-native uses and that prosperity isenhanced when each specific resourceis used to produce that good or serv-ice that consumers value more highlythan any other good or service thatthat resource can be used to produce.The “sophisticated” protectionist (ifwe may call him that) also understandsthe argument based on comparativeadvantage—namely, free trade encour-ages resources to be used in their mostefficient ways.

But the sophisticated protectionistis still a protectionist. He cannot shakeoff his uneasy sense that imports somehow harm hiscountry’s prosperity. So he eagerly latches onto almostany excuse to proclaim that he of course staunchly sup-ports free trade “but not when foreigners do” this, that,or the other thing that allegedly nullifies the case forfree trade.

The length of the list is limited only by protection-ists’ fertile imaginations: Foreign governments subsidizeexporters; taxes and regulations in foreign jurisdictionsare less burdensome than taxes and regulations in the

home jurisdiction; foreign governments don’t have asmuch respect for human rights as the home govern-ment does; foreign industries are older and more expe-rienced and hence have an unfair advantage overdomestic industries; imports are sold by their foreignproducers at unfairly low prices; capital can freely movefrom one country to another. . . .Truly, the list is longand ever-growing.

An Idea With No Currency

Asound treatment of each item on the list requires more space

than is available here. (Suffice it fornow to say that none of these allegedexceptions to the case for free tradewithstands careful scrutiny.) So let’sfocus on just one such reason heardfrequently now for why free trade is unwise: undervalued foreign cur-rency.

The protectionist complaint aboutundervalued foreign currency restson the indisputable argument that the lower the price of a foreign cur-rency—for example, the Chineseyuan—the greater the quantities ofthis currency that will be bought. Justas a lower price for apples makes

apples a more attractive purchase for consumers, alower price for a currency makes it more attractive.

If the price of the yuan falls—that is, if it takes fewerdollars today than it did yesterday to buy yuan—peoplewith dollars will buy more yuan.


Donald Boudreaux ([email protected]) is a professor of economics atGeorge Mason University, a former FEE president, and the author ofGlobalization. He is the winner of the 2009 Thomas Szasz Award forOutstanding Contributions to the Cause of Civil Liberties (generalcategory).

The sophisticatedprotectionist is still aprotectionist. Heeagerly latches ontoalmost any excuse toproclaim that hesupports free trade“but not whenforeigners do” this,that, or the otherthing.

Americans are importing more from China. Pro-tectionists abhor this fact.

Yuan, like dollars, are not themselves consumablebut instead can be exchanged for goods, services, andassets. In the case of yuan, the goods, services, and assetsthat they can be directly exchanged for are supplied bythe Chinese. So the greater the number of yuan thatcan be bought for a dollar, the less expensive for Americans are Chinese products relative to Americanproducts.

Therefore, a lower-priced yuan causes Americans tobuy fewer U.S. products and more Chinese products.

Governments being what they are, it’s undeniablethat many of them—including the one headquarteredin Beijing—intervene in their economies in countlessdistorting ways. Let’s assume for theremainder of this article that the Chi-nese government does in fact keepthe price of the yuan artificially low.

Does this policy help the Chineseand harm Americans?

False Savings

Alow-priced yuan certainly shiftsbusiness to some Chinese pro-

ducers and away from American pro-ducers who compete with them, justas genuine efficiency improvements inChinese industry take some businessaway from American producers whocompete with Chinese producers. But contrary to pro-tectionists’ claims, Beijing’s efforts to lower the price ofthe yuan harms the Chinese economy and benefits theeconomies (including that of the United States) whosepeople trade with the Chinese.

To see why, let’s use a close-to-home example.When I was a child my elementary school—Immac-

ulate Conception School (ICS)—held two fund-raisingfairs each year.At these fairs we kids bought tickets thatwe could exchange for various trinkets and food. Ofcourse, some items cost more than others.A big stuffedpanda bear might have been priced at, say, 50 tickets, ahotdog at three tickets, and a pencil sporting the schoollogo at one ticket.

Using dollars, each of us students could buy as manyor as few tickets as we pleased (or, more accurately, as

many tickets as our parents could afford or would allowus to buy).

Suppose that ICS had undervalued its tickets. Sup-pose, if the “correct” price (by whatever calculus) was$1, ICS sold each ticket for 75 cents.

Undervaluing its currency in this way surely wouldhave resulted in more sales at the fairs.A 25 percent dis-count on trinkets and junk food is a darned attractivedeal for kids.

Would ICS have benefitted itself by such undervalu-ation of its medium of exchange? Some of its employeeswould have benefitted. The fairs would have requiredmore clerks and food preparers to handle the larger

demand. But it’s clear that undervalu-ing these tickets would have harmedICS on net. Instead of raising moneyfor its operations, ICS would have lostmoney. By underpricing its trinketsand junk food, it would have subsi-dized its students’ consumption ofthese things. Undervalued ticketswould have enabled its customers (usstudents) to acquire valuable goodsand food at prices below ICS’s cost ofsupplying them.

No student (including me) wouldhave complained about underval-ued fair tickets. Such undervaluation

would have been to our benefit.But the school principal (Sister Quentin, if I

recall)—who we can imagine was the architect of thisself-destructive scheme—would have realized, on com-ing to her senses, that artificially stimulating the school’sexports of trinkets and food on fair days is no path tolong-run and widespread prosperity for ICS.

The situation with the Beijing government is identical. The real costs of the resources and outputsexported by the Chinese people are not lowered simplybecause Beijing keeps the price of the yuan artifi-cially low. And the resources spent to supply the extraAmerican demand that results from an artificially lowprice of yuan—even though they are unseen by theuntrained eye—represent a huge cost that harms theChinese economy.


D o n a l d J . B o u d r e a u x

The real costs of theresources and outputsexported by theChinese people arenot lowered simplybecause Beijing keepsthe price of the yuanartificially low.

Walmart is one of the world’s largest, mostsuccessful, and most vilified corporations. Itwas ranked number four in the Fortune

500 from 1995 through 1998, reached number one in2002 and stayed there until 2009, when it fell behindExxon Mobil. It’s also the only firm in the top four ofthe Fortune 500 that isnot an energy company.

The concentratedpublic-relations cam-paign against Walmarthas been moderatelysuccessful, and the com-pany has drawn criti-cism from all sides:Commentators on theleft criticize the com-pany for its allegedimpact on wages andjobs; those on the rightcriticized its decision tojoin the National Gayand Lesbian Chamberof Commerce and tooffer “abortion pills” in 2006. Recently, Walmartannounced support for mandatory health coverage bylarge employers, bringing more criticism. Walmart’shandling of the attacks has been less effective than thecompany would have liked, and its attempts to defenditself have been a distraction.

The criticisms too often rely on anecdotes or statis-tical comparisons that are difficult to interpret. Whenone considers that Walmart is the world’s largest corpo-ration, with revenues of about $300 billion and almost

two million employees, anecdotes that cast the com-pany in a good or bad light are not particularly surpris-ing. Similarly, a simple comparison of employment (orwages) in a city with a Walmart to a city without one isonly minimally informative because such comparisonsoften fail to control for other explanatory characteris-

tics. Current research sug-gests that the economic,political, and social caseagainst Walmart is exagger-ated. Further, Walmart’s“Every Day Low Prices”do not come at an unac-ceptable social cost in theform of negative spilloversnot reflected in prices.Wal-mart is certainly imperfect,and there are reasons toview the company with acritical eye, but the usualcriticisms of the companycollapse under the weightof the evidence.

Does Walmart Squeeze Workers and Suppliers?

Economists Jerry Hausman and Ephraim Leibtagargue that we systematically overstate the rate of

price inflation because we don’t account for Walmart’sand other big-box companies’ impact correctly. Wal-mart claims to save consumers $2,500 per capita per

B Y A R T C A R D E N

Walmart’s Bottom Line


Art Carden ([email protected]) is an assistant professor of economicsand business at Rhodes College in Memphis and an adjunct fellow at theIndependent Institute.This essay was written while he was a visitingresearch fellow at the American Institute for Economic Research.

Walmart might incite the “yuck factor,” but differing aesthetic judgments donot justify government intervention.Kevin Ball

year. This is probably an overestimate, but studies I have done with Charles Courtemanche of the Univer-sity of North Carolina-Greensboro do suggest that Walmart increases our options.

Critics claim that Walmart can deliver low pricesbecause it destroys jobs, lowers labor standards, andsqueezes suppliers. The data, however, do not supportthe first two, while the third is misleading. Retail labormarket studies by University of Missouri economistEmek Basker show that Walmart modestly increasesretail employment. Critics are quick to counter byquestioning the quality of those jobs, correctly notingthat Walmart pays less than its unionized competitors.However, this should be qualified. Union pay scalesrestrict the labor pool from which unionized stores canhire: If the union contract specifies minimum compen-sation of $12 per hour, then people whose labor cannotproduce at least that much in revenuewill not be hired. Since Walmart is anopen shop, it has no such artificialfloor for the productivity of the peo-ple it can hire.Those who would notbe employable under union condi-tions are made better off despite theillusion of exploitation.

The company’s critics correctlypoint out that the last several decadeshave seen a large gap open between manufacturing andretail wages. But these data must be interpreted withcaution because immigration and changing labor partic-ipation have altered the distribution of the workforce.People who are today earning Walmart’s “Every DayLow Wages,” as the critics call them, might not have par-ticipated in the labor force several decades ago and theirwages would not have appeared in the official data.

Supposedly, Walmart drives small local mom-and-pop retailers out of business, spreading economic havocand weakening a community’s social fabric. In a paperpublished in Economic Inquiry, West Virginia Universityeconomists Andrea M. Dean and Russell S. Sobel fail todetect a statistically significant effect of Walmart on self-employment, the number of small businesses, orbankruptcy among small businesses. It is true that Wal-mart causes some businesses to close, particularly in sec-tors that directly compete with the company. However,

these businesses can be replaced by businesses in othersectors. In a summary of their research that appeared inthe Spring 2008 Regulation magazine, Dean and Sobeloffer the example of Main Street in Morgantown,WestVirginia, which was decimated by Walmart but whichsoon recovered as clothiers and electronics stores werereplaced by small businesses in other industries.

They also discuss the obvious objection that perhapsWalmart’s wake leaves a swath of low-value, low-wagebusinesses. They show, however, that Walmart penetra-tion does not appear to reduce the values of small businesses. Stacy Mitchell, author of The Big-Box Swin-dle, argues that Dean and Sobel’s result relies on an incorrect interpretation of Census data. For their part,Dean and Sobel say Mitchell misunderstands the data. Ifthey are correct, the effects of Walmart’s penetration areconsistent with what economists believe about technol-

ogy and economic growth as well aswith Joseph Schumpeter’s well-known concept of “creative destruc-tion.” Walmart’s expansion allowspeople to produce more with fewerresources and less labor, which freesthose resources and that labor tomove into other occupations.

Walmart also allegedly uses its rawbargaining strength to extract conces-

sions from suppliers. It is usually able to get lowerprices, but it also provides something of great value inreturn: access to its supply chain and logistical support.While anecdotes of Walmart’s hard bargaining abound,a 2001 Journal of Retailing study by Paul N. Bloom andVanessa G. Perry found that while dealing with Walmartcan hurt financial performance for companies that doonly a small share of business with the company,“large-share suppliers to Wal-Mart perform better than theirlarge-share counterparts reporting retailers other thanWal-Mart as their primary customers.” Bloom andPerry note that Walmart offers access to broad marketsand that companies taking advantage of this prosper asa result.

Sweatshops

Another common refrain is that Walmart and otherlarge retailers obtain their goods from third-world


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Walmart’s expansionallows people toproduce more withfewer resources andless labor.

“sweatshops.” In an important 2006 study published inthe Journal of Labor Research, economists BenjaminPowell and David Skarbek showed that “sweatshop”labor paid better than the alternatives. In a June 4,2008, article for the Library of Economics and Liberty,Powell summarizes this research and points out thatcriticisms of “sweatshop wages” (like those aimed at afactory in Honduras making clothes for Kathie LeeGifford in 1996) invariably compare the wages andworking conditions to American rather than Honduranworking conditions—a comparison he calls “irrelevant”because of restrictions on international labor mobility.Sweatshops are a blessing, not a burden. As Powellpoints out, sweatshop wages more than double theaverage in some countries. Unfortunately, boycotts andlegislation will not improve workingconditions around the world. Powellsummarizes the conditions that createlow wages in countries like Honduras:

Wages are low in the third worldbecause worker productivity is low(upper bound) and workers’ alter-natives are lousy (lower bound).Toget sustained improvements inoverall compensation, policiesmust raise worker productivityand/or increase alternatives avail-able to workers. Policies that try toraise compensation but fail tomove these two bounds risk raising compensationabove a worker’s upper bound, resulting in his losing his job and moving to a less-desirable alter-native.

Unwillingness to recognize this can lead to policiesthat do more harm than good. Abuses undoubtedlyoccur, but Walmart has the resources to be able to havean effective monitoring program—not necessarilybecause of explicit humanitarian impulses, but becauseconsumers are willing to pay for the guarantees andassurances that they are not buying the products of slavelabor. Since consumers demand information about theconditions in which those who make these goods labor,it is in Walmart’s best interests to monitor carefully the

conditions in which people produce the goods theyobtain from abroad.

The thesis that Walmart’s ethical-standards monitor-ing is an elaborate ruse is tempting, and a ruse mightpay off in the short run. However, Walmart should bedisciplined by the capital market. Failure to provideconsumers with what they demand—guarantees aboutinternational labor conditions, for example—at theprice they are willing to pay will hurt long-run prof-itability and, therefore, the stock price. It is wise to readwith a critical eye, but if Walmart’s managers are run-ning a systematic campaign of misinformation, thenthey are failing in their responsibility to shareholders.Someone who discovered such a ruse would be in aposition to profit handsomely by acquiring Walmart

stock and fixing the problem.

Walmart, Communities, and theEnvironment

In his 2000 book, Bowling Alone,political scientist Robert Putnam

documented a decline in “social capital”—which he defines as “net-works and norms of reciprocity” thathold communities together—in theUnited States since the 1950s.Walmart has been accused of con-tributing to this phenomenon. In a2006 study agricultural economistsStephan Goetz and Anil Rupasingha

reported evidence that Walmart reduced several meas-ures of social capital like census participation, voting,and a measure they themselves constructed. However,in a study published in Public Choice in early 2009,Charles Courtemanche, Jeremy Meiners, and I use Putnam’s data to show that there is no identifiable, sys-tematic negative relationship between increased Wal-mart density/longevity and measures of noneconomic“quality of life” or civic participation. As Walmart pen-etration increases, we cannot tell that people spend systematically less time with friends or less time civi-cally engaged.

Others have alleged that Walmart erodes Americanvalues. United States of Wal-Mart author John Dickercalls the company a “conservative cultural gatekeeper,”


Wa l m a r t ' s B o t t o m L i n e

Criticisms of“sweatshop wages”invariably comparethe wages andworking conditionsto American ratherthan local workingconditions.

and right-wing critics like those who operate theChristian website www.saveWal-Mart.com took Wal-mart to task for joining the National Gay and LesbianChamber of Commerce. (The company discontinuedthis affiliation in 2007.) Using similar data and methodsto those used in our study of social capital, my coau-thors and I were unable to find a systematic relationshipbetween Walmart’s penetration and individual values. Itappears that while people get their groceries at Wal-mart, they get their politics and their values elsewhere.

Finally, Walmart has been criticized for its allegedcontributions to environmental degradation, but itscost-cutting has considerably reduced the amount ofpackaging manufacturers use. This was particularlyimportant in 2008 as gas prices hit record highs.A May29, 2008, article on CNNMoney.comused Hamburger Helper as an exam-ple:To meet Walmart’s demands, Gen-eral Mills produces “denser pastashapes” that can be put into a box thatis 20 percent smaller, saving “890,000pounds of paper and eliminat[ing]500 trucks from the road.” Conditionscreate solutions: Walmart has beenable to use recent increases in fuelprices to trim additional fat from thesupply chain and to innovate in waysthat will lead to permanent increasesin productivity.

Discrimination, Health Care, and Subsidies

Finally, Walmart has been criticized for alleged sys-tematic discrimination against women and for

aggressive patterns of seeking local government subsi-dies.Walmart is the defendant in the largest class-actioncivil rights lawsuit in history—Dukes versus Wal-Mart,in which an estimated 1.6 million women allege adecades-long pattern of discrimination—but the cen-tral tenet of the case is inconsistent with Walmart’salleged morbid obsession with profits. In spite of theirincompatibility, these criticisms often appear side byside.There are conditions under which firms can max-imize profits while discriminating in employment, butbefore we can reconcile discrimination with profitmaximization we have to prove that these conditions

are in place. Otherwise, the hypothesis of profit maxi-mization works against discrimination and discrimina-tion works against profit maximization. If an employerinsisted on discriminating by refusing to hire produc-tive women or by paying them less than they wereworth, he would create profitable opportunities forcompetitors to scoop up members of the victim groupand earn profits by paying them something closer totheir market value.An employer’s ability to discriminatewill be sharply limited by competitive pressure.

Walmart’s critics have also argued that the companyplaces undue burdens on the government’s publichealth infrastructure. But this is a “problem” that existsbecause that infrastructure exists and not because ofWalmart as such. One could argue more plausibly that

by paying better than their employ-ees’ next-best alternatives, Walmartactually relieves some of the pressureon the public health infrastructure.The critics also miss that Walmart’sexistence provides a larger pool ofresources that can be taxed to providethese benefits.

One robust criticism remains:Wal-mart has sometimes used the State toredistribute resources to itself and tocripple its competitors. Walmart isaggressive about seeking subsidies,such as acquiring properties through

eminent domain, from governments eager to “attractnew jobs” and new tax revenue, as critical groups likeGood Jobs First, WalMartWatch.com, and WakeUpWalMart.com point out.These subsidies distort patternsof economic activity and sometimes can have the per-verse effect of taxing one firm to subsidize a competi-tor.The problem is compounded further by the allegedneed for more subsidies to redevelop areas blighted inWalmart’s wake. This issue provides a setting in whichWalmart’s critics can play a constructive role.

In 2005 Walmart supported an increase in the mini-mum wage, and in July 2009 it earned a front-pagemention in the Wall Street Journal for teaming up withthe Service Employees International Union and theCenter for American Progress to advocate mandatoryemployer-provided medical coverage. Walmart’s seem-


A r t C a r d e n

The hypothesis ofprofit maximizationworks againstdiscrimination anddiscrimination worksagainst profitmaximization.

ingly counterintuitive advocacy is a classic example ofwhat economist Bruce Yandle terms the “Baptists andBootleggers” phenomenon. Among the supporters ofProhibition were Baptists, many of whom felt that con-suming alcohol is a sin, and bootleggers, who stood toprofit handsomely if the government crippled potentiallegitimate competition. In the health care scenario the“Baptists” are groups that believe everyone has a funda-mental right to health care. The bootleggers are largefirms (like Walmart) that know that mandates will hurttheir smaller competitors.

There is also reason to believe thatWalmart’s business model is partiallyunderwritten by transportation subsi-dies. Critics often overlap with peoplewho criticize the American “loveaffair” with the automobile. The twoare related.While it is true that, all elseequal, Walmart has been good forconsumers, it is also an unintended consequence of the massive subsi-dies to transportation infrastructurethat created today’s urban sprawl. Tothe degree that Walmart is undesir-able, it is a symptom of a larger pat-tern of interventionism rather than a cause.

Perhaps most unsettlingly, Walmart’s embrace of the proposed health care mandates and advocacy of ahigher minimum wage illustrates a disturbing truthabout the reality of doing business in the twenty-firstcentury. By backing President Obama’s health care pro-posal, Walmart might be able to use this to fend offmore damaging legislation later. In short, Walmartcould be aiding and abetting what Ayn Rand called “anaristocracy of pull.” A 2006 volume of critical essayscalled the company “the face of twenty-first-centurycapitalism.” If twenty-first-century capitalism means

competition by politics rather than competition byproduction, we will see lower economic growth as aresult. This does not excuse the company’s use of thecoercive power of the State for its own benefit, but Wal-mart is an effect rather than a cause.

The economic, political, and social case against Wal-mart has been tried and measured against the best avail-able data. For the most part, it has been found wanting.We are left with a rather flimsy criticism, which is thatfor all its virtues (or at least its non-vices), Walmart isaesthetically unappealing.This visceral reaction to capi-

talist aesthetics has been called “theyuck factor,” and economist AlvinRoth has argued that we have to take“repugnance” seriously as a politicalconstraint. However, just because Ifind another’s choices repugnant, Idon’t have the right to supplant thosechoices with my own. People haveargued that what happens in some-one’s bedroom is none of the govern-ment’s business. By the same logic,what someone puts in his or hershopping cart is none of the govern-ment’s business. Even if Walmartcauses people to make bad aestheticchoices, the civility necessary for a

functioning society must take over.Walmart’s “Every Day Low Prices” policy has been

alleged to reduce labor standards, to squeeze suppliers,to decimate small retailers, and to tear the social fabric.In virtually every instance, the empirical evidence avail-able suggests that what Charles Fishman called The Wal-Mart Effect is at best positive, at worst benign.Walmart isa retailing innovator and a force for competitors andsuppliers to reckon with. As a social phenomenon,however, the alleged negative spillovers from Walmartare greatly overstated.


Wa l m a r t ' s B o t t o m L i n e

Walmart’s embrace of the proposedhealth care mandatesillustrates anunsettling truth:Companies competemore by politics thanby production.

Short selling is a little-understood, much-malignedtactic by which traders can profit from their beliefthat a company's stock is overvalued.

Following the financial problems of the last twoyears, short selling has come under fire, with new orrevived regulations proposed to curb the practice. It isunpatriotic, destructive, and destabilizing, say the critics.Such complaints are nothing new. President Hooverblamed short sellers for the continuing market declinesof 1931 and 1932, threatening regulation or even out-right prohibition. “Individuals who use the facilities ofthe [stock] Exchange for suchpurposes are not contributing tothe recovery of the UnitedStates,” he grumbled.

Defenders say short sellers add liquidity to markets. Whenshort sellers are present, buyersencounter a more liquid marketbecause they face a larger pool ofsellers than they would other-wise. More sellers—more liquid-ity—means more predictableprices and smoother pricechanges. Shorts can put a damper on runaway enthusi-asm, and when they are right, they can hasten thedemise of failed businesses.

The mechanics of short selling are simple.You bor-row stock and sell it, hoping its market price willdecline so you can repay your loan with stock that youbuy cheaply. In the meantime, you are said to be“short” that stock, the opposite of the situation ofsomeone who owns the shares and is “long.” For widelytraded stocks, brokers can easily find shares to borrow,

either from their own inventory or from customerswho have agreed to make their shares available. Forthinly traded stocks it may be difficult or impossible tofind shares to borrow. The short seller must pay thelender the amount of any dividends that the stock pays while he is short. And most brokers require cashon deposit to cover the obligation to buy the stock later on.

Most short sellers simply think a stock is overpricedand hope to profit from a decline. But sometimes shortsales are used as part of a hedging program. If you want

to “hedge your bets” you can shorta stock to offset possible losses in arelated stock that you own. Forexample, if you aren’t sure wherethe oil industry as a whole is goingbut you think Chevron is over-priced relative to Exxon Mobil,you can buy XOM and sell CVXshort. Or you may have shares ofyour employer’s stock coming toyou as part of your year-end bonusbut you fear a price drop beforethen. You can sell short and then

cover your position with the shares you receive. (Hedgefunds, incidentally, were originally organized to engagein hedging, but have since expanded into all sorts ofexotic trading strategies.)

Since there is no limit on how high a stock pricecan go, short sellers who are not hedging expose them-selves to unlimited potential loss. Amateur investors

B Y W A R R E N C . G I B S O N

The Long and Short of Short Selling


Warren Gibson([email protected]) teaches mechanical engineering atSanta Clara University and economics at San Jose State University.

flickr.com: Perpetual Tourist

should be very careful about selling short and shoulduse stop orders to exit their position if the market goesagainst them.

Failure is an essential feature of free markets. Com-panies that suffer losses must be allowed to fail so thatscarce capital can be redeployed into lines of businessthat better serve consumers. Short sellers, when they areright, hasten the necessary decline of the stock of a faltering company. In extreme cases, short sales can predict liquidation or bankruptcy. In other cases thestock of a generally sound company may have beendriven to unsustainable heights by bandwagon psychol-ogy, and short sellers can help deflate those spikes andhasten a return to more realistic levels.

But the message that the short seller brings is notalways popular. We don’t like to hearbad news.We may think there’s some-thing unseemly about speculatorsprofiting from other people’s troubles.Executives of companies whose stockis being shorted can be particularlyvocal about blaming speculators forbeating up their company shareswhen in fact their own managementblunders are at fault. Almost since thebeginning of organized stock trading,short sellers have been suspected ofdistorting markets, destroying goodcompanies, and reaping unjust profits.

Abusive Short Sales?

Can speculators start a run on a stock using massiveshort selling? Dumping large blocks of stock

could cause a price drop that would frighten manyholders into selling out, driving the stock still lower—awaterfall decline. Then at just the right moment, theshorts could cover their positions (buy shares to repaytheir stock loans), taking a big profit.Their profit wouldcome at the expense of other shareholders, with nofundamental developments accompanying the priceswings.

Such maneuvers are possible in theory but quite dif-ficult to pull off successfully.You have to find shares toborrow, and lots of them, if you’re going to have anoticeable impact on the share price.Then you have to

get the timing just right. If you don’t and the shareprice rebounds before you can get out, you’re left hold-ing the bag, with unlimited potential losses as the stockrises. If you are conspiring with others, there is alwaysthe danger that one of your group will break ranks andgrab profits ahead of the others. Manipulation, there-fore, is much easier said than done.

“Naked short selling” has come under scrutinyrecently and has been the subject of an increasing num-ber of lawsuits. One plaintiff ’s lawyer calls the practice“the largest commercial fraud in U.S. history, involvinghundreds of billions of dollars.” In a naked short sale,the seller has not borrowed the shares that he is obli-gated to deliver, but seems to be making them up outof thin air. Clearly this is fraudulent behavior. Clearly

someone has been cheated.Not necessarily. Sellers, short or

not, are given three business days todeliver the shares they have sold.Short sellers are required to have bor-rowed the shares or have good reasonto expect to find them by the settle-ment date. If that day arrives and thestock has not been delivered, a “fail-ure to deliver” event is recorded. Tosee what happens next, we need tounderstand a little of how stocks areheld and traded these days.

Stock trading has evolved into ahighly efficient business. Customers

can enter orders online and see the results in just sec-onds. Commission rates are low, often under $10, andproblems are extremely rare. This happy situation hasbeen made possible in part by the elimination of paperstock certificates. When you buy stock in today’s mar-ket, you actually acquire an entitlement to shares thatare kept in the possession of an organization called theDepository Trust Co. (DTC).When you sell your stock(or, strictly speaking, when you sell your entitlement),another organization, the National Securities ClearingCorp. (NSCC), issues an order to DTC to record thenew entitlement. The physical securities are nottouched. Most brokers are members of the NSCC andconduct virtually all their trading by electronic trans-mission of orders to transfer entitlements.


T h e L o n g a n d S h o r t o f S h o r t S e l l i n g

Failure is an essentialfeature of freemarkets. Short sellers,when they are right,hasten the necessarydecline of a falteringcompany.

Failures to deliver are rare, and the DTC and theNSCC have procedures in place to handle them whenthey do occur. First, the seller does not receive fundsuntil the shares are delivered. Likewise, the buyer doesnot relinquish funds until the shares are delivered. If thesettlement date passes and the seller has not delivered,the buyer can send a “buy-in” order to the NSCC.Theseller gets two more days to deliver the shares, and afterthat if there has still been no delivery, the NSCC willpurchase the shares and charge the account of themember who failed to deliver.

In this situation the only difference is who acts asthe effective lender of the security. While this is cer-tainly not the normal course of events, it is hard to seehow the economic effect on the market as a whole isany different from the effect of a shortsale completed in the normal way.

Thus naked short selling does notappear to be a major problem, nordoes it have the dire consequencesone might expect.

Regulation of Short Selling

The Securities and ExchangeCommission (SEC) regulates

stock trading in the United States.Regulation of short sales began in1938, and the current “RegulationSHO” was adopted in 2005. Shortsales are explicitly permitted except, according to anSEC commentary (www.tinyurl.com/adcwy), when“effected to manipulate the price of a stock.”The com-mentary does not state how the intent of a seller is to bedetermined. Presumably, an expression of satisfactionwhen the stock falls is not enough. Nor, one hopes, isknowledge that any sale will put at least marginal down-ward pressure on the price. But this is just the sort offuzzy, non-objective law that opens the door to abusiveprosecution.

The SEC commentary on regulation specificallyaddresses failures to deliver and naked short selling.Interestingly, it declares that naked short selling is notalways a bad thing, but rather, in certain circumstances,it “contributes to market liquidity.” It cites as an exam-ple a market maker (a specialist or a broker/dealer)

whose job is to offer to buy and sell a particular stockcontinuously even when there are no other buyers orsellers. To meet a sudden surge in buying, a marketmaker may sell short without having first found sharesto borrow.The public benefits from a smoother market,and there is almost no risk that the market maker willbe unable to net out his position in a reasonable time.

The SEC has been fielding a growing volume ofcomplaints alleging possible market manipulation viashort sales—about five thousand between January 1,2007, and June 30, 2008. Of these, just 123 were for-warded for investigation. None were pursued. The SEC staff has downplayed the importance of nakedshort-selling abuses.

This has not deterred politicians from gunning forshort sellers. Leading the charge is agroup of six senators led by EdwardKaufman (D-Del.). So, notwithstand-ing its relatively benign view of shortselling, even some forms of nakedshort selling, the SEC has decided topropose rule changes to curb shortselling. Reinstatement of the “uptickrule” is one proposal, and there mightalso be “circuit breaker” provisions tofurther inhibit waterfall declines. TheSEC’s recent proposal to reinstate therule was met with mainly negativereactions from people in the securities

business, and at this writing no decision has been made.From 1938 to 2007 an uptick rule was in effect. At

any given moment, a stock has “ticked up” if its lastprice was higher than the previous price.When a stockwas declining, short sales were forbidden until anuptick occurred. This was supposed to help curb run-away declines.

A major change in trading took place a few yearsago when the time-honored practice of quoting pricesin dollars and eighths of a dollar (sometimes sixteenths)was abandoned in favor of decimal quotes.The changewas welcomed by just about everyone, especially thosewho had to do arithmetic with prices. The economicimportance of the change was that stocks now move inone-penny increments rather than eighths (12.5 cents).An uptick rule in the one-penny environment has far


Wa r r e n G i b s o n

The SEC regulationon short selling is just the sort of fuzzy,non-objective lawthat opens the door to abusiveprosecution.

less effect than under the old fractional regime simplybecause there are smaller and more frequent pricechanges, so that the tick changes direction more fre-quently. But reinstating the rulewould let politicians take credit forpressuring the SEC into “doingsomething” about the nasty short sell-ers.And they will probably cause littledamage to the markets in the process.

Circuit-breaker rules were put intoeffect after the crash of 1987. In caseof a severe selloff, trading on the NewYork Stock Exchange, as measured bythe Dow Jones Industrial Average, canbe interrupted or halted, dependingon the time of day and the magnitudeof the decline.The proposed new rulewould extend this idea to individualstocks, interrupting or halting short sales of stocks thathave experienced rapid declines.This rule may or may

not make much difference depending on how theparameters are selected. It could give an unfair advan-tage to sellers of a stock who already own it.With com-

peting short sellers temporarilylocked out of the market ordinarysellers, still allowed to sell, could enjoya price advantage. It might also bedifficult for market makers to distin-guish ordinary sell orders from shortsales.

In the long run stock prices aredetermined by fundamentals. In theshort run all sorts of influences drivestock prices: exuberance, despair,rumors. Those who choose to engagein short-term trading should under-stand this and be prepared for volatil-ity. Restraints on honest short selling

can only hinder the recognition of failing companies andstymie the efforts of hedgers to reduce their risk.


T h e L o n g a n d S h o r t o f S h o r t S e l l i n g

In the long run stockprices are determinedby fundamentals. Inthe short run all sortsof influences driveprices. Short-termtraders should beprepared for volatility.

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B Y S H E L D O N R I C H M A N

Frustrating Michael Moore

Peripatetics

If Michael Moore would study a little politicaleconomy he might turn into a potent champion ofindividual liberty.

As we see in Moore’s new movie, Capitalism:A LoveStory, Moore is offended by some truly offensivethings: banks engaging in wild speculation withoutconcern for the risk, taxpayer bailouts for banks andother businesses, cozy relations between Wall Street andWashington, politicians getting favors from companiesthat want benefits from government, and big institu-tions pushing less powerful individuals around. True,he’s offended by some inoffensive things as well, such as the cut in the 90 percent topincome-tax rate years ago. But byand large, what he rails against shouldbe railed against.

Had he called his movie StateCapitalism: A Love Story, I might beapplauding (with some reservations).But he’s targeting the more ambigu-ous “capitalism,” which he usesinterchangeably with “the free mar-ket.” He can be forgiven for this,however. Most people would say thatthe current U.S. economic system is capitalist. Moorehas probably heard that all his life. He’d hear it if hewatched a Fox financial program. Would Ben Stein orLawrence Kudlow disagree? Moore has also heardRepublican politicians—George W. Bush, for exam-ple—praise the existing system, with all its deep gov-ernment interventions, as capitalist. Bush did this evenas he and Treasury Secretary Henry Paulson, formerchief of Wall Street behemoth Goldman Sachs, stam-peded Congress into passing the $700 billion TARPbailout last year. Moore takes such people at their word:The free market is capitalism, and capitalism is what wehave today.

Yes, it’s sloppy thinking, and had he been morecurious and read beyond the confines of “Progressive”literature, he could have gotten the straight story. Butmany knowledgeable advocates of the free market con-tribute to the confusion by exhibiting what Kevin Car-son calls “vulgar libertarianism,” or what RoderickLong describes as “the tendency to treat the case for thefree market as though it justified various unlovely fea-tures of actually existing corporatist society.” How oftenhave you heard a free-market advocate condemn pro-

business intervention in one breath,then defend existing dominant corpo-rations in the next—as though theydid not arise in the interventionistenvironment just condemned? Pro-market is not the same as pro-business.If some market advocates don’t under-stand that, why should Moore?

This may go a long way in explain-ing Moore’s aversion to profit—at leastother people’s. He associates profit withbusiness, which he associates with

(state) capitalism. So for him, profit per se is suspect. Buthe should see a problem here. Does he think he’sexploiting moviegoers when his production companyends up with a profit? Do the co-ops and worker-owned firms he loves exploit their customers when theysell their products for more than their money costs?

Cornered like this, Moore might say he’s onlyagainst the excessive profits that capitalist market power permits. But now we’re back where we started.To the extent that intervention hampers competitionby erecting barriers to entry—which is the usual effect,


Sheldon Richman ([email protected]) is the editor of The Freeman.

Pro-market is not thesame as pro-business.If some marketadvocates don’tunderstand that, whyshould Moore?

Vulgar Libertarianism

Can we blame him for thinking this way?

intended or not—protected firms are free to chargehigher prices and reap more profits than would havebeen the case in an open market. Corporate power andprivilege derive from political power and can’t exist without it.In contrast to existing capitalism, the truly free marketwould have no legal barriers to competitive entry,assuring that prices and returns are economically justi-fied and not the fruits of privilege. Only the State per-mits business to make profits by withholding benefitsfrom consumers.

But Moore doesn’t know this. What he “knows” isthat the choice is between the current corrupt sys-tem—and it is corrupt—and some vaguely definedscheme of control by benevolent politicians, which hecalls socialism and democracy.

In his movie Moore expressesaffection for socialism, but he’s notclear what he means. He never advo-cates collectivization of the means ofproduction or the abolition of mar-kets. Instead he suggests that socialismmeans workers having a say in how thecompanies they work for are run. Butwhy assume that’s anti-free-market?He praises worker-owned companiesand notes that hundreds of them existin the United States today. He mightbe surprised to learn that these thingsare entirely compatible with the freemarket. In fact, it’s a perfectly libertar-ian intuition to abhor being subject to the arbitrarywhim of anyone—yes, even a private employer. If gov-ernment regulatory and tax obstacles to new competi-tion and self-employment did not exist, workers wouldhave their maximum bargaining power and widest arrayof alternatives. I imagine we’d see more departures fromthe traditional firm. People used to get their “socialinsurance” from mutual aid societies. Maybe in a truefree market, we’d see a bigger role for the employmentcounterpart to these public, yet not governmental,organizations.

What would Moore think about a system in whichno one could collude with politicians to legally plunderthe rest of us for his or her own benefit and everyonewas free to enter into any cooperative arrangements to

produce and offer goods to others in voluntaryexchange? Michael, that’s the free market!

The Nirvana Fallacy: A Love Story

Of course, Moore naively looks to government toprovide things. His movie laments that FDR died

before he could see his Second Bill of Rights enacted.Roosevelt wanted government to guarantee everyone agood education, job, home, health care, and so on. HasMoore ever wondered where government would get theresources for this? He can’t really believe that somewherethere’s a massive pot of collective wealth waiting to be dis-tributed. He must realize that the tax system would pro-vide the money. But how can he not know that ifgovernment appears to penalize wealth creation with con-

fiscation, less wealth will be created?Moore is unaware that he com-

mits the “Nirvana fallacy.”This is theerroneous idea that our choice isbetween the admittedly imperfectworld we’re bound to live in if gov-ernment leaves us alone and animagined utopia in which benevo-lent and all-wise rulers oversee andregulate everything. Of course that isnot the choice. Moore’s preferredsystem, whatever he calls it, would berun by individuals whose insightsinto the public interest would be nosharper and whose motives no purer

than other people’s. However, since they would wieldpolitical power—which is the legal authority to compelobedience—they would be far more dangerous thananyone in a free market could ever be. He knows howcorrupt politicians are. Why does he think differentpeople would run things in his utopia? Does he reallywant them in charge of everyone’s job, education,health care, housing, pension, and the rest? It’s hard tounderstand why he isn’t uncomfortable with the idea ofthe people being tenants and employees of the State.

Whether he realizes it or not, Moore favors a systemin which an elite necessarily would make critical deci-sions for the rest of us. He’d be incredulous to hear that,but if he ever comes to understand it, libertarians mightend up with an unlikely ally.


F r u s t r a t i n g M i c h a e l M o o r e

It’s hard tounderstand whyMoore isn’tuncomfortable withthe idea of the peoplebeing tenants andemployees of theState.

During the current recession a number of com-mentators have made various comparisons tothe Great Depression, mostly because of the

dramatic decline in the stock market and ongoing trou-bles in the financial industry.When oil prices also begana dramatic decline in the autumn of 2008, pulling theoverall consumer price level downward for the firsttime in a very long time, yet another fear of the GreatDepression era came to the forefront of the public’sconsciousness: deflation. Many observers pointed out,quite correctly, that the deflation thatfollowed nearly immediately after thestock market crash in 1929 was a majorreason that what would have been aserious, though likely short-lived,recession was transformed into theGreat Depression. With these fears ofdeflation, and the damage it diddecades ago, now part of the discus-sion, it is a good idea to remind our-selves just what we should and shouldnot fear about deflation, and howdeflation can be, and was historically, a major contribu-tor to economic catastrophe.

The key to understanding deflation is to realize thatit comes in three forms: the Good, the Bad, and theUgly.To make sense of these three forms we need to beclear on some terminology and definitions. First, theword “deflation” itself requires additional clarity. Nor-mally, the definition is something like “a sustaineddecline in the average level of prices.” That definitionimmediately raises the question of why anyone wouldthink deflation is bad. After all, what could be badabout things getting cheaper? For one thing, “prices”

are normally understood to include “wages” (althoughin the Ugly version we’ll see what happens when thisisn’t the case), so whatever gains one gets from lowerprices are likely to be offset by lower wages. Foranother, that definition says nothing about whether theprocess by which prices fall is a painful one. (Could notone say of inflation: “What’s the big deal? Sure, pricesare going up, but your wages will too, so aren’t you justeven?” We know enough about the process by whichprices rise to know it’s not that simple and the same is

true of the process by which theyfall.)

With that common definition inmind, we then need to make a fur-ther distinction about the cause offalling prices. A decline in the gen-eral level of prices can come fromtwo broad sources: improvements in economy-wide efficiency (thedecreased relative scarcity of somelarge number of goods) or a defi-cient supply of money. We might

further distinguish between these two by referring tothe first as “price deflation” and the latter as “monetarydeflation.” Price deflation, as it turns out, is the “Good”of the Good, the Bad, and the Ugly. Monetary deflationis the “Bad” and can lead to the “Ugly.”

Price deflation, sometimes called “benign deflation”is, or at least should be, the normal by-product of agrowing economy.To see why, we need one last digres-

B Y S T E V E N H O R W I T Z

Deflation:The Good, the Bad, and the Ugly


Steven Horwitz ([email protected]) is the Charles A. Dana Professor of Economics at St. Lawrence University and the author ofMicrofoundations and Macroeconomics:An Austrian Perspective,now in paperback.

What could be badabout things gettingcheaper? For onething,“prices” arenormally understoodto include “wages.”

sion, this time into monetary theory. Understandingboth inflation and deflation requires that we recognizethat the demand for money is a demand to hold realcash balances: We demand money when we hold bal-ances in our wallets or our checking accounts. Whenwe spend money we actually reduce our demand formoney as we shift how we hold our wealth frommoney to whatever we buy.Think of a wallet or check-ing account as part of a larger portfolio of assets wechoose to hold at any given time. We want a certainportion of our wealth in the form of housing, some inthe form of food, some in the form of clothing, andsome in the form of money. Thus our demand formoney is a demand to hold money balances, and wecare about the real purchasing power ofthose money balances—what they arecapable of buying, not just what num-ber is stamped on the bills.

A correct understanding of thedemand for money helps us to under-stand why sometimes people can haveeither more or less money than theywould prefer. For example, during infla-tion the monetary authority has createdmore money than people wish to holdat current prices, so they spend those“excess” money holdings on goods andservices, driving up their prices. Duringa monetary deflation, as we shall see, a deficient supply ofmoney means that people do not have large enoughmoney balances and will act to get more.

All of this implies that a good monetary system isone that supplies exactly the amount of money thepublic wishes to hold at the current level of prices. It isworth noting that this view, called “monetary equilib-rium theory,” implies that not every increase in the sup-ply of money is inflationary. Should the demand formoney rise, it is the appropriate response of the mone-tary system to increase the supply to match it. In ourdiscussion of monetary deflation below, we will seewhy monetary equilibrium theorists make this argu-ment. This argument also distinguishes those Austrianeconomists who work from the monetary equilibriumtradition from those who work from a more Rothbar-dian tradition, in which any increase in the money sup-

ply not matched by an increase in the quantity of goldis necessarily inflationary and the ideal monetary sys-tem is not one that matches changes in money demandwith changes in the money supply.

The Good

If the monetary system is doing its job and matchingchanges in money demand with changes in supply,

the long-term trend of the price level will be gentlydownward as economy-wide productivity rises. Put dif-ferently, increased productivity will cause benign pricedeflation as the real cost of goods and services falls.Thissort of deflation is not only not harmful; it is beneficialbecause the cost of living is lower. In the United States

this is precisely what happened tothe price level during the last fewdecades of the nineteenth century,since the pre-Federal Reserve bank-ing system based on gold was reason-ably effective at getting the moneysupply right much of the time andproductivity gains caused a steady,slow fall in the price level. Over thelast few decades the same downwardpressure on prices from productivitygains has been taking place, but it hasbeen outweighed in the aggregate bythe inflationary policies of the Fed,

so the price level continues to climb in spite of theseproductivity-induced deflationary pressures.

One implication of this last observation is that con-sumer price index figures may well understate the realdegree of monetary inflation in a given economy. Forexample, if productivity increases are pushing pricesdown 3 percent per year, but excesses in the moneysupply are pushing prices up by 3 percent per year, thecommon measures of inflation would show stableprices. However, on the monetary equilibrium view,that stable price level is disguising underlying inflationof 3 percent, as prices should have fallen by 3 percent.Austrian economists have long argued that somethinglike this may well have been at work in the 1920s,where relatively stable prices concealed a multiyearinflationary boom that culminated in the recession andthen the stock market crash of 1929.


D e f l a t i o n : T h e G o o d , t h e B a d , a n d t h e U g l y

A good monetarysystem is one thatsupplies exactly theamount of money the public wishes tohold at the currentlevel of prices.

To the extent that a fall in the overall level of pricesreflects increased productivity, it is Good. Similarly, adecline in the price level caused by the decreased rela-tive scarcity of key goods is not problematic.The dra-matic fall in oil prices in the autumn of 2008 wasenough to cause the average level of prices in theUnited States to fall, which is the source of much ofthe concern about deflation. However, this sort ofdeflation is not the type to be concerned about, andcertainly does not warrant the comparisons to theGreat Depression. In fact, falling oil prices in this caseprobably did much to prevent the early months of therecession from being any worse than they were, aslower gasoline prices eased financial pressures on manyhouseholds.

The Bad

The “Bad” sort of deflation arises from an insuffi-cient supply of money. When

people do not have as much of theirwealth in the form of money as theywould like, they will make attempts toincrease those money balances.Assuming that in the short run addi-tional income is not possible, peoplehave essentially only two otheroptions: sell off other assets or reducetheir expenditures. Either one will work, but selling offassets is problematic for two reasons. First, it is nottotally under the individual’s control since it requires abuyer, and second, if everyone is short on money, find-ing a buyer will be especially difficult because every-one else is looking to sell. Therefore, the most likelyresult of a deficient money supply is that people willrestrict their expenditures to allow more of theirincome to build up as checking account or currencybalances.

As everyone reduces spending, firms see sales fall.This reduction in their income means that they andtheir employees may have less to spend, which in turnleads them to reduce their expenditures, which leads toanother set of sellers seeing lower income, and so on.All these spending reductions leave firms with unsoldinventories because they expected more sales than theymade. Until firms recognize that this reduction in

expenditures is going to be economy-wide and ongo-ing, they may be reluctant to lower their prices, bothbecause they don’t realize what is going on and becausethey fear they will not see a reduction in their costs,which would mean losses. In general, it may take timeuntil the downward pressure on prices caused by slack-ening demand is strong enough to force prices down.During the period in which prices remain too high, wewill see the continuation of unsold inventories as wellas rising unemployment, since wages also remain toohigh and declining sales reduce the demand for labor.Thus monetary deflations will produce a period, per-haps of several months or more, in which businessdeclines and unemployment rises. Unemployment maylinger longer as firms will try to sell off their accumu-lated inventories before they rehire labor to producenew goods. If such a deflation is also a period of recov-ery from an inflation-generated boom, these problems

are magnified as the normal adjust-ments in labor and capital that are required to eliminate the errorsof the boom get added on top of the deflation-generated idling ofresources.

Over the course of U.S. historythe economy has been subject to anumber of deflationary episodes, all

of which were the consequence of a variety of govern-ment interventions in the monetary system. In each ofthose cases before the Great Depression, policymakerslargely allowed the economy to repair itself by standingby and doing little to nothing while prices and wagesfell sufficiently to get the demand for money back intoalignment with the supply. No doubt these were painfulrecessions that could have been avoided by having abanking system that responded to changes in moneydemand by more quickly adjusting the money supply,rather than allowing the price-level adjustment processto cause the problems noted above. However painfulthey were, these recessions did not become the “Ugly”version of deflation precisely because policymakersallowed the necessary downward adjustments to takeplace, which was the correct thing to do given the mon-etary system’s errors that caused the monetary deflationin the first place.


S t e v e n H o r w i t z

The “Bad” sort ofdeflation arises froman insufficient supplyof money.

The Ugly

During the Great Depression, what should have justbeen a Bad deflation became an Ugly one. This

deflation was unlike earlier ones for two reasons. First,the scale of the deflation was unmatched. The U.S.money supply fell over 30 percent between 1929 and1933, a period in which the demand for money wasactually rising as a consequence of the stock marketcrash and the bank failures that followed it. The com-bined effect was a massive downward pressure onprices.The Fed did not actively reduce the money sup-ply during this period; it failed to react strongly enoughto actions the public and banks were taking, such as thepublic’s holding more currency rather than bankdeposits, which caused a multipliedreduction in the total money supply.As Milton Friedman and AnnaSchwartz’s A Monetary History of theUnited States describes it, there was agreat deal of internal debate withinthe Fed over whether it had thepower to respond as we now believe itshould have and whether, even if ithad the power, such a response wasthe right one. Those who argued infavor of doing nothing won the dayand substantially worsened thedepression in the process.

The second difference from earlierrecessions was that policymakersadopted the view that the key torecovery was to “maintain” prices andwages at their pre-deflation levels. Both PresidentsHoover and Roosevelt strong-armed business leadersinto keeping prices and wages up and pushed laws thatdirectly or indirectly did the same.

The effects of these misguided attempts at price andwage maintenance were devastating. Firms continuedto pay unjustifiably high wages, while watching salesslacken because prices also stayed high; they coveredtheir losses out of their profits, causing some firms tofail and others to see severe declines in their stockprices. This contributed to the low levels of privateinvestment that prolonged the depression since firmsdid not have profits to recycle back into their own

activities. More brutally, keeping wages so high led tothe horrific unemployment rates of the Great Depres-sion, which peaked at around 25 percent in 1933. Onlyby around 1934 did prices and wages fall enough tostart bringing unemployment rates back down. How-ever, unemployment remained at historic highs becauseeven with the declines in prices and wages, privateinvestors were hesitant to take risks in light of the policymakers’ earlier mistakes and the constantly shift-ing political environment. During the Great Depres-sion, unemployment stayed above 14 percent from1931 through 1940.

Current observers are quite right to point to theGreat Depression as an example of what can go wrong

from deflation.There is no doubt thatthe very large monetary deflation ofthe early 1930s made the recessionthat began in the summer of 1929much deeper and more severe than itwould have been otherwise. But evenso, had prices and wages been allowedto adjust, that recession would havebeen Very Bad, but not Ugly.Attempting to keep prices and wageshigh during the monetary deflationprevented the cleansing price adjust-ments from taking place and forcedsellers to make “quantity” adjustmentsin the form of reduced productionand historic levels of unemployment.

Avoiding the Last Big Mistake

The price level declines seen in the fall of 2008 andearly 2009 do not seem to be harbingers of signif-

icant deflation.As noted earlier, the decline in oil pricesis the leading factor pushing down the overall pricelevel, and this is the benign price deflation that we havelabeled Good. In fact, the Fed’s initial response to thetroubles in the banking system in the fall of 2008 was toflood the system with reserves, remembering the mis-takes the Fed made at the onset of the Great Depres-sion. Given the worries about a cascade of bank failuresand the major deflationary effects this would have hadon the money supply and the economy as a whole,injecting some additional reserves was probably the


D e f l a t i o n : T h e G o o d , t h e B a d , a n d t h e U g l y

There is no doubtthat the very largemonetary deflation ofthe early 1930s madethe recession thatbegan in the summerof 1929 much deeperand more severe thanit would have beenotherwise.

right reaction at the time. Two key questions remain,however:

1) Did the Fed overreact and create too many reserves?A look at the Fed’s balance sheet suggests it may well havedone so, especially given how many ofthose new reserves are just sitting in thebanks right now (helped along by theFed, now paying interest on suchreserves).

2) Will the Fed be able to with-draw those reserves as the economyrecovers and thereby avoid a poten-tially massive and damaging inflation?If it cannot do so, we will face a muchbigger threat in the near future frominflation than from deflation.

All of that said, we do not know forcertain what is going on with thedemand for money. We know thatexpenditures are down, which suggeststhat people are quite possibly increas-ing their demands for money. But in the absence of thethousands of bank failures that characterized the 1930sand with evidence that banks, on the whole, are contin-uing to lend (despite scare-mongering media and gov-ernment stories to the contrary), the concern that anyincrease in money demand will translate into significant

monetary deflation seems remote. As Milton Friedmanonce said, central banks are always trying to avoid theirlast big mistake. In this case, that big mistake was theGreat Depression, and the Fed has clearly shown a will-

ingness to err on the side of inflationrather than deflation, even at the costof putting itself in a difficult positiononce the recovery starts.

What all of this goes to show isthat the best way to avoid both Badand Ugly deflation and to generatethe Good kind is to minimize therole of government intervention inboth the monetary system and theregulation of prices and wages. Acompetitive banking system—onewithout a central bank but with frac-tional reserves—would avoid bothdeflation and inflation. Even under acentral bank, the effects of a mone-tary deflation can be minimized by

restricting government’s involvement in the setting ofprices and wages. In a free economy the only deflationwe would see is the slow, long-run decline in pricesthat results from the productive powers of competitivecapitalism. That deflation would be just another Goodproduced by truly free markets.


S t e v e n H o r w i t z

The Fed has clearlyshown a willingnessto err on the side of inflation ratherthan deflation, even at the cost of puttingitself in a difficultposition once therecovery starts.

B Y S T E P H E N D AV I E S

Dangerous Historical Myths

Our Economic Past

One of the most powerful influences on humanaffairs is historical myth—beliefs about thepast that are simply wrong. Some historical

myths have far-reaching and baleful effects because theyshape the way people understand not only the past butalso the present, leading them to make harmful or evendangerous decisions.This seems to be especially so witheconomic history.

Take the standard account of the Great Depressionand the New Deal. In many ways theNew Deal itself was one result ofanother historical myth: the widelyreceived account of what had hap-pened to the German economy in thefirst half of the twentieth century,particularly during World War I andthe Third Reich.That myth probablydid more harm than almost any otherin that century.

In the case of the Third Reich, thewidely held perception even now isthat whatever else may be said abouthis regime, Hitler managed to bringabout a dramatic revival of the Ger-man economy. After 1933 Hitler andhis finance minister Hjalmar Schachtstabilized the economy and managedto solve the huge unemployment cri-sis that had destroyed the Weimar Republic’s legitimacy.This was partly due to Schacht’s imaginative monetarypolicy and partly to massive public works programs,such as the autobahnen.There was a sharp move awayfrom free markets to a much more interventionisteconomy that worked better than what had gonebefore. During World War II this economy was able toachieve great success in terms of war production,notably under Hitler’s armaments minister, AlbertSpeer.

Obviously there is some truth in this account, orelse it would not be credible.There was indeed a sharpmove in the direction of a more state-controlled econ-omy. In fact few people realize just how interven-tionist—even socialist—the policies of the Nazi state were (although the full name of the party should give some indication of this). However, the pictureoverall is mostly wrong. Adam Tooze conclusivelydebunked this account in his masterful work, The

Wages of Destruction: The Making andBreaking of the Nazi Economy. Toozeshows that the public works programshad little effect on unemployment and wasted resources; that the 1930ssaw constant financial and foreign-exchange crises for the Reich; that by1939 the condition of the Germaneconomy was desperate and that thiswas in fact a major factor in Hitler’sincreasingly aggressive policy; that thesupposed success of Speer simply didnot happen; and that overall the regimewas so crippled by its economicincompetence that it is nothing shortof a miracle that it had as much mili-tary success as it did.

Fortunately, while Nazi Germany’seconomic policy and its supposed suc-

cess had some influence in the 1930s (not least amongsome New Dealers), it had none after 1945. However,an earlier episode in German economic history hadmuch greater consequences and influence—bothentirely malign. When war broke out in July 1914 theGerman government and High Command planned andhoped for a short and decisive war.Things of course did


Stephen Davies ([email protected]) is a program officer at the Institutefor Humane Studies.

Massive public works like Albert Speer’sBerlin were long credited with correctingfailures of the free market.German Federal Archives

not work out that way and by the fall of 1916 it wasclear that this strategy had failed, while the Britishblockade grew ever more stringent. In the face ofimpending defeat, the German Empire’s governmentwas effectively taken over by the military in the personof the army’s quartermaster general (and effective chiefof staff) Erich Ludendorf. His thinking and policy wereset out in his 1935 work and apologia, Der Totale Krieg(The Total War).

Ludendorf argued, first, that all the human and phys-ical resources of a nation made up its military capacity,or Wehrkraft.To ensure victory and survival in the zero-sum game of nations, all these resources had to be con-trolled and directed to a single purpose.Who was to dothis? The answer for him was simple:Since the goal was victory in conflict,it had to be the military. What thismeant in practice was a form ofplanned economy in which all eco-nomic activity was directed by thegeneral staff through a series of plan-ning boards and detailed regulationsand targets.

The main point was to remove theprofit motive—Ludendorf never tiredof ranting against unpatriotic profitseekers and selfish individualists—andreplace it with structured commandrelations. In one sense the aim was totransform the entire economy andsociety into an army, with the typicalcommand-and-control structure of the modern mili-tary. In another sense the goal was to turn Germanindustry into one giant corporation by a process ofplanning and cartelization. One important aspect of theregime created by Ludendorf, just as for Nazi Germany,was a close alliance between the military, the politicaland bureaucratic classes, and the managerial elite oflarge corporations, or at least some of them.

Ludendorf ’s policy was a disaster. Production actu-ally declined or was wasted, and the financial methodsled to severe inflation, which of course became evenworse after the war. The policy also led to increasingresistance from the population, as his ever-more-furious

outbursts revealed. Eventually the increasingly desper-ate situation led to the gamble of the huge springoffensive of 1918. Its failure meant the war was defini-tively lost.

However, the policy of Germany after 1916 was notseen at the time or for long after as the enormous mis-take that it was, even from the High Command’s pointof view. Instead it was thought to have been a hugesuccess. Strangely this view became even more wide-spread after 1918—not least among the victoriouspowers. A myth took hold: that the organization of theeconomy under Ludendorf was a model for othernations in peacetime.

This belief had disastrous consequences. It certainlydid in Germany itself since it pro-vided much of the basis for the eco-nomic policies of the Third Reich, aswell as providing yet another justifica-tion for slave labor and the systematicplunder of subject populations. Inmilder form this received view had amajor impact in both Great Britainand the United States during theinterwar years.

However, its most significant effectwas felt in the east.When the Bolshe-viks came to power in 1917 they hadno real idea of what socialism wouldlook like.Their initial effort, so-calledwar communism, proved utterly cata-strophic and was reversed with the

introduction of the New Economic Policy in 1921.What followed was a huge debate as to what kind ofmodel to adopt.The “center” argument that eventuallytriumphed under Stalin was to adopt the supposedlysuccessful model of the World War I German war econ-omy. So the Soviet economy was in many ways theproduct of a mistaken idea about Germany’s war econ-omy and how it had worked.

Misunderstandings of what is actually happening ineconomic affairs do not only have immediate conse-quences. When they shape the politicians’ and public’sview of history, their effects can be immense, sometimescomically, but more often tragically.


S t e p h e n D a v i e s

The belief in the war economy’seffectiveness justifiedthe Third Reich’s useof slave labor and hadprofoundly tragiceffects from the U.S.and U.K. to theSoviet Union.

Efforts in Washington to write a major climate-change law are causing some Bootlegger/Baptistcoalitions to fall apart and new ones to emerge.

In late September Exelon Corporation, a major electricutility, followed industry partners Pacific Gas & Electric(PG&E) and PNM when it resigned from the U.S.Chamber of Commerce. The Chamber opposed theWaxman-Markey climate-change bill, which wouldsharply limit carbon emissions, raise the cost of power,and in effect impose asmuch as a 15 percent taxincrease on each U.S.household. Exelon, PG&E,and PNM favor the law.They are also heavynuclear-power producers.

In an earlier commenton the fracturing of theU.S. Climate Action Part-nership (USCAP), anindustry-environmentalistcoalition pushing for cap-and-trade carbon emissioncontrols, EnvironmentalDefense Fund president Fred Krupp repeated a com-monly held misconception about government regula-tion when he said: “It’s very unusual for bigcorporations to raise their hands and say, ‘We want tobe regulated for something that we’re not regulated fornow.’” Exelon, PG&E, and PNW apparently make hispoint.

But as a matter of fact, industry support of regula-tion is not rare at all; indeed, it is the norm.And in theUnited States it is as American as apple pie.

Historical Examples

Asomewhat casual investigation of business historyreveals that it was the U.S. Chamber of Com-

merce, with the special assistance of General Electricpresident Gerard Swope, that supported passage ofPresident Roosevelt’s 1933 National Industrial Recov-ery Act. The Act, with its Blue Eagle codes affecting 2.3 million employers, attempted to place all Amer-ican industry in a price-fixing cartel. But while the

Chamber and many largefirms supported FDR’s car-tel, many other firms, includ-ing Ford Motor Company,did not.

Going back further, weare reminded by HowardMarvel, writing in the 1977Journal of Law of Economics,that it was the owners of thenewly built water-poweredtextile plants that supportedthe English Factory Acts(1802 and on), not the own-ers of older mills that used

far more labor per unit of output.The legislation lim-ited child labor and hours and conditions of work,which raised the costs of labor-intensive producers.Theindustrialists who joined with other crusaders to sup-port the legislation are remembered as philanthropists.

B Y B R U C E YA N D L E

“We Want to be Regulated”


Bruce Yandle ([email protected]) is Alumni Distinguished Professor ofEconomics Emeritus, Clemson University; Distinguished Adjunct Professorof Economics, Mercatus Center, George Mason University; and seniorscholar, PERC. He is coauthor with Andrew P. Morriss and AndrewDorchak of Regulation by Litigation.

Owners of nuclear power plants support strict regulation of carbonemissions.flickr.com: huntz

In 1907 it was the electric utility industry, led bySamuel Insull, that lobbied for state regulation in thehopes of escaping less predictable and intractablemunicipal control. In 1910 American Telephone andTelegraph Company chairman Theodore Vail success-fully called for federal regulation of long-distance tele-phone calling just when the Bell patents were expiringand new competition was, as he putit, “skimming the cream” from themarket. Even the Magna Carta (line35) specifies a standard width for allcloth sold in the kingdom—all in thename of consumer protection, schol-ars tell us. The standard happened tobe the width of looms operated bythe London weavers. The less fortu-nate Bristol weavers had to break andmodify their looms to compete.

A focus on environmental regula-tion reveals a host of Bootleggers andBaptists who have coalesced, some-times quietly, to support output restrictions. In hearingsbefore passage of the 1972 federal Water PollutionControl Act, industrialists located along the Ohio Riverargued for the law. They faced pollution controlsimposed by the Ohio River Sanitation Commissionand wanted a national level playing field. Only federalregulation would solve their problem, and they sup-ported it. It was the coal interests in Ohio and West Vir-ginia, along with environmentalists, that lobbied for the

1990 Clean Air Act amendments requiring scrubberson newly built and modified coal-fired electric utilities.As Bruce Ackerman and William Hassler famouslynoted in their 1981 book, Clean Coal/Dirty Air, thescrubber requirements eliminated the clean-burnadvantage of western coal and kept the eastern coalproducers happily burning their higher-sulphur coal.

Yes, industry support of legislationthat imposes restrictions on output iscommonplace, but one begins tounderstand this more fully after care-ful scrutiny of the lobbying process. Itis seldom the case that every firm inan industry supports restrictions.When John Deere petitioned theEPA (Environmental ProtectionAgency) to increase the stringency ofthe air-emission standard on smallgasoline engines, it was becauseDeere had a patent on cleanerengines. When the Chicago meat

packers lobbied Congress to pass the 1906 MeatInspection Act, it was because of markets lost to con-sumer fear over Upton Sinclair’s The Jungle and Argen-tine beef producers who were invading the U.S. marketwith lower-priced food.

And when nuclear-power producers Exelon, PG&E,PNM, and others lobby for a federal statute that wouldimpose high costs on coal-fired competitors, thereshould be no question why.


B r u c e Ya n d l e

Industry support oflegislation restrictingoutput is common-place, but it is seldomthe case that everyfirm in an industrysupports restrictions.

B Y J O H N S T O S S E L

Transfer Machine

Give Me a Break!

he government who robs Peter to pay Paulcan always depend on the support of Paul,”George Bernard Shaw once said.

For a socialist Shaw demonstrated good sense withthat quotation. Unfortunately, America has become alaboratory in which his hypothesis is being tested.

The theory of government I was taught says thatgovernment provides benefits, primarily security, to theentire population. In return we paytaxes. But lately the government hasbeen a distributor of special privi-leges, taking money from some andgiving it to others. America is nowabout evenly split between those whopay income taxes and those who con-sume them.

The Urban-Brookings Tax PolicyCenter recently disclosed that close tohalf of all households will pay noincome tax this year. Some will payless than zero—that is, they’ll getmoney from those of us who do paytaxes.

The Tax Policy Center adds thatthis year the average income-tax ratefor the bottom 40 percent of earnerswill be negative and that their cashsubsidy will equal 10 percent of thetotal amount the income tax bringsin, thanks to the Earned Income TaxCredit and President Obama’s “Making Work Pay” pro-gram.

The view from the top also shows the lopsidednessof the tax system.The top 20 percent of earners makeabout 53 percent of the income in America but pay 91 percent of the income tax. The top 1 percent pay 36 percent.The IRS says the bottom half of earners payless than 3 percent.

How the Other Half Votes

This presents a serious problem because governmenthas such vast powers to dispense favors. As Shaw

suggested, people who pay no tax will not hesitate tovote for politicians who promise big spending. Whynot? They will get stuff without having to pay for it.

Yes, working people who pay no income tax still paytaxes: sales tax and payroll (Social Security and

Medicare) taxes. But the income taxis big and visible, so it’s a problem thata growing number of people don’tpay but get benefits from those whodo.

Frédéric Bastiat, the great nine-teenth-century French economist,defined the State as “that great fictionby which everyone tries to live at theexpense of everyone else.” I don’tknow if he envisioned one half of thepopulation living off the other half.

It’s important not to confuse theinterests of the taxpayers with theinterests of the politicians and othertax consumers.Yet that is done all thetime. When the government boughttoxic assets (of zero market value)from the banks, it said taxpayerswould profit when the economyrecovered and the assets once againcommanded a positive price in the

market. Even if we make the dubious assumption thatthe government is savvy enough to buy low and sellhigh, it’s not the taxpayers who would benefit from any

T“


John Stossel hosts Stossel on Fox Business Network and is the author ofMyths, Lies, and Downright Stupidity: Get Out the Shovel—WhyEverything You Know is Wrong. Copyright 2009 by JFS Productions,Inc. Distributed by Creators Syndicate, Inc.

The top 20 percentof earners makeabout 53 percent of the income inAmerica but pay 91 percent of theincome tax.The top1 percent pay 36 percent.The IRSsays the bottom halfof earners pay lessthan 3 percent.

profits. The politicians will spend every penny ratherthan cut taxes.

To put it bluntly, we are not the government.The built-in unfairness of the tax

system has prompted a range of tax-reform proposals, such as a flat tax andreplacing the income tax with a salestax. These alternatives are better, butthey have their drawbacks, too. For thatreason, there is something more urgentthan tax reform: spending reform.

The true burden of government,the late Milton Friedman said, is not the tax level butthe spending level.Taxation is just one way for the gov-

ernment to get money. The other ways—borrowingand inflation—are also burdens on the people.The bestway to lighten the tax burden is to lessen the spending

burden. If government spends less, ittakes less. And if it takes less, the taxsystem will weigh less heavily on usall.

Once again, we find wisdom inAdam Smith:“Little else is requisite tocarry a state to the highest degree ofopulence from the lowest barbarismbut peace, easy taxes, and a tolerable

administration of justice: all the rest being broughtabout by the natural course of things.”


J o h n S t o s s e l

The true burden ofgovernment is notthe tax level but thespending level.

Book Reviews

A Failure of Capitalism: The Crisis of ’08 and theDescent into Depression by Richard A. PosnerHarvard University Press • 2009 • 368 pages • $23.95

Reviewed by Chidem Kurdas

Richard Posner’s latest bookbelongs to the fast-expand-

ing cottage industry of financialcrisis books.A federal judge with agrounding in economics, Posnerwould seem to be an ideal personto tackle this complicated subject.Alas, he provides neither fresh

material nor an interesting perspective.Posner describes well-known events—the failure of

investment banks Bear Stearns and Lehman Brothers,the series of bailouts by the Treasury and the FederalReserve, the stimulus package passed by Congress—then tries to explicate the causes of the crisis. Hisaccount, unfortunately, merely hews to current conven-tional wisdom.

Here’s a capsule version: Deregulation of bankscombined with cheap and easy credit to cause inter-linked debt and real estate bubbles.“Free market ideol-ogy” left banks and other financial firms free to takehuge risky bets on mortgages, which they did. In2007–08 the twin bubbles collapsed, resulting in a steepdownturn in economic activity. The government had to shore up the system with extraordinary measures.The long-term solution is more government action torestrain and supervise financial institutions, althoughPosner would wait until the dust settles before reregu-lating.

It’s true that some household borrowing was chan-neled to risky instruments like adjustable-rate mort-gages and much of the lending by banks was turnedinto complex securities backed by debt.When propertyprices declined and foreclosures spread, the values ofthese securities also declined, decimating bank balance

sheets. But all that is a consequence not a cause of thetrouble.

At the heart of the story is the ready availability ofcredit that fueled excessive borrowing and lending. Pos-ner describes how the Fed flooded the economy withmoney in the early 2000s in response to the collapse ofthe previous bubble in stocks. However, he claims thateven without the Fed’s loose monetary policy, analleged global capital surplus brought in enough moneyfrom abroad to keep interest rates low.

That claim is dubious. Yes, Asians saved a lot, butother people, notably Americans, saved relatively little.In the world as a whole there was no surge in saving todrive down interest rates. It was the Fed’s easy moneythat pushed markets into a credit binge.

Posner’s line is that “Laissez-faire capitalism failed us,but government allowed the preconditions of depres-sion to develop and wreak havoc with the economy.”He discusses the Federal Reserve’s culpability for thecrisis, granting that it “would be a powerful argumentagainst re-regulation,” but places more blame on thathobgoblin, “free market ideology.” The “free market”canard requires one to ignore that the United Stateshasn’t had anything close to a free financial market in acentury.

Major mistakes by experts pose a challenge for Pos-ner’s way of looking at behavior. For example, hedescribes Fed Chairman Ben Bernanke’s neglect of thewarning signs of an impending crash as “extremelypuzzling.” As a proponent of neoclassical economics,Posner assumes that people act rationally in the sense ofmaking the best choices in view of all available infor-mation. And the Fed must be even more rational thanthe rest of us.

Another academic tribe, behavioral economists,attributes the crisis to human quirks like herding orimitation. Posner rejects those explanations on theground that such behavior is not really irrational. Onregulatory issues, however, he does not differ frombehavioral economists who assume that governmentexperts are trustworthy because they’re better informedthan the general population.

Long before the currently fashionable behavioralschool emerged, F. A. Hayek criticized the neoclassicalrationality premise but came to a different conclusion


from today’s proregulation behavioral economists. Hefound that government agents possess less wisdom thanthe market, which pools the knowledge of many indi-viduals. The “fatal conceit” (as Hayek put it) that gov-ernment knows better has resulted in economicdisasters ranging from the Soviet Union to the FederalReserve’s destabilizing policies.

Now the Fed is to become an even more powerfulregulator of vaguely defined “systemic risk.” Posnergrasps that “The successive Federal Reserve chairman-ships of Greenspan and Bernanke must be reckonedprime causes of the financial crisis,” but even so agreeswith President Obama that more government interven-tion is needed.

As a reform, Posner advocates the consolidation ofagencies like the Securities and Exchange Commissioninto one top regulator along the lines of Britain’sFinancial Services Authority. He appears oblivious tothe fact that this authority with its overarching powersdid not save Britain from financial crisis.

This highlights the book’s great flaw: Posner clingsto the myth of benign government rationalism.

Chidem Kurdas ([email protected]) is a financial journalist in NewYork. She writes investment analysis on www.HedgeFundSmarts.com andpolicy news spoofs on www.JenniferKerfuffle.com.

Unsanctioned Voice: Garet Garrett, Journalist ofthe Old Rightby Bruce RamseyCaxton Press • 2008 • 309 pages • $17.95

Reviewed by Brian Doherty

This is a curious book about a curi-ous man. It’s not a biography in a

normal sense, but a biographical essaybased on the limited material leftbehind by Garet Garrett, the journalist,novelist, and powerful voice speakingup for individualism and free markets

as the New Deal eclipsed them.Bruce Ramsey, an editorial writer for the Seattle

Times, has already edited three collections of Garrett’sjournalism. But Garrett’s own papers were mostly

destroyed except for one year’s worth of a journal; justone small book had been written about him in the1960s by an author who had access to many peoplewho knew Garrett directly. Ramsey had to go to suchunobvious sources as biographical works by or aboutthe likes of journalist Gay Talese, newspaper magnateRandolph Hearst, and financier Bernard Baruch to getmuch useful secondary information.

What Ramsey had access to, and condenses andexplains with skill and affection, is a lifetime of printedjournalism and commentary on his times from Garrett,a clear writer and interesting thinker. From that,Ramsey paints a fascinating and complicated man whochampioned classic American political (and other)virtues.

Garrett is remembered by modern libertarians asone of their forefathers in the prewar “Old Right.”Garrett was a fellow traveler, friend, or mentor to manyfigures important in the early growth of the modernAmerican libertarian movement, from FEE founderLeonard Read to novelist and polemicist Rose WilderLane to Richard Cornuelle, early functionary of thelibertarian support organization the Volker Fund.

As Ramsey demonstrates, Garrett was too individuala thinker and writer to be slotted in as simply an earlymodern libertarian. He’s best seen as an eclectic consti-tutionalist, for “an America-first foreign policy, eco-nomic laissez-faire and a gold-backed dollar.” ButGarrett was not categorically for free trade and had asoft spot for national autarky, which he saw as both an economic and foreign-policy good. He was againstlegal gambling, free banking, and free immigration (andnot just prospectively—he believed the American spiritof individualism had been sullied by the pre-World WarI immigration of a European proletariat).

Garrett was born in Illinois in 1878, and by age 18(at most) had launched a lifelong career as a journalistand editorialist in the Midwest and later Washington,D.C., and New York. He got an early start studying theworlds of twentieth-century business and finance, andhad a gift for winning the respect of highly placed menand difficult interview subjects such as Bernard Baruchand Henry Ford.

The most educational part of Ramsey’s book tothose who only know Garrett by his later political essays


B o o k R e v i e w s

on the death of a free America (kept in print throughmuch of the past 50 years by various libertarian andconservative publishers) consists of discussions of theseries of novels Garrett wrote in the 1920s.All are set inthe world of business and industry. His belief in thevirtue and efficacy of individual effort was at the core ofhis social philosophy. He once wrote,“I have never seena good farmer with a good wife in a state of failure,”which sums up his attitude toward how one succeeds.

Garrett’s intellectual approach differed from the systemic rationalism of such libertarian founders as Ayn Rand and Ludwig Von Mises. He once wrote tohis friend the socialist Lincoln Steffens that “there is not one damned thing I am sure of . . . it is much moreimportant to believe something than that what youbelieve should be right.” His shock at how quickly theindividualist America he thought he knew from pre-New Deal days embraced creeping socialism led him todeclare,“I am too humiliated to have an opinion aboutanything. Everything I believed about my own peoplewas wrong.”

He came to think that Americans of the postwar erawere, sadly, getting exactly the type of government theywanted and that the original Americans belonged to adifferent breed entirely. This sense of loss led to thegrim mood of the early libertarian movement—therealization that believers in limited government andfree markets were fighting to reverse a defeat, not pre-serve a system. As the title of Garrett’s most famousessay put it,“The Revolution Was.”

A major theme of Garrett’s intellectual life was espe-cially prescient: an understanding of the importance ofgold as a monetary standard, that bankers and gov-ernment “must be limited by something they cannot control . . . the gold standard.”

Ramsey sums up why American, and certainly liber-tarian, historians should remember Garrett:“Because hestood against state dominance at home and state inter-vention abroad, and showed that the two are con-nected.” Alas for Garrett’s cause, his relevance is asstrong as ever.

Brian Doherty ([email protected]) is a senior editor at Reasonmagazine and author of Radicals for Capitalism:A FreewheelingHistory of the Modern American Libertarian Movement and GunControl on Trial.

The Legal Foundations of Free MarketsEdited by Stephen F. CoppInstitute of Economic Affairs • 2008 • 257 pages • $34.00

Reviewed by George Leef

T he Legal Foundations of Free Markets, a recent book from

the veteran British free-marketInstitute of Economic Affairs, bringstogether essays by nine leadingexperts in law and economics thatdelve into the interface between thelegal system and the economy. Thebook blends historical analysis, eco-nomics, and legal theory, yielding

many penetrating insights.Each of the ten essays is an estimable work, but some

are likely to be of particular interest to Freeman readers.I’ll focus on four.

At the top of that list, I would place Peter Leeson’sessay, “Do Markets Need Government?” Most free-market advocates assume that “the rules of the game”must come from and be enforced by the government.Leeson, however, argues that market participants maydo a better job than the State, writing, “The long-standing existence of vibrant markets under conditionsof real or quasi-statelessness suggests that private ‘rulesof the game’ must be possible without government.” Incommercial transactions, he points out, the participantshave a lot at stake in the performance of contractualobligations.That led them to develop commercial lawcompletely independent of government, as well as tri-bunals to adjudicate disputes. Those tribunals did nothave enforcement powers, but the need to maintain agood business reputation minimized flouting of theirdecisions.Violators were apt to face ruinous ostracism.Adam Smith’s “invisible hand” worked remarkablywell.

Leeson goes on to show that the spontaneous orderof the market also devised mechanisms to deal withcriminal conduct. After reading his essay, it’s evidentthat the Hobbesian notion that society would bechaotic violence without a powerful state is untenable.

Another particularly valuable contribution is the lateNorman Barry’s essay,“Economic Rights,” in which he



laments that “for most of the time, in all countries, eco-nomic rights have been at the mercy of legislatures . . .with little or no protection from the courts or writtenconstitutions.” He attributes this unfortunate state ofaffairs to the abandonment of the Enlightenment con-cept of the unity of liberty. In this concept, economicliberty is integral to an overall concept of liberty; mostmodern thinkers, by contrast, conclude that someaspects of liberty are important and others are not.Theysay they can tell wheat from chaff, with property rightsand economic liberty being chaff. “There is scarcelyany recognition of the connection between economicrights and other, more fashionable notions,” Barrywrites.

He concludes that nations would reap huge produc-tivity gains if they would steer away from “welfarerights” and regulatory intervention, and instead allowedpeople to produce and trade as they choose.

Julian Morris also merits special mention for hisessay,“Private Versus Public Regulation of the Environ-ment.” He takes issue with the presumption that theState alone is capable of solving environmental prob-lems: “The reader may be surprised to learn that manyenvironmental problems have in fact been caused bygovernments, sometimes in spite of attempts by privateindustry or businesses to stop them.”

I’ll mention one more essay, Cento Veljanovski’s“The Common Law and Wealth.” In it Veljanovskilooks at this intriguing question: What kind of legal system is apt to contribute more toward a nation’s abil-ity to produce wealth—common law or civil law? Henotes that Gordon Tullock, among others, has observedthat common law tends to be “untidy,” with duplicativecosts, inefficient methods of ascertaining facts, and greatlatitude for wealth-destroying judicial activism. Otherscholars, however, such as Richard Posner, maintain thatsince common law is premised on the legality of thestatus quo, it places a restraint on the use of law toredistribute wealth. This is an interesting debate withno resolution in sight.

Scholars who are interested in the field of law andeconomics will want to have this book on their shelves,and professors teaching a variety of law, economics,and political science courses will find in it a good manysupplemental readings to get sharp students thinking

about questions that mainline textbooks almost alwaysoverlook.

George Leef ([email protected]) is book review editor of The Freeman.

Unmasking the Sacred Lies by Paul A. ClevelandBoundary Stone Publishing • 2008 • 184 pages • $25.00

Reviewed by Joseph G. Lehman

U nmasking the Sacred Lies is anexcellent introduction to the

major economic policies of theUnited States. Author and Freemancontributor Paul A. Cleveland tracesthe history of those policies up to2008, explains their effects, andexplores their alignment with the

nation’s founding principles.The book aims to “shed lighton the underlying lies which threaten the foundationsupon which the nation’s achievements are based.” Cleve-land succeeds with an ideal primer for college and manyhigh school students interested in economics, politicalscience, American history and current events.

Think of Sacred Lies as an economic history surveyof American public policy. The book does not standalone as a text on economics, history, political science,or American government, but Cleveland connects all ofthem. It’s easy to imagine that Cleveland wrote it togive his students at Birmingham-Southern College notjust a grasp of key economic policies but also the meansto evaluate them.

He devotes each of his nine chapters to one majorpolicy area—fiscal, monetary, transportation, agricul-ture, education, labor, welfare, business, and environ-ment. Two special sections bookend those topics. Thefirst describes the role of property, trade, and humanaction in the exercise of freedom. The last sectionaddresses the limitations of the law and the State asways to solve human problems.

This last section alone, entitled “The Lawlessness ofToo Many Laws,” makes the book a standout. Mosttextbooks that cover economics and policy seem totreat law as a force that lacks inherent limitations.



Authors may acknowledge that new laws or programsinvolve tradeoffs, but they seem to say, “If you can getthe money and if you can get the votes, then what’s theproblem?”

The problem is that the cumulative weight of multi-tudinous laws, regulations, and administrative diktatseventually undermines the workings of the law itself.Cleveland explains the burden of too many laws as avicious circle that creates moral and practical problems.Excess law leads to ignorance of the law, which breedsdisrespect for the law, which then leads to lawlessness,which must bring about ever more laws.As civilizationbecomes increasingly politicized, it declines.

Hidden political bias is a problem in many booksaimed at students. But Cleveland shows respect forreaders by forthrightly stating his perspective.The lensthrough which he analyzes public policy characterizesgovernment as force. He builds his arguments from theground up, making them accessible to those unfamiliarwith the Austrian school or Public Choice.

Cleveland leads readers to understand that the com-mon conception of government has changed. Onceviewed as the institution of last resort that protectedrights and punished wrongdoers, government is nowwidely seen as an expedient means of acquiring thingsfor oneself.

The book shows up at just the right time. Politicalenergy and interest in government spending havesurged since the enactment of trillion-dollar “stimuluspackages,” government bailouts and takeovers of majorcorporations, and renewed efforts to nationalize healthcare. A federal sprint toward Keynesian policies hasreintroduced the term “paradox of thrift” to the newslexicon. Public awareness of the “housing bubble” ishigh. Cleveland describes Keynes’s “paradox,” as well as

the history of government interference in housing mar-kets, as if he knew what economic disasters were aboutto happen.

The chapter on business policy is especially good,debunking common myths. The chapter devoted tolabor policy takes a complicated subject too often por-trayed as merely a refereed contest between workersand owners, and shows how current law tilts the play-ing field decisively in favor of unions.

A strength of the book—its concise treatment ofcomplex policies—may sometimes leave readers wish-ing for more thorough discussion. A more extendedanalysis of federalism, for example, would have fit espe-cially well in the education chapter. And sometimesCleveland weakens his work by departing from strictscholarly exposition. For instance, in the environmentalchapter, he describes a statement by biologist DavidGraber as “the ravings of a morally reprehensible madman.” Similarly, regarding fiscal policy, calling FranklinRoosevelt “either delusional, a liar, or some combina-tion of the two” will be agreeable to FDR’s critics, butit won’t help convince students who were taught torevere Roosevelt and his New Deal.

Sacred Lies is a welcome counterweight to the biasand misinformation soaked up by students who havenever been exposed to a fair treatment of free-marketideas. The book will work even better for individualspredisposed to those ideas by challenging them tosharpen arguments and increase understanding of con-victions they already hold. Most important, all readerswill better appreciate that we have gone far beyond theproper functions of government and suffer from manylaws that are destructive.

Joseph G. Lehman ([email protected]) is president of the MackinacCenter for Public Policy in Midland, Michigan.



B Y D AV I D R . H E N D E R S O N

The Balance-of-Payments Deficit:Not to Worry

The Pursuit of Happiness

Quick. What’s the trade deficit between Cali-fornia and the rest of the world? Don’t tryGoogling it because you won’t find an answer. No government agency—or private

entity—computes the dollar value of goods that peoplein the rest of the world sell to or buy from Californians.Why not? Because it doesn’t matter.

Yet governments do that computation for countries.Do trade deficits between countries matter? They do,but a lot less than most people think. A high tradedeficit is not a definite sign of an economy’s weakness,and a low trade deficit or high trade surplus is not adefinite sign of an economy’sstrength.

First, let’s define our terms.By the most comprehensivemeasure, there can never be abalance-of-payments deficit.If we import a higher dollarvalue of goods and servicesthan we export, then the extradollars we spend on importsbalance that difference, andthe net balance is zero.

Of course, when peoplerefer to a balance-of-pay-ments deficit they are not thinking about this compre-hensive measure; they’re thinking about a narrowermeasure—the merchandise trade deficit.This is the dif-ference between the dollar value of what we spend onimports and what we are paid for exports. In 2008, thelatest year for which these data are available,Americansspent $840 billion more on imports than foreignersspent on U.S. exports. Offsetting this was a U.S. surpluson services of $144 billion.The net balance of trade ongoods and services, therefore, was $696 billion. To putthis into perspective, this was about 4.8 percent of thetotal U.S. gross domestic product.

Where did this $696 billion go? It went to othercountries, of course, but most of it came back in one ofthree forms: 1) foreign purchases of American bonds,mainly government bonds; 2) foreign purchases ofother assets such as stocks, land, and property; and (3)so-called direct investment whereby foreigners buildplants and equipment in the United States.

Is this bad? Consider each in turn.1) If foreigners refused to buy government bonds,

the U.S. government would need to offer higher inter-est rates to make holding the bonds attractive to Amer-icans. That would drive up the cost of financing the

U.S. budget deficit.We candecry this deficit—and Ido—but given that itexists, which is better: hav-ing the irresponsible fed-eral government paying ahigher or lower interestrate? I vote for the latter.

2) One reason foreign-ers invest in U.S. stocks,land, and property is thatthe United States is still arelatively safe haven forinvestment. Granted, it’s

probably less safe than it was before the U.S. govern-ment changed the rules with its bailout, the so-calledTroubled Asset Relief Program (TARP), and with theso-called stimulus package. But it’s still safer thaninvesting in much of the rest of the world. So ratherthan being bad, the size of this investment is actuallygood.


David Henderson ([email protected]) is a research fellowwith the Hoover Institution and an economics professor at the GraduateSchool of Business and Public Policy at the Naval Postgraduate School inMonterey, California. He is the editor of The Concise Encyclopedia ofEconomics (Liberty Fund) and blogs at www.econlib.org.

Trade deficits are usually a good sign for the U.S.Imelda Bettinger

3) The same reasoning applies here. It’s good, notbad, that foreigners find it attractive to invest directly inthe United States. It’s especially good for U.S. workers.The more capital there is per worker, the higher workerproductivity is and, therefore, the higher are real wages.

Dollars on the Penny

What if the money doesn’t come back in any ofthe above three forms of investment but,

instead, is held in U.S. dollars? That’s even better forAmericans. Instead of giving up capital in return formerchandise, we are giving up paper money.Accordingto the Bureau of Engraving and Printing, the averagecost of a unit of paper money is 6.4 cents. Because ofthe production process, the cost is probably higher for aone-hundred-dollar bill, and presumably a dispropor-tionately high number of such bills isheld abroad. But it’s still likely to costunder 25 cents to print a one-hundred-dollar bill, and the bills take an averageof 89 months to wear out. Getting valu-able goods in return for paper moneythat sells for dollars on the penny is agood deal for Americans. Jay Leno, in a1980s ad for Doritos, said “Crunch allyou want.We’ll make more.” Similarly, ifpeople in other countries hold on totheir paper U.S. bills, the FederalReserve can make more.

But aren’t we as a nation, by spending more onimports than our exporters earn, actually saving less andimplicitly giving up capital for consumption goods? Yes,we are. But that’s the result of decisions that millions ofus make individually. And it really doesn’t matter, at anindividual level, whether we save less to buy imports orto buy domestically produced consumption goods.Either way, we’re giving up capital for consumption. Isthis a bad idea? We’re showing by our actions that wethink it’s not. We’re showing that many of us valuethose high-quality Toyotas more than we value theshares of General Motors stock or U.S. governmentbonds that we could have bought instead. Do you thinkyou’re giving up too much capital for consumer goods?Then spend less and save more.

I mentioned earlier that a small balance-of-paymentsdeficit is not necessarily a sign of economic strength.Between 1980 and 2008, there have been only threeyears in which the United States has had a merchandisetrade surplus: 1980, 1981, and 1991. Those were allyears in which the U.S. economy was in recession.Thatis no coincidence.When economic growth is high, wetend to spend a higher share of our income on imports.The years with the highest merchandise trade deficitsalso tended to be the years with the highest economicgrowth.

What about the danger that foreigners will own alarge share of the U.S. capital stock? First, it’s not adanger. Even if it happened, it would simply mean thatU.S. workers would work for foreign employers.Whilesome of these foreign owners would be worse than

U.S. employers, some would bebetter. Incidentally, during the 1988U.S. presidential campaign, Democ-ratic candidate Michael Dukakistold workers at a St. Louis auto-motive parts plant: “Maybe theRepublican ticket wants our chil-dren to work for foreign owners . . . but that’s not the kind of a future Lloyd Bentsen and I andDick Gephardt and you want forAmerica.”The problem? The work-

ers he was speaking to were employed by an Italiancorporation.

Second, the amount of U.S. capital owned by for-eigners at the end of 2008 was $23.4 trillion. But theamount of foreign capital owned by Americans was$19.9 trillion. This difference of $3.5 trillion is onlyabout 7 percent of the $48 trillion total value of phys-ical assets.

To look at the $3.5 trillion another way, it is lessthan $70 trillion.Why is that relevant? Boston Univer-sity economist Laurence Kotlikoff says that’s theamount by which the present value of the U.S.government’s future promises to spend exceeds thepresent value of the government’s future projected taxrevenues.

Now that’s something to worry about.


D a v i d R . H e n d e r s o n

What about thedanger that foreignerswill own a large shareof the U.S. capitalstock? It’s not adanger.

the freeman

Documents

cost of government

government intervention

government intrusioninto

executive compensation

chrysler financial

bank of america

bad thing

short of short selling