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Rothbard 2nd Edition Ludwig von Mises Institute... From 1982 to 1995, the Free Market was home to Rothbard’s monthly explanation of economic events.. With the specialization of the mode

Making Economic Sense

Murray N Rothbard

2nd Edition

Ludwig von Mises Institute

All rights reserved No part of this book may be reproduced in any manner whatsoever without written permission except in the case of reprints in the context of reviews For information write the Ludwig von Mises Institute,

518 West Magnolia Avenue, Auburn, Alabama 36832.

ISBN: 0-945466-46-3

C ONTENTS

Preface by Llewellyn H Rockwell, Jr .xi

Introduction to the Second Edition by Robert P Murphy xiii

MAKING ECONOMIC SENSE 1 Is It the “Economy, Stupid”? 3

2 Ten Great Economic Myths 7

3 Discussing the “Issues” 19

4 Creative Economic Semantics 23

5 Chaos Theory: Destroying Mathematical Economics From Within? 25

6 Statistics: Destroyed From Within? 28

7 The Consequences of Human Action: Intended or Unintended? 31

8 The Interest Rate Question 33

9 Are Savings Too Low? 37

10 A Walk on the Supply Side 40

11 Keynesian Myths 43

12 Keynesianism Redux 45

THE SOCIALISM OF WELFARE

13 Economic Incentives and Welfare 53

14 Welfare as We Don’t Know It 56

15 The Infant Mortality “Crisis” 58

16 The Homeless and the Hungry 62

17 Rioting for Rage, Fun, and Profit 64

18 The Social Security Swindle 68

19 Roots of the Insurance Crisis 71

20 Government Medical “Insurance” 74

21 The Neocon Welfare State 77

22 By Their Fruits .81

23 The Politics of Famine 84

24 Government vs Natural Resources 87

25 Environmentalists Clobber Texas 89

26 Government and Hurricane Hugo:

A Deadly Combination 92

27 The Water Is Not Running 96

POLITICS AS ECONOMIC VIOLENCE 28 Rethinking the ’80s 103

29 Bush and Dukakis: Ideologically Inseparable 106

30 Perot, The Constitution, and Direct Democracy 110

31 The Flag Flap 113

32 Clintonomics: The Prospect 116

33 Clintonomics Revealed 119

34 Price Controls are Back! 123

35 The Health Plan’s Devilish Principles 127

36 Outlawing Jobs: The Minimum Wage, Once More 133

37 The Union Problem 136

38 The Legacy of Cesar Chavez 140

39 Privatization 144

40 What To Do Until Privatization Comes 146

41 Population “Control” 150

42 The Economics of Gun Control 153

43 Vouchers: What Went Wrong? 156

44 The Whiskey Rebellion: A Model for Our Time? 160

45 Eisnerizing Manassas 164

ENTERPRISE UNDER ATTACK 46 Stocks, Bonds, and Rule by Fools 169

47 The Salomon Brothers Scandal 173

48 Nine Myths About the Crash 176

49 Michael R Milken vs The Power Elite 181

50 Panic on Wall Street 185

51 Government-Business “Partnerships” 189

52 Airport Congestion: A Case of Market Failure? 192

53 The Specter of Airline Re-Regulation 195

54 Competition at Work: Xerox at 25 199

55 The War on the Car 201

FISCAL MYSTERIES REVEALED 56 Are We Undertaxed? 209

57 The Return of the Tax Credit 212

58 Deductibility and Subsidy 215

59 That Gasoline Tax 217

60 Babbitry and Taxes: A Profile in Courage? 221

61 Flat Tax or Flat Taxpayer? 224

62 Mrs Thatcher’s Poll Tax 227

63 Exit the Iron Lady 230

64 The Budget Crisis 233

65 The Balanced-Budget Amendment Hoax 236

ECONOMIC UPS AND DOWNS 66 The National Bureau and Business Cycles 243

67 Inflationary Recession, Once More 246

68 Deflation, Free or Compulsory 250

69 Bush and the Recession 254

70 Lessons of the Recession 258

71 The Recession Explained 264

THE FIAT MONEY PLAGUE 72 Taking Money Back 271

73 The World Currency Crisis 295

74 New International Monetary Scheme 300

75 “Attacking” the Franc 302

76 Back to Fixed Exchange Rates 306

77 The Cross of Fixed Exchange Rates 311

78 The Keynesian Dream 315

79 Money Inflation and Price Inflation 317

80 Bank Crisis! 321

81 Anatomy of the Bank Run 325

82 Q & A on the S & L Mess 328

83 Inflation Redux 333

84 Inflation and the Spin Doctors 336

85 Alan Greenspan: A Minority Report on the

Fed Chairman 339

86 The Mysterious Fed 341

87 First Step Back to Gold 344

88 Fixed-Rate Fictions 347

ECONOMICS BEYOND THE BORDERS 89 Protectionism and the Destruction of Prosperity 355

90 “Free Trade” in Perspective 367

91 The Nafta Myth 370

92 Is There Life After Nafta? 375

93 “Fairness” and the Steel Steal 378

94 The Crusade Against South Africa 383

95 Are Diamonds Really Forever? 385

96 Oil Prices Again 388

97 Why the Intervention in Arabia? 392

98 A Trip to Poland 397

99 Peru and the Free Market 399

100 A Gold Standard for Russia? 402

101 Should We Bail Out Gorby? 404

102 Welcoming the Vietnamese 408

THE END OF COLLECTIVISM 103 The Collapse of Socialism 413

104 The Freedom Revolution 416

105 How to Desocialize? 419

106 A Radical Prescription for the Socialist Bloc 422

107 A Socialist Stock Market? 425

108 The Glorious Postwar World 428

109 The Revolution Comes Home 431

110 The Trouble with the Quick Fix 436

OUR INTELLECTUAL DEBTS 111 William Harold Hutt : 1899–1988 443

112 Friedrich August von Hayek: 1899–1992 446

113 V Orval Watts: 1898–1993 450

114 Ludwig von Mises: 1881–1973 452

115 Margit von Mises: 1890–1993 455

116 The Story of the Mises Institute 458

POSTSCRIPT 117 The November Revolution And What to Do About It 467

INDEX 499

P REFACE

The academic contributions of Murray N Rothbard(1926–1995) are legion, but he also had a passion for pub-lic persuasion A free society can only be sustained if the generalpublic is aware of the vital importance of the market and theterrible consequences of statism That’s why Rothbard hoped toconvince everyone about the virtues of the free economy ForRothbard, educating the public was strategically necessary andmorally obligatory It was also lots of fun

From 1982 to 1995, the Free Market was home to Rothbard’s

monthly explanation of economic events He presented theoryand policy in clear, sprightly prose while never sacrificing intel-lectual rigor Keeping with Mencken’s rule, Rothbard’s clearwriting was a product of his clear thought Even when dis-cussing subjects like interest rates and excise taxes—subjectseconomists typically take pains to make unbearably boring—Rothbard teaches and entertains at the same time

The Free Market essays are a crucial part of the legacy he has

left us As he skewers both parties in all branches of ment, and all their connected interests, we see a principled Aus-trian School economist at work

govern-The Second Edition is expanded to include “Protectionismand the Destruction of Prosperity,” a monograph printed by theMises Institute in 1986; “Taking Money Back,” a piece crafted

xi

in 1991 to make a populist case for radical monetary reform,and a brief but moving obituary of Mises published in 1973

No matter how specialized and distant from reality the nomic profession becomes, Rothbard proves it is always possi-ble to communicate truth more broadly In this area, as in somuch else, Rothbard shows us the way

eco-Llewellyn H Rockwell, Jr

Auburn, Alabama January 2006

I NTRODUCTION TO THE S ECOND E DITION

Murray Newton Rothbard (1926–1995) was one of the most

important thinkers of the twentieth century I choose thesomewhat vague term thinker because Rothbard’s interests were

so diverse that they defy conventional classification Yes, bard was an economic theorist in the “Austrian” tradition ofLudwig von Mises and Friedrich Hayek But Rothbard alsowrote a detailed history of the Great Depression, two volumes

Roth-on the history of ecRoth-onomic thought, several methodologicalarticles, as well as an incredibly lucid text on economic princi-ples With the specialization of the modern economics profes-sion, these feats alone would be unusual: You do either eco-nomic theory, economic history, history of economic thought (ifyou don’t care about getting a job, at any rate), or—if you’re one

of the few economists who can actually produce prose that dents and the lay public find comprehensible—you go aheadand write an introductory textbook Except for freaks like PaulSamuelson (and Murray Rothbard), you don’t do all of thesethings, just as a surgeon specializes in the heart or the brain, butnever both

stu-And yet we can’t stop there In addition to his contributions

to all areas of economics, Rothbard wrote four (provocative)volumes on the history of colonial America He also drew onphilosophy, political science, and legal theory to synthesize a357-page deductive treatise on the nature and content of thelegal code in a just and free society Oh yes, I almost forgot:

xiii

Rothbard virtually single-handedly created the modern tarian movement through his ceaseless agitation and two books,one explaining the terrible consequences of all governmentintervention and the other giving the virtual blueprints for asociety with no government.

liber-“An impressive fellow,” you may say, “who was no doubt agenius Yet surely he was a humorless robot of a man, spewingforth lonely and bitter critiques of all those lesser mortals withwhom he could not identify.”

Now this relates to the really surprising aspect of MurrayRothbard—the guy was funny, and he was a real person Youwill see this immediately as you read the essays, but I fear that

if the present volume is your only sampling of Rothbard’s work,

it may give the impression that his writing was remarkablyentertaining in light of how, well, stuffy the topics were Butwhat do you expect? Most of these essays were originally pub-

lished in the Free Market, a newsletter obviously devoted to

economic and political issues, subjects that can at times (despitetheir tremendous importance) be a bit dry If this is indeed your

reaction, you absolutely must go on to read The Irrepressible

Rothbard, a collection of some of his lighter essays There you

will see the same impeccable logic, brutal honesty, and ful wit, but in the context of antiwar polemics, politically incor-rect musings on various racial and sexual conflicts, surprisingly

wonder-plausible conspiracy theories, insensitive ad hominem (yet

unde-niably funny) attacks on people Rothbard can’t stand, good oldClinton bashing, and, believe it or not, movie reviews that arefar more insightful than what you will likely get in your localnewspaper

As I mentioned above, most of the essays in the present

vol-ume originally ran in the the Free Market, a monthly newsletter

put out by the Ludwig von Mises Institute, which was founded

in 1982 to promote and advance the legacy of Rothbard’sbeloved mentor Ludwig von Mises (1881–1973) was the undis-puted champion of the Austrian School of economics during hislifetime (The term “Austrian” refers to the nationality of the

School’s pioneers; Austrian economists do not study the ployment rate of Vienna.) Among his theoretical achievementswas the incorporation, in the early twentieth century, of moneyprices into the subjectivist, marginalist framework that othereconomists of that day had used only to explain prices in abarter economy Mises also drew on the work of his own men-tor, Eugen von Böhm-Bawerk, as well as Knut Wicksell, toelaborate a theory of the business cycle that laid the blame not

unem-on capitalism but rather unem-on the central government’s tions of the banking system (It was for his elaboration of theMisesian cycle theory that Friedrich Hayek won the NobelPrize in economics in 1974.)

manipula-Another major contribution was Mises’s work on ogy, in which he argued that economic laws were a subset of

methodol-“praxeology”—the logic or science of human action—and werenot comparable to the physical laws of the natural sciences Inthe natural sciences, we observe the actual outcome—the tra-jectory of a cannonball, let us say—and then we must come upwith hypotheses to explain the causal forces at work In contrast,

in the social sciences (whether criminology, sociology, ogy, or economics) we presumably know the motivating forces

psychol-at work, psychol-at least psychol-at a certain level of generality: When a manrobs a bank, we do not study the physical forces on the atoms inhis body, but rather ask, “What drove him to this desperate act?Didn’t he have a strong role model to teach him right fromwrong?” and so on (It’s not so much that we couldn’t use themethods of the physicist or chemist, but just that they wouldn’ttake us very far They certainly wouldn’t help detectives recoverthe loot! For that task, we need to “get inside the head” of thethief.) Mises looked at the growing body of economic analysis(at least in the early twentieth century) and crystallized itsessence as logical deductions from the fact that people act; inother words, Mises felt all valid economic laws were implied bythe fact that people are rational (though fallible) beings whochoose means to (attempt to) achieve desired ends I bring thispoint up because there is a tendency among certain people tolump all “free market” economists together, so that Milton

Introduction to the Second Edition xv

Friedman and Ludwig von Mises (or Murray Rothbard) are

“basically saying the same thing.” This issue of the proper dation of economic science is one major example of the error ofsuch careless grouping; in exact contradiction to the view ofMises and Rothbard, Milton Friedman is famous for his defense

foun-of positivism in economics, i.e., the application foun-of the methods

of the physical sciences to the social sciences

There is another difference between Mises (and Rothbard)and such popular advocates of laissez-faire as Milton Friedman

or, more recently, heroes of American political “conservatives”such as Lawrence Kudlow or Alan Greenspan It is true that all

of these economists would agree, say, that a cut in the capitalgains tax would be good for the American economy, or that rais-ing the minimum wage to $10 per hour would hurt inner cityminorities In that sense they are all “anti-government.” ButMises (and even more so, Rothbard) were far more consistent intheir promotion of individual liberty and free enterprise, andtheir condemnation of government intervention in the econ-omy Thus Friedman could advocate a “negative income tax”—i.e., a welfare program that is novel only in the method bywhich the amounts of the checks are calculated—andGreenspan and Kudlow certainly do not feel “government is theproblem” when it comes to the Federal Reserve

Of course, some may feel that these last remarks are bothunfair and politically nạve Indeed, one of the biggest com-plaints against Mises, and especially Rothbard, is that they werestubborn, “dogmatic” ideologues, who couldn’t support a move

in the right direction because of their unrealistic principles.Although I don’t subscribe to this objection, this Introduction ishardly the place for me to answer it Let me mention, though,that another popular objection is that Rothbard was a selloutwho would ally with various communists, Democrats, protec-tionist Republicans, etc based on the shifting political winds.Now say what you will about his strategic vision—and the hugegrowth of the extremely radical “anarcho-capitalist” movement

is a point in his favor—but Rothbard can’t be both a dogmaticpurist and an opportunistic sellout at the same time!

I wish I could include some of my personal anecdotes ofRothbard to give you a sense of the man, but unfortunately Inever met him As many say of John F Kennedy, I can trulyremember exactly where I was when I learned the news I was

an economics major at Hillsdale College, and another studentmentioned to me that “some big free market economist” haddied With a sinking stomach I asked, “It’s not Murray Roth-bard, is it?” to which my friend replied, “Yeah, that was hisname.” I was extremely disappointed because, in many respects,Rothbard’s work (in both economics proper and political phi-losophy) had been the standard by which I would judge my own

On those issues where we disagreed—and there were many—Iwanted to hear him reply to my critiques, and now that would

be impossible (Yes, I was as self-absorbed as any other can undergrad.) But on those issues where we agreed—whereRothbard really nailed the issue on the head, in my mind—wowdid he do it beautifully

Ameri-You will see this in the present collection In addition tobeing correct, Rothbard’s prose is also precise and direct (Incontrast, Hayek’s points are often valid and extremely precise,but might involve seven clauses and three semicolons.) You willalso get a sense of Rothbard’s extreme breadth of knowledge Toparaphrase Mark Twain: the older I get, the smarter MurrayRothbard becomes I realized this when I first taught anadvanced class in Austrian economics, and one of the readingswas Rothbard’s famous (1956) essay, “Toward a Reconstruction

of Utility and Welfare Economics.” Having just graduated from

a fairly highly ranked doctoral program in mathematical nomics, I considered myself quite knowledgeable about abstractconcepts such as von Neumann-Morgenstern utility functions

eco-I was quite surprised, then, to see that Rothbard was perfectlyadept with the mathematical sophistication in these demonstra-tions, and could point out their underlying (false) assumptions

I was surprised yet again when rereading the present collection,and came across Rothbard’s essay on chaos theory Because of

an honors seminar on “spontaneous order” (i.e., the emergence

of orderly macro phenomena from simple micro foundations) I

Introduction to the Second Edition xvii

had just read an entire book on the history and current tions of chaos theory—and that’s how I knew that Rothbard hadapparently done the same, because his essay contains references

applica-to names and subtle points that suggest a deep understanding.What’s particularly ironic is that I had read this essay years ear-

lier, when Making Economic Sense first appeared, and must have

skimmed over these subtleties because at the time I didn’t quiteknow what Rothbard was talking about

The one other anecdote I can share concerns a roadtrip that

I was taking with my mother and her friend I had taken my

(first edition) copy of Making Economic Sense even though I had

read it cover to cover before At some point in the trip, mymother’s friend became bored and asked if she could look at it

I agreed with hesitation; even though I knew Rothbard wasgreat, surely a “real person” would find him boring and/orcrazy! But as it turns out, she was chuckling after a few pages,and even began discussing the book with my mother She par-ticularly liked Rothbard’s observation that new houses can’t bebuilt to last as long as older ones, because, “Oh, we couldn’tafford to build it that way today.” In short, although I can’tremember exactly what drove my insecurity—hey, I think I wasstill a teenager—it was completely unfounded

Although many of us younger libertarians were shocked anddisillusioned with the Republican Party over George W Bush’sunprecedented deficits and propensity to conquer other coun-tries, some of the enclosed essays show us that this is nothingnew Of Ronald Reagan Rothbard writes,

It is no accident that the same administration that manages

to combine the rhetoric of ‘getting government off our back’ with the reality of enormously escalating Big Government, should also have brought back a failed and statist Keynesian- ism in the name of prosperity and free enterprise

In a later essay he continues:

Since the beginning of the Reagan administration, the much heralded “cuts” in the officially dubbed “income-tax”

segment of our payroll taxes have been more than offset by the rise in the “Social-Security” portion But since the pub- lic has been conditioned into thinking that the Social Secu- rity tax is somehow not a tax, the Reagan-Bush administra- tions have been able to get away with their pose as heroic champions of tax cuts and resisters against the tax-raising inclinations of the evil Democrats

As far as the Middle East, Rothbard’s essay “Why the tion in Arabia?” is cogent reading for today (A similar phe-nomenon occurs if one listens to the stand-up rantings of thelate comedian Bill Hicks Even though he died before the inva-sion of Iraq, one could listen to his criticism of “Bush’s” justifi-cations for war, as well as his hypocritical demonization of Sad-dam, for several minutes without realizing that Hicks is refer-ring to George Herbert Walker Bush.)

Interven-I began this Interven-Introduction by stating that Murray Rothbardwas one of the most important thinkers of the twentieth cen-tury Largely through the efforts of the Mises Institute, hiswork, of which the present collection is just a morsel, continues

to reach ever wider audiences Although it’s much too soon to

be confident, perhaps future writers will refer to Murray bard as one of the most influential thinkers of the twenty-firstcentury

Roth-Robert P Murphy

Hillsdale College December 2005

Introduction to the Second Edition xix

Making Economic Sense

1

I S I T T HE “E CONOMY , S TUPID ”?

One of the persistent Clintonian themes of the 1992

cam-paign still endures: if “it’s the economy, stupid,” then whyhasn’t President Clinton received the credit among the publicfor our glorious economic recovery? Hence the Clintonian con-clusion that the resounding Democratic defeat in November,

1994, was due to their failure to “get the message out” to thepublic, the message being the good news of our current eco-nomic prosperity

Some of the brighter Clintonians realized that the Presidentand his minions had been repeating this very message endlesslyall over America; so they fell back on the implausible alternativeexplanation that the minds of the voting public had been tem-porarily addled by listening to Rush Limbaugh and his col-leagues

So what went wrong with this popular line of reasoning? Asusual, there are many layers of fallacy contained in this politicalanalysis In the first place, it’s crude economic determinism,what is often called “vulgar Marxism.” While the state of theeconomy is certainly important in shaping the public’s politicalattitudes, there are many non-economic reasons for publicprotest

3

First published in February 1995

The public is particularly exercised, for example, aboutcrime, gun control, the flood of immigration, and the continu-ing wholesale assault by government and the dominant liberalculture upon religion and upon “bourgeois” as well as tradi-tional ethical principles

Other non-economic reasons: a growing pervasive cism about politicians keeping their pledges to the voters, askepticism born of hard-won experience rather than of some

skepti-infection by a bacillus of “cynicism.” A fortiori removed from

economics is an intense revulsion for the president, his wife, andtheir personal traits (“the character question”), a visceralresponse that made a powerful impact on the election

But even apart from the numerous non-economic tions for political attitudes and actions by the public, the com-mon “it’s the economy” argument even leaves out some of theimportant features of economic-based motivation in politics.For the famous Clintonian slogan does not even begin to focus

motiva-on all the relevant features of the ecmotiva-onomy

Instead, to capture the Clintonian meaning, the sentimentshould be rephrased as “it’s the business cycle, stupid.” For whatthe Clintonians and the media are really advocating is “vulgarbusiness-cycle determinism”: if the economy is booming, theins will be reelected: if we’re in recession, the public will oustthe ruling party

The “Business cycle” may at first appear to be equivalent to

“the economy,” but in fact it is not There are vital aspects ofthe economy felt by the voters that are not cyclical, not part of

a boom-bust process, but that rather reflect “secular” (long-run)trends What’s happening to taxes and to secular living stan-dards, and among such standards the intangible, unmeasurablebut vital concept of the “quality of life,” is extremely important,often more so than whether we are technically in the expansion

or contraction phase of the cycle

Indeed, the major economic grievance agitating the publichas little or nothing to do with the cycle, with boom or reces-sion: it is secular and seemingly permanent, specifically a slow,

inexorable, debilitating decline in the standard of living thatgrinds down the people’s spirit as well as their pocketbooks.Taxes, and the tax bite into their earnings, keep going up, on thefederal, state, county, and local levels of government Semanticdisguises don’t work any more: call them “fees,” or “contribu-tions,” or “insurance premiums,” they are taxes nevertheless,and they are increasingly draining the people’s substance And while Establishment economists, statisticians, andfinancial experts keep proclaiming that “inflation has beenlicked,” that “structural economic factors preclude a return to

inflation,” and all the rest of the blather, all consumers know in

their hearts and wallets that the prices they pay at the market, at the store, in tuition, in insurance, in magazine sub-scriptions, keep going up and up, and that the dollar’s valuekeeps going down and down

super-The contemptuous charge by economic “scientists” that allthis experience by consumers is merely “anecdotal,” that hardquantitative data and their statistical manipulations demonstratethat economic growth is lively, that the economy is doing splen-didly, that inflation is over, and all the rest, doesn’t cut any iceeither In the end, all this “science” has only succeeded in con-vincing the public that economic and statistical experts rank upthere with lawyers and politicians as a bunch of—how shall weput it?—“disinformation specialists.”

If everything is going so well, the public increasingly wants

to know, how come young married couples today can no longerafford the standard of living enjoyed by their parents when theywere newlyweds? How come they can’t afford to buy a home oftheir own? One of the glorious staples of the American experi-ence has always been that each generation expects its children

to be better off than they have been This expectation was neverthe result of mindless “optimism”; it was rooted in the experi-ence of each preceding generation, which indeed had beenmore prosperous than their parents

But now the reality is quite the opposite People know theyare worse off than their parents, and therefore they rationally

expect their children to be in still worse shape Everywhere youturn you get a similar answer: “Why couldn’t you construct anew building with the same sturdy qualities as this (50-year old)

house? Oh, we couldn’t afford to build it that way today.”

Even official statistics bear out this point, if you know where

to look For example, the median real income in dollars, (that is,corrected for inflation) of American families is lower than it was

in 1973 Then, if we disaggregate households, we get a fargloomier picture Family income has not only been slightlyreduced; it has collapsed in the last 20 years because of the phe-nomenal increase of the proportion of married women in theworkforce

This massive shift from motherhood and the domestic arts tothe tedium of offices and time clocks has been interpreted by ourdominant liberal culture as a glorious triumph of feminism inliberating women from the drudgery of being housewives so thatthey can develop their personalities in a fulfilling career Whilethis may be true for some occupations, one still hears on everyside, once again, that the “reason I went to work is because wecould no longer afford to live on one salary.”

Again, since there is no way to quantify subjective tions, we can’t measure this factor, but I suspect that the greatbulk of working women, i.e., those in non-glamorous careers,are only working to keep the family income from falling steeply.Given their druthers, I suspect they would happily return to themuch-maligned “Ozzie and Harriet” family of the Neanderthalera

motiva-Of course, there are some sectors of the economy that areindeed growing rapidly, where prices are falling instead of ris-ing; notably the computer industry, and whatever emerges fromthe much-hyped “information superhighway,” when, at somewonderful point in the near or mid-future, Americans candrown their increasing miseries in the glories of 500 interactive,digital, cybernetic channels, each offering another subvariant ofmindless pap

This is a future that may satisfy techno-futurist gurus likeAlvin Toffler and Newt Gingrich, but the rest of us, I bet, willbecome increasingly unhappy and ready to lash out at thepolitical system that—through massive taxation, cheap moneyand credit, social insurance schemes, mandates, and govern-ment regulation—has brought us this secular deterioration, andhas laid waste to the American dream Z

2

T EN G REAT E CONOMIC M YTHS

Our country is beset by a large number of economic myths

that distort public thinking on important problems and lead

us to accept unsound and dangerous government policies Hereare ten of the most dangerous of these myths and an analysis ofwhat is wrong with them

Myth 1: Deficits are the cause of inflation; deficits have nothing

to do with inflation

In recent decades we always have had federal deficits The

invariable response of the party out of power, whichever it may

be, is to denounce those deficits as being the cause of perpetual

inflation And the invariable response of whatever party is in

power has been to claim that deficits have nothing to do with

inflation Both opposing statements are myths

Deficits mean that the federal government is spending morethan it is taking in in taxes Those deficits can be financed intwo ways If they are financed by selling Treasury bonds to thepublic, then the deficits are not inflationary No new money iscreated; people and institutions simply draw down their bankdeposits to pay for the bonds, and the Treasury spends thatmoney Money has simply been transferred from the public to

First published in April 1984.

the Treasury, and then the money is spent on other members ofthe public

On the other hand, the deficit may be financed by sellingbonds to the banking system If that occurs, the banks createnew money by creating new bank deposits and using them tobuy the bonds The new money, in the form of bank deposits, isthen spent by the Treasury, and thereby enters permanentlyinto the spending stream of the economy, raising prices andcausing inflation By a complex process, the Federal Reserveenables the banks to create the new money by generating bankreserves of one-tenth that amount Thus, if banks are to buy

$100 billion of new bonds to finance the deficit, the Fed buys

approximately $10 billion of old Treasury bonds This purchase

increases bank reserves by $10 billion, allowing the banks topyramid the creation of new bank deposits or money by tentimes that amount In short, the government and the bankingsystem it controls in effect “print” new money to pay for thefederal deficit

Thus, deficits are inflationary to the extent that they are

financed by the banking system; they are not inflationary to the

extent they are underwritten by the public

Some policymakers point to the 1982–83 period, whendeficits were accelerating and inflation was abating, as a statisti-cal “proof’ that deficits and inflation have no relation to eachother This is no proof at all General price changes are deter-mined by two factors: the supply of, and the demand for, money.During 1982–83 the Fed created new money at a very high rate,approximately at 15 percent per annum Much of this went tofinance the expanding deficit But on the other hand, the severedepression of those two years increased the demand for money(i.e., lowered the desire to spend money on goods) in response

to the severe business losses This temporarily compensatingincrease in the demand for money does not make deficits anyless inflationary In fact, as recovery proceeds, spending picked

up and the demand for money fell, and the spending of the newmoney accelerated inflation