Summa Against the Keynesians

SUMMA AGAINST THE KEYNESIANS A Treatise on Economics

By DMITRY A. CHERNIKOV

THIRD REVISED EDITION

3rd Revised Edition.

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Publisher’s Cataloging-in-Publication Data Chernikov, Dmitry A. Summa against the Keynesians : a treatise on economics , third revised edition / by Dmitry A. Chernikov. p. cm. Includes bibliographical references. ISBN 978-0-9850103-2-4 1. Keynesian economics. 2. Keynes, John Maynard, 1883-1946. 3. Austrian school of economics. 4. Monetary policy. 5. Economics – History – 20th century. 6. Economics – Philosophy. 7. Business cycles. I. Title. HB72 .C442 2015 339 – dc23 Published by Fireside Books Akron, Ohio, United States

2015904775

To Lew Rockwell for helping me to climb onto the shoulders of giants; and to David Gordon for the calm of contemplation. The whole world groaned and marveled to find itself Keynesian. – Imitating St. Jerome Померяемся силами, нечистая сила. – Russian fairy tales

CONTENTS Introduction: Economics and the Economist 1.

That economics is both speculative and practical or Mises vs. Marx ....................................................................................... 1

2.

That the mission of the economist is an exalted one ................. 29

Book I: The Master 1.

That the notions of the evenly rotating economy, the final state of rest, and the state of equilibrium are distinct yet complementary .......................................................................... 47

2.

That Keynes’ denial of Say’s Law is unwise ............................. 56

3.

That workers may, indeed, care about their nominal wages more than about their real wages ............................................... 62

4.

That wages must fluctuate, lest capitalism be for naught .......... 66

5.

How involuntary unemployment is defined by Keynes, and how it ought to be defined ......................................................... 72

6.

That Keynes vainly tries to dispose of the heterogeneity of labor ........................................................................................... 75

7.

That there is no such thing as unemployment for labor as such ............................................................................................ 82

8.

That, contrary to Keynes’ “outline of our theory,” real wages increase by means of savings, well invested................... 90

9.

That short-term and long-term business expectations follow each other ....................................................................... 96

10.

How entrepreneurial expectations affect prices, Part I .............. 99

11.

Expectations, Part II................................................................. 112

12.

That human practical wisdom and “animal spirits,” when combined, compose human action, Part I ................................ 128

13.

Prudence and courage, Part II .................................................. 136

14.

Of the strange case of neoclassical “rationality” ..................... 145

15.

That hoarding is distinct from consumption and investment ... 155

16.

That, in contrast with entrepreneurs, a worker is a combination of the Guardian and Idealist ideal types.............. 163

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17.

That money is useful to both society and the individual in numerous ways........................................................................ 170

18.

That fiat money must have its origin in commodity money ... 176

19.

How the notion of neutrality of money is to be understood .... 184

20.

That saving occurs for a variety of reasons, and that saving differs from investment ........................................................... 188

21.

That Keynes’ “psychological law” does not hold ................... 195

22.

That the share price of a public company is influenced by capital owned and entrepreneurial direction ........................... 199

23.

That sinking funds are not a vicious form of saving ............... 204

24.

That changes in the rate of interest can affect the rate of saving in contrary ways........................................................... 207

25.

The philosophy of economics: that there are three grades of being ................................................................................... 211

26.

That the 1st grade and the 2nd grade of being are not the same ........................................................................................ 233

27.

That the top level of each grade defines that grade ................. 242

28.

That the 3rd grade belongs to God alone ................................. 262

29.

That God is perfect on every level .......................................... 276

30.

That what link past, present, and future are human plans ....... 284

31.

That the will and the free-will are selfsame powers but have different connotations ..................................................... 289

32.

That free-will compatibilism is essential to both ethics, theology, and economics ......................................................... 299

33.

That free-will compatibilism stands up to objections ............. 308

34.

How judgment connects to the grades of being ...................... 315

35.

That physical, moral, and metaphysical goods are distinct ..... 322

36.

That evil is counterposed to every kind of good ..................... 332

37.

That marginal analysis completes subjectivism ...................... 337

38.

How physical goods are divided ............................................. 345

39.

That economics studies acting men and not “contemplating” men .............................................................. 347

40.

That interest rate cannot be defined via the marginal

Contents

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productivity of capital .............................................................. 353 41.

That the reason for time preference and the partial cause of interest are disutility of waiting; and that (I) production takes time ................................................................................. 358

42.

That consumer goods are hardly a subsistence fund for producers of future wealth ....................................................... 369

43.

That the interest rate is subdivided into its aspects of originary, personal, and equilibrium ........................................ 374

44.

How the various interest rates are determined ......................... 378

45.

That human action generates profit or loss not interest income ..................................................................................... 389

46.

That risk preference corresponds to hoarding as time preference, to investing; of the complete cause of interest; and that (II) the success of production is uncertain ................. 398

47.

That, similarly to the interest rate, the confidence rate is subdivided into its aspects of personal and equilibrium .......... 402

48.

That production has a structure................................................ 407

49.

That there is no such thing as generalized “investment” ......... 422

50.

That anticipating consumer demand and anticipating demand for capital goods call for different entrepreneurial talents ....................................................................................... 429

51.

Why longer processes are more productive ............................. 432

52.

That the economy grows by means of net saving .................... 439

53.

That Solow’s theory’s puzzles are easily solvable .................. 447

54.

That speculators perform a social function .............................. 450

55.

That the multiplier effect works, but so what? ........................ 456

56.

Keynes’ “observations” on the nature of capital and their refutation .................................................................................. 466

57.

Interest rate as the root of all evil: the gospel according to Keynes ..................................................................................... 475

58.

That lower wages are a cure for unemployment, Part I ........... 484

59.

Wages, Part II .......................................................................... 492

60.

That “forced saving” is less forced than fraudulent and less saving than consumption and investment ................................ 501

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61.

How business cycles occur, Part I: Introduction ..................... 513

62.

Business cycles, Part II: A consumption boom ....................... 519

63.

Business cycles, Part III: An investment boom ...................... 527

64.

Business cycles, Part IV: The bust .......................................... 536

65.

That a business cycle can also occur due to (1) moral hazards in banking and (2) changes in government policy but not (3) sheer bad luck ........................................................ 540

66.

That depressions cannot be fought with (I) bailouts ............... 550

67.

… with (II) public-works projects .......................................... 554

68.

… with (III) (more) easy money ............................................. 557

69.

That a “stamped money” policy will produce results opposite to those Keynes wants to achieve ............................. 563

70.

Conclusion: Keynes ................................................................ 567

Book II: The Disciples 1.

That individualism remains the proper methodology of economics, contra some Post Keynesians ............................... 568

2.

That business cycles cannot be blamed on changes in the voluntary savings rates ............................................................ 577

3.

That the money supply curve under fiat money can be horizontal ................................................................................ 581

4.

That growth stimulates investment only in special senses ...... 585

5.

That there are difficulties with the concepts of aggregate demand, aggregate supply, and aggregate equilibrium ........... 589

6.

That another kind of AS-AD diagram illustrates the alleged inflation-unemployment trade-off ........................................... 596

7.

That Keynesians love saving too much in a boom, when it is channeled into consumption or investment, and too little in a bust, when it tends to be hoarded ..................................... 600

8.

That Keynes unwisely treats hoarding as uneconomic ........... 605

9.

That cyclical unemployment is only one of the alleged Keynesian market failures ....................................................... 614

10.

That a deflationary depression has a natural limit to it ........... 626

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11.

That Keynesians cannot get even toy economies right or Krugman goes Stalinist ............................................................ 633

12.

That the monetary and fiscal policies are at war with themselves ............................................................................... 640

13.

That stagflation may be our interventionist best and that the present state of the banking industry is hardly free market ...................................................................................... 645

14.

That naïve underconsumptionism is nonsense......................... 653

15.

That Thomas Hall’s “Keynesian business cycle theory” does not explain business cycles.............................................. 657

16.

That the rational expectations school’s theory of business cycles is based upon irrational expectations and falsely so ..... 660

17.

That the monetarist account of the business cycle is bastardized Austrianism........................................................... 665

18.

That the “real business cycle theory” is not even wrong ......... 671

19.

That the “Keynesian cross” combines Keynes’ psychological law, the circular flow chart, and the multiplier ................................................................................. 675

20.

That in the IS-LM model, the IS curve illustrates the workings of the monetary policy, and the LM curve, of the fiscal policy, but not much more ............................................. 677

21.

That price inflation and liquidity trap obstruct monetary policy, and consumer pain and the crowding out effect obstruct fiscal policy ................................................................ 682

22.

That the term “natural real GDP” is best defined as the GDP prevailing under unhampered free market ...................... 686

23.

That the state is not an uncertainty-reducing institution .......... 687

24.

That there is no such thing as “war prosperity” ....................... 693

25.

That the size of the government and government deficits feed on each other .................................................................... 701

26.

That the Keynesian objections to free trade fail ...................... 708

27.

That “mark-up” pricing is absurd ............................................ 714

28.

Conclusion: The Keynesians ................................................... 719

Appendix: Some Interesting Problems

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Summa Against the Keynesians

1.

Solving the Gettier problem .................................................... 721

2.

That the will remains free even when survival is at stake ....... 726

3.

How taxes are socially unprofitable ........................................ 729

4.

That presentism is false ........................................................... 732

5.

Solving the reswitching problem ............................................ 735

6.

Solving the Newcomb paradox ............................................... 741

7.

hat Gödel’s and Tarski’s theorems suggest a way in which human and machine intelligences differ ................................. 743

8.

Some examples of the moral / metaphysical goods distinction ................................................................................ 746

9.

That public corporations are not greedy enough ..................... 750

10.

That ideological actions and mass movements are distinct phenomena .............................................................................. 754

Bibliography ..................................................................................... 759

Introduction Economics and the Economist 1. THAT ECONOMICS IS BOTH SPECULATIVE AND PRACTICAL OR MISES VS. MARX Ludwig von Mises’ interpretation of Karl Marx is curious. According to him, Marx tried to do two things. First, to sap the prestige of economics, such that the economists’ criticisms of the socialist system may be uniformly deflected with a blithe, and both false and irrelevant, ad hominem attack to the effect that these economists were nothing more than paid “sycophants,” i.e., disreputable toadies, of the bourgeoisie and capitalists. The “economists” do not care about the truth; in fact, they are incapable of caring about the truth; in fact, there may not be such thing as truth at all; their minds, by virtue of their belonging to a particular class, produce only “ideology” which justifies their or their employers’ selfish interests. That is, it was a brilliant though crude smear job of an entire profession. Second, to discover a law of historical evolution, according to which socialism and communism both are inevitable and will be the crowning achievements of human civilization. “As every true prophet styles himself the humble mouthpiece of his deity, so Marx pretended no more than to speak the logic of the dialectic process of history.” (Schumpeter 2008: 7) In other words, Marx destroyed reason in one area where it in reality occupies a commanding role, viz., economic analysis, and enthroned false reason in the area where it is precisely of questionable utility, viz., prediction of far-flung distant future and spontaneous human action. Consider now that political democracy can be construed in two ways. First, as a squabble between pressure groups each defending its own particular interest. Second, as a fight between ideologies understood as means to the general interest, such as the greatest happiness for the greatest number. Ambrose Bierce’s The Devil’s Dictionary tries to be clever by conflating the two: politics, it says, is “a strife of interests masquerading as a contest of principles. The conduct of public affairs for private advantage.” America’s founders, too, welcomed the latter yet

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decried the former as dangerous and anti-social factionalism. Assume, as socialists do, that the workers are the only “class” worthy of consideration, and that the interests of all workers coincide. The first aspect of democracy is thereby eliminated. This is actually a most salutary effect! Libertarians, though recognizing the value of considerable class diversity in society, too, speak out against special interests, unions, crony capitalists, “welfare” tax eaters, etc. milking the government for all it is worth and announce a long-term harmony of interests among all classes and all people under laissez-faire capitalism. However, instead of dissolving politics through theoretical universal equality as socialists had suggested, libertarians offered an actual solution: the public opinion would be so strong and unequivocal that no selfish private interest could reliably subvert the commonweal. There are similarities and differences between socialists and libertarians regarding the second aspect of democracy, as well. Both groups prefer that the ideology they advocate be accepted by the vast majority. However, the libertarians ask each person to think hard and convince himself that liberty, private property, and peace are to the benefit of both him and society at large and through astute grasp of the issues, in an alliance with rest of the people, purposively install liberty throughout the realm. Every party, according to the libertarians, even socialists, is free to contribute its arguments regarding the best system of economic organization to the conversation of mankind. Socialist leaders, however, felt that such persuasion was superfluous and more than a little tiresome, because they were merely helping to move “history” along. As a result, building socialism appeared to them to be a simple affair. The masses of people are a passive flock to be shepherded by the vanguard of the proletariat toward communism. We obtain the ideas of the vanguard’s coercive “dictatorship,” perhaps over the entire world, and that only one party is needed: democratic competition between visions and parties is not only pointless but positively harmful to society. Socialists then professed to know the designs of the First Cause but ignored the secondary causes of free speech and deliberative lawmaking; libertarians disclaimed any insight into the works of divine providence but hoped to realize their dreams by means of rational discourse. The theory and practice of collectivism diverged widely. For example, the advertised “communist” egalitarian primitivism proved to

Introduction: Economics and the Economist

3

be entirely unworkable; so recourse was had to the “socialist” comprehensive subservience. All socialist utopias bear striking similarities to each other, the only real difference being which socialist is in charge. Specifically, regarding our first point, human conflict is eliminated by means of integrating everyone into a hierarchy bonded hegemonically: each man is required unconditionally to obey the orders of his boss; to the extent that one issues orders himself, they are attempts to carry own the commands of the supreme dictator or council. Yet this simplicity was merely apparent. Competition between citizens in socialist commonwealths did not subside. As everyone was now a government bureaucrat working for one gigantic “firm,” office politics came to be highly exaggerated. Second, just as there were numerous would-be dictators, a large number of collectivist sects thrived that hated each other’s guts. It turned out that central planning was a lucrative job, worth liquidating other people for. The socialists’ understanding of the process of transition to their favored system differed exceedingly. That communism is inevitable does not mean that humans have no say in how long the journey to it will take or in how to take care of the recalcitrant. Perhaps communism is inevitable only because the alternative – capitalism – is so hellish, presenting a harsh incentive to get out of it ASAP. But here come economists demonstrating that socialism is a hopeless cause. This is not a mere reaction to “progress” on the road to serfdom but a fundamental challenge. The socialists chose to deal with it first, by denying scientific legitimacy to economics and second, by denying basic humanity to economists. Richard Weaver claims that war can make sense, but only when it is used as an ultimate means of arbitration. He argues that civilized warfare… assumes that there is an arbiter of the destiny of nations… When a nation has done its best, when it had exerted its maximum lawful strength, it accepted the “arbitrament of the sword,” whether that was given for or against it. If against it, the defeated party had to admit that the other side had “the better reason” and had to accept a settlement that accorded with that reason. (1995: 100) “Might makes right,” especially in such an exquisitely pure form, has rarely been defended with greater eloquence. I doubt that Weaver was under any illusion that any actual war in human history was fought for the reasons he laid out. I personally had

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not seen or imagined this justification for war before reading him. The 20th century’s association between war and nuclear annihilation – one version of what Weaver calls “pure and ultimate unreason” – may have been too strong. A sufficient cause of total war is the “national” brand of socialism, though there is no evidence that Weaver picked it as the culprit. The idea that all people, regardless of country of residence, can be part of a differentiated economy that functions without central command and control was decidedly rejected. Again, socialism would have it that the only way to harmonize human interests is to make everyone a bureaucrat in an all-encompassing state. One person can have peaceful relations with another only when one is a subordinate and the other, superior clerk. But if socialism is national, then each nation has its own bureaucratic hierarchy. Hence, there can be no peace between citizens of different nations. Nor can there be any sort of benign indifference, seeing that each nation lays claim on easily contested resources. As a result, nations logically came to regard themselves as deadly enemies of each other. Capitalism, the 4th level of human economic development (after the 3rd-level feudal order), was replaced with slavery (2nd level) within nations – remember that genuine socialism does not permit even the labor market – and total war (1st most primitive level) in between them. This state of affairs can be regarded as a manifestation of the Thomas Hobbes’ considerably depressing theory: war of all against all (i.e., our total war) can allegedly be prevented only though perfect universal tyranny (our socialism). As nation-states were nevertheless not abolished, both of these co-existed with shocking consequences. For example, let us say that total war between group A and group B results in victory for A and annihilation of B. What then is to prevent A itself from splintering into factions that turn on each other? The same logic that made B an implacable enemy of A will inevitably make some A2 the same kind of enemy of A1. A1 will fight with A2 to the death, again, with A1 winning and A2 getting wiped off the face of the earth. And so on we go until there is only one. Similarly, the ideal of socialism lies in the strictest possible worldwide bureaucratic order. In it, almost every person is a pawn, a tool in the hands of his superior official, bound robotically to obey his commands. Only one man, the chief bureaucrat, is permitted to have his own desires and to work on satisfying them by planning and acting. Again we see that there is only one truly human being remaining. Call this last man or creature Satan, and we see how prescient the Christians were in identifying the precise intentions of the leader of the fallen angels. His apparent aim is to have us humans murder each other or, as a second-best outcome, bow down and worship him. We all,

Introduction: Economics and the Economist

5

I think, have just reason to feel much joy and triumph that we, too, have survived the devil’s century. Take this expression literally or figuratively, it was certainly “the century of horror, the century of collectivism, the century of mass destruction and genocide.” (Rothbard 2000: 1920) Hobbes can be exculpated only if take his admittedly slick argument to mean that slavery is better than death, a kind of early “better red than dead” slogan (entirely correct, mind you), and if we do not stop there but proceed to affirm still further that capitalistic freedom is far better than either. Weaver, too, considered this situation to be “a ‘universal wolf’ which must ‘make perforce a universal prey, and last eat up himself.’” (101) He agrees that his understanding of a legitimate war may seem “quixotic” but suggests that it should be affirmed by all good people as an ideal to be striven for. There are two problems with it, however. First, Weaver makes the divine providence into a trivial and predictable thing: those in the right, he alleges, are always or usually aided by God and therefore win. Mises counters him effectively: “Nothing is fair in war. … God is for the big battalions, and… those who are better equipped defeat poorly equipped adversaries.” (1996: 827) Second, a nation is ostensibly composed of free individuals each with his own life and measure of innocence and guilt. By insisting that nations fight each other as wholes – inescapably via their states which readily absorb those individuals as soldiers – Weaver is promoting the very version of collectivism he is speaking against. Still, a wicked aggressor who knows that he is in the wrong will never fight as valiantly, defiantly, and with as much courage and determination as the just, proud, and noble defenders of the homeland. (This argument is forcefully made in de La Boétie 2008: 43-4.) Could the “arbiter of the destiny of nations” be our human sense of justice and freedom which strengthens the righteous in their resolve and weakens the evildoers? No. Remember that for Weaver, a nation declares war in order to determine right and wrong in battle, not enforce a prior right. Let Smith and Jones have a dispute. They go to court. As soon as the judge announces the verdict that Smith has won, Jones pulls out a gun and shoots Smith dead. Immediately, the verdict is overturned by the higher court of violent conflict. It turns out that Smith was always wrong, because he lost; and Jones was always right, because he won. Similarly, the seemingly holy nature of the defenders turns morally corrupt upon defeat, and the ruthless invaders acquire good qualities, having won.

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If mighty Ruritania wins in court against puny Laputania, then it wins; if it loses in court, then it wins in war. Why then bother with peaceful adjudication, when violence can bring not only loot and happiness but virtue, as well? It may be countered that the only way to confirm oneself in moral goodness is to follow the strict rules of war. But both reason and incentives are against this. People generally obey “you shall not murder” in civil society. Moreover, the “victors” are given long prison sentences. The “old chivalric concept of the war of limited objectives” counseled only that “you shall not murder too much” or perhaps “inelegantly,” hardly a consistent or rigorous moral code; and the winner got to come home in triumph. It was a slippery slope: an unstable and transient set of rules. If the argument is that war at least resolves the dispute, then the reply is that to accomplish that, one can much more cheaply and efficiently toss a coin. Why cannot our “arbiter” work his grace through luck, as well? Another solution is to set up a duel between the best fighters of each side, similar to what happens in the movie Troy (Warner Bros. Pictures, 2004). Unable to counter the proofs of the unrealizability of their system, socialist theorists decided to subject the economists to all manner of persecution; unwilling to discard their cause, they abandoned logic as a means of solving their disputes and resorted to savage infighting in order to determine the ultimate victor. They probably took their cue from Georges Sorel rather than Weaver, but the latter’s ideology, though at first glance less offensive, upon reflection turns out to be just as pernicious. The last communist standing would rule whoever was still alive. In addition, Marx’s subversive role consisted in splitting mankind into hostile groups which must inevitably fight an irreconcilable battle he termed “class warfare.” The membership in a class was determined by one’s economic function. Marx singled out capitalists and entrepreneurs who, according to him, were hindering history’s march towards the bliss of communism. These classes were to be liquidated or suppressed. It was expected that the power of individuals and incentives to them one way or another to come to own capital goods and employ factors of production to make things for use or exchange (a kind of natural law, if you will) could never be fully obliterated; hence, the class warfare would continue throughout the socialist stage and be completed only upon the arrival of communism and complete transformation of man. The odd quirk in Marx’s theory, as Mises noticed, was that the social classes differed not only in their tasks in the economy but even in

Introduction: Economics and the Economist

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the logical structure of their own minds! They were, in essence, different kinds of human beings. Because of that, they were unable to understand or communicate with one another. No truce, therefore, could be negotiated. Capitalists and workers, Marx said, were implacable enemies. These differences in the natures of men belonging to different classes would seem to be manifested in the fact that no class was able to consider the general interest or the common good but only its own narrow selfish interests. It so happened, Marx believed, that the selfish interests of the capitalists hurt the selfish interests of the workers. But Marx did not take the side of the workers arbitrarily. For the logic of the workers was not just some logic, and their interests, some interests, but the true logic and the true interests, whereas the capitalists’ thinking was objectively vicious. Perhaps, he thought that social peace could be achieved only when everyone was a worker rather than in the equally impossible situation when everyone was a capitalist saver / entrepreneur. Or perhaps, he simply took the side of the majority. Although seemingly a preposterous doctrine, it is rather eerie in how many cases the de facto correctness of Marxian polylogism can be observed. As Henry Hazlitt famously summed it up, “the art of economics consists of looking not merely at the immediate but (a) at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for (b) all groups.” (1996: 5) But if one is (1) incapable of doing so (lacking knowledge of economic causes and effects) or (2) unwilling to act on this knowledge (because of moral turpitude or indifference), then the reality is precisely as if his “logic” changed depending on his occupation, social position, and so forth. For example, regarding (1), Mises connects the dots: Under government interference with business the unity of government policies has long since disintegrated into badly coordinated parts. Gone are the days when it was still possible to speak of a government’s policy. Today in most countries each department follows its own course, working against the endeavors of the other departments. The department of labor aims at higher wage rates and at lower living costs. But the same administration’s department of agriculture aims at higher food prices, and the department of commerce tries to raise domestic commodity prices by tariffs. One department fights against monopoly, but other departments are eager to bring about – by tariffs, patents, and other

8

Summa Against the Keynesians means – the conditions required for the building of monopolistic restraint. And each department refers to the expert opinion of those specialized in their respective fields. (1946: 85)

There are a multitude of conflicting directives issued by an alphabet soup of semi-autonomous bureaus. The hidden reason for this is that the unified science of economics has been shattered into numerous subfields: Economics deals with the operation of the whole system of social cooperation, with the interplay of all its determinants, and with the interdependence of the various branches of production. It cannot be broken up into separate fields open to treatment by specialists who neglect the rest. It is simply nonsensical to study money or labor or foreign trade with the same kind of specialization which historians apply when dividing human history into various compartments. … you cannot deal with wage rates without dealing at the same time with commodity prices, interest rates, and profits. Every change occurring in one of the economic elements affects all other elements. One will never discover what a definite policy or change brings about if one limits his investigation to a special segment of the whole system. (1946: 83) Even though people may still care about the common good, this disastrous corruption of economics has taken away people’s prudence and rationality. They no longer have a means toward securing that common good. If economics is a guide to long-term prosperity for all people, then its fragmentation has resulted in every person’s seeking immediate gratification for himself only, resulting, indeed, in a kind of war of all against all. The dismal science, people think, can no longer offer any direction to the government on policy. The second aspect of democracy has all but disappeared. No tool is left to the people to help them judge ideologies. As a result, the first aspect has intensified dramatically. Everyone wants to use the government to benefit himself personally, yet, uneasy with such obvious rapacity, still seeks to absolve himself in the court of public opinion, thereby making up precisely a Marxian-style ideology. This is one reason for “big government.” Next, suppose with regard to (2), that a certain person, call him Smith, thinks: “Other people mean nothing to me; hence, I will not

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differentiate between honest toil and theft; I will get to where I want even if I have to step over the dead bodies of my fellows.” In such a case, as Glaucon argues in Plato’s Republic, “the perfection of injustice is to seem just without really being so; a perfectly unjust man, while committing the grossest acts of injustice, has won himself the highest reputation for justice.” This reputation is again due to a kind of “ideology” that Glaucon’s villain was able to bamboozle society with. If these two bear any family resemblance to polylogism, then surely, we must consider Marx’s cynicism to be staggering; but despite his disdain for humanity, we will see that, in order to be successful, an economist must be far from selfish and must rather have affection for the entire world. An objection might be lodged against the foregoing. Do not people, in fact, seek only their own happiness? Are not all interests selfish? We may for the sake of argument tentatively endorse this version of psychological egoism. However, it is one of the greatest discoveries of economics that laissez-faire capitalism harmonizes the long-term interests of all. Even a welfare-warfare state owes whatever success it has to show to those sectors of its economy that are left free. A great civilization built over the life spans of many generations benefits all of its members except, perhaps, a few misanthropes who can be dismissed as evil.1 Let Socrates deal with Glaucon; our interest is whether it makes sense for our psychopathic Smith’s attitude to spill into his politics. The answer is no: even Smith will want to enjoy the fruits of economic development. The efficacy of the system of production is a crucial means to one’s own prosperity. Every person has an incentive to care about society at least in his capacity as a voter, because that is one important way in which his own happiness is furthered. A speedy rate of economic progress affects everyone and can for that reason be called a “common good.” Such a good is common precisely because it is in the “selfish” interests of everyone, including Smith! Even if Smith would jump at the chance to be unjust while looking respectable, he has every reason to detect and prosecute other people’s injustices and deny them legal privileges. Moreover, in the short run, though there is competition, this competition is not biological, in which only the most ruthless survive, but catallactic, meaning that producers compete for who can best serve the consumers. Producers bend over backward and exhaust themselves in trying to improve the welfare of their customers. It is true that efficient 1

That anyone can be “dismissed as evil” depends upon a distinction between commutative and distributive morality, expounded on in (I, 35).

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producers thrive, and inefficient producers leave the market, but the consumers’ well-being is perpetually enhanced by the market process. Therefore, a worker can labor, a capitalist can save, and an entrepreneur can direct production with full knowledge that their actions promote social welfare. The process of biological evolution, such as it is, is zero-sum, continuously privileging some lucky group of organisms at the expense of others; the market process is positive-sum. Since every person is a consumer, everyone is intensely interested in the preservation and intensification of social bonds within the free enterprise system. These interests are common to all people, or so economics proposes. Furthermore, a man need not prima facie justify his seeking happiness. It is his nature to be doing just that. Justification is only necessary with respect to particular ways of seeking happiness, when human interests conflict. Marx’s belief, as Mises understands him, was that an entrepreneur, for example, is literally unable to say: “A society in which private entrepreneurship is permitted is inferior to a socialist society.” The entrepreneur’s own social role alters and guts his very intellect. A capitalist qua owner of capital inescapably must be capitalist qua his political ideology. Likewise, a “proletarian” in his own personal life cannot also fail to endorse socialism as a system of economic organization. Given Marx’s additional assumption that the proletarians constituted the vast majority of people who would not be deceived for long, it is from this peculiar theory that the alleged inevitability of socialism was inferred. I agree to an extent that people’s “selfishness,” emotions, and undue partiality cloud their judgment. People defend themselves when they are clearly in the wrong. A counterfeiter, though he obtained his money without producing anything of value for other people, may try to soothe his conscience by telling himself that he will “stimulate” the local economy. He deceives himself with regard to his contribution to human happiness; he does not see himself for what he truly is. His actions indicate that he does not love his neighbor; he despises him and seeks to benefit at his expense. Unable to face such evil within himself, our criminal concocts a story in which his actions, far from being perverse, are actually helpful. He has thereby made up an “ideology,” as Marx conceived of it. This does not mean, however, that the counterfeiter cannot care for the common good, only that he is tempted not to. But contra Marx, temptations can be resisted. Personal need not be political. Consider that “do not do evil” (and how) is the first moral law the mind apprehends; even little children are quite aware of the basics

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of right and wrong, fair and unfair, etc. “Do good” (and again, how) is, on the contrary, the last wisdom. The key to harmony of interests lies in the will (rooted in love for fellow man) to abide by these two precepts. For short-term interests, love is far more crucial; it is a trivial matter to grasp the 10 Commandments, much harder always to follow them. For long-term interests, the opposite state of affairs prevails; one needs only a most rudimentary sort of love often referred to as disinterested benevolence, lest when a vote is taken on what sort of society to create, each individual will seek to privilege himself in the resulting social order, destroying the possibility of agreement. At the same time, prudence requires at least a thorough grasp of economic theory. Not doing evil is quite at home with “you shall not steal” addressed to an individual. Doing good, i.e., the long run part of economic rule utilitarianism, cannot be content with anything less ambitious than an entire system of laws which intend to guide behavior toward the greatest good for the greatest number. “Punish stealing,” addressed to society, is but a cog of such a system. One may inquire why we deal with laws. An act utilitarian (AU) strives to maximize overall happiness, and one day he notices that his actions follow a pattern; they are lawlike. He can be said thereby to be a rule utilitarian (RU), such that the rules describe what he actually does. A RU prescribes rules which, if followed, will result in the greatest utility for as many people as possible. He can be said to be an AU, insofar as he does not indulge in rule worship but rather orders the rules to achieving the greatest good for the greatest number. If the acts in act utilitarianism do not obey any regularities, then act utilitarianism is an impossible ideal. No man can calculate the consequences of his actions in a Godlike manner. At the same time, if the rules in rule utilitarianism do not maximize utility, then it is not true utilitarianism. In other words, we can start with act utilitarianism and employ “maximize utility” as the highest law from which we derive secondary rules. The reason for having these secondary principles is two-fold: we have rules, because acts recommended by pure utilitarianism naturally form a system of laws; and we use these rules in moral deliberations instead of considering acts directly because of the inadequacy of human love (which might otherwise have permitted interpersonal comparisons of utility) and the limitations of human prudence. We work our way down from prudence, with the help of which we discover and enact particular laws judged to be most profitable to the community.

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But we can also go up from secondary laws to the most formal rule of utility, if we can show that whenever these laws are made by some “natural” process other than explicit rational legislation, such as the way common law is made in the process of dispute resolutions by judges, then this process will yield laws that – surprise! – happen to be good. Now the most typical way in which an AU can further “total happiness” is to take care of his own. The overwhelming part of the universal happiness is simply the “sum” of the happiness of all individuals. Concepts and devices like self-ownership, non-aggression, private property, contractual exchange serve to isolate individuals from each other to an extent, such that Smith’s search for his happiness does not impinge upon and even promotes Jones’ search thereof. Given these institutions, “If it feels good, do it” is remarkably sound advice. Similarly, the rules that a RU as a free citizen obeys typically have the form “Do not do X”; as long as he abstains from doing X, he is free to do anything he likes. Whatever is not explicitly forbidden is permitted. A RU says: “Within the law, act however you please!” Utilitarianism of either sort then never compels any specific action. Here is the difference between economics or government policy and the economy. The former is an abstract passive theory or system attempting to guide human actions. The latter is the concrete active life of a society. Human laws and human actions are therefore both complements and rivals. We can see from this that utilitarianism is not even an ethic! The defining characteristic of an ethical doctrine or teaching is promulgation of duties. But utilitarianism at the most suggests laws. The laws may be enforced, but unlike duties, through servile rather than filial fear. Insofar as positive laws, however enacted, are built on the foundation of the natural laws of social cooperation, we obtain a society that secures the long-term success of every person and every group. The distinction between short-term and long-term interests is well illustrated by historian Will Durant’s brilliant summary of a great deal of political philosophy: “Forced to choose, the poor, like the rich, love money more than political liberty; and the only political freedom capable of enduring is one that is so pruned as to keep the rich from denuding the poor by ability or subtlety and the poor from robbing the rich by violence or votes.” (1966: 122) Consider now the two-party system in the United States. The Democrats are supposed to be the party of the “people,” the masses, the rabble, the mob, representing their interests against the Republican Party’s “aristocracy,” land-owners, the rich, the privileged, big business, etc. In the minds of the partisans of both parties, the battle is real enough. But think of the absurdity of this antagonism

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in a free market economy. In the short term, it may, indeed, pay for each group to loot the other one, a war limited only by the need for somebody still to produce. It is of course rare that the poor riot or that the rich commit explicit fraud; most commonly, it is the government that pits the rich and the poor against each other as a ploy to divide and conquer; all the looting is done legally through the machinery of state. Even if the human killer instincts have been dulled or at least rerouted in civil society, one still finds it expedient to use the state to pillage and plunder. Somehow, any crime perpetrated via a government loses its immediacy, poignancy, and evil character and becomes a banal status quo. That is what Durant says must be stopped. But in the long run, things are different. The rich can keep their wealth only by serving the “poor” (working and middle class) consumers better and better. Ownership of capital goods has a social function; it benefits less the owners than those they serve; indeed, “ownership of the means of production is not a privilege, but a social liability.” (Mises 1996: 311) The capital goods and money slated for investment are by definition not consumed and enjoyed. On the contrary, one is forced by the nature of the market to work extremely smart to use those things to produce goods for the consumers and exceed in doing so his competitors. An entrepreneur throws himself into a race; either he wins it or perishes. If he wins, then he may be able to spend some of his profits on himself. If he keeps losing, then his entire capital will evaporate, and he will be left with nothing. The more capital he owns, the greater the trepidation with which he approaches running his business. As for the “poor,” “it is one of the most important social effects of capitalism that it deproletarianizes all strata of society. It raises the standard of living of the masses of the manual workers to such a height that they too turn into ‘bourgeois’ and think and act like well-to-do burghers.” (Mises 1996: 669) For example, there are those who recommend outlawing casino gambling on the grounds that this measure will stop people from losing their life savings or bankrupting themselves altogether. The masses of the common people, it is argued, are improvident to the extreme. However, under capitalism, there is no great army of the poor and afflicted. There is instead a small underclass of criminals, the insane, the uncontrollably addicted to alcohol or drugs, and indeed, of those with some kind of a “gambling problem.” The dubious benefits of saving the members of this tiny collection of aberrations from themselves by banning gambling seem to pale in comparison with the benefits of fun from a bit of judicious levity for the vast majority. Thus, it is on the contrary arguing that gambling should be allowed is “elitist,”

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because it proposes that the interests of the bourgeoisie, into which most of the former proletarians have now turned under the influence of classical liberalism – if not 100% social elite than at least the respectable middle class – should prevail over the supposed interests of the lumpenproles. In a purely free market society, the rich, the captains of industry, are always in danger of losing their capital. They can never relax for fear of being outcompeted and thereby joining the poor. And poor newcomers are perpetually eager to dethrone them and themselves become rich. The inescapable property of a free society is social mobility with respect to net worth, both upward and downward, whose purpose is to guide the titles of ownership to the means of production into the hands of the most capable people. Not so long ago, even in the feudal age, there was no such thing as mass production, and practically all goods beyond a few essentials were luxuries, accessible only to people high up in the social hierarchy. With the coming of capitalism, things have turned 180°, and now almost no goods are permanent luxuries. Not only love but the market, too, can level ranks. It is true that the social hierarchy in those bygone days was much more stable than it is today, when it twists and writhes wildly, and the father’s performance does not guarantee the son’s results. Dukes would marry duchesses; and peasant boys, peasant girls. The caste or class one was born into was destiny. Hence, “arms races” were largely contained under feudalism. For example, even after the abolition of slavery, well into the th 20 century, the American South was a status society: rigid, unfree for all people, black or white, featuring little social mobility up or down. Many blacks seemed “happy” in it, because they knew that they could not by their own will and power change their social position. They could relax, because their destiny was not in their own hands. The marked inferiority of blacks was made evident only in the “civil rights era,” when white Americans agreed to give blacks (artificially, via unjust government privileges) a boost at making their own way in society. It turned out that when given this freedom, blacks eagerly voluntarily renounced it to the welfare state, and what freedom they decided to keep, they used mostly for violence and doing evil. No wonder blacks ended up “unhappy.” Who wouldn’t after first-hand intimate acquaintance with one’s own abject failure? It is the same perhaps with Denmark which, despite some of the highest taxes in the somewhat developed world, has been found the “happiest country in the world” in “experienced well-being.” I suggest

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that this is the well-being of slaves. A slave, admittedly, is not permitted to seek his own happiness. But he also cannot, in seeking this happiness, fail. Some people may judge this effect so wholesome and salubrious that slavery (or high taxes) will seem to them attractive. The exasperating Weaver continues that a society of status “contributes much to the freedom and independence of the individual, because the man who ‘knows where he stands’ is always more confident in approaching others and in declaring his opinions than the man who neither knows who he is nor where he is from. It keeps the individual from being intimidated by public opinion.” (1995: 31) It is clear that Weaver refers to the idea of aristocracy. He fails, however, to distinguish between too kinds of aristocracy or elite: natural and inherited. Natural aristocracy deserves its titles and recognitions, precisely because its members did great things. An honorary doctorate bestowed by a university should be issued at least to someone who has done important scientific or humanitarian work. Weaver’s model aristocrat just “knows that he is a great man” without any actual accomplishments to back up his conceit. It may even be that the whole reason for rigid social hierarchies is to defuse arms races. We have seen how even socialism can be an improvement over total war. But economists have invented a way to channel human competitiveness into actions that benefit society overall. If we like, we can add the middle class to our rather formulaic classes of the “rich” and “poor.” For example, Hayek (1960) distinguishes between two kinds of taxes. In one case, the majority of the middle class voters taxes the minority of the rich in order to benefit itself. In the other case, the same majority taxes “itself” in order to support the minority of the poor. The first is basically robbery or tyranny of the majority, unprincipled, self-defeating, and destructive, and Hayek does not hesitate to point that out. The second, Hayek does not condemn, though Mises does as unfitting: “No civilized community has callously allowed the incapacitated to perish. But the substitution of a legally enforceable claim to support or sustenance for charitable relief does not seem to agree with human nature as it is.” (1996: 839) It is clear that it is not only in the short term that the rich and the poor must respect each other’s property rights. In addition, there must be no protectionism, nor trade or migration barriers, nor legal or regulatory barriers to entry into any industry or profession, nor above-minimal taxation, so as to permit success, whereby the competent poor become rich, and cleansing failure, whereby the incompetent rich become poor.

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For example, according to Schumpeter, it is “obvious and indisputable” that there occurs “the incessant rise and fall of individual families into and out of the upper strata.” (2008: 18) Jude Wanniski, one of the founders of supply-sidism and a fan of Marx, called the order answering to this vision, reasonably, a “fluid society.” In the free market, there is no shadowy, sinister, and permanent elite pulling the strings out of sight or ruling the world in an unseen and unaccountable manner that is the stuff of conspiracy theories. The social position of every member of society is deeply precarious: for the very rich, for example, there is nowhere to go but down. This way, the interests of all classes and all people subsist in a long-term harmony. That does not mean that the Republicans and Democrats have no natural specialization. At their worst, the right likes socialism for the rich, i.e., government privileges for the rich and big business. Conservatives are plutocratic. In their turn, also at their worst, the left likes socialism for the poor, i.e., taking away opportunities for poor people to become rich. Left-liberals are egalitarian. Notice that these amount to the same thing: a curtailment of the social creative advance! The difference is trivial: conservatives would use the force of law to forbid or deter competition; liberals would use what they consider to be “morality” to pull down anyone who stands out from the crowd. Either way, new entrepreneurs are unable to challenge the current elite and in the process of earning their own fortunes, enrich society, as well. At their best, however, each party would seek to counter precisely the other party at its worst. The Democrats would protect the masses against the conspiracies of the elites. They would be economically knowledgeable, seeking to educate the public about the most expeditious means to prosperity. At the same time, the Republicans would most appropriately scream bloody murder whenever there is filthy talk of “redistribution.” They would be morally astute, always ready to brand as envious thieves and sore losers any leftist demagogues who preached the alleged virtues of “equality.” Of course, ideally, a politician would be a good Democrat and good Republican rolled into one, regardless of which party he actually belonged to. Only his emphasis, i.e., economics vs. ethics, would differ. Today such a politician would be called a libertarian. As things actually stand, for example, philosopher Michael Levin called left-liberals the “anti-experts: they can be depended on to

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be wrong.” (1999: 131) Conservatives in their turn are enamored with the idea of the “noble lie” with which the rulers must manipulate the masses in order to have their national greatness and heroic values of mutual slaughter. You can see how deep in trouble our society is. Another objection would run as follows. According to our psychological egoism, even a saintly person is concerned solely with his own pleasure. It is just that he has chosen a life of service to others as a means to that pleasure. He justifies his life by showing the good he has done. But this is merely a mask for his real interest which is his own happiness. When exposed, he looks no better than the worst murderer. Both pursue their own agenda. I will tackle this argument in (I, 27) when I discuss aspects of interaction of nature, virtue, and happiness. Marx wrote that “philosophers have only interpreted the world, in various ways; the point is to change it.” There is nothing wrong with this ambition; Mises, too, said bitterly: “I set out to be a reformer, but only became the historian of decline.” (1978: 115) At the same time, Mises would surely reply to Marx that the first job of an economist is to tell governments what they cannot do. Insofar as philosophy and economics are used to change the world, they are practical disciplines. Insofar as economics is used “only” to understand the world and moreover constrains the ways in which it can be changed, it is speculative and theoretical. While discussing the idea that “with righteous men any utopia might be realized,” Mises combines the speculative and practical aspects of economics by arguing that if man “wishes to succeed,” then he “must study the laws of human action.” (1996: 2) This practical advice, I must point out, refers to the species man, to the whole society. Economics counsels which behaviors should be encouraged by a citizen in others, and which, deterred. It does not tell anyone what to do. In other words, economics teaches, among other things, how to channel private self-interest into socially beneficial outlets by structuring the system of property rights and incentives appropriately. But economics is not ethics, and it does not postulate, for example, any duty to obey the law. Economics can make a theoretical case, pace Marx, that capitalists and entrepreneurs are not mortal enemies of the workers. But it is an empirical observation that in recent centuries and decades, there has occurred tremendous economic progress. As a thought experiment, consider that people today seem to be born, on average, no different from those born 2,000 years ago. This statement may be false, but let us assume it. What, then, accounts for the dissimilarity between the society of 2010 America and AD 10 Palestine?

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According to Marx, if the people are more or less the same, then these differences must be due entirely to the “mode of production,” which splits into (a) forces of production (technology) and (b) relations of production (patterns of ownership). These two things make it true that “it is not the consciousness of men that determines their being, but on the contrary it is their social being that determines their consciousness.” These condition, according to Geoffrey Thomas’ interpretation of Marx, “all social phenomena from the legal system through to moral and religious beliefs.” (1993: 113) Now on the one hand, what Thomas says is trivially true, insofar as people are born into some community, some state, and particular extant legal, moral, religious rules, social etiquette, and suchlike. Persons of a certain temperament tend to become socialized most easily into these structures and in any society grow to become a stabilizing and conservative force. But everyone gets habituated to a greater or lesser extent to play by the rules. If the prevailing ideas amongst the populace sanction a regime of private property rights, then people will generally consider misappropriation to be wicked and make it illegal; under a socialist system, private “speculators” will always be in danger of having their goods confiscated and of being imprisoned by the state. But seen from another perspective, Marx’s notions are outrageous. For technology built on natural sciences and the capital used according to technological recipes are veritable extensions of the human body. They enhance human nature and amplify human powers; they make it possible for people to do more things. Tools affect human behavior (understood as bodily motions) and through those, human actions (understood as pursuit of happiness). Technology is precisely human ideas of how to attain the most of their ends or satisfy the most of their desires with the least amount of effort. Far from “conditioning” or determining human personalities, technology extends the range of human choices. It thereby makes humanity more varied, more diverse. It allows for much more differing results from self- or soul-making. Technology, in other words, does not constrain; it empowers people. It is true that the consumer goods and services available on the market change both human institutions and human personalities. People in AD 10 did not have to contend with nuclear weapons, surrogate motherhood, or addictions to video games. But this is only to make the trivial observation that not all uses of technological powers make people happier. The point that technology and consumer and capital goods accumulated make life more interesting stands.2 2

The most momentous difference between the two time periods is the

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Some ungrateful to civilization people argue that it is unclear whether within firms, machines are appendages to people or vice versa. There is a sense in which this is true: often the machines “do most of the work,” and the people are technicians, tending to and keeping the machines. If the machines could repair themselves, then perhaps the workers might be entirely expendable. I will deal with the distinctions between man and machine in due course. Economically, however, every piece of equipment is invented and ultimately built by humans. Even if machine A maintains machine B, every capital good is imputable to original factors, such as natural resources, land, labor, and time. Case in point: C.S. Lewis’ attempt to demonstrate the immortality of the human soul from “desire.” He asserts: “Creatures are not born with desires unless satisfaction for these desires exists. A baby feels hunger; well, there is such a thing as food. A duckling wants to swim; well, there is such a thing as water. Men feel sexual desire; well, there is such a thing as sex. If I find in myself a desire which no experience in this world can satisfy, the most probable explanation is that I was made for another world.” (2002: 76; Mere Christianity, Bk. III, Chap. 10, “Hope”) There are many problems with this proof, one of which is that it uses a distinction between “natural” and “artificial” desires. This distinction is illusory. It is just as “natural” to walk from point A to point B on foot as it is to desire to get to one’s destination much quicker which means desiring to travel by car or airplane. It is just as natural to want sex as it is to wear beautiful clothing to look sexy. Or to desire the “natural” knowledge of the terrain in which one finds himself as the “artificial” knowledge of using or building navigation systems. There is no basis for giving the honorific appellation “natural” only to coarse bodily needs and powers. Mises objects: All ends and all means, both material and ideal issues, the sublime and the base, the noble and the ignoble, are ranged in a single row and subjected to a decision which picks out one thing and sets aside another. Nothing that men aim at or want to comparatively vast amount and variety of capital goods by now saved up. Creation of novel capital is a time-consuming and painful process, requiring as it does renunciation of present pleasures for the sake of future bounty. We must be thankful to previous generations for loving us, their children and descendants, so much as to choose not to die broke and instead sacrifice for our sake. Technology and capital goods are tightly complementary produced factors of production.

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Summa Against the Keynesians avoid remains outside of this arrangement into a unique scale of gradation and preference. (1996: 3) It is arbitrary to consider only the satisfaction of the body’s physiological needs as “natural” and therefore, “rational” and everything else as “artificial” and therefore, “irrational.” It is the characteristic feature of human nature that man seeks not only food, shelter, and cohabitation like all other animals, but that he aims also at other kinds of satisfaction. Man has specifically human desires and needs which we may call “higher” than those which he has in common with the other mammals. (1996: 20) The obvious truth is that reason, man’s most characteristic feature, is also a biological phenomenon. It is neither more nor less natural than any other feature of the species Homo sapiens, for instance, the upright gait or the hairless skin. (1996: 176)

But if reason is natural, then so are the desires suggested by reason and the civilizations built up with the help of reason. Now neither cars nor clothing nor navigation systems are available in the state of wild nature. It may be objected that they are possible at least in principle. But what about a trip to the Andromeda galaxy? Or what of living for 900 years? One may want these, but it is not unreasonable to argue that such goods will be forever out of reach for humanity. It also follows oddly that immortality might be available only to people living in an advanced civilization; people in more primitive societies may well search for it in vain. The point is, technology and laissez-faire allow men to do things unimagined by the previous generation. Abstract science which grows alongside economic and technological progress, too, frees man from slavery to superstitions and pagan gods, from whom he finds no repose.3 3

St. Thomas Aquinas’ proof of the same from “desire” is far better. He argues: Moreover, we may take a sign of [the incorruptibility of the human soul] from the fact that everything naturally aspires to existence after its own manner. Now in things that have knowledge, desire ensues upon knowledge. The senses, indeed, do not know existence, except under the conditions of “here” and “now,” whereas the intellect apprehends existence absolutely, and for all time; so that everything that has an intellect naturally desires always to exist. But a natural desire cannot be in vain. Therefore, every

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But technology is not only natural but social, as well. By this, I do not mean the alleged technology of a “social engineer” or central planner who treats his wards as cogs in his machine. I do mean that human beings make use of one another, and there are more or less successful forms of social cooperation. The description of these forms is the task of economics. For example, Mises explains: The inhabitants of the Swiss Jura prefer to manufacture watches instead of growing wheat. Watchmaking is for them the cheapest way to acquire wheat. On the other hand the growing of wheat is the cheapest way for the Canadian farmer to acquire watches. (1996: 395) And Steven Landsburg echoes him in writing that there are two technologies for producing automobiles in America. One is to manufacture them in Detroit, and the other is to grow them in Iowa. … First you plant seeds, which are the raw material from which automobiles are constructed. You wait a few months until wheat appears. Then you harvest the wheat, load it onto ships, and sail the ships eastward into the Pacific Ocean. After a few months, the ships reappear with Toyotas on them. International trade is nothing but a form of technology. The fact that there is a place called Japan, with people and intellectual substance is incorruptible. (ST, I, 75, 6) It is true that some animals learn from the past (e.g., dogs) and provide for the future (e.g., squirrels). But they do not dwell in either time period. They live in the now, locked into the present time. Humans, on the contrary, can imagine life everlasting and naturally, as one, always desire to live forever. This colors their every deed. And no natural desire is in vain, therefore… Notice that a crucial objection to the C.S. Lewis’ version of this argument no longer applies in this case. For Lewis’ desire was clearly for “heaven” and therefore, within his own Christian worldview, grace-infused or God-influenced and not at all natural. It was above nature. Unfortunately, this causes it to be open to an atheist – who does not believe that God exists at all, let alone bestows grace – to call this desire unnatural in the sense of below nature: pathological, maladaptive, or even sick. We will not get anywhere with this. St. Thomas is far more modest here. He does not argue that there must be a perfect world for which we are meant; he simply says that humans desire to live forever, having the capacity to imagine and therefore, long for eternal life of whatever quality, heavenly or otherwise.

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Summa Against the Keynesians factories, is quite irrelevant to Americans’ well-being. To analyze trade policies, we might as well assume that Japan is a giant machine with mysterious inner workings that convert wheat into cars. Any policy designed to favor the first American technology over the second is a policy designed to favor American auto producers in Detroit over American auto producers in Iowa. A tax or ban on “imported” automobiles is a tax or ban on Iowa-grown automobiles. (1993: 197-8)

The (speculative) science of economics has become the cornerstone of the (practical) ideology of classical liberalism, a.k.a. libertarianism. This ideology regards the political economy; it is concerned with the question of how to organize the system of production to achieve the greatest possible prosperity afforded by social cooperation. Libertarianism “promises nothing that exceeds what can be accomplished in society and through society. It seeks to give men only one thing, the peaceful, undisturbed development of material well-being for all, in order thereby to shield them from the external causes of pain and suffering as far as it lies within the power of social institutions to do so at all. To diminish suffering, to increase happiness: that is its aim.” (Mises 1985: 192-3) The industrial revolution, for example, was made possible by the ideological revolution that preceded it. It is true that the legal system did not arise entirely as a result of ideological influences or through grand rational society-building. It also evolves according to its own dynamics “by human action but not human design.” But ideology has always played a central role.4 In comparing libertarianism with its antipodes, we are led to the conclusion that the greatest problem of various socialist regimes was always that they would invariably fail to achieve the goal that they set for themselves, namely, to improve the standard of living of the “masses” beyond that of capitalist nations. Many people focus their attention on the communist atrocities, such as forced collectivization (especially of farms), famines, political murders, religious persecution, vast prison camps for dissenters, and so on. These are important, but I contend that if socialism had, in fact, turned out to be a superior system of production – if “history” had really been on the side of the 4

It is interesting how Hayek vacillates at times between his defense of the obeisance that we must pay to these evolutionary forces and his admission that the institutional structure of both capitalism and socialism “can be described as being the product of rational planning.” (1948: 135)

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revolutionaries – then those crimes would have been forgotten if not forgiven. What are the lives of even millions of “class enemies,” when billions of people and their descendants will enjoy the lives of kings until the end of time? Such is human nature. The biggest failing of socialism is that it both impoverished the masses and thrust them under brutal, despotic regimes. They traded liberty for prosperity, and ended up with neither. Thus, socialism fails on its own terms. Capitalism has been accused of practically every evil known to man. But one accusation, namely, that it “fosters poverty,” cannot in principle be applied to it. For the defenders of laissez-faire argue that abject poverty, i.e., lack of wealth, is the natural human condition, and that capitalism is the fastest way out of poverty, i.e., the fastest way of creating wealth. The very essence of libertarianism is that free enterprise allows the vast majority to enjoy ever increasing unparalleled prosperity. If this property is denied to capitalism, then numerous advocates of freedom have wasted their entire lives in thrall to a vicious ideology. Capitalism enriches by its very essence or fails to do so; it cannot “foster poverty” as a some kind of nasty side effect, one among allegedly its many other horrid consequences, from “greed” to “pollution” and so on. Ideology is a summary of this social technology. In other words, as economics is a science, so libertarianism is technology. Far from being a clever justification for one’s own self-interested actions, it is simply a systematic view of the world, where the system need not at all be “what is true is only what is good for number one.” Nor is ideology a fanatical commitment to a dogma. Cassidy (2009) calls laissez-faire “utopian” and suggests that it “goes beyond a scientific doctrine: it is a political philosophy, a secular faith.” (33) It is true that ideology is not pure but applied science. But Cassidy is again presciently countered by Mises: libertarianism is no religion, no world view, no party of special interests. It is no religion because it demands neither faith nor devotion, because there is nothing mystical about it, and because it has no dogmas. It is no world view because it does not try to explain the cosmos and because it says nothing and does not seek to say anything about the meaning and purpose of human existence. It is no party of special interests because it does not provide or seek to provide any special advantage whatsoever to any individual or any group. (1985: 192)

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A person who holds, for example, that blueberries can help one to stay fit has an idea of the linkage of means to ends. An ideology differs from a mere idea in two ways. First, ideology is more comprehensive; it is a system, a vision of how a society best operates. Its parts cohere, fit together. Second, a person who wants to do good to his body can eat blueberries without asking anyone’s consent. But if someone wants to see his ideology acted upon and implemented, then he cannot be content with knowing the truth himself; he must convince the great majority of people that he right, i.e., that his ideology does, indeed, serve the common good. These differences, however, do not make ideologues any more “fanatical” than people with regular ideas. Indeed, there is no reason not to extend the utilitarianism, on which welfare economics is based, to include every human being on the face of the earth, even perhaps the unborn, and most economists of whatever school do exactly that. Concern for social harmony need not stop at the water’s edge. It is true, of course, that in popularizing an ideology, one might somewhat simplify it, but that is only to affirm that rhetoric is distinct from dialectic. If what offends Cassidy is that libertarianism has often been defended with passion, then the reply is that passion need not be indicative of mental fog but rather of devotion to a good cause (in this case, not to libertarianism but to its advocacy) and to that extent is perfectly praiseworthy. St. Thomas argues that the cause of devotion is precisely contemplation of good things. The head and the heart of libertarianism are united as follows: “Science and anything else conducive to greatness, is to man an occasion of self-confidence, so that he does not wholly surrender himself to God. The result is that such like things sometimes occasion a hindrance to devotion; while in simple souls and women devotion abounds by repressing pride. If, however, a man perfectly submits to God his science or any other perfection, then by this very fact his devotion is increased.” (ST, II-II, 82, 3, reply 3) Economic understanding need not be an obstacle to devotion, nor vice versa. As a scientist grows older, his views solidify, and he becomes less receptive to new ideas. What a disappointment to come to the conclusion that one’s books and papers are wrong! One may avoid pain by clinging to his existing notions and refusing to budge. Again, a man may believe that X (such as a particular economic system) is good and devote his efforts to X’s preservation and improvement. If he later comes to a realization that X is actually bad, then this does not entail just a change of opinion but a destruction of what he has built. To that extent, theory and practice go together, and the costs of error are increased.

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No doubt these points are true. The stakes are extremely high. This does not mean that one should not fight for what he believes. While the task of economics is to describe the relationships between means and ends irrespective of the ends chosen, the task of ideology is to postulate actual ends (such as material prosperity) and by using economic theory, find the means to attain them. Ideology is not the way the politically powerful justify their depredations. Not every person is an egotistic aggressive lout. There is room to be concerned not only with how one can get ahead in the entrepreneurial competition with his fellow men (with which there is nothing wrong) but also with how the whole society can prosper. Ideology is a toolkit describing how a commonwealth or world as a whole can be just and successful. Moreover, ideology has supreme power. Cynical notions that “public education exists in order to provide jobs for teachers” or that “congressmen buy favors by sending stolen money to voters” are useful as reality checks but ultimately entirely otiose. For there are vested interests in every society. Any change will probably be unwelcome to such people. But only in the short run. If government schooling were abolished, then economic resources would flow elsewhere, and very soon, new richer and poorer entrepreneurs and factors would emerge. Teachers would find new jobs, perhaps more, perhaps less lucrative; voters receiving pork would relocate to get money in less corrupt ways; and so forth. But society as a whole would be better off. Someone has complained to me that the middle class seemed to be paying for everyone else’s toys. I informed him that there are only two classes of people: whose who pay taxes, and those who devour them; those who are protected from competition, and those who suffer high prices and bad customer service. Both kinds of people are found in every other conceivable division of individuals into groups, including “the poor, the middle-class, and the rich.” If teachers have an interest to maintain their above-market returns, then parents have an interest to pay less in taxes. If voters have a reason to repay “job-creating” projects steered their way with loyalty, then the taxpayers who are brutalized when forced to fork over money for these projects have a contrary interest not to be bled dry. Why have the former solidly defeated the latter? And more important, how can these latter turn the tide of battle? Only through correct ideology. For they can ask: Does the whole society benefit from, or is it hurt by, mutual plunder? It may well be that taxation for the most part is theft, to be resorted to only when no other way of securing social cooperation has

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been found. If taxes are abolished, and theft by government comes to be considered as objectionably immoral as slavery, rape, and Mafia extortion, then this rule will surely be a powerful guarantor of liberty throughout the realm. But a useful way to jump-start the process to such moral reformation is by means of finding out whether public education, taxation, inflation, and all the rest are or are not harmful to the social body. In the short run, teachers, doctors, retirees – whatever – may be disadvantaged by a change in the legal regime, though others will benefit. To an unreflective mind, especially one under the illusion that perpetuating the status quo is always some sort of moral duty, this may seem lacking in compassion, and one can usually shut people up by calling them “greedy capitalists” who “do not want to pay their fair share,” or “kooks” and “cranks” for finding fault with fiat and credit money, or some such scurrilous nonsense. But think of how these very same temporary losers – and their children – will benefit from the economy’s creative potential unleashed in the longer run. As consumers and citizens, all will be happier in toto and on average. The issue is overall happiness in a progressing economy, not distribution of a fixed amount of booty. Perhaps India’s upper castes, too, resented having their privileges revoked. But even they came to enjoy the blessings of freedom for other people to ascend or descend in the social order, in the process creating wealth. A Brahman may like being what he is. But he would be wise to dislike that fact that other Brahmans are what they are. The modern semi-feudal exploitation and abuse by the tax-lords of the tax-serfs is in the end not in the interest of the tax-lords! No member of society, no matter how personally high and mighty, in the long run benefits from a crippled and beaten down economy. Unfortunately, the tax-lords are stuck at an inferior equilibrium: if they could all collectively, that is, together as one, renounce their disgraceful parasitism and create a taxless laissez-faire economy, then they would benefit dramatically, while at the same time, of course, benefiting their victims, as well. However, such a move is implausible, and no individual tax-lord would reasonably be willing to let go of his privilege unilaterally. The reason why the status quo can be so entrenched is that unstarted companies and unsatisfied consumers do not lobby the government. Often the only avenue of action open to young entrepreneurs is to percolate their wares through loopholes in the laws. It does not help that the majority of people consider every liberty to be such a (lamentable in their view) loophole. Poor government “regulators,” always striving to “catch up” with some new and unpredicted market development! Finally, the system of production within the legal, moral, etc. social system undergirding it is also a product of human minds and

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bodily powers. The particular structures of production, industries, and firms operating in the market in existence right now were all started by specific people: this man, Tom, and that man, Bill, having specific aims and ideas on how to profit. Rather than determining human consciousness, all the economic units we observe and their interactions are outcomes entirely of human individual initiative, planning, and acting. The consequences of those billions of free, spontaneous, and to a large extent unpredictable human actions that occur every day are felt both by the actors themselves and their fellow men. The task of building a civilization of which everyone can be proud, whether by advancing natural and social science and technology, accumulating capital, or setting up production, has always resided in mortal hands. Not just production processes, but consumer tastes, too, become highly refined and sophisticated, a mark of an advanced civilization. Contra some anti-capitalists, advertising and economic progress do not “create” desires in humans; rather, by surveying the goods available for consumption people discover their latent desires. These are essentially self-discoveries of what gives them pleasure. They help people to come to know themselves. Integrating oneself into society means becoming specialized not only for production within the division of labor (e.g., by learning a trade) but for consumption, as well. Economic theory, thus, deals with highly practical things, though the fact that it is so entangled in day-to-day human activities should not be viewed as evidence for the triviality of theory; far from it, economics is wonderfully complex. Studying economic theory, therefore, is an eminently practical affair. As the science fiction writer Kurt Vonnegut said, “Don’t joke about economics, because that’s how you get food.” (Kemp 12/12/2001) Mises complained about people’s labeling economics a “dismal science,” as if obtaining truth about economic laws was beyond human powers. (1996: 9) Keynes himself charged that “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” (2008: 383) It remains to be seen whether Keynes himself is defunct, and this book is dedicated to finding an answer to this question. I will conclude (II, 20) with a horrifying epiphany about a key connection between Marxism and Keynesism. It is interesting to note at this point that Marx does not shrink from talking like a proto-Keynesian:

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“It is enough to mention the commercial crises that by their periodical return put the existence of the entire bourgeois society on its trial, each time more threateningly.” (2008: 16) Schumpeter speculates (though considers it a non sequitur in Marx’s thought) that Marx “displays a tendency to link those recurrent crises with this unique crisis of the capitalist order. He even suggests that the former may in a sense be looked upon as previews of the ultimate breakdown.” (2008: 41) The business cycle for Keynes and his followers, of course, is a powerful indictment of capitalism, and it will occupy us to a considerable extent. Marxism was a particular attack on economic science in Mises’ days. This evil salvo has been complemented by a foolish one from the neoclassical school. It is argued that economists can use any number of inaccurate assumptions, as long as their models allow their employers to make correct predictions. Taleb’s interesting Black Swan is one recent vigorous reaction – if unenlightened by familiarity with the Austrian school – to this outrageous idea. If economists are so smart, then why aren’t they rich? Better, if they are so smart, then why do crises occur that cause their clients to lose vast amounts of money? (Even the bank owners who in certain ways benefit from the ability to keep fractional reserves may balk at this privilege. This is because they lose from the flimsy and brittle banking system, of which they are part. In the longterm, their investors’ entire gains over 5 years from vigorous credit expansions may be wiped out in a single 1-month-long systemwide crush.) We will discuss this question in the following chapters. Thus, the Historical school claimed that there was no such thing as economic theory. The Marxists argued that there was no such thing as an economist: do not trust economists, because they are bad people. For the neoclassicals, economics is quantitative prediction. The Keynesian synthesis gave us macroeconomics not rooted in praxeology. It is safe to say that if there is a fallacy regarding economic theory, then it has been entertained publicly by someone and in some school of thought. Concludes Mises: “Even in the heyday of liberalism only a few people had a full grasp of the functioning of the market economy. Western civilization adopted capitalism upon recommendation on the part of a small elite.” (1994: 27) But interventionist Keynesism was adopted later in exactly the same manner. Therefore, “whoever neglects to examine to the best of his abilities all the problems involved voluntarily surrenders his birthright to a self-appointed elite of supermen.” (1996: 878) Without solid economic understanding, man is set adrift, guided by nothing better than his instincts, cooperating, perhaps, only within

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small groups, and otherwise fighting a perpetual war of all against all. In the long run, he is as likely to promote his welfare as to ruin it. As I will express the matter in the next chapter, we must do everything in our power to ensure that this latter tragedy does not happen ever again. 2. THAT THE MISSION OF THE ECONOMIST IS AN EXALTED ONE A little moralistic urging may be in order. In the movie 1492: Conquest of Paradise (Gaumont & Paramount Pictures, 1992), there is the following piece of dialog: Sanchez: You’re a dreamer. Columbus: [shooting a glance out of a window] Tell me, what do you see? Sanchez: [pausing to look] I see rooftops, I see palaces, I see towers, I see spires that reach… to the sky! I see civilization! Columbus: All of them were created by people like me. And in the movie Elektra (Twentieth Century Fox, 2005), there is this dialog: Abby Miller: You really kill people for a living? Elektra: Yeah. Abby: Why? Elektra: It’s what I’m good at. Abby: That’s messed up. First, economists defend neither the privileged status of the vested interests nor the brutal war of all against all which chaotically churns the social hierarchy. On the one hand, the job of the economist vis-à-vis policy is precisely to struggle to enable people like Columbus to build the human civilization by freeing them from anti-social restraints. They recommend permitting both the opportunity to advance for the lowly and the threat of ending up in the gutter to the rich and powerful, because these things are in the service of society as a whole. On the other hand, it is also the job of economists to discover and lay down those laws, again, consistent with society’s own evolutionary dynamics, that will most efficiently prevent the Elektras of this world, that is, people with an advantage in violence or deception, including the government itself, from doing their deadly work. Economists see no value in permitting the masses to abuse the

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social elites. In a free society, the elites belong in their places for a reason. Consumption may be predicated of the “masses”; but production, invention, saving are always the result of individual merits. Almost by definition, nothing of value has ever come out of the “people”: only the natural aristocracy has produced greatness and progress. There is no reason to sanction frequent coups and civil wars, either, with numerous generals rising to the post of a tin-pot el Presidente for a week, only to be violently deposed by another military strongman. The upheavals of economic booms and busts are equally counterproductive. When Lmart shrinks or closes stores because Nmart provides a superior service, the consumers are happier. When Colonel X topples dictator Y and a few days later himself is overthrown by junta leader Z, there are rivers of blood, and the people suffer. The (c1) rule of general law and (c2) the possibility of social climbing in such a way that society benefits as well are inherent in full-featured capitalism, just as (s1) the rigidity of bureaucratism and (s2) the senseless chaos of endless intrigues and internecine conflicts are inherent in socialism. Consider your government’s military. People say that the soldiers risk their lives. That is true. They are strong and courageous. True, as well. But these virtues are in the service of what ends? Are the soldiers defenders of the homeland or bandits looking to plunder the taxpayers and foreign people? Are they courageous protectors or courageous destroyers? War does not evoke in me patriotic images and “conservative values” but thriving cities reduced to ruin. I see bombs falling on houses. I see plague being spread by biological weapons. I see heads on spikes. In the movie Gladiator (Dreamworks Pictures, 2000), the empire-making project was described as follows: In the winter of 180 A.D., Emperor Marcus Aurelius’ twelve-year campaign against the barbarian tribes in Germania was drawing to an end. Just one final stronghold stands in the way of Roman victory and the promise of peace throughout the empire. We are led to believe that the Roman killing and destroying and taxing were all in the name of peace.5 But the beginnings of peace lie in division 5

The older rationale for perpetual war for perpetual peace was that “there can be only one”; international anarchy will allegedly give rise to endless wars until a some sort of global government is commissioned. The more modern rationale would have it that perpetual peace will be

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of labor and trade. The bravery of the military men is a red herring. As an economist, I must speak out against the mindless adoration of force. We might call the skirmishes between the right and the left a conflict between pure order – suffocating, unscrupulous, immoralist, and intolerant of any improvement – and pure chaos – foolish and destructive that despises and rejects the contributions to society of its natural elites. Both are barren and fruitless on their own. There is never an inner peace on our politics, a union of proper change-amidst-permanence. Secondly (to continue with these few examples from popular culture), a song by Tom Lehrer has the following stanza: “When the rockets are up, who cares where they come down? That’s not my department,” says Wernher von Brown. Economics is as value-free as this version of Wernher. Praxeology, of which economics is a branch, can teach how to destroy just as well as how to create. Mises points out: “Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings. To stress this point is the task of economics as it is the task of biology and chemistry to teach that potassium cyanide is not a nutriment but deadly poison.” (1996: 680) Armed with knowledge of economics, one could advise a society on how most promptly to commit suicide. At the same time, political disagreements are usually not about ends but only about means to those ends. For example, classical liberals are often accused of being callous and insensitive to the wants of the poor. But it is an unjust accusation. For let a socialist proclaim: “I desire good universal health care.” A libertarian will reply: “I agree with you completely. I, too, desire excellent universal health care. However, the way you, the socialist, seek to bring about that good is faulty. For if we go your socialist route, then we will have very bad and stagnant health care for 100% of the population. On the other hand, if we go my free market route (which does not entail that a radical reform of the present interventionist status quo is not essential), then we will have great, affordable, and perpetually improving health care that does not, unlike your system, in addition sap the personal ‘will to health’ for 99% of the population, with the other 1% of the genuinely deserving poor who do achieved when every nation has a democratic form of government. The pretext for wars is no longer to conquer and integrate into an empire but to build democratic states.

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not participate in social cooperation, such as the mentally ill, adequately taken care of by private charity. My solution brings good and progressive health care to the masses, precisely what you claim to want but what your solution will fail to achieve.” Surely, debates must be solved by rational analysis not by emotional appeals or calumnies.6 Thus, on the one hand, economics is neutral to all value judgments but gives to human beings all the necessary knowledge and causal laws in order to succeed at social cooperation. It imparts into an arbitrarily picked person the answer to the questions: “What kind of society do I want to live in? What kind of legal and moral order should I try to foster in my society in my capacity as legislator or voter? If there is a town meeting, how can I best contribute to it?” It tells such a person how he can best benefit from the existence and actions of other people under conditions of universal laws. The meaning of the term “arbitrary” here is that our citizen is not in any way privileged relative to other people in the eyes of the law. For example, if Smith is a good computer programmer, then his being employed at a well-paying job is not a privilege: Smith makes a living by being useful to society. But if the government restricts the number of programmers immigrating into the country or entering it on visa or in some other way, then Smith enjoys an artificial privilege. Consumers are no longer best-served by this state of affairs. The restriction is un-utilitarian, and the climate of opinion should be such that any attempt by computer programmers to restrain trade in this or any other manner would be met with public opprobrium and fail. 6

This supplies us with an easy way to distinguish between liberals and conservatives. Left-liberals have many and varied ideas on how to improve the human condition. Unfortunately, those ideas fail to produce the desired improvements and actually make things worse. For that, the liberals are hated by the conservatives, in many ways justly. Unfortunately, the conservatives themselves are completely sterile and have no ideas about how to improve anything. They wallow in hatred of the left and have no positive platform. American conservatives may be standing athwart History yelling “Stop!” but they are yelling “Stop!” to both bad and good things alike. They simply cannot tell one from the other. We have a perpetual battle between those who try (perhaps, inadvertently) to ruin the world and those who merely want to freeze it the way it is and prevent any and all progress. I understand the conservatives, though. They have seen too many failed leftist “experiments” on humans. Nevertheless, their response is over the top, another extreme. They do not realize that no society or institution can merely stay the way it is. For all X, X either improves with time or deteriorates. The correct answer to bad ideas is good ideas, not no ideas.

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On the other hand, economics is concerned specifically with social cooperation rather than, say, military conflicts or games. Those individuals who are interested only in conquest and destruction will generally find economics a useless science. To be sure, an important qualification to this point is that “it would be foolish to deny that the profit system produces the best weapons. … The most important thing in war is not to avoid the emergence of high profits, but to give the best equipment to one’s own country’s soldiers and sailors.” Even a person for whom the object of persecution is persecution, the object of torture is torture, and the object of power is power will eschew socialism. He will know, for example, that socialism will undermine his power, because one cannot extract tax money from a broken or dead economy. The wealthier the people are, the more there is for the government to steal, the more horrifying weapons of mass destruction one can build, and the higher the budgets of the CIA, to use the United States as an example, and of the rest of the alphabet soup will be. Why, to take a modern case in point, is North Korea so wretched? Precisely because it is so poor that even its omnipotent socialist state is poor and would offer no resistance, if the US state, say, were to attack it. Adds Mises: “There is no record of a socialist nation which defeated a capitalist nation.” (1996: 827-8) Even a thief, then, is expected to have the “virtue” of being a hypocrite. Even he knows that his anti-social behavior is only possible when the vast majority of other people are morally upright. It is his civic duty, in a way, to support the libertarian ideology, even if he personally does not practice what he preaches. If he fails at this duty, then he will harm society twice: first, by his actions, i.e., by stealing, and second, by teaching others that stealing is OK. However, all people, whether thieves or honest men, “are driven by a fanatical zeal to get more amenities and by an unrestrained appetite to enjoy life.” (Mises 1996: 318) The teachings of economics are crucial, if they are to get what they want. Economics admits two more points. First is enormous variety of human desires and human insatiability. Second is willingness of people to enforce the rule utilitarianism that arises out of the demands of social cooperation, such as respect for private property rights. The liberal ideology presumes that people do agree to go to the trouble of safeguarding cooperation within social bonds and reaping the fruits of such cooperation; that they are neither indifferent to the existence of parasitic aggressors on other people’s persons and property nor otherworldly ascetics. Economics is the engine that animates libertarianism. As a result, the second task of the economist is to teach people how to cooperate successfully, to expose economic destructionism, and to refute errors,

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acting on which will fail to lead to the greatest happiness for the greatest number. Third, consider the following view of the state. Picture a village situated near a sea. It has no way of financing its own defense. Every year, it falls continuous prey to random raids by a band of pitiless Viking marauders. As a result, the villagers have no incentive to accumulate wealth. Why bother, when everything they have will be plundered within months? So, the Vikings, when they come, make off with a few sheep and chickens but not much else. Other rival gangs try to muscle in on the action, as well, further reducing the profits from raids. This is a bad deal all around. At some point, the Viking chief originates a brilliant plan. Why not settle within the village and become its ruler? He will allow, he thinks, the peasants to keep some of the fruits of their labor, just enough to permit capital accumulation and economic growth, and extort the rest as tribute. This way, he and his pals will enjoy continuous and evergrowing income. With that income, they can purchase more ships and hire more men and conquer other villages. The government is seen in this light as a device for the benefit of both the predators and the prey by curbing excessive overexploitation of the populace by violent invaders who would otherwise kill the proverbial goose. The idea is to privatize the “geese” and avoid the tragedy of the commons. Of course, the Vikings now treat the villagers as beasts of burden; but morals, shmorals: it is good to be king. For example, when the Mongol khans invaded Russia, the Horde did not devastate the entire country (though it still did plenty of damage); it “wisely” imposed дань or tribute on the Russian dukes and, give or take an occasional demand for a show of submission, otherwise left them alone. A wonderful illustration of this scenario is found in the movie Dick Tracy (Touchstone Pictures, 1990). A Mafia don, Big Boy Caprice, describes his plan for enriching himself and his cronies in this manner: We got a problem with organization. We’re all split up. That’s bad business. While we’re divided, the cops can keep us under control. But use your imaginations. We form this big company, see. Each of us here at the table is on the board of directors. … We got a town with thousands of small stores and businesses, people who are workin’ real hard. I think they should be workin’ real hard… for us. Because we are for the people… We will become the people’s silent partner. Every time

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some citizen buys a pound of hamburger, we get a nickel. Every time some guy gets a haircut, we get a dime. We’ll dress like bankers, join the Rotary Club. Together, we will own this town. When one of the gangsters objects, Big Boy replies: “It only works, if we’re all in.” From mere outlaws skulking in darkness on far edges of society who rob the townsfolk only occasionally and haphazardly, Big Boy and his minions want to become… the government! They want to establish a monopoly of force and a permanent tax system over the people. And they want the glory and prestige accorded to the chief bureaucrats. In the end, they are slaughtered by Tracy and his men, with the moral apparently being “Don’t steal! The government hates competition.” It follows that it pays for the state to control its gluttonous instincts somewhat. Many so-called economists concentrate precisely on instructing the government thieves on how best to “manage” society. Hence, for example, the supply-siders’ emphasis on the Laffer curve. The state, whose purpose is, again, the control of violence in order to prevent overexploitation, should understand precisely how its job is to be done. This is a crucial part of the “art of statecraft.” By setting the taxes just right, they can maximize revenues, and with a lot of resources in their possession they can crush or buy off other centers of power. The difference between America, say, and Third World countries can now be seen in the fact that the rulers of poor nations are too savage. Like wild animals, they aim to destroy, not to control. God bless America, where the war leaders are wise and possess the ruthless selfcontrol necessary in their single-minded pursuit of power. But every so often, they need help. This is where “economists” come in.7 In short, a person who plays the role of an “intellectual bodyguard” of the political class or its connected pressure groups is not an economist. An economist looks at the well-being of everybody both in the short- and in the long-run. Like Marshall, he is “devoted to the doctrine that the well-being of the whole people should be the ultimate goal of all private effort and all public policy.” (1964: 39) He is wise to imitate Senator Gracchus in the movie Gladiator: “I never pretended to be a man of the people, Senator. But I do try to be a man for the people.” None of this should be taken to imply that the state is superfluous or “evil.” Even a federal government the size of the United States can be useful, if it is limited to the sole function of enforcing free trade 7

This is a model of the state; it has truth in it but also has limitations; other models are available.

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and free movement of people, money capital, and goods through the borders of lower jurisdictions, i.e., of striking down trade barriers that states and municipalities might attempt to erect. Indeed, the Constitutional power of the feds to “regulate commerce” should always have been interpreted as the power to “make commerce regular; promote it,” not “interfere with commerce however we feel like.” (How to promote it? Laissez-nous faire.) Many modern “anarcho-capitalists” imagine that individuals and business owners can buy enforcement services on the market in much the same way they buy supplies at the convenience store. They do not grasp that the executive branch of the local government, complete with a police force, is society’s strength in numbers. The police are supposed to be able to crush any single person or organization in a town yet be tractable enough so that the citizens collectively, whether together in a town meeting or represented by a city council, could themselves crush, i.e., dismiss or prosecute, the police, if corruption or abuse of power is detected. If the townsfolk do not hang together, then they will assuredly hang separately. The reason why enforcement is done by professional cops rather than irregular posses made up of citizens is simply to take advantage of division of labor. The unique problem of getting out of the state of nature then concerns uniting all for the sake of protecting each. This enterprise cannot get off the ground if everyone is assumed to be a “rational” individual, out to betray his fellows the first chance he gets. Deterrence is a prototypical public good, affording plenty of opportunities for free riding. Rather, it takes certain submission to a common purpose, a temperamentally Guardian outlook on life; perhaps even a sense of honor and duty: one for all and all for one. At the same time, the Hobbesian absolute sovereign is an overkill: must one obey even if the ruler orders him to squeal like a pig? There is no need in regard to common defense to impart unto the sovereign any functionality beyond that praxeologically necessary. Hobbes must have had no concept of separation of powers (or rejected this idea), such that the executor’s scope of action is enumerated and limited. All the government requires is the entire citizen body’s willingness either to be drafted as law enforcers from time to time or simply to pay to hire some organized muscle, perhaps on a permanent basis, to step in and mete out some punishments when requested. This helps to clarify the reasons for popular sovereignty. Why must the “people” collectively rule? Why cannot each person simply do what is right in his own eyes? First, there must be a discussion, a conversation of what kind of society each person wants to live in. Lawmaking is a deliberative process. It is true that while participating in such

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deliberation, one “foregoes… the animal freedom of living without any regard to the existence of other specimens of his species.” (Mises 1996: 281) But that surely is a small sacrifice. Second, once the system of laws (natural, discovered by judges; positive, enacted by the legislature; or both) is in place, the executive branch of the government must be birthed in order to enforce those laws. But only the citizens collectively, united with the Guardian glue, can keep the mayor and the cops under control. To illustrate, consider a big corporation like Microsoft. I personally think that it is a superlative company. But suppose that anarchy suddenly arrived. We all, including the owners and employees of Microsoft surely are good people, habituated to do our duty. But perchance a thought crosses the mind of Mr. Ballmer, somehow out of the blue, that it might be nice, if he were to hire some goons and explosion experts and blow up the headquarters of, say, Oracle Corporation, especially before Oracle does the same to him! Under normal circumstances, this would be merely a pleasant if malicious fantasy. But seeing that no one seems powerful enough to retaliate, Ballmer cannot shake the thought. Why not, if he can get away with it? A few days later, the CEO of the destroyed Oracle, Mr. Ellison, is wandering amidst the ruins of his company, contemplating a scheme of murdering Ballmer and taking his place as head of Microsoft. Not so superlative now, is it? Hoppe (2002) has identified the transition from monarchy to democracy as a step towards decivilization (i.e., a process of regressing into savagery), in particular, because (1) the monarch owns and is interested in preserving both the capital value of his “property” and its current income stream, while a democratic ruler owns only the latter and therefore, has an incentive to devalue long-term prosperity; and (2) the various positions of enforcers are in a democracy open to all, resulting in a competition of who can devalue that long-term prosperity more. A move from democracy to anarchy in enforcement (though not necessarily in arbitration) would be the final nail in the coffin of any society. In a democracy, a man intent upon entering the ruling class must at least convince the majority that will uphold the Constitution, the laws, etc. Under anarchy, anyone can, of his own free will, round up a few of his buddies, grab machine guns, and start shaking down the local businesses. Schumpeter explicitly calls businessmen “unheroic” and even cowardly. (2008: 137; 160-161) Can an average business owner commit seppuku on demand? Well, then, he cannot be a samurai. A “private defense company,” a.k.a. a gang, in contrast to both monarchy and democracy, owns neither the capital value of the properties they are robbing nor the income derived from it in any legal sense. So, the incentive to

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them is to kill everyone and take everything. The main problem of political philosophy is precisely how to prevent an orgy of mass murder and looting among the populace without at the same time preventing constructive human actions. By saying “let there be no state,” market anarchists neatly dissolve the problem. But it is a cop-out. The objection is not that violence ought not to be traded; the situation of Smith’s hiring Jones to assassinate Robinson is no worse than that of Smith’s doing the dirty deed himself. Cops are paid for their services, too, after all. It is that society as a whole cannot dispense with commissioning an agency of coercion and compulsion that is more powerful than any identifiable subgroup within that society, including Smith and Jones, except the society as a whole or its representatives. If a group does arise that wants to do its own thing and can outgun the police, then its members can be offered the opportunity to secede. The problem is not so much that under anarchy, justice will be unreliable, i.e., that some crimes will not be punished, and some restitutions will not be made, though it will be; but that many crimes will not be deterred, leading to a massive spike in violence in society. In other words, under anarchy, there are no “defense agencies”; only offense agencies that aggress against the citizens. Again, the cops control individuals; the community as a whole, either directly or through the legislature and ultimately courts, controls the cops. The reason why anarcho-capitalism will be difficult to implement is that the customers of a protection agency will have trouble uniting and defending against their own protectors, if the agency starts preying on them as individuals. An individual does not choose an agency to protect him, as if it were an insurance company; rather, the agency chooses individuals to victimize. Smith cannot say: you people of P, Inc. are robbers; I am switching to Q, Inc. Q will not care to protect him; it will evaluate whether P is strong enough to retain Smith as a victim, a sheep that it exploits (as the Viking chief, the villagers). If P seems powerful, then Q will be uninterested in dealing with Smith in any capacity; otherwise, Q may try to conquer P and take the spoils of war, namely, Smith as a serf, especially if Smith is a young woman, for itself. A protection agency, as a private business, is answerable solely to its owners not the commonwealth or the legislative branch of the government. As the toughest firm out there, unless restrained by the entire citizen body, it will be able to use unjust violence against anyone with impunity. In the end, the biggest and baddest gangs will wreak havoc over all the land, and the long struggle against tyranny and for freedom

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will begin again… from the very beginning. I do not deny that the police in their modern incarnation can be profitably limited. For nowadays they perform four functions. First, they patrol the area under their jurisdiction, providing on-the-spot deterrence services. A robber never knows if a cop on the beat will show up during the commission of the crime. Second, they investigate crimes. Third, they find criminals on the lam. Fourth, they enforce judicial verdicts by sending the condemned criminal to jail or forcing him to pay fines or damages. Of these four, only the last requires a true-blue government police force. The other three can be handled privately. The today’s militarized trigger-happy police including their ultra-violent ninja SWAT teams which treat citizens as enemies of the state are most likely a grotesque if predictable reaction to the Drug Prohibition. Both the cause and effect here, too, can be abolished with happy consequences for all concerned. The refutation of anarchism then consists of three arguments. First, the city as a whole must contract with the executive branch. Second, multiple sufficiently powerful enforcement “firms” allowed to operate in one city will be a thorough nightmare. We are not talking here about cops cruising down streets ticketing speeders or hiring park rangers or inspectors. These folks can, indeed, belong to different departments within the government. We are interested in enforcement of judicial verdicts. From these two it follows that the police are a natural monopoly. Third, it is at this point still conceivable that several companies will be competing to protect a community. But there are two problems with this. First, a big business able to protect two hundred towns will be far too powerful to be controlled by any one town. Such a business would be essentially an army, able (and likely willing) to overpower any municipality. Second, it has been shown to be more efficient, instead of firing one entire police force and hiring a brand new one, simply to hold regular elections of the mayor who will then have the mandate to implement whatever reforms of police procedures are desired by the people. For example, the new mayor may forbid hiring ex-military. There is still the possibility of letting people voluntarily “subscribe” to police enforcement services or withhold their patronage. The subscribers can call upon the police to enforce arbitration decision that have been made in their favor; the non-subscribers are out of luck, because private uses of violence cannot be tolerated, lest there would be endless outbreaks of private wars. (The whole point of monopoly policing is to suppress such wars, nip them in the bud by threatening to crush

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the would-be warriors with overwhelming force.) A market is thereby created in the place of a government-provided service, seemingly a happy development. But there are complications. First, for civil cases, there is a case of positive externalities: the more people subscribe without the criminals knowing exactly who is and who is not subscribed, the greater the deterrence effect will be. It is somewhat like concealed carry: every subscription helps one’s neighbor by creating uncertainty in the criminal’s mind. This might be a case for subsidizing police subscriptions, if we were not dealing with the problem precisely of funding the police in the first place and assuming that the government collects pretty much no taxes for anything else. Second, for criminal cases, the district attorney obviously has his own “subscription” and can file a complaint of his own. But no particular individual but society as a whole benefits from punishments administered (as opposed to restitutions or civil lawsuits won). This creates a presumption for public financing of criminal prosecutions. Third, as a matter of common sense, it is absurd to cut oneself off from the justice system by refusing to subscribe. Anyone can prey on such a person, and he will not be able to get his verdicts enforced for him. He is almost an outlaw. Therefore, most communities decide to solve these problems with one stroke by insuring everybody and requiring universal subscriptions. There is admittedly some coercion involved, but it is minimal, and the benefits seem to outweigh the costs. The contradiction is real and unfortunate; but let justice be done unless the heavens fall. Note that “protection” agencies in the anarchists’ fervid imaginations bear no relation to the real police officers who do not protect anybody at all. It is neither their legal duty nor their theoretical social function to be anyone’s bodyguards. For example, in a web article, Ken Hess argues that government surveillance is “good,” because he has “the right to feel safe in his home, in his city, and in his country.” (6/7/2013) The article is self-contradictory, because Hess says on the one hand that “if you have nothing to hide, then you have nothing to worry about. … If you have something to hide, I don’t want it hidden. I want it exposed”; and on the other that it is absurd to “print your bank account numbers, passwords, and Social Security number on a T-shirt and wear it everywhere you go.” Apparently, we do all have secrets worth hiding. The more fundamental error, however, is the idea that government should fight crime directly by divining which persons are likely to become criminals in the future. Presumably, the government can then dispatch agents provocateurs who, by pretending sympathy with these

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people’s aims, will goad them into action and then arrest them redhanded. In fact, the function of the state according to any reasonable ideology is to prevent crimes only indirectly by punishing criminals after the fact and, having established credibility as this sort of scourge of evildoers, discourage aggression by threatening people who are still contemplating committing crimes with discovering them, catching them, and kicking their behinds once they have committed these crimes. The government deters crimes by having the fear of punishment permeate society as a whole. It does not read any individual’s mind or collect his Internet and phone data to figure out whether he is to be incarcerated as a preventive measure. The government is or represents the people. But the people ought not to know an individual’s passwords. Hence, Hess suggests, the government should snoop on people but keep its findings secret. Reflect on how deeply irrational this is. First, normally, the state ought to make its actions as public as possible in order to strike fear into the hearts of potential lawbreakers. Second, the actions of the executive branch must be fully transparent, so that the legislature and the people can monitor the police for any abuse of power. Secret surveillance is as unhelpful and corrupting of public officials as it gets. The only “right” people have is “to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures…,” as per the 4th Amendment to the US Constitution, again, in the process of investigating a wicked deed already done. The amendment tries to establish a compromise between the security and privacy of a suspect (who has not at that point been convicted, charged, or even arrested) and the interests of the people in having a crime solved. There is no compromise at all regarding direct attempts to prevent future crimes: an individual should be absolutely protected against government spying. If we accept the assumption that crime should be prevented by direct measures, then no objection can be adduced to the proposition that the people should help the government by spying on each other. The government’s task of predicting who would commit crimes would be made far easier if it could enlist the entire populace as informers. Neighbor will spy on neighbor, mother will inform on her son, and son on his father, and maybe we will prevent a few attacks this way. Will this be a society worth living in, though? It may be true that the Constitution is not a suicide pact, but neither is collective security a pact that will usher in the world of Orwell’s 1984. It also follows from this that anti-private gun ownership advocates fail to grasp that defense of oneself and neighbor is and always has

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been in the hands of each individual not the police. In principle, the police might be able to perform even if disarmed; the people have a moral obligation to be armed and dangerous to law-breakers. There are then not so much gun rights as gun duties. It is questionable whether a soldier fighting in a war “serves his country” (as opposed to using taxpayer money to murder foreigners), but it is a certainty that a man who carries a gun and knows how to use it in defense of himself and loved ones serves his community. Thus, my own personal failure to pack heat properly is my weakness, my surrender to the illusion of safety we tenuously enjoy in “better” neighborhoods. As the Drug Prohibition is the stupidest “conservative” policy, so gun control is the least defensible of the leftist ones. Not that the two are unconnected, of course: the massive increase in violent crime due to the Prohibition supplies the left with a (bad) argument in favor of attempting to lower it via gun control. Even if the conservatives are guilty as sin, the left-liberal remedy fails to improve matters. The third function of the economist, then, is to restrain and weaken the state and downsize its size, scope, and reach to the absolute minimum necessary to secure common defense. But even these do not exhaust the economist’s duties. For the first step to loving people, which any advanced ethics unconditionally demands, is to think of them, of everyone, as one’s complements, first and foremost in the worldwide division of labor. Consider a typical illustration of the law of comparative advantage, a.k.a. the law of association. Let Smith and Jones produce goods A and B as outlined in Table Intro.2.1. Smith A B

Jones 5 / hour 21 / hour

1 / hour 3 / hour

TABLE INTRO.2.1. EFFICIENCY OF TWO PRODUCERS

Smith is 5 / 1 = 5 times more efficient than Jones at making A; at the same time, Smith is 21 / 3 = 7 times more efficient than Jones at making B. Hence, Smith has an absolute advantage over Jones at making both A and B but a comparative advantage at making B only, because 7 > 5. Consider the following scenarios, assuming that Smith and Jones each work 8 hours per day: Scenario 1: Isolated production: Smith and Jones both work 4 hours on

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A and 4 hours on B without trading with each other. The total amount of goods produced is: 20 + 4 A / day + 84 + 12 B / day = 24 A / day + 96 B / day. Scenario 2: Cooperative production: Jones works 8 hours on A, Smith works 3.2 hours on A; Jones works 0 hours on B, Smith works 8 – 3.2 = 4.8 hours on B. The total amount of goods produced is: 16 + 8 A / day + 100.8 + 0 B / day = 24 A / day + 100.8 B / day. Just by Jones’ specializing entirely on making A, there is a total gain of 100.8 – 96 = 4.8 B / day. Scenario 3: Cooperative production and exchange: Jones trades his 4 A for Smith’s 14 B. The results are tallied up in Table Intro.2.2. At the end of the day in Scenario 1 Scenario 2 Scenario 3

Smith has 20 A + 84 B 16 A + 100.8 B 20 A + 86.8 B

Jones has 4 A + 12 B 8A 4 A + 14 B

TABLE INTRO.2.2. PAYOFFS UNDER AUTARKY AND DIVISION OF LABOR

In Scenario 3, Smith is richer by 2.8 B than in Scenario 1, and Jones is richer by 2 B than in Scenario 1. All this is because Jones has decided to specialize in making A, and Smith has decided to devote more time to making B. Notice that there have not been any investment of new capital, any new technologies, any discoveries of new natural resources, any changes in the environment. Smith and Jones simply chose to make good use of each other when making production decisions. The point is that Scenario 3 dominates Scenario 1, meaning that both Smith and Jones are better off with cooperation and trade than with isolated autarkic production under conditions of moderate scarcity. Both Smith and Jones benefit from each other’s existence. This is just one example of the numerous opportunities for specialization and trade in an advanced society, in which division of labor is minute, both within firms and between firms. Therefore, Mises has wisely written that: We may call consciousness of kind, sense of community, or sense of belonging together the acknowledgment of the fact that all other human beings are potential collaborators in the struggle for survival, because they are capable of recognizing the mutual benefits of cooperation, while the animals lack this

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Summa Against the Keynesians faculty. However… in a hypothetical world in which the division of labor would not increase productivity, there would not be any society. There would not be any sentiments of benevolence and good will. (1996: 144, italics added) The greater productivity of work under the division of labor is a unifying influence. It leads men to regard each other as comrades in a joint struggle for welfare, rather than as competitors in a struggle for existence. It makes friends out of enemies, peace out of war, society out of individuals. (1962 [1]: 261)

(Of course, social cooperation is only necessary for good will, etc. to arise among its participants, certainly not nearly sufficient.) John Stuart Mill similarly argued that “the social state is at once so natural, so necessary, and so habitual to man, that… he never conceives himself otherwise than as a member of a body; and this association is riveted more and more, as mankind are further removed from the state of savage independence.” (2001: 32) To the world’s distancing itself from primitive autarky, Mises referred as the “cosmic becoming” of society. (1996: 145) To be sure, it is possible to engage in cooperation without dividing labor – an example would be a clique of hunters killing a mammoth with spears or several lumberjacks felling a large tree, but such groups are unstable. They can be disbanded as soon as the quarry is divided up, or the tree is down. This can never result in the establishment of permanent social bonds, as the recognition of higher productivity of human effort under division of labor can and does. In other words, here the natures of human beings and society, the natural usefulness of men to each other in peaceful labor and the resulting dependence of every person on the rest of society, lend a foundation for (the theological virtue of) charity. No loving one’s neighbor as oneself is possible, unless the nature of the society in which these neighbors live is uncorrupt with such perversions as socialism or government interventionism. Life in the Soviet Union, Hedrick Smith observed, was for average people like “a mass settling of scores on a personal level: put a Russian in charge of a little plot of ground or a doorway somewhere, and he will use his meager authority over that spot to make life hard on others.” (quoted in Reisman 1979: 180) Reisman also describes in detail the mutual antagonism between buyers and sellers under price controls, such as between tenants and landlords in rent-controlled apartments, unheard of under free markets. (1998: 239ff) Mises, echoing Frederic

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Bastiat, noted: “If men and commodities are prevented from crossing the borderlines, why should not the armies try to pave the way for them?” (1996: 832) Economics teaches how to look beyond the immediate future and into the long-term and beyond the welfare of any particular group and into the welfare of all, even ultimately the entire world. In short, economics gives an expression to universal natural sentiment which for St. Thomas “ministers to charity.” (ST, I, 1, 8, reply 2) With that sentiment secure, its extension into grace-infused charity becomes possible. For grace requires nature, but wicked nature will be unresponsive to grace. Consider, for example, that “love your neighbor as yourself” consists of three precepts. First, to extend love to everyone. Second, to will to those one loves the sovereign good as one conceives of it, e.g., eternal fellowship with God. Third, to devote one’s life to the improvement of the world as much as to the improvement of oneself. These are individually necessary and jointly sufficient for love of friendship to take root. Economics is nature on which grace builds, because it lays the groundwork for fulfilling all three precepts. For (1) the whole planet can be united by peaceful trade. In the market, “everybody acts on his own behalf; but everybody’s actions aim at the satisfaction of other people’s needs as well as at the satisfaction of his own. Everybody in acting serves his fellow citizens. Everybody, on the other hand, is served by his fellow citizens. Everybody is both a means and an end in himself, an ultimate end for himself and a means to other people in their endeavors to attain their own ends.” (Mises 1996: 257) It is surely easier to love others under these conditions, when their actions are consistent with the good of the world, and when their social positions are not unjustly seized; the best route to loving one’s enemies, a difficult instruction, no doubt, is to turn them into friends. Knowledge of economics reliably destroys one’s parochial attitudes. Landsburg calls the view that “an American worker is more worthy of protection than a foreign worker,” “repugnant. What moral foundation could support such an ugly division of humanity?” All human beings without exception are united into a kind of network, in which they support and succor each other. No individual is dispensable; no one is irrelevant; no one can be unlawfully sacrificed for another’s benefit. “Protectionism is wrong because it robs individuals of a basic human right: the freedom to choose one’s trading partners. The freedom, for example, to buy any car, at any price, from any willing seller. … We need to care about others. We need to care about those who are close to us, and we need to care about strangers. But to care more about strangers

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who happen to be American than about strangers who happen to be Japanese or Mexican is an expression of the basest and most wrong-headed instincts that a person can have.” (1997: 14-5) It is true, of course, that protecting American producers hurts American consumers and is illogical from the point of view of the great majority, but the moral point is that the person who seeks to “protect” himself or his favored group from competition should at least know that in so doing he will be harming the social body. There is a breaking of symmetry here: Smith the protected producer no longer depends upon Jones the consumer as much as Jones the unprotected producer depends upon Smith the consumer. In being allocated income by other members of society, Jones is subject to the discretion of the consumers whom he is serving. But Smith is not or is to a lesser degree. Smith can act anti-socially without suffering the consequences. When libertarians talk about freedom, they do not mean the freedom of privileged aristocratic elite to enjoy the life of leisure. They refer rather to the freedom to improve one’s own life via improving the lives of other people, the consumers. This freedom is the same for all people, from whatever country they may hail. (2) I am hard put to imagine how one can will to his neighbor the “heavenly” goods, if he does not even will to him the temporal goods that social cooperation can sprout forth. Love is measured by two things: first, absolutely, by the vehemence of the joy felt upon achieving a goal; second, relatively, by what one is willing to sacrifice or give up in order to bring about the good loved. How can one pretend to love, if he is not even prepared to let go of his ill-gotten gains? And (3), given that in the market, individual enterprise redounds to the common good, even a man who devotes his life to money-making, automatically, as it were, contributes to the welfare of his fellow men. A successful entrepreneur is a benefactor of society, a fact all too often forgotten. Thus, and fourth, economists should think of themselves as guardians of the world’s natural integrity of hearts and minds and as handmaidens to the Author of nature Himself. Let us now proceed to the gory details of Keynes.

Book I The Master 1. THAT THE NOTIONS OF THE EVENLY ROTATING ECONOMY, THE FINAL STATE OF REST, AND THE STATE OF EQUILIBRIUM ARE DISTINCT YET COMPLEMENTARY

Let me abbreviate the evenly rotating economy as ERE, the final state of rest as FSR, and the state of equilibrium as SEQ. Consider a Crusoe-Friday economy in which Crusoe exchanges his fish for Friday’s berries. Every morning both men go to work, procure the goods, and exchange them in the evening. The equilibrium prices at which they exchange are those prices at which quantity supplied of each good equals its quantity demanded. The act of exchange at the equilibrium price constitutes a SEQ. The SEQ prevails only at the moment of exchange; it is the state of neither before the exchange nor after it. Crusoe and Friday then consume everything and go to sleep. Upon waking up, they start producing anew the next day. Every night, the economy enters the FSR which continues until the exchange of fish for berries in the evening of the next day. The next day, the exact same activities repeat. This interminable series of cycles is an ERE. An ERE is an established routine of production and consumption. I will, therefore, define the foregoing terms as follows: An ERE is a sequence of identical cycles of production and consumption. An FSR is a single cycle minus the instantaneous acts of exchange. A SEQ is a set of all the acts of exchange, such as between a worker and a firm or between a firm and its customers. The FSR encompasses two things: (1) submarginal actions, such as Crusoe’s repairing his fishing rod, despite the fact that he may be working hard, and (2) the state of affairs when all the exchanges have been made, the market has cleared, and there are no more obvious to the economist (as opposed to entrepreneur) benefits to be derived from social cooperation and division of labor in a given period of even rotation.

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In the ERE, on the other hand, there are continuous exchanges; it is just that these exchanges are repeated according to the same pattern one time period after another. Plain state of rest can occur in a disequilibrated economy, in which case even an academic in his seclusion can perceive cash on the table or opportunities not yet taken. The final state of rest is a special case of the plain state of rest in which the latter is fully equilibrated. The ERE is a reasonable concept for two reasons. First, some desires are soothed today and come back again tomorrow. Hunger is an obvious candidate. It is necessary to produce food every day. Second, some desires are held in perpetuity, but goods that satisfy them depreciate in the process of being consumed. Thus, Smith may use a voice recorder every day, but the batteries used to power the recorder continuously lose charge until the recorder shuts down, notifying the user that new batteries are needed. Again, production must go on cyclically. Each exchange made within the ERE is profitable for both parties; if it were otherwise, then the exchange would not be made. A worker benefits from selling his labor; a capitalist benefits from receiving interest for abstaining from present consumption; and so on. Everybody is better off participating in this economy, evenly rotating though it is, rather than (a) not exchanging in this particular case (and therefore, doing the same whenever this case comes up in other cycles of the ERE) or (b) creating a autarkic society in which there are no exchanges, and no thought is given to producing for exchange in the first place. Exchanges go on as long as people perceive opportunities for mutual benefit and stop whenever no such improvements can any longer be discerned. But an equilibrium arises far sooner than at the objective point when for all people, the only way of increasing one person’s welfare is at the expense of some other one, again, as far as matters appear to an economist qua scientist rather than entrepreneur. We are not obligated to presuppose “perfect knowledge” or consumer omniscience, call it PCK. Private property rights are assumed in order to disallow a situation in which Smith forces Jones not to exchange with Robinson as would be Jones’ will; at which point Jones, no longer having that option, will choose to exchange with Smith. It is a part though not the whole of the definition of ERE that it does not permit capital gains or losses; there is neither new investment (or saving for this purpose) nor disinvestment (or new spending). These hold not just for the entire economy but also for every stage of production and in fact, for every producer. Thus, Crusoe’s fishing rod is maintained in perpetuity, and Crusoe never seeks to replace it with fishing

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nets. In an ERE, (a) what is being produced, (b) how it is being marketed, (c) the methods of production, and (d) the firms’ internal organization stay the same. The money profits, like the savings, too, must be zero, though business owners may be paid wages for their services as worker-CEOs. Companies neither produce anything different nor produce goods by means of different techniques one cycle after another. The ERE is an imaginary construction. People repeat the same activities one cycle of economic rotation after another. Time is abstracted from in between periods of production which repeat, though not within them, where time is still a full-featured factor of production. The same goods are produced and consumed in the same way. There is no depletion of natural resources. No new technologies are implemented. There is, most important, no action aimed at deviating from the routine. The economy is in constant flux, but it always looks the same from one cycle to another. The FSR is a time period between the act of beginning consuming the goods just bought and buying new final goods, once the previous set of goods has been fully consumed. It encompasses both “doing nothing” and the time it takes to produce the consumer goods. All income is permitted in the ERE except monetary business profit and loss, if those things come about as a result of novel and unpredicted human undertakings. A “novel undertaking” is defined as the act of changing any (a)-(d), that is, (a’) introducing a new product or service to the market, (b’) attracting customers to an existing product, (c’) trying a new and more efficient combination of factors within a firm, and (d’) lowering costs through better management. Call a successful such project “creative advance” or CA, improvement in consumer welfare. My contention is that there is an ERE, if and only if there is no CA. The technology-management nexus on the supply side is characterized by physical productivity and unit cost. These are different per se and alike per accidens. First, that some method combining factors 3A + 4B + 10C yields product 2P is separate from the fact that A costs $20, B costs $50, and so on. Second, an increase in productivity that makes the same factors produce 5P is identical to a decrease in costs of all factors by 2.5. The product-marketing nexus deals with unit revenue and value productivity. These, too, are different per se and similar per accidens. The fact that so many people are willing to pay $500 for one P is separate from the fact that they are willing to sacrifice such and such other goods to buy Smith’s own (which is the economically relevant measure of value productivity). On the other hand, both product development and

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marketing are united in the purpose of influencing demand. Both the substance and style of the good contribute to profitability, and revenues can pick up via either (a’) or (b’). The essence of (b’) will be revealed shortly. In the presence of PCK, creative advance can emerge only via actions of entrepreneurs, call this entr-CA. At t1, Smith may choose A over B. Later, at t2, Smith may change his tastes to the opposite preference. It is not clear that Smith is happier at one time as opposed to another. This is because there is a lexicographical priority of Smith’s nature N, character C, and happiness H. If we hold N and C fixed, then we can compare Smith’s H at different points in time. But it makes no sense to do this, if C has also changed from one time to another, and Smith is now a “different person.” But if an entrepreneur has come up with product X, and Smith prefers it to A, then Smith could continue to evenly rotate by consuming the old bundle of goods, but he voluntarily likes some new bundle containing X and switches. There is a clear sense in which Smith’s more important desires are now soothed, and the economy has grown. In a realistic economy, when consumers learn new things about the state of the market, they, too, bring about CA or con-CA. Thus, if Jones was going to buy a kitchen table at Macy’s, and his neighbor suggested that he try IKEA, then there is also economic improvement. Consider that advertising can seek either to inform or to persuade. Informing ads are part of (a’), establishing a good’s unit revenue by presenting “just the facts” about it and its price; persuading ads, of (b’), resorted to in order to make a good more attractive and increase its value productivity. The former attempts to get more people to buy the item (such that to maximize the firm’s profit); the latter, to get people to agree to pay more for it. The distinction is not clear-cut. This entr-CA is paired with con-CA, to the extent that consumers respond to ads. CA then can come from the consumers, as well, such as by way of finding out new products through personal research, word of mouth, web reviews, and all that. Advertising in order to persuade has sometimes been derided as a race in which a great deal of resources is spent but with no social benefit to it. Even if the relative positions of the firms advertising their wares change a little, this does not justify the sheer amount of budgets devoted to this industry. But now we see that persuading advertising aims primarily at kindling desires for existing products, as per (b’). The products do not change, but consumer receptiveness to them does. The consumer “melts” upon being exposed to well-made commercials, and

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things that are frozen are closely bound together, so as to be hard to pierce. But it belongs to love that the appetite is fitted to receive the good which is loved … Consequently, … melting denotes a softening of the heart, whereby the heart shows itself to be ready for the entrance of the beloved. (ST, III, 28, 5) The “race” excites the consumer, enlivens him, and prepares him for hearty enjoyment of life and prosperity. What is not for an economist to like? The consumers are sovereign and can be more or less active. Normally, entrepreneurs are in control; they decide the extent of choices available to the consumers. Consumers react to a new object for sale in their environment. With con-CA, however, it is the consumers who take initiative, decide what they want, and signal the entrepreneurs to adjust production. The latter are compelled to deviate from their routine, because the former do. But creative advance takes place nonetheless. A change in the demand for Smith’s product affects this product’s price and quantity supplied. Changes in the demand for other people’s products affect (1) derived demand for factors of production; therefore, (2) the prices of those factors; therefore, (3) Smith’s costs of production; and finally, (4) his supply as a whole. These events produce profits and losses and therefore, take us out of the present ERE. Entr-CA marches on not for its own sake for the sake of consumer happiness. There is no “upgrade for upgrade’s sake.” Improvement in (a) is a quintessential novelty: better quality of products. Improvement in (b) signifies more happiness from the consumption of an old product. Improvement in (c) entails higher quantity of goods produced; and improvement in (d) lowers prices to the consumers. It does not matter whether a consumer desire is somehow made known, and some entrepreneurs proceed to satisfy it; or an entrepreneur creates a new product, and consumers, upon being exposed to it, suddenly perceive that they cannot live without it. Both are indicative of a creative advance. From the point of view of an individual entrepreneur Jones, there are three not two categories of people: Jones himself, the consumers, and other entrepreneurs. Adventures of consumer demand make Jones’ life risky; actions of other producers make his life full of surprises; of course, Jones himself is fully on top of things in his own business and suffers from neither. We will see later the exact difference between risk and surprises; for now, note that if Jones is empathetic

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enough, understands his customers well, and is tuned in to the flows of demand, then he can (almost) eliminate risk; the ability to surprise one’s competitors, however, is profoundly a disequilibrium phenomenon. To recap: changes in consumer tastes within the existing set of goods and services do not necessarily bring about any new creative advance; improvements in consumer knowledge of the market result in con-CA; and explicit successful introductions of novelty constitute entrCA. (Unsuccessful such introductions are less creative advance than destructive retreat.) Keynes, therefore, is doubly wrong when he writes that “in equilibrium… both the value and the cost of current investment must be equal to the amount of current savings, and profits must be zero; … the condition of zero-profits means that aggregate profits are zero.” (1935: 152) First of all, if the money supply does not change, then if money flows to A, B, and C, then it must of necessity flow away from some P, Q, and R. If A profits, then P loses. Aggregate monetary profits, therefore, normally hover close to zero, even in a real economy; just as overall psychic profits are never zero, even in an ERE. Secondly, this condition, namely, the aggregate profits’ being zero without the specific profits’ and losses’ of each company also being zero, is not sufficient to ensure that the economy is evenly rotating. If profits and losses from novelty-generating entrepreneurial undertakings are permitted, then the matter and pattern of either consumption or production or both are able to change, and there is no ERE. On the one hand, an ERE is a fiction, a “world of soulless unthinking automatons” (Mises 1996: 248), since we ex vi termini force people not to act. On the other hand, an ERE is neither logically nor praxeologically impossible; merely economically implausible and unrealistic; it is almost never the actual state of human affairs. This is because as long as psychic profits are being had from exchanges (relative both to not exchanging then and there and to life without division of labor at all), the members of the ERE will remain living and breathing human beings, even if monetary profits are everywhere zero. The reason is that action is defined as an exercise of human power over nature that causes the future to be different from the past in terms of the happiness of the actor. Within an ERE cycle, there are such actions. In between cycles, there are not. The difference may be put this way: people in an ERE cannot choose to alter or stop their activities from one cycle to the next, but they are free to arrange the initial cycle. Of course, the phenomenon of excess of monetary profits over monetary losses does occur, but it requires an unusually precise convergence of anticipations of the future by the various entrepreneurs in the

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economy. If Smith has an idea for producing good A, which he deems particularly profitable, then in the process of saving money, he (1) drives down the demand for Jones’ B (by refusing to spend this money on B). By the time he finishes saving, many of the capital goods he needs have been created; one way or another, (2) some factors of production are bid away from Jones. Finally, when A is ready to be sold, (3) demand for B falls still more, as consumers spurn B in favor of A. If Jones foresees these calamities, then he will fire or sell some of his factors of production, reduce quantity supplied, and come out even. He may even try to one-up Smith by imitating him quickly enough. Smith’s profits, then, will be at the expense of income to Jones’ factors of production. More likely, however, is the scenario in which Jones is ignorant of Smith’s designs. He is surprised by higher costs of making B and fails to foresee lower demand for B, thereby paying his factors more while receiving less revenue. Smith’s profits in this case will be counterbalanced by Jones’ losses. An economy in which profits exceed losses is progressing and a “good” thing. Interestingly, Taleb (2010) reverses this argument, claiming that failing companies subsidize the consumers – “the more bankruptcies, the better it is for us.” (181) In other words, the idea is that for failing firms, costs exceed revenues which means that the revenues are “too low” which means that their prices are low which is good for the consumers. Of course, this is nonsense. It is true that a businessman who is losing money may be said to be giving his stuff away. But an economy is characterized by a measure of stability. A company that is losing money cannot evenly rotate, which means that it is taking resources away from uses deemed more urgent by the consumers. The consumers are telling the poor company that it had best revise its business plan. The factors involved in production will have to be let go, and who knows how soon they will again find employment and how wellpaying their new jobs will be. An unprofitable endeavor sucks scarce resources out of the economy improvidently. In other words, prices can be low and consumers, well-served, even if the costs of doing business are also low, and the company is making profits. Yet it can also be that prices are high, while costs are higher still, preventing continuous production and service and necessitating business contraction and curtailment of services to the firm’s customers. A loser subsidizes his workers not his customers. Losses then are evil per se but may be good per accidens as signs that someone else is profiting. A progressing economy is defined as a conjunction of two conditions: (1) capital accumulation and (2) profitable use of that capital. An economy is retrogressing if either (1’) capital is consumed

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and destroyed, even if doing so is profitable, such as due to a rise in time preferences; or (2’) there is accumulation of capital whose owners lose money in the act of using it. This is because such a thing is not accumulation at all. These goods will cease to be capital in future rounds of production, because evenly rotating is not an option. So, if profits exceed losses, that is, when foresight is correct, then an economy is progressing, if there is capital accumulation; and retrogressing, if capital depreciates without being replenished. But an economy can retrogress even if attempts are made to accumulate capital, if use of that capital is not profitable.1 Often the situation is less pleasant. In order to create new capital goods, people save money, converting their consumption into investment. But profits are obtained precisely via consumer spending. A progressing economy constantly brings precisely losses to existing producers and reroutes production from consumer goods to novel capital goods to be used in new and longer production processes. Thus, on the contrary, in a progressing economy, in the beginning and without superior foresight, there may be an excess of losses over profits. Overall, however, profits will need to outweigh losses, if any progress is to be had. Unlike what its name suggests, creative destruction consists of four phases, not two: destruction of existing firms via capitalist saving; creation of new firms via innovation in (a)-(d) and investing; uneasy survival of the new firms via consumer spending for several production cycles; and finally, destruction of the now old firms’ profits via imitation. An ERE is characterized by both perfect knowledge and perfect ignorance in different respects. Every businessman knows exactly what he needs to produce to satisfy his customers. If Smith owns a machine whose life span is 10 years, and to produce which takes Jones a month, then Jones starts production at the right time and delivers the new machine to Smith precisely when the old one breaks down. For his part, Smith has accumulated enough money to pay Jones. There is perfect coordination of actions, such that everyone’s expectations are fulfilled. At the same time, though everyone is dancing in step, everyone is also a slave to a routine. Everyone’s plans dovetail each other, 1

It is possible for a real economy to be neither progressing nor retrogressing but more-or-less stationary over a period of time, as in producing little change in the people’s standard of living. However, (1) the idea of a stationary economy, unlike an evenly rotating one, bears no value for economic theory; moreover, (2) there is no such thing as a stationary capitalist economy. Perhaps one could exist and endure in a feudal society. But that is hardly our concern.

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synchronized, but no one’s plans ever change. Nobody has any idea how to escape the monotonous drudgery of even rotation. Nobody tries to do things better. Note Cassidy’s opinion that “a market is simply somewhere things are bought and sold.” (2009: 25) That is a perverse definition, because things are bought and sold in an ERE, as well, but the ERE is hardly a free market. The market proper is not a place (like a marketplace); nor does its essence lie in exchanges made within it; rather, it is a process of entrepreneurial discovery, planning for the future, and acting under the condition of uncertainty. It is a process of creative destruction or creative advance. For example, Friday may up and invent and build a tool that allows him to gather berries quicker. He then uses the freed-up time to gather nuts, counting on them to be so valuable that Crusoe will eagerly exchange plenty of fish for them and will later on even work harder to catch more fish for exchange. This is an example of free market in action. The old ERE is dead and gone; the new one has not yet arrived. The relevant freedom is to try to improve one’s own life and the lives of one’s customers within an overall utilitarianism-satisfying framework. We may call Cassidy’s understanding of the market “crude” and my understanding, “subtle.” The crude concept of the market emphasizes exchanges of justly acquired titles to property. It is linked with natural law: we assume that no one does evil by violating people’s property rights. The subtle concept emphasizes continual economic progress and pertains to positive actions: everyone does some good by improving society. Just as we read the Defoe’s novel curious about the steps Crusoe will take to gain control over nature and grow richer, so we are even more interested in watching our own more complex economy evolve. Consider, for example, the following argument. It is asserted that the government’s Post Office “works.” It appears indeed that it “gets the job done.” It delivers letters without annoying its customers too much. But the relevant question is “it works in comparison with what?” The Post Office has been “working” in much the same way for hundreds of years. Improvements to its monopoly services have been few and far between, measured only by major technological shifts. What is seen is a production process that achieves certain definite results. What is not seen is how a private competitive mail delivery industry would have evolved in place of the state-run enterprise. Experience suggests that the former would by today have become vastly better and cheaper than the latter is. The market is free, insofar as people are able to depart from the

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customary and habitual, innovate in any (a) through (d), and promote new or cheaper products to the consumers. The market is a living organism, ever evolving toward either greater complexity or greater unity, eventually increasing in both. The market’s “identity,” such as it is, is the goods offered for sale and their prices; otherwise, it is fully constituted by what it does, for it flows and will flow swirling on forever. 2. THAT KEYNES’ DENIAL OF SAY’S LAW IS UNWISE The conventional formulation of Say’s law, “Supply creates its own demand,” is an a posteriori statement and is not, generally speaking, true; but its alternative synopsis, namely, “Under laissez-faire, if there is a demand, then it must have been preceded by a certain supply,” is undoubtedly true and almost self-evident. Here supply means a supply schedule, detailing at what minimum price (which is a ratio that may be expressed in terms of either money or another good per unit of the supplied good) one is willing to give up N units of the supplied good for all N. Demand, similarly, means a demand schedule or the maximum price one is willing to pay for M units of the demanded good for all M. Since Keynes’ rejection of Say’s law does not stem from any analysis of the maladies that plague the economy as a result of government interference with business, it is not at this early point necessary to enumerate the guilty interventions. Now the fallacy of composition is mistakenly attributing to the whole a property of its part or vice versa. A constituent of a house is a brick and is shaped like one, but the house as a whole does not look like a brick. Keynesians have deafened our ears with repeated assertions that policies that work for a family, such as a balanced budget, are not appropriate for the government. Given that it is false that “we” are the government, and the government is “us”; that we are sort of kids of whom the Republican dad and Democrat mom are taking care, they are correct. Moreover, this is a truism, insofar as it is assumed at the beginning of the argument that the government does or ought to possess powers unavailable to a family and (alleged) duties with which a family is not burdened. For example, the government can monetize its debt by borrowing from the Fed. If the common ideology demands that the state prosecute fiscal policy, then government deficits, far from being an outrage, are considered by the public to be fully in the interest of the common good. Thus, the government, indeed, is not like a family, having

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the ability to tax and print money, but maybe it ought to be. But there is a much less dubious composition fallacy of which the Keynesians themselves are guilty. The price and quantity supplied of an innovative product depend upon consumer demand. From this we cannot conclude that the “price level” and “total output” depend upon “aggregate demand.” There are two sides to the distinction. First, Smith sells his labor to person X for money and uses the money to buy widgets from person Y. Second, in buying widgets, Smith refuses himself trinkets sold by person Z: the opportunity cost of enjoying the services of a widget is failing to enjoy the services of a trinket. For aggregate quantities, neither hold: Smith, X, Y, and Z belong to one and same group of people. Total output is everything that is sold by all members of the economy. And there are no opportunity costs to buying everything. Say’s law affirms that in an evenly rotating economy, there are no obvious errors that leave either producers or consumers unhappy. For example, no good is unsold, and no money is unbought. There seems to be no reason to sell, unless one looks forward to buying. The only way to buy is to sell first: the purchasing power to buy is obtained by selling. These seem trivial: who could possibly deny these points? Well, Say’s law regards not only the present exchange but future exchanges; not only the present production period but future periods, as well. If the future turns out to be different from the past which is a case of disequilibrium, then Say’s law may not hold. There are at least two relevant kinds of equilibrium here: that between supply and demand (SD) and that between revenues and costs (RC). A disequilibrium in either, though temporary, may make it false that either supply calls forth its own demand, or demand calls forth its own supply. Consequently, there are three distinct situations under laissez-faire where Say’s law may not hold. First, it is a conceivable though highly improbable state of affairs that entrepreneurs will make so many errors at the same time as to frustrate, by creating gluts and shortages, temporarily a tendency towards equilibrium. If quantity supplied does not match quantity demanded, then either some goods remain unsold or some amount of money that people are eager to exchange remains unbought. But even without such a cluster of errors, correcting SD imbalances takes time, and while this process is taking place, the economy does not obey Say’s law. Second, the economy is always only partially coordinated with respect to RC, as well, because disequilibrating entrepreneurial actions perpetually disturb and devalue the aspects of the economy that might

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prefer to be left alone and blithely to evenly rotate (and which do not?). As a result, there are always winners and losers in the competition. The winners underproduce, profit, and demand (e.g., $100 for the widgets) more than they supply ($75 for factor services); the losers overproduce, lose, and supply more than they demand; leading to a violation of Say’s law. In other words, Smith the winner cleverly produces “too little” of X, can price it low but monopolistically prices above the long-run equilibrium price, and his factors get paid less than their discounted marginal value product. (The economy tends toward equilibrium but never reaches it; moreover, the equilibrium price and quantity supplied are not something that can be discovered by economic reasoning; they are created via the market process. The SEQ is not “out there,” such that it can come to be known; it is a human creation. The only thing we can say is that the monopoly price is above the hypothetical equilibrium price which would obtain sans further human actions.) Moreover, the winners’ overall investment is too low, causing higher consumer spending and higher profits. Smith and other winners will eventually be imitated, and their profits will disappear, thus bringing the macroeconomy toward an ERE. If Smith’s factors are perfectly scarce, then Jones’ imitating him will result in the prices of the factors employed by Smith skyrocketing quickly and zeroing out the profits of both producers, creating an ERE; if the factors are not scarce but on the contrary, superabundant, and Jones can pick them up elsewhere in the economy without going through a competitive process with other imitators of bidding up their prices, then production and quantity supplied of X will happily increase, and X’s price will fall, until again an ERE is reached. In the real economy, the situation is somewhere in between: numerous imitators of Smith and other winners obtain their factors from the economy at large (as well as try to rip them from each other), but their actions do make a difference even there. Hence, imitation will take resources away from and dampen production to some extent of other unrelated firms which will have to contend with higher costs of doing business. Similarly, Jones the loser foolishly produces too much of Y, needs to price it high in order to justify production but must price below the equilibrium price, so as to move the entire stock, and pays his factors of production above revenues. This behavior is unsustainable, and the quantity supplied of Y is too high, necessitating a contraction of production in the future. Symmetrically, Jones’ malinvestment entails previous capitalist saving and therefore, lower consumer spending. If the losers collectively had not invested, then they might have spent their money

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on each other’s products, thereby boosting their revenues. As he fires his factors and pays less to those that remain, this spending increases. Jones and others like him will curtail production, with the marginal entrepreneurs leaving the market altogether, so that losses will disappear, as well. If there are profits and losses, then Smith can price his product lower, such that there is an RC equilibrium, but does not want to; Jones wants to price it higher but cannot. There is a discrepancy between the RC and SD equilibrium prices. For Smith, at the former price, quantity demanded will exceed quantity supplied; and vice versa for Jones. For the time being, at most only one equilibrium is going to be attained. For example, an SD monopolist may own 20 widgets yet face such a market that his revenues are maximized, if he destroys or at least withholds 5 and sells only 15. An SD disequilibrium obtains (qs of 20 > qd of 15), even if the entrepreneur breaks even. This strange result is unlikely to happen, of course, because it must have cost the entrepreneur something to produce these extra 5 widgets. An RC monopolist, then, may find that his profits are maximized, if he produces and sells 12 widgets. Here an RC disequilibrium is paired with an SD equilibrium. Again, perverse Central Bank policy will trigger a recession as part of the business cycle, in which the economy is revealed to be affected with a high level of discoordination, with losses far outnumbering profits. Say’s law is its victim. The price at which Y (Jones’ good) ought to be sold in order to avoid losses is different from the price at which the consumers prefer to buy the entire quantity supplied of Y. Keynes maintains that trusting the equilibrating forces to operate is a naïve course of action and suggests ways to increase aggregate demand instead. This, he hopes, will increase the particular demand for Jones the loser’s Y and therefore, his revenues and profits from producing Y. In other words, we are not here dealing with Crusoe and Friday exchanging fish and berries. Even a loser will sell his goods at a marketclearing price; it is just that in so doing, he will be bleeding money and will have to rethink his plans. However, unless we are considering the business cycle, the normal functioning of the market process is not sufficient to do any genuine violence to Say’s law. Third is the matter of hoarding. This will be dealt with exhaustively further on. For now, I will say that hoarding may be considered to be a voluntary reduction in the money supply, i.e., monetary deflation. The hoarded money is like insurance: one never really wants to find himself in a position in which he needs to resort to using it. In a real monetary economy, Say’s law is false, because I sell first and buy only

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later. The implication is that having sold, I may still fail to buy and choose to hoard instead, even though my goal in selling at the time may have been to buy. It is clear that the introduction of time and money as a store of value into the economy has deep implications. In addition, one can supply something for free, as a gift, refusing to honor the common purpose of supplying at all. Other motives for hoarding or for keeping cash balances in general are outlined in (I, 20): e.g., the purpose of hoarding for insurance is to prepare for unforeseen future pains; while the purpose of hoarding to take advantage of presently unfathomed opportunities to consume or produce is to prepare for unforeseen future pleasures. (Keynes concurs on p. 196 of General Theory). For example, we may read in a business article that a big company is “sitting on a mountain of cash.” Etc. The argument is that when this happens, the absolute price level becomes too high. Hence, there is a general glut of goods on the market. I answer that when Smith hoards $k, and Jones hoards $l, they fail to buy certain specific goods; therefore, hoarding causes only specific prices to be too high, not all prices. It may be the case in a depression that numerous people hoard money. Still, hoarding is a result of individual decisions. There is no coordinated hoarding, in which all people agree to withdraw large amounts of money from circulation. For this reason, it is necessary to look at this problem from the point of view of an individual hoarder who is faced with the market data, over which he himself has no or almost no control. For such an individual, hoarding has clear opportunity costs: the hoarded money can be neither spent nor invested. Moreover, as other people hoard, prices fall, enticing him and others to spend. Even with mass hoarding, prices, wages, rents, etc. of those goods and services for which the demand has decreased should normally come down in response to the greater purchasing power of the remaining money. It is true that some business plans will be shown to be faulty because of hoarding; such erring entrepreneurs would have been better off keeping their capital in the form of money in the bank and waiting for it to appreciate. However, the people’s success at security seeking is more important than the entrepreneurs’ success at garnering profits. At any rate, prediction of deflationary hoarding is part of the job of the entrepreneurs. Even when making such predictions is exceedingly hard, as predicting the bust during an economic boom, the fault for economic destructionism lies not with the hoarders but with those institutions that induced the boom and bust cycle in the first place. If the large crowd of losers during the bust is fed with government money, receiving windfall profits, then the market price signals telling them to

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quit producing are disregarded. These entrepreneurs (and society as a whole) are deceived, imagining that they can evenly rotate and even profit in the future; but when factors prices adjust, the forces demanding that losses be purged from the system reassert themselves and present the government with yet another opportunity to do things right and avoid the childish game of coddling the losers with empty “profits.” Finally, hoarding in a depression has healing properties to be described in (II, 10). Hoarding under normal circumstances is not a significant factor that can vitiate Say’s law and induce serious discoordination. To recap, Say’s law is excepted a) in supply-and-demand disequilibrium, which is an aspect of consumption; b) in revenues-and-costs disequilibrium, including the situation of mass losses and bankruptcies of numerous businesses during a bust, corresponding to investment; and c) when money is withdrawn from circulation by individuals for the sake of hoarding or, alternatively, put back into circulation. In a recession, (b) may be accompanied by an increase in (c), but they remain different phenomena. The alternative wording of Say’s law is true necessarily, simply because if one stands ready to buy goods with money, then his money must have been earned, and if so, then, barring theft or government work, he must have happened upon it by supplying something of value to other people. Keynes claims that a free economy does not tend toward equilibrium, which is why Say’s law is completely irrelevant. The market does not always clear, and therefore, Say’s law does not work in practice. It is part of the purpose of this book to describe what real and apparent features of the economy caused Keynes to believe that the market process was irrational or at least inefficient. Some of those are: (1) wage stickiness, (2) scarcity of money, (3) high (or non-zero) interest rates, (4) uncertainty of the future, (5) the business cycle, (6) investing and hoarding as opposed to spending, and some others. I will cover all of these in due time. In short, Keynes does not acknowledge Say’s law, and there is a little truth to this conclusion, but for all the wrong reasons. Even in the case of the business cycle, the only phenomenon he notices that can, in

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actual fact, play havoc with an economy, he fails to identify its cause. 3. THAT WORKERS MAY, INDEED, CARE ABOUT THEIR NOMINAL WAGES MORE THAN ABOUT THEIR REAL WAGES

This is a psychological claim which can be defended as follows. First, it is easier to calculate one’s nominal salary than the price index of some arbitrary basket of goods. But this logic can only be taken so far, for, as Mises writes, “a judicious housewife knows much more about price changes as far as they affect her own household than the statistical averages can tell.” (1996: 222) By way of commentary, the purchasing power of money (PPM) is an intuitive and imprecise notion. This is because comparing the PPM at two different moments is hindered by (1) relative price changes, (2) improvements in the quality of articles, (3) emergence of brand-new products, (4) all-out disappearance of old products, (5) changes in the techniques and capital used in production (in short, the changes due to creative advance), and (6) the necessity of looking not at all prices but only at a certain subset of them, arbitrarily excluding everything else. Admitting the problem, Keynes uses the notion of “the public’s standard articles of consumption.” (1935: 233) Of course, there are no standard articles of consumption. Mises counters that on the market “every penny spent has the power to work upon the production processes. The publishers cater not only to the majority by publishing detective stories, but also to the minority reading lyrical poetry and philosophical tracts. The bakeries bake bread not only for healthy people, but also for the sick on special diets.” (1996: 271) By whose authority are the consumers of poetry, etc. not given consideration? These complicating factors make determining PPM “scientifically” all but impossible while still permitting easy rough generalizations via “understanding,” as Mises has noted. It follows that one cannot fool all of the people all of the time about their real wages. Second, I theorize that nominal income may for some people be a status symbol. A diminution of that income may appear to them as an insult, a slight, even as being treated with contempt, regardless of how economically reasonable and even necessary for him to stay employed the pay cut might be. It is as if the employee’s faithfulness to the company has been betrayed. His seniority and years of service are not properly appreciated or given their obligatory “esteem.” These two reasons are the most important ones that Keynes can advance if he is to justify his belief that wages are sticky upward and downward. Every other idea, such as alleged efficiency gains from long-

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term contracts or from stable remunerations brought to support this doctrine, either fails to differentiate sufficiently between wages and all other prices which are presumably less sticky or not at all, or it depends on lamentable government interventions into the free market, such as prounion and minimum-wage legislation, which are merely signs of our corrupt times and have no necessary need to exist. In principle, there is no reason why wages and salaries cannot be renegotiated at a moment’s notice and at will. Why must an employer lay people off during a deflationary economic downturn instead of offering to keep them working but at lower wages? What is wrong with wages’ fluctuating every week? If prices are falling, then workers may no longer contribute enough to the company’s product to justify their current wages. Why should an employer take a loss? He should be able to say: you can either go, or you can stay and keep working at a lower cost to me (such that the worker’s average product is no less than his wage), and perhaps, fewer hours (such that the employer profits even on the margin). Modern-day Keynesians bring in other reasons for price inflexibilities. The first one is “listed prices.” These refer to the fact that most stores do not allow negotiations between salesmen and customers. (It would be too time-consuming or inefficient; the salesmen would not have the authority to change prices, etc.) Moreover, one does not generally go into a department store, buy up all the shoes, and attempt to resell them at a profit, meaning that there is no instant arbitrage. However, these features of today’s economy do not prevent equilibration of supply and demand. The owners may set prices by trial and error and with understanding of past prices in such a way as eventually to dispose of their entire stock. Competition is usually sufficient to prevent firms from capturing the entirety of the consumer surplus, and a single market price for similar items prevails. Finally, arbitrage can take place at the level of the suppliers or wholesalers in the structure of production. Different business models call for different pricing strategies. The retail price of gasoline can fluctuate every day, because buying gas is a reluctant sacrifice for the sake of a separate end: being able to drive. Coffee, on the other hand, is actually enjoyed as a final consumer good. The reason why Starbucks does not change its prices often is that it wants its customers, especially the regulars, to have the same experience in its stores. Many people are creatures of habit, and they want this kind of stability and permanence, for which they repay with loyalty. Moreover, the demand for coffee is more elastic than the demand for gas, such that today a cup may be worth the money, and tomorrow, if the price increases, it may not. Must I phone Starbucks every day to find out its prices and decide whether to have my daily cup or not? This sort

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of arrangement (or rather lack thereof) benefits nobody. Hence, the relative “rigidity” which, however, does not mean that if push came to shove, and the business was changing, then Starbucks would not raise its prices enthusiastically and to the maximum it could afford. Again, prices may be rigid in industries in which quality competition prevails at the expense of price competition. In the past two decades, computers have improved with respect to some physical parameters 1,000-fold, but their prices have hovered around a constant value and may even have dropped, if we adjust for inflation. There is nothing economically perverse in this. Menu costs and long-term contractual agreements are alleged to be responsible for other instances of inflexible prices. The idea with the former is that a restaurant, say, would incur the cost of printing new menus every time it wanted to update the prices of its dishes. It may be cheaper to keep prices stable, if these costs are prohibitive. Consider though, first, what rigid prices imply. It is an (admittedly informal) definition of insanity that it is doing the same thing over and over again and expecting different results. An alternative definition might be doing the same thing in response to different environments and expecting the same results. Keeping prices the same in an always changing market amounts to precisely that. Therefore, the Keynesian insistence on price rigidities is tantamount to presuming market participants to be – literally – nuts. And that is far too strong a condemnation to be true. Human beings go to enormous lengths to earn a living. Surely, they can be expected to strive to minimize menu costs and to avoid long-term contracts whenever possible. Secondly, it is unsatisfactory to have to choose between a small loss from low prices and a greater loss from printing the menus. If menu costs are high, then people will simply not start the businesses that lay themselves vulnerable to such costs in the first place, thereby easing competitive pressures on those entrepreneurs who still decide to operate such businesses. Long-term contractual agreements are useful if there is a need to prevent a worker with unique skills that are impossible to replace easily from blackmailing the employer. Thus, an actor starting work in a comedy show may be required from the outset to limit his future demands if the show becomes successful, lest he threatens to leave and ruin the show (which is defined in the minds of the viewers by the actors). The idea is to make prices sticky upward, i.e., to lock in the prices of resources, for the length of several periods of production and thereby reduce surprises in calculating costs and revenues. I agree that the darker side of this is that prices are also made sticky downward. But how is that

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beyond the economic pale, if the benefits of this practice outweigh the costs for all concerned? Besides, factors prices can still change upon the completion of one or more rounds of production. “Another explanation for price stickiness,” writes Thomas Hall, “is the notion that many firms routinely engage in markup pricing, basing their pricing decisions more on the cost than demand considerations.” (1990: 111) That cannot be the case, because the firms that did that would be irrational and ensuring their own destruction. One cannot make business decisions by calculating the costs of production of an arbitrary item, adding a no less arbitrary mark-up, and pricing the product with this sum. In the vast majority of cases, this “strategy” will, to say the least, fail to yield any profit. (See (II, 27) for more on this.) And insofar as costs of production help to determine prices, they do so only in an ERE which, for all intents and purposes, admits no profits whatsoever. John Hudson suggests that a firm may be “often faced with the cost of dismissing unsatisfactory workers and rehiring others. To minimize such costs the firm may pay above the market wage, reasoning that workers know their own abilities and poor workers will recognize that this is a job that they will soon be fired from and hence not apply.” (King 2003: 114) This is supposed to explain why wages may be set above the workers’ discounted marginal value product (DMVP). Hudson does not grasp that any wage rate voluntarily agreed upon is a “market” wage. Furthermore, it is the definition of “unsatisfactory worker” that his wages are not justified by his productivity. A “good” worker may be quite unsatisfactory, if he is overpaid; and a “poor” worker may be an asset, if his wage is sufficiently low. What the firm is actually doing is simply getting better workers at higher prices, a perfectly ordinary behavior. Finally, this strategy is entirely self-defeating, if every firm is engaging in it. Allow me illustrate another argument of this sort with an example from biology. Ants display an interesting behavior. Any time a group of ants is dragging a caterpillar or leaf or some other useful to them object toward the ant hill, some of the ants are, indeed, dragging it toward their home, while others, bizarrely, are dragging it away from it; it is just that the number of ants moving in the right direction is greater than the number of ants moving in the wrong directions, and so, the item slowly advances toward its destination. It may be contended that companies are somewhat like that. If most of their employees’ productivity exceeds their wages, then they tolerate a few bad apples hiding here and there who do not, on the contrary, justify their salaries. They remedy the situation only occasionally, such as during yearly employee performance

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reviews. The excuse is that the cost of the reviews is very high. Note what this means again, however. Apparently, what is difficult is calculating profit and loss, whereas the market system is designed around the ability of individuals to look after their own self-interest. Even if reviews are rare, if a company is suddenly experiencing losses or even a general considerable diminution of its profits, then I guarantee that it is going to decide to conduct reviews very speedily and cost-effectively or go bankrupt. To the extent that some large corporations have slow to react bureaucratic management, the alleged difficulty of performance reviews is the least of their problems: such companies, barring government subsidies or protection or monopoly privilege, are already half-dead and on their way out. In addition, if carrying out reviews is so expensive, then this work will be a goldmine for consultants who could offer advice and assist companies with doing the reviews. Their entering the industry will assuredly serve to lower costs. The claim of wage stickiness, Keynes believes, may help to explain certain features of economic life, and though it is not the central feature of Keynesism, I will show how Keynes uses it in the (I, 5). My own view is that again, there is a variety of business models, many of which may involve wages or prices that stick. This, however, would most likely be a benign practice that hurts neither the buyers nor the sellers. 4. THAT WAGES MUST FLUCTUATE, LEST CAPITALISM BE FOR NAUGHT

Our author is not done yet, however. He appears to argue as follows. Labor as a whole, Keynes asserts, cannot reduce its real wage by means of individual laborers’ negotiating their own personal money bargains with their employers. This statement is erroneous, but let me assume it. Therefore, any fall in anyone’s wages will harm that person, call him Smith, and will benefit every other worker. A decrease in the money wages of group X lowers X’s command over consumer goods and benefits ipso facto group Y whose money wages have remained intact. For example, let it be that the demand for the product of X’s employers has shrunk, necessitating leaner operations. The derived demand for and income to factors, including X, go down, while Y, in its capacity as a consumer, is happier. Or, again, X’s bosses have invested into labor-saving capital goods, as a result of which their labor costs have decreased. Productivity is up which hurts in the short run those workers who were displaced by

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the new machines but helps everyone else. Keynes would have it that those who “consent to a reduction of money-wages relatively to others, will suffer a relative reduction in real wages, which is a sufficient justification for them to resist it.” (2008: 14) Any change in wages will, according to Keynes, simply redistribute income from one set of workers to another. Each worker knows that his wage’s falling will not result in a social good, such as the proper relationship between wages and prices; nor, of course, in any individual good to him; hence, he has no motivation to let it happen. I detect two problems with this line of reasoning. First, even if the foregoing did result in some social benefit, on the market, the butcher and baker and Smith do not care about social welfare but act in their own interest. Smith would resist in this scenario, even if his resistance was socially vicious. Second, in order for Smith to be working for his employer, call him Brown, two necessary conditions must be satisfied, namely (1) that Smith’s receiving the agreed-upon wage outweighs the marginal disutility of labor for him, and (2) that this wage is no higher than Smith’s (average or marginal) contribution to Brown’s production process. If the wage leaves this gap, then Smith will not work for Brown for long. If (1) is violated, then Smith will switch to another line of work where the distance between the benefits and costs of working is positive for him, or at the very least cut the number of hours waited on Brown’s business; and if (2) is violated, then either his wage or, again, hours worked or both will have to be reduced. It is true, of course, that each worker decides, I might say “in pure theory,” where to spend his time working. He will allocate his marginal hour to that project, to which he can contribute and for which he can be paid the most, proper allowance being made for profit; thus, Smith’s hours will be dealt like cards in a deck into “stacks” representing companies A, B, and C: e.g., the first 3 hours to A, the second 2 hours to B, the third 1 hour to A again, the fourth 6 hours to B again, the fifth 5 hours to C, etc. These are summed up; Smith does not actually have to run from his A’s office to B’s and C’s and back this many times. Now businesses are always started and wound down; they expand and contract; they discontinue old products and begin making new ones; thus, entrepreneurs continuously churn the market which results in constant updates to Smith’s and everyone else’s discounted marginal value product. It may so happen that Smith is presented with a choice to keep working at a lower wage or be fired. Therefore, Smith cannot “resist” adapting to a changing environment; if he refuses a pay cut, then he will soon be entirely without income. Incredibly, Keynes denies both (1) and (2)

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and mysteriously claims that the wage level “depends… on a different set of forces.” (2008: 14) More can be said about the determination of wages. First, there are factors of production other than labor, such as space and time; even if Keynes insists on dealing with “labor as a whole,” still, transfers of income are possible from one kind of factor to another. Second, the demand for labor is derived from the expectations of profits in the next round of production. The profits are estimated by looking in part at the projected original demand for the goods being manufactured. These expectations and projections are subject to constant revisions. The phenomena of entrepreneurial profits and losses entail that relative wages are perpetually changing, and “resistance” to such changes is futile. Third, hoarding / dishoarding and inflation will affect prices and therefore, wages, again requiring re-negotiation of employment contracts. Fourth, a crucial point of freedom of contracting is to accommodate entrepreneurship. Whenever profits come to exceed losses by more than before, there is a decline in money wages, though profits do indicate that consumers are being served. Here temporarily lower nominal wages end up bringing about permanently higher real wages; and workers would be harming themselves if they failed to let the market process operate. Further, as this process moves us from one evenly rotating economy to another, the two economies will differ in who is receiving what money income, but this reshuffling of cash is hardly the only significant event, since the overall consumer happiness, standard of living, and real income in one economy will also be different from those in the other one. The free market is not a zero-sum game (in fact, it is not a “game” at all; it is real life): that wages can fluctuate has a social purpose; hence, society has a reason to allow this. Finally, Keynes’ worry is that even if some Smith is accepting a lower wage, then overall employment will not increase. I will deal with this assertion in (I, 58; 59); for now, I will make the following points. First, if demand for the product of company A has slackened, then it is possible that the demand for the products of companies B, C, and D has picked up. If Smith who is working for A must take a pay cut, then workers employed by B, etc. will receive a raise. There is redistribution of income and in the end two final states of rest and two evenly rotating economies. But in an ERE, there is no employment problem; as far as everyone is concerned, every resource is fully employed, and every factor’s wage equals its DMVP. If labor as a whole cannot “reduce its real wage to a given figure by making revised money bargains with

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the entrepreneurs,” (2008: 13) then I would not put it past Keynes to have focused his attention on a perfect triviality: of course, employment will be the same, namely, “full,” from one ERE to the next. Second, the reason why a considerable number of money wages need to fall at the same time may be to help society overcome a recession. But the whole awfulness of a recession is that there are no entrepreneurs to bargain with in the first place; they all have collapsed, from small speculative ventures to the erstwhile high and mighty financial giants. The economy has imploded, and with it, attempts to produce and aggregate real wages. Money savings have become more valuable, because consumption and investment have spiraled down, replaced with hoarding; material goods and human capital that were overvalued and competed for in the boom part of the business cycle are now plentiful, with worker competition high, and business competition low. Is there any wonder that smaller compensations will help the economy? Third, there is the income effect on the supply of labor. At $40 / hour, Smith might want to work 40 hours per week; and at $80 / hour, he is willing to be burdened only 30 hours per week. The reason is that the 40th hour in the first case will supply $40 worth of goods but at a lower overall income (namely, $1,600 / week), such that the desires satisfied by the extra $40 are relatively high on Smith’s values scale and higher than the utility of spending the marginal hour on leisure. In the second case, the 31st hour will supply $80 worth of goods, but the set of desires this amount will satisfy is relatively lower on the values scale, because the first 30 hours have already yielded income that has served to make Smith quite happy. This amount happens to be prized less than the utility to Smith of consuming the 31st hour on leisure. Hence, the different choices. It is true that lower wages may induce some people to work less, as per the substitution (of work for leisure) effect on the supply of labor. At the same time, the workers who were in hindsight overpaid during a boom may in a recession choose to work longer hours for more modest wages. The income effect may in this case dominate the substitution effect, leading to higher employment overall. Fourth, if employing Smith is no longer profitable for X, yet (a) neither can a new contract with a lower wage be negotiated, (b) nor can Smith be fired, then Smith’s master will have to go out of business. “Jobs” will be “lost.” Therefore, even if lower wages do not generate new employment, they surely at least prevent the loss of old employment. Fifth, if Brown can replace Smith with a more gifted worker who is willing to work for less, then Brown’s business efficiency has improved and his profits are up. He can use the freed-up resources to

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hire other people or factors. Straightforwardly, employment will have increased. Lastly, with economic growth, entrepreneurial endeavors result in, if not necessarily fuller employment, then surely in better or smarter employment. Keynes’ blunders go on. He claims that “if employment increases, then, in the short period, the reward per unit of labor in terms of wage-goods must, in general, decline and profits increase.” (2008: 17) The reasoning is set out as follows: “n men are employed, the nth man adds a bushel a day to the harvest, and wages have a buying power of a bushel a day. The n + 1th man, however, would only add .9 bushel a day, and employment cannot, therefore, rise to n + 1 men unless the price of corn rises relatively to wages until daily wages have a buying power of .9 bushel. Aggregate wages would then amount to 9/10(n + 1) bushels as compared with n bushels previously.” (2008: 17n) There are two scenarios here; first, regarding quantity; second, quality of employment. In the first case, we have competition between workers for a job which lowers wages; in the second case, competition between entrepreneurs for a worker which raises wages. First, let employment increase with a recent graduate, Jones, entering the job market and ending up working for Brown. Since Jones is not bid away from another job, he adds to the competition between workers and lowers the wage level. If Jones can fill a vacancy somewhere else, then the opportunity cost of working for Brown for the Brown’s workers will decrease; they will have fewer jobs to choose from which will grant Brown extra bargaining powers and reduce their wages. However, with Jones working alongside the rest of Brown’s employees, Brown’s output will increase, and its prices, fall. Because of Jones’ involvement, two events will occur: (1) the nominal money wages will go down, but at the same time, (2) there will be out there a greater abundance of goods at lower prices. Economic reasoning cannot tell whose real wages will have risen or fallen. It is, after all, obvious that with more people working, more will be produced. The important for the whole society caveat is that the increase of capital invested does not fall behind increases in the size of the labor force. For example, there is a reason why Jones’ entry into the labor market will temporarily depress real wages. Jones is advanced present money, with which he buys present goods, yet the fruits of his labor will materialize only in some more or less distant future, when the entrepreneurs employing him will have finished the production to which Jones is contributing. But since Jones is now comfortably ensconced in his

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new job, we must judge that, on the whole, society is better off with him existing, disregarding the possibility that Jones’ employer will lose money from his investment and demonstrate thereby that Jones was employed in vain. In the short run, that is, with given capital equipment, technology, management style, etc., an increase in employment entails pairing more labor with the same number of capital goods; therefore, lower marginal productivity of labor; therefore, lower real wages. Keynes’ “effective demand” seems to be that level of employment at which society will be worse off if an extra worker is added to the rolls. But in the short-term, that is true for all levels of employment; while in the long-term, given that humans are creators of novel capital goods, it is true for none. Thus, Keynes takes this argument too far, because by his logic, we are led into the conclusion that when Crusoe meets Friday, instead of being overjoyed at the possibilities of greater prosperity when the two work together, he should instead kill him in order not to lower his “real wage” or not to become unemployed. In the longer run, division of labor benefits every member of society. Second, as more workers are hired by a firm, the firm’s marginal cost increases and marginal revenue declines. In other words, the employer pays his workers more and more (because each additional worker is lured away from ever more valuable occupations elsewhere in the economy, and of course, a single price rules the market), yet the workers produce less and less (because with more output each new unit of this output will satisfy an ever lower-ranked consumer desire and therefore, have an ever lower price). These are corollaries of the laws of increasing marginal cost and diminishing marginal utility. That number of workers is optimal which maximizes the company’s profits. In this case, let there be no confusion between physical productivity and value productivity. There is no reason why the (n + 1)th man must be less efficient than the nth man. Keynes should have written something like this: “the addition of an (n + 1)th worker increases the quantity supplied of corn to such an extent that the price at which the market clears goes down by 10%, say, from $10 / bushel to $9 / bushel.” Marginal costs come closer to marginal revenues; hence, it may not be as profitable to employ the marginal worker or, indeed, every worker at the old (or slightly higher) wage. Here, on the contrary, profits may decline. Thus, let 5 workers each spend 40 hours / week at $10 / hour producing 200 widgets priced at $10 each. A sixth worker hired will increase all wages to, say, $11 / hour. Overall production will be 240 widgets which can all be sold for only, e.g., $9 / widget. The loss to the company is $480 / week. If the 6th worker is Jones, the loss may be

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smaller. These are all very well, but how do they support Keynes’ argument in favor of involuntary unemployment? 5. HOW INVOLUNTARY UNEMPLOYMENT IS DEFINED BY KEYNES, AND HOW IT OUGHT TO BE DEFINED

Mises did not explicitly use the term “involuntary unemployment,” but he would approve of defining it as the existence of men, who, although able and ready to work, cannot find regular jobs because there is no room left for them in the social system of production. … They are poor or paupers in the old sense of the term, supernumerary and superfluous, a burden to themselves and a latent threat to the minority of their more lucky fellow citizens. Even though the wage rate of an unemployed person is zero, companies have no resources left to pay that person anything for any work he is capable of doing. He cannot find work at any rate sufficient to sustain his life. He cannot contribute to any production process whatsoever. In short, he is dying of hunger in the middle of a large city. If such is the state of affairs, then that person is unemployed involuntarily. Mises goes on: As far as there is unhampered capitalism, there is no longer any question of poverty in the sense in which this term is applied to the conditions of a noncapitalistic society. The increase in population figures does not create supernumerary mouths, but additional hands whose employment produces additional wealth. There are no able-bodied paupers. (1996: 836) It is precisely this claim that Keynes disputes. His definition is: Men are involuntary unemployed if, in the event of a small rise in the price of wage-goods relatively to the moneywage, both the aggregate supply of labor willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment. (2008: 15) Keynes’ contention is that a small change in real wages affects

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employment, if and only if there is involuntary unemployment. Here is the argument: 1. People are resistant to lowering of their nominal wages. 2. People are much less resistant to lowering of their real wages, if their nominal wages remain the same (as per (I, 3)). 3. Therefore, a sufficiently small decrease in real wages will not cause workers to work less or less hard or to go on strike. 4. But such a decrease, if brought about by higher prices of “wagegoods” (which I understand to be consumer goods minus, perhaps, some extraordinary luxuries unaffordable to most workers), will garner higher profits for companies. 5. These profits will not be eaten away by the presently employed workers’ demands for raises (from (3)). 6. Some of those companies will choose to use a part of those profits to employ more labor. 7. But if they succeed, then there was not full employment. 8. Therefore, there is involuntary unemployment. And, conversely, I. II.

III. IV.

Let there be involuntary unemployment. Then for any sufficiently small decrease in real wages (i.e., small enough not be noticed by existing workers), though no matter how small, job opportunities will be created. Some of those jobs will be filled with new people. Therefore, employment numbers will be affected.

The argument works if there is an increase in some or all prices unaccompanied by a corresponding increase in wages that would equalize wages and productivity. Then the only way for companies to grow is to employ more people, and that is possible, only if there was involuntary unemployment. (We can ignore the obvious point that with higher prices across the board, workers in the aggregate will not have enough money to pay those prices.) The argument is best understood as involving a counterfactual: If it were the case that the profits of various companies suddenly increased by a small amount due to higher prices of their products, as if by magic, and with no attendant losses to other companies, yet none of those companies could expand operations by hiring additional labor, then it would be the case that at present there is full employment. This is true, even though the antecedent is never true in any actual laissez-

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faire economy. The demand for labor increases because of the rise in prices; and the supply of labor increases, because the unemployed become up for grabs, wherein before, though they were counted among the labor force in toto, they were not counted among the employable labor force at all. Joan Robinson, a disciple of Keynes and one of the earliest Post Keynesians, defines full employment as follows: “The point of full employment is the point at which every impediment on the side of labor to a rise of money wages finally gives way.” (1937: 9) She must mean that if there are unemployed, then their attempts to find jobs drive down wages. But when everyone is working, and especially when everyone is in a union, workers can demand higher wages and be unconcerned with such competition. Unfortunately for this definition, competition between workers does not cease with the disappearance of unemployed: any firm will fire a worker, if it can get a better one at a lower price: without unemployment, underemployment would still be rampant and pervasive, as discovered and taken advantage of by entrepreneurs. It is implausible for all workers in a society to demand wage increases as some kind of a monolithic bloc; and even if it could happen, it would only result in a rise in prices so as fully to counter the wage increases. A crucial implication of defining involuntary unemployment this way is that Keynes can now be interpreted as saying that there is under laissez-faire “the possibility of equilibrium with involuntary unemployment (excess supply of labor).” Keynes’ argument starts with an evenly rotating economy and then, as a mental experiment, raises revenues of business firms, so as to test whether excess labor is out there and available. To the extent that the experiment could be conducted in the real world at all, and very roughly at that, it would have to be by means of the government’s fiscal policy, such as borrowing and spending. The setup would be something like this: (1) the economy is left alone for a long time with unemployment persisting throughout; then fiscal policy comes to the rescue which (2) diminishes unemployment (3) unambiguously due to the policy. However, until we see what happens in each particular case, Keynes establishes only the logical possibility of free market with unemployment. At the very least, Keynes is arguing that “making money wages more flexible by eliminating trade unions, minimum wage laws, and the dole might just make things worse. …involuntary unemployment might be a disequilibrium phenomenon, but the system might not have any mechanism to move it back to the full-employment equilibrium after a sufficiently large negative demand shock.” (Bateman 2010: 96-8) This view is dissected in the chapters on the business cycle, especially (I, 61-

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64) which supplies the most important case of a “negative demand shock,” and in (II, 9). As we will see, in addition, cyclical unemployment is just one of the failures that Keynes attributes to the unfettered market. According to him, a free economy would not deliver the goods efficiently even in the absence of the business cycle. Let me suggest that the free economy’s property of a large unemployable underclass, even if for some Keynesian reason it was there, must be highly unstable, because any one of these people can become an entrepreneur, call such a representative person Smith, and pick up the other unemployed as workers for some ridiculously low price. Either the unemployed have no skills, in which case they can still be trained by Smith, or train themselves at their own expense, or both, whatever seems reasonable; or they have no skills useful to anyone other than Smith, in which case they can work for him even more readily; or they do have marketable skills, and then their failure to find work is mysterious even with Keynes’ assumptions.2 Even if one has savings, the longer he out of work, and the more the savings dwindle, the more amiable he will be to working anywhere even for low wages. 6. THAT KEYNES VAINLY TRIES TO DISPOSE OF THE HETEROGENEITY OF LABOR

In constructing his “theory of employment,” Keynes (2008) proposes “to make use of only two fundamental units of quantity, namely, quantities of money-value and quantities of employment.” (41) He takes the skill and number of laborers “as given” and is interested in the “volume of employment.” (245) Is his project realizable? We may distinguish between (1) production by an entrepreneur, (2) an act of working by an employee, and (3) labor as a factor of production. The four Aristotelian causes can be identified for each. 2

In an episode of the TV show Seinfeld, “The Bookstore,” Kramer decides to start a rickshaw business in New York. When Jerry asks where he is going to find workers, Kramer suggests the homeless: “They’re always walkin’ around the city. Why not just strap something to them?!” Jerry replies: “Now that’s the first sensible idea I’ve heard all day.” Afterward, Newman tells a homeless guy: “You’re gonna have to do this all day for very little money.” Now the joke, of course, is that the homeless would likely be unemployable even under the best external circumstances, while Keynes suggests that the fault for mass unemployment lies within the laissez-faire system of social organization which would doom even regular people to idleness. But the point, I hope, is clear.

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Each such cause sustains a thing, call it X, in existence right now. Take even a single cause away, and X vanishes in a puff of smoke. The formal cause answers the question “What is X?”; the material cause, “What is X made of?”; the final cause, “What is X’s purpose? What is it for?”; and the efficient cause, “How does X work?” “What production is” is obtaining capital goods and carrying them down the structure of production toward a more completed item sold by the firm. The factors of production and the technologies employed are the material causes of (1). Entrepreneurial direction of the firm via management of factors and use of the methods of production is its efficient cause. And the final cause is the output and (a) profits to the entrepreneur from selling this output on the market. With respect to (2), the matter of doing work is made up of three things. One, the amount of energy, whether physical or mental, that the worker expends while making the product and the disutility and fatigue associated with that expenditure. Two, the skills necessary to handle the raw materials and to operate the tools and machines being used in production. Three, the time it takes to complete the project. (It is true that time is a factor of production in its own right, but it is labor that takes time, which is why I am including it in this list. The answer to the question “How long will it take you to complete this project?” may be counted as part of the material cause of labor.) The act of working combines numerous energies, skills, and time periods. The formal cause of labor is determined by the answer to the question “What are you doing?” or “What are you working on?” If Smith is putting together a presentation, then doing that is the essence of his work right now. As for (3), the labor factor is materially composed of the steps toward completion of work and formally may be called intelligent use of one’s powers and arts. The final cause of both (2) and (3) is output and (b) wages. And human self-control and self-motion yield the efficient cause. In this chapter, I will focus on the material causes of (2) and (3). In (3), labor is distinct from capital, whether original or produced, human or real. Labor is a directing and creative agency. But in (2), labor and capital are complementary, and there is no disentangling them. Labor cannot be discussed in isolation from actual tasks of varying complexity to be performed. Labor and capital are separate for the economist but always found together for the entrepreneur. As we will see, Keynes has confused these two points. The energy expended and even the feelings of tiredness from

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work can, perhaps, be added and subtracted; that part of labor’s matter is, indeed, somewhat homogeneous. But not skills and arts or labor as a whole. What, for example, is five hours spent programming a computer plus three hours spent laying bricks? To get around this primordial difficulty, Keynes resorts to an ingenious maneuver. A good worker using a bad machine, he says in effect, may well produce as much as a bad worker who uses a good machine. So, for any two workers, their differences in skill can be reinterpreted as the differences in the equipment they use. The situation of any two workers with different skills who use the same equipment is as if they had the same skills but used different equipment, one more, the other less productive. Thus, differences in skills can be reduced to differences in tools. But tools, capital are already heterogeneous. We lose nothing, then, by making them “even more” heterogeneous and by ignoring the differences in labor skills. In addition, if I may continue Keynes’ thoughts, powerful machines cut down on the time needed to create the product. A perfect machine might do its work instantaneously. So, time, too, is reducible to differences between capital goods. (2008: 41-44) I judge this trick wanting for three reasons. First, for numerous skills, there are no actual machines that can replace the skill. It might as well be an economic law that the demand for skilled workers in a wide variety of occupations will never cease to exist. Second, even and especially if there are such machines, labor becomes merely an expense of human energy simpliciter; there is no indication, when we use mathematics on homogeneous units of labor, as to how this labor is used. Keynes’ stratagem causes there to be no definition of “ordinary labor,” into which “special labor” is supposed to be converted. For it makes little sense to define a unit of labor as any expenditure of life energy equal to, say, 10 calories. Even if it could be so defined, a machine could always be constructed that performed the same function by expending even less energy. Both aspects of labor are thereby eliminated, and this is a reductio of Keynes’ argument. If superadvanced robots can exist that will do anything that men can do, only better, including walking, parenting, and economic reasoning, then a world is possible in which human beings will be bereft of all rationality, no longer having to figure anything out for themselves. I have my doubts about such a thing, however, which I express in (I, 25). In other words, the money-wage of a labor-unit depends crucially on the expected revenues from the product being built. Not all labor-units are created equal, as they would be, if the labor theory of value were true. But the value of the factors of production is imputed to or arises from the value of the consumer goods they cooperate in

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producing. The higher the worker’s DMVP, the more he can be paid. Focusing solely on how “hard” one works in terms of calories expended abolishes labor as a factor of production. In matter of fact, no one cares how hard a worker one is; employers reasonably demand results, and results are unique to each human resource. If labor is not evaluated on these merits, i.e., its contribution to society, then it is of no consequence to economics. Moreover, the calories expended are a cost to the laborer. He would do well to minimize them, and an ideal worker would lose no energy during the act of producing at all. The entire matter of labor again vanishes entirely, leaving nothing to help the economist. Third, one difference between labor and capital is that capital is owned by the entrepreneur, whereas workers are self-owners and owners of their “human capital”; they rent out their skills. (Workers receive rents on their human capital, while businessmen receive quasi-rents.) It is impossible in a regime where slavery is not tolerated to reduce labor to capital. It seems that Keynes’ attempt to make labor calculationally tractable fails. If Keynes abandons his artifice, then he can try to define ordinary labor as operation of any kind of equipment or the worker’s body valued at $1 / hour. Then 1 hour of special labor earning $20 / hour would be equal to 20 units of ordinary labor. I must protest that first of all, one cannot draw his curves of aggregate supply of and demand for labor without observing the actual market and the prices for various kinds of labor. Only the market can inform the economist that one hour of labor of kind X costs as much as N hours of labor of kind Y or rather did cost in the immediate past, a datum of economic history. But the market relations are always changing, and so does the relationship of the “labor-unit” to special labor. Both of the above must adjust with time; the purchasing power of money varies, as well; and it is hardly “scientific” for a unit to be subject to such change. If the measuring stick is always changing, then what can we possibly affirm of the things measured? Secondly, this attempt falls prey to the objection Keynes himself raises, namely, that it is not in general true that special labor can actually be replaced simply with ordinary labor working for a longer period of time. To see why this is so, it is enough to consider workers’ skills as their human capital (the next chapter traces the implications of this idea). But Keynes specifically affirms the heterogeneity of capital, though he makes little of this crucial fact in his writings. A sophisticated robot on a car assembly line cannot at all be replaced by an automatic hammer that drives nails into things just working longer than the robot. Neither can Smith’s salesmanship skills which

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garner him $40 / hour be substituted with Jones’ powers which consist in his being able to swing a chainsaw (even if generally competently) for $10 / hour only spending 4 times as much time doing his thing. Aggregating the demand for and supply of labor in this fashion is worse than useless. Human capital is a form of intellectual property with its own peculiar attributes: it does not depreciate, except by being made obsolete as an outcome of economic progress; it can be copied from one person to another via teaching or training; this copying is not costless, which is why human capital is scarce and commands a definite premium on the market; it is what makes each human being economically one of its kind; etc. Dillard ascribes the following motive to Keynes for using the “wage-unit”: “because changes in output are measured by changes in the amount of employment.” (1948: 73) To be sure, the quantity of employment has an effect on the output. But by far the most crucial determinant of output is rather quality of employment, or the states of technology, capital accumulation, and entrepreneurial competition. The values of the sheer number of workers and hours they work do not “measure” output. Keynes claims to be able to explain “poverty in the midst of plenty.” I imagine that he is referring to the poverty of the Great Depression coupled with the abundance of capital goods accumulated. I do not believe that his explanation has anything to do with the Great Depression, but I will let it go. Our author defines full employment as that state of affairs in which a worker’s DMVP does not exceed his disutility of labor. In other words, full employment occurs, when a person works as much as he would like at the given wage. (For example, let Smith be paid $50 / hour. He would allocate his 5th hour to leisure if offered only $25. As such, at 5 hours per day, he is not fully employed. 6th hour’s leisure is worth $30; …; 8th hour’s, $45; 9th hour’s, $60. Smith is fully employed, according to Keynes, if he works 8 hours.) In a poor community, “a very modest measure of investment will be sufficient to provide full employment.” (2008: 31) There are several ways to interpret this. First is to question whether Keynes is making sense altogether: is not poverty defined as low overall investment? It is the epitome of a poor community that there are few consumer goods being enjoyed and capital goods aiding production. Keynes argument then is reduced to “employment is promoted by poverty,” a grotesque transvaluation of economic values, if there ever was one. Second, that insofar as “worse still,” propensity to consume is weaker and investment opportunities, less attractive in a wealthy community, Keynes is again talking about hoarding, since consumption,

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investment, and hoarding exhaust all possibilities of using money. As we will see, this, too, is a non-issue. Even empirically, a community’s greater wealth tends to lower any propensity to hoard. Third, Keynes’ reasoning may be that a poor man reckons that his real wage is very low; hence, why bother working for such a pittance? This is one of the many paradoxes in General Theory: is it not obvious that a poor man has a far greater incentive to work than a rich man does? Of course, the solution lies in the fact that in a rich community, labor is more productive than in a poor one. By working, a poor man satisfies desires that are very urgent but only a few such desires. On the other hand, by working an extra hour, a rich man satisfies his less urgent desires but many more of them. (If Smith is poor, then his very urgent ends thusly attained rank higher than any of the Smith’s rich doppelgänger’s less urgent ends, but they need not rank higher than all of such ends put together.) These two factors balance each other out, such that full employment in Keynes’ sense is attainable in both a rich and poor society. It is not true that as society grows richer, attaining profits becomes more difficult or the marginal efficiency of capital declines. New products will be continuously synthesized, and new technologies, invented. Successful entrepreneurship that makes use of these is compatible with any level of economic development. For example, Dillard offends us by writing that “the very fact that a community is rich in accumulated capital assets weakens the inducement to invest, because every new investment must compete with an already large supply of old investments.” (1948: 55) Surely, that is not the case, if the prices of the consumer goods made with the aid of these old capital assets are so low due to high material abundance, low time preferences, and stable money supply, that there is plenty of money in the consumers’ hands left over to buy the fruits of new investments. Is Dillard really suggesting that the sheer number of even rotators can somehow intimidate a new entrepreneur? On the contrary, for an enterprising individual, all of those people are pushovers, ripe for the plucking. Keynes argues that “the greater… the consumption for which we have provided in advance, the more difficult it is to find something further to provide for in advance, and the greater our dependence on present consumption as a source of demand.” He sympathizes with the following argument: “What will you do… when you have built all the houses and roads and town halls and electric grids and water supplies and so forth which the stationary population of the future can be expected to require?” when applied to both public and private investment.

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(2008: 105-6) Keynes displays a puzzling lack of imagination: how about that trip to the Andromeda galaxy due to the human “insatiability” that I mention in (Introduction, 1)? Economic progress is not about to end any time soon. Keynes cares about the “quantity of money-value” because of his belief in inflation as a panacea for macroeconomic distortions which can raise the “quantity of employment.” He does not realize that all things are good by virtue of their form, and labor is no exception. Thus, an economic boom imbues existing capital goods including human capital with high illusory worth (for no time to create new capital is provided for) and devalues and cheapens them in the recession, causing them to be salable only below costs and throwing people out of the work for which they may have spent years training and preparing. The answer to “What are you working on?” ends up being “Something I will not succeed at.” Inflation cannot ameliorate this judgment of the market. The challenge to the political economy regarding labor resides in the dual problem of (1) creating, updating, and transferring human capital and (2) matching the human skills with their complementary physical capital. Quantity of employment and how backbreaking the labor is for the people measure precisely scarcity of capital, both physical and human, relative to labor. Long working hours and “hard” work are indicative of a rude economy. President Obama’s desire to “put Americans back to work” evokes in me the resolution of a master to put his slaves back to work and this time, squeeze every last bit of performance from them. By casting his gaze at the “volume of employment” as a whole, Keynes forgets that what one does for a living is an intensely personal choice, almost as intimate as the choice of a spouse, depending on the wage, the pleasantness of work, as in, how interesting or exciting the job is, the disutility of labor, the length of the commute to work, the state of national prosperity, and a hundred other factors.3 The variable “manhours worked” conceals all these distinctions. In addition, quantity of employment is of no interest without additional data about productiveness of employment, in particular, without knowing the refinement and variety of useful skills and human capital that the workers possess. Unfortunately, Keynesians have rarely 3

Disutility of labor is measured in the pleasures sacrificed to perform a definite quantity of work. Thus, work may be enjoyable in itself but still cost much in the good things (such as spending time with family or pursuing hobbies or some life-long dream) given up for its sake and therefore, have high disutility.

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shown interest in matters as prosaic as consumer happiness obtained via human labor. It is as if they have given up at making the economy efficient and resolved at least not to permit the suffering attendant on the Great Depression-style mass unemployment. We will be poor, they reason, but at least no one is an economic pariah. In the course of the book, we will see that this program fails on its own terms; the similarities between Keynesism and socialism in which “they pretend to pay us, and we pretend to work” will be put in stark relief; and I will argue that despair about general prosperity need not at all be counseled. 7. THAT THERE IS NO SUCH THING AS UNEMPLOYMENT FOR LABOR AS SUCH

Labor is the most non-specific factor of production; any person can work at a variety of occupations. But most kinds of labor require skills that cannot be acquired easily in a day or two. These skills, handson experiences, knowledge of the tricks of the trade, attitude toward work, and work-related virtues such as punctuality are collectively called “human capital.” Human capital at first sounds like “slaves,” but it means rather workers’ investments into achieving competence in some field. Therefore, since a laborer can easily move from one line of work into another and so need never be unemployed, what can be unemployed is his human capital. Inasmuch as this capital is composed of original factors, it is materially the same as real capital. These factors are: a natural resource or the worker’s mind and body; labor, because acquiring a skill takes effort and has disutility; and time, because few skills can be learned overnight. Human capital arises out of self-making or self-production or transformation of the self into that kind of a person who will be useful in satisfying the desires of other people in their capacity as consumers – for a price. Becoming a professional means integrating oneself into social cooperation. We might distinguish between four types of human capital, each in the sequence scarcer than the previous one: (1) general abilities or valuable qualities shared in varying degrees by most workers, such as physical health, literacy, or ability to drive a car, i.e., a kind of common endowment of a nation’s labor force, (2) transferable skills or qualities of an individual worker that help him succeed in most occupations, such as intelligence, conscientiousness, communication skills, and the like, (3) specialized abilities or technical knowledge of and proficiency with methods of production within a particular firm or industry; and (4)

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unique powers, such as inventiveness, inimitable artistic genius, or ability to come up with solutions and moves yet unimagined by competitors. Human capital (1)-(3) may well be as important as real capital; the fourth kind of human capital is of far greater importance than all of the above. It is the most scarce and precious of all commodities. I hasten to add regarding (3) that real capital is the source of human capital. For example, an argument came up in a conversation that Labor Day “celebrates the productivity of American workers.” I replied that this is no accomplishment of the present workers who are so productive only because they have access to capital goods that workers of other countries lack. Education and human capital matter, but only derivatively, because most useful training occurs on the job, precisely while using those capital goods in training mode, so to speak, to acquire the skills of working with them competently. Since those capital goods – tools and machines – are provided to the workers not by the workers themselves but by capitalists and entrepreneurs, it would perhaps be more appropriate to celebrate “Capital Day” instead. Understanding this reduces labor-based macroeconomics into a kind of capital-based macroeconomics, the difference being that human capital need not decrease in value (and may even appreciate) with use as physical capital does. (Again, workers cannot be owned by firms, as if they were capital goods, but human capital can be owned by workers.) It shows notions like “full employment” in its traditional sense to be barely meaningful, because employment cannot be measured in manhours but only in (a) the human capital in use and (b) creative entrepreneurship of workers to keep their skills up to date or learn new skills in order to pursue careers in greener pastures. A robot cannot pick up new skills, which is why human beings are so protean, and why human labor is highly malleable and can in time be applied to numerous fields. But the skills themselves are much more particular and must be cared for by the workers, lest they become obsolete and worthless. Note that inequality of workers is an impetus toward further progress. Consider the strange notion of “planned obsolescence.” The idea is deliberately to shorten the useful life of one’s product, so that the consumers will be “forced” to buy replacements more frequently. This understanding is absurd both on the consumer level and on the producer level. First, there is an effect on consumer well-being: when choosing a light bulb, one will usually prefer a more durable item to a less durable one at the same price. Even if their prices are proportionate, one is likely to buy a longer-lasting bulb in order to economize on storage and replacement. Even in industries with strong quality competition, there is

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no obsolescence, because consumers voluntarily, without being “forced,” replace products for reasons other than their wearing out. By investing less into durability, companies are simply responding to consumer demand with no objectionable hanky-panky whatsoever. Second, producing 5 light bulbs that last 1 year each is almost certainly going to be more expensive than producing 1 bulb that lasts 5 years. The benefit to the consumer is at least as high in the second case than in the first, and the costs to the producer are smaller. More durable products, therefore, are selected for on both sides of the equation. Somewhat analogously, there is a clear incentive to any worker to become more efficient, as this brings the possibility of a higher wage. On the other hand, a businessman is not indifferent between hiring one man who produces 80 widgets per day and hiring 8 men each of whom produces 10 widgets, even if the total labor costs are the same. First, the businessman economizes on management (one man is easier to direct than eight) and transaction costs of finding labor. Second, each worker utilizes capital goods, and machines and equipment both are occupied less (and so are available for other projects) and depreciate more slowly in the first case than in the second. Increasing one’s personal efficiency pays for both the employer and the employee. Let me delve into this subject a little deeper. Employment is simply a contract to exchange labor for money. But what is full employment? Can we say that a man is fully employed, if he is exhausting himself chopping firewood 16 hours per day every day, in which case he physically could not work still more, if the antecedent of the (I, 5) counterfactual were true? Surely not. A simple definition of full employment is that level of work, at which the worker’s wage is equal to his DMVP or to his disutility of labor. It means that either even if the worker would like to work more, no more work can be offered by the employer, or even if more work is available, the worker prefers to enjoy his leisure. The state of full employment has no meaning outside of the wage agreed upon by the entrepreneur and worker and the actual state of the market. If company X employs Smith 40 hours per week at $20 / hour, such that X is not willing to employ Smith more, yet Smith does want to work more, then Smith can try to find work with another company Y. However, the best job he can find given his skills will pay only $10 / hour. At this wage, Smith is not willing to work more at all. We conclude that Smith is fully employed. The same analysis can be reversed. At $20 / hour, Smith is willing to work no more than 40 hours per week. X wants him to work 10 extra hours per week overtime, but Smith would agree to do so only at $30 / hour. But at this wage, it is

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unprofitable for X to employ Smith. Again, Smith is fully employed. However, consider a situation in which the employer (such as X) does demand more labor, but the employee is unaware of that. Then only partial employment prevails. The same conclusion must be drawn if another employer (such as Y) could offer a worker a higher wage for a higher DMVP, if only both knew of each other’s situation. I suggest, therefore, that full employment occurs when the great majority of workers perceive their investments into their human capital to have been worth the trouble; when these investments bring them psychic or monetary profit. I would be concerned with entrepreneurial profit or “breaking even,” despite the fact that any initial investment is in the past and is a sunk cost, because it is a necessary (though not sufficient) condition for the entrepreneur’s evenly rotating in the future. Profitable enterprises may have the luxury of choosing to do next year the same thing they did this year. The past to the acting man matters only as a benchmark for determining whether the future can be identical to the past or needs to be different from it and how. What is important about this contrast is that each creative human action is as beautifully unique as every moment of life itself. It is a birth of something new, as painful and ecstatic as the birth of a child. There is no imitation of oneself or others but creation and re-creation. Such a power is not granted to all or at all times. No entrepreneur, no matter how successful in the past, can guarantee for himself the creative spark later in life. But he can hope that other people will not upstage him too soon. If he is right, then mindless, tedious, and abject even rotation can be his respite for a bit. I am, at the same time, concerned with worker profit, because it allows identification of full employment. A worker would need to compare the opportunity costs of acquiring his human capital (“pleasures unfelt”) together with whatever struggle and the delaying of gratifications were part of this acquisition (“troubles endured”) with the overall yield from his new skills he has received so far and is hoping to receive in the future. The costs as contemplated at the time of paying them are compared with the benefits as they roll in. For example, some Smith is fully employed, if he is pleased that he not unwisely spent his money, two years’ time, and plenty of effort in a technical school learning a trade. To flesh out the issue, a man expends labor in acquiring his human capital; and having acquired it, he then expends labor on his job using the capital accumulated. A careful reader will notice a regress: in order to build human capital, a man must use labor on some previous possessions. The regress is not infinite, because the remotest original

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factors here are human natural powers in the self both to make and to be made. One mixes his labor with original factors to train himself; then one mixes more labor with these produced factors to create consumer goods. However, in continuing to desire the future income from the skills invested in, the worker remains an acting man. In this sense, full employment is illusory, just as the state of equilibrium is also a mirage. Workers who know what they are doing constantly seek new skills, so as to remain competitive under changing market conditions; they are perpetually in the rat race, adapting and improving. They do not necessarily stay long with the same employer but jump from one gig to the next, going to where they are most needed. They usually build on their existing skill set, but if they perceive that the market is making them an offer they cannot refuse, then they are always prepared to start at the beginning, teaching themselves brand new arts. Since, again, learning takes time, and life is essentially surprising, entrepreneurial errors are possible. The business cycle, for example, can deceive workers into learning skills the demand for which cannot be sustained for long. As entrepreneurs react to changes in consumer demand and act themselves to introduce creative advance into society, they alter the data used by workers to decide on careers or occupations. Human capital is as heart- and mind-dependent as real capital, and the derived demand for skills is always changing. If full employment meant simply that one “works as much as he wants,” then the evolution of the economy (a) would falsely show that employment could not always become fuller and therefore, was absolutely full at any given moment and (b) would hurt the short-run interests of those workers the demand for whose skills falls and seemingly diminish employment. My definition at least suggests that full employment is possible given good foresight, if, in fact, unlikely. The paradigm of a worker-capitalist-entrepreneur is an independent consultant who offers to his customers “solutions to their problems.” He seeks to make his clients more efficient, reduce their costs, and raise their revenues. He is paid for results not for faithfulness. Since the economy and technologies are perpetually in a flux, and both problems and the most efficient solutions to those problems change all the time, the consultant keeps himself abreast of all the new developments in his field. For example, entrepreneurs and consultants who drive and lead the market do not merely implement “best practices” found within their occupations or adhere to “industry standards.” They discover new and better practices than the ones presently conceived by most market players, exceed the standards, and through those, outdo

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their competition. In (a) building himself up, a consultant like this is a worker, because he suffers disutility of labor during training; he is a capitalist, insofar as he invests time and money into acquisition of skills (having found himself “with himself” as a natural resource), bearing disutility of waiting; and he is an entrepreneur, because he directs his own studies, makes use of present resources, and reaps (uncertain) future gains, taking up unto himself the disutility of fear. Likewise, in (b) using his new abilities, the consultant is a worker, because he receives present goods for his services and endures toil and trouble; he is a capitalist, because he has accumulated (produced) human capital in conjunction with (original) inventiveness and creativity; and he persists in being an entrepreneur, as long as he finds his own clients. Note that a consultant often promises a deliver a project even if he does not know how to solve all the problems involved. He hopes to figure them out as he goes along. In this case, we might say that he has human capital but is his ingenuity. Even a business owner is directed by the consumers, and even the lowliest peon has to figure out the most efficient way of doing the task assigned to him and use his special expertise to (i) advise the manager on the possible technological solutions to the problem at hand and (ii) have him choose the most profitable solution. Just as patients are urged to take control over their health and treatment, so workers ought, if they know what is good for them, to take charge of their own advancement. It may well be that human capital is specific to a particular line of business, with the human and real capital tightly bound to each other. Smith may be getting $50K / year at company X; if he were to leave, then he could only get $25K elsewhere; at the same time, the company would lose $100K, even if it hired a replacement. It does not pay Smith to leave; and it does not pay X to fire him. Smith’s wage will be determined by bargaining and end up somewhere within the (25K, 150K) segment. Another simple definition of full employment is that state of affairs in which “everyone who wants to work can find work.” This, however, is manifestly unhelpful, because the natural question is, “You want to work as what?” Practically anybody can chop firewood, say. Perhaps, one is an architect, and the market for architects has been saturated at the going price. Now of course, one can get a job even there, if one is better than other architects or agrees to work at lower pay. But the point is stinging: capital does not “beget” profit, even worker profit. These distinctions suggest that thinking about labor in the

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aggregate is outrageously sloppy. To be convinced of that, it is sufficient to consider the resulting aggregate supply and demand for labor. Unless these curves are interpreted in a frightfully fantastic fashion, as I am forced to do it in (II, 6), they are entirely trivial. The supply curve is vertical, because the aggregate quantity supplied of workers, whom we want to get busy doing something, whether wood chopping or architecting, is given. The demand curve is also vertical, because as long as wages and prices are in a reasonable relation with each other, there is no threat of permanent unemployment, and the absolute price level is irrelevant. Both curves thus coincide and are identical to each other. For these reasons, I would go so far as to drop the notion of full employment from economics altogether and recast it in moral or politico-philosophical terms, to wit, that each person ought to seek to make himself maximally useful to society and for that usefulness, be compensated by society accordingly. The notion of full employment of capital is similarly preposterous, and this for two reasons. First, by transferring capital from a less valuable use to a more valuable one, one makes that capital’s employment “fuller.” Second, there may be unowned resources of which an entrepreneur might want to take possession. Even sand in the Sahara desert might in the future turn out to be useful for something important, becoming an inexhaustible source of new capital. The analogy to human capital is plain: a worker can always be reallocated to his own and society’s benefit, and the demand for brand-new kinds of skills can be elicited by technological progress. Full employment of anything, in fact, is an illusion that one foists upon himself due to lack of alertness, to use a preferred term of Israel Kirzner, to profitable opportunities. For an example of vicious thinking regarding full employment, I direct your attention to H.R. 2847, “Hiring Incentives to Restore Employment (HIRE) Act” passed by the US Congress on March 18th, 2010. Among other things, the bill establishes a payroll tax holiday for employers who hire “qualifying workers” – individuals who have not worked more than 40 hours during the last 60 days. It is a bill like any other in the sense that the government considers the people to be trained monkeys who dance to the regulators’ both clumsy and highly intricate behavior modification tune of financial incentives and disincentives. It legislates a tax cut, in that the employers are freed from the necessity to pay their portion of Social Security for a period of time for those people they hire who have not worked for a while. In preparing this bill, the Congress was animated by a faulty view of full employment. As far as the government is concerned, employment is full when everyone is busy doing something, anything. It does matter whether a worker is being

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productive or not, whether the company he is working for is making a profit or not, or whether the company is serving the consumers or building bridges to nowhere. There is no realization that even if one hires Smith who was previously employed by someone else, employment still increases, if not in quantity, then, on average, certainly in quality. There is no reason whatsoever to prefer one to the other. The level of employment, then, cannot be calculated by government statisticians. The human capital is entangled into the worker’s soul and body; it is the property of his mind and is unseen by other people. Whether investing into this capital was fortuitous or not; whether the person is thinking into investing into something else while still working at his old job – all these things are beyond the power of mere human beings to discover and aggregate into a database. Incidentally, this analysis shows the absurdity of the macroeconomic moniker “involuntarily unemployed” for people who lost their jobs and are actively looking for new ones. (Samuelson 2005: 311) Keith Joseph, a British MP, when told during the United Kingdom’s dark days of Fabian socialism that the government-run steel industry that was losing money was so inefficient that it could not be sold, replied famously, “I hereby bid one pound for British Steel.” Similarly, an allegedly involuntarily unemployed person can always be told by any company: “I hereby offer you, Smith, $1 / hour if you work for me.” What has happened, in other words, is that the worker’s human capital has been wrecked by changing market data to such an extent that it now commands a very low price. This means that Smith can still secure a job, provided that he sets his ambitions low enough. The reason why he is not taking that opportunity is that he hopes that his old skills are still useful to someone, and it is bad manners to get a job and leave a week later for the sake of another one. In so doing, he remains an entrepreneur who deals with risk and surprises and thereby faces uncertain future. Or it could be a vacuous case of full employment: Smith’s reservation wage is higher than $1 / hour, i.e., at that wage, Smith voluntarily prefers to work zero hours. Since testing the market takes time, Smith is foregoing a sure but low-paying job now for an unsure possibility of a better job in the near future. This seems to be a most voluntary choice and therefore, a case of mere frictional unemployment.4 4

The common meaning of involuntary unemployment seems to lie in the fact that a worker wishes that his old skills were still marketable. Well, I wish I had a girlfriend named Lola, but that does not mean that I am “involuntarily chaste.” In other words, no one Jones owes Smith a living, such that Smith is unjustly harmed and coerced into idleness, when Jones refuses to hire him.

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Skott (1989) argues that “the economic system needs unemployment as a means of disciplining workers.” (157) We had better believe it does, just as it needs losses as a means of disciplining entrepreneurs, high interest rates as a means of disciplining people with bad credit history, and in general, possibility of unhappy failure as a means of encouraging attempts to succeed. The “metaphysical” institution of failure consists of two parts: first, threat of it which injects prudence, sound judgment, and care into human decision-making and actions; second, smooth and swift liquidation and recovery upon actual failure to redeploy resources to their more highly valued uses. “But this need does not make unemployment voluntary unless the legitimacy of capitalist relations of production is taken for granted.” There is no reason to take them for granted, and socialism is analyzed in some detail in (I, 48). 8. THAT, CONTRARY TO KEYNES’ “OUTLINE OF OUR THEORY,” REAL WAGES INCREASE BY MEANS OF SAVINGS, WELL INVESTED Suppose, Keynes begins by saying, that employment increases. Presumably, this means for him that more people are working, longer hours, and harder. This causes more goods to be produced, resulting in an increase of real income to labor. What Keynes writes next, however, defies reason: “The psychology of the community is such that when aggregate real income is increased, aggregate consumption is increased, but not by so much as income.” (2008: 27) I will have more to say about

Similarly, John Cassidy (2009) allows himself to write sentences like: “In the 1930s and 40s, it was already glaringly obvious that ordinary people needed decent medical care, breathable air, and money to retire on, and that the market had failed to provide these things.” (46) I stared at this gem with incomprehension for a minute. Well, it is also glaringly obvious that I need a personal jet, a fur coat, a diamond ring, a big Cadillac car, and everything, but the market has failed to satisfy me. How dare the world not serve my every whim?! Heads will assuredly roll. It is clear that Cassidy thinks that wouldn’t it be nice if ordinary people had “decent” medical care in the 1930s? Perhaps if he personally had been in charge, then he would have done better than the wretched market. Cassidy must be dreaming that, like Burnett’s heroine, if he was a prince, then he could scatter largess to the populace. But could it be that the “market” failed to provide the goods, because it was sabotaged by government interventionism? Or simply because the economy had not yet progressed to such an extent as routinely to perform medical miracles?

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this alleged “psychological law” in (I, 21). For now, it is enough to notice that real income is precisely all those goods and services that are actually consumed. When real income for an individual or a community goes up, consumption increases by exactly the same amount, because they are one and the same thing. Therefore, “real income exceeds aggregate consumption” is a false and self-contradictory analytic proposition, because it is part of the meaning of the term “real income” that it represents all the final consumer goods purchased and enjoyed. By aggregate real income Keynes really means all the consumer goods lying in retailer inventories and waiting to be bought, such that not all of them will be. Some of these goods will be languishing on the shelves, eventually to be disposed of at a loss. The entrepreneurial errors of this kind come to pass in the situation in which out of their nominal money income people unexpectedly decide to consume less and save more than they did before. Let me assume that they save in order to invest. Instead of being demanders of present goods, the savers become suppliers of present goods and demanders of future goods. Of course, they supply and demand money, but money is used to buy goods, now or in the future. The word “present” means in this context “complete, finished”; the word “future” means “incomplete, requiring further work to become ready for consumption.” A saver exchanges the money he has saved on factors of production, whose owners then use this money to buy finished consumer goods. He then waits until production is executed and sells the finished product for money, which he also uses to buy finished goods. The factors buy finished goods now, which is why they are called demanders of present goods; while the saver-entrepreneur buys them in the future, when his profits come into existence, which is why he is called a demander of future goods. Let me in the second place assume that the initial starting point is an evenly rotating economy, in which there is no net saving. If people decide to save more, then one can readily understand Keynes’ next sentence, in which he writes that “employers would make a loss if the whole of increased employment were to be devoted to satisfying the increased demand for immediate consumption” (2008: 27), i.e., if entrepreneurs attempted to keep replenishing presently existing goods as opposed to, as the higher level of saving now pointedly tells them, altering their plans toward increasing the length and complexity of the production structure and building more future goods. Consumers are supreme, ultimately determining the nature, quality, quantity, and prices of all goods, as well as appointing entrepreneurs and dictating the locations and methods of production. A decline in the demand for present consumer goods, associated with an increase in savings, leads to

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a decreased derived demand for the factors employed in making those goods. But the savings are not lost but invested into more physically productive enterprises that are projected to yield more and better consumer goods in the future than there would be, had everything instead been blithely consumed. The demand for the factors, including labor, used in those projects and especially in early stages of production rises. The factors are reallocated from evenly rotating old-fashionedly to novel projects. Net savings are a disturbing factor in the economy. A decision to save more than is needed for capital maintenance causes a readjustment of the production structure. Keynes goes on: “to justify any given amount of employment, there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level.” (2008: 27) The “excess” exists, because that portion of the total income that is not consumed but is rather saved and invested is higher than the similar portion in the previous production cycle. There are at the moment too many production processes that are churning out the same goods that are already available, so as simply to replace them when they are bought; and too few production processes that use the higher level of savings to increase the standard of living in the future to a greater extent than it would be in the counterfactual situation, in which there is more present consumption at the expense of slower economic growth. To “absorb the excess” is precisely the job of entrepreneurs. The entrepreneurs must foresee which goods must be outputted at which time in the future that for the savers will justify their sacrifice of immediate consumption. They must arrange production in such a way that the exactly right amount of goods is delivered at the right time, as consumer (whether of present or future goods) time preferences bid them. In saying these things, I assume laissez-faire “sound” money and banking. Let me try to interpret Keynes on this matter literally. Assume that real wages rise, destroying some ERE. I will take Keynes as holding that this happens, if aggregate nominal wages rise (goodness only knows how this could happen), or if prices of consumer goods fall (e.g., due to higher supply of consumer goods), ceteris paribus. In the first case, costs of doing business increase; in the second case, sales revenues decline. Either way, some firms will be taking losses, because they are spending more on the factors than they are receiving in revenues. Therefore, they need investments to continue operating; otherwise, the quantity of consumer goods produced will actually decline, contrary to the assumption. Keynes deduces that investment must have increased, even

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as consumption has gone up, as well. With regard to this, I must raise two questions. First, why would the consumers choose to give their money to a company rather than buy its products? Are they giving the company the money which the company will then use to pay them their wages? That surely is absurd. The savers must be investing money into those companies that promise higher returns on new and better goods that at the moment exist only in the minds of the entrepreneurs; it is presumably advantageous to produce such goods despite the fact that doing so takes more time and more of other resources as compared with existing production processes. Second, what would cause the real wages to rise in the first place? I answer that it is sound investments into longer and more productive enterprises or capital accumulation. Various savers delay their own gratification by postponing consumption in order to set up some definite (usually longer) methods of production. The very act of capitalist saving by one entrepreneur causes other entrepreneurs (directly or indirectly) to build novel capital goods. Resources are channeled into making intermediate goods that make labor more productive. As I point out in (I, 6; 7), this causes laborers to be employed more “fully.” When the output of these new production endeavors is complete, it is presented to the consumers for judgment. By approving, the consumers willy-nilly have their standard of living raised. Now for Keynes, greater employment causes greater investment which must needs cause greater savings. This has things exactly backward. On the contrary, it is the choice to save for the sake of (sensible or profitable) investments that results in economic growth and higher real wages. Keynes considers consumption and investment to be a part of the same blob of aggregate spending. He has no concept of capital structure and production stages. In the long run, if the economy grows, then it is true that there will come into existence both more consumer goods and more producer goods per capita. If Crusoe has labored to make an axe, sacrificing his consumption of fish in the meantime, then he will have to spend some time each day using the axe, and a little bit more time maintaining or making repairs to the axe for as long as he wants to keep it, bringing back his fish consumption almost – but not necessarily quite, all other things being equal – to the old amount. But we can reasonably rest assured that the new production and consumption pattern of chopping wood plus fishing is superior to the old pattern of just catching fish. If there is so much capital being used in the economy that complementary to it labor becomes dear, then increase in population figures becomes possible that affects positively every existing human’s standard of living. Capital accumulation thus makes people more and more

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valuable to each other, creating economic friendships where before there was only competition. Again, in saving, budding businessman Smith is redirecting his demand from consumer goods (not from all consumer goods but from the particular goods Smith himself would otherwise enjoy) to capital goods (not, once more, to capital goods in general but to the specific kinds of items that he is intending to use in his enterprise). He is doing this, because he anticipates that the output that he could manufacture by means of that physical capital will come to be more in demand than the goods presently in production. While Smith is saving, other consumers are unharmed; Smith bears the entire weight of his sacrifice of immediate consumption. By the time Smith is done accumulating money, entrepreneur Jones will, assuming good foresight, have created the capital good, say, a loom, that Smith wants to buy. In fact, Jones may be the very worker who lost his job as a result of the diminished demand for consumer goods on Smith’s part. Jones was enterprising enough to respond to Smith’s decisions correctly. When Jones receives Smith’s money, he may want to get right back to work making a replacement loom, to have one in stock for when the loom he just sold to Smith has worn out. For his part, Smith is more productive than before. When he at long last carries out the steps to stitch together rugs by exploiting the loom, there will be better goods out there then there would be, had no saving and investing taken place. Consumer demand will be restored, though with a greater material abundance. Jones is now employed at loom-making and possibly back at his old job (though, again, not to the same extent), from which Smith had borrowed him for his task temporarily, with some of Jones’ labor formerly spent on creating the old set of goods replaced with the loom’s productive power. The factors of production in those firms that have suffered because of Smith’s cleverness will be reallocated, and all will eventually be well. In this example, the consumer demand for Smith’s rugs will substitute for the demand for other goods. The overall selection of goods improves in quality, though not in quantity. The ways for a single firm to increase supply and the equilibrium quantity supplied of the good it is already producing are to (1) lower the unit costs of production, (2) use a superior technology, or (3) be imitated. But the way to do (1) and (2) would normally also be to introduce labor-saving machinery into production. In the short run, however, consumption and investment move opposite to each other: more of one entails less of the other. Intermediate

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goods are submarginal, bearing no value until consumer goods are created with their help. While the former are being built, and while provisions are being made to maintain them for more than one round of production, the quantity of the latter decreases. Again, this is not a problem, because Smith suffers the disutility of waiting voluntarily. In doing so, he becomes a capitalist-entrepreneur. His return, again assuming no errors, will cover the annoyance of waiting. Note that this return would consist of at least three parts. First, compensation for the disutility of labor. Second, worker surplus. Third, entrepreneurial gain. Thus, if Smith were willing to perform the same amount work or work the same number of hours for someone else for no less than (1) $25K / year, and he actually can get a job elsewhere in the economy for as much as $40K / year, then his worker profit is (2) $15K. If, in addition, he is making 70K / year at his business, then his entrepreneurial profit is (3) $30K. In other words, Smith’s managerial income can be calculated by looking at his opportunity costs of running his own business, such as how much he could be earning as a worker for some other company. His worker profit depends on those costs and his reservation wage. Anything above that is Smith’s entrepreneurial profit. NB: the fact that Smith has a reservation wage does not mean that he prefers dying from hunger to working. He may want to live off his savings. Thus, if Crusoe gets sick, then he may find his daily work much more difficult than before and choose to consume his stockpile of fish while he recovers. Extra savings for an individual firm can come not only from general abstinence from present consumption but also from investments in other firms. In such a case, one firm will expand at the expense of others which will be winding down their production. New technologies, lands and resources therein, and consumer tastes can make such reshuffling of resources profitable and therefore, socially valuable. But increasing saving rates are at least as crucial for economic growth. The foregoing is a way of increasing real wages across the board while ultimately jumping from one full employment equilibrium to another. It turns out that this is also the only way, as well, i.e., by increasing investments into productive activities, either into new laborers who come into the market or into capital goods that increase the physical productivity of workers. This is not a trivial notion, because false alternative doctrines of raising real incomes for every participant in social cooperation have been proposed, such as labor unionism, price controls, cutting off international trade, credit expansion, and numerous others. I do not mean, of course, that labor unions, etc. cannot exist alongside the process of capital accumulation; rather, all of the above

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are negative-sum and create conflicts between one group of people – such as union members – and other groups – such as the presently unemployed. Gains to one group are counterbalanced by losses to other groups, and furthermore, overall wealth decreases. In other words, whatever progress in society does occur, occurs despite labor unionism, etc., not because of it. Only positive net saving and profitable investing can increase the wealth of all groups in the long period. To put it another way, (a) capitalist saving that is used to bring increasingly more resources, original, natural, and produced, under human control, together with profits received from employing these resources to make consumer goods realized by means of (b) consumer spending, are a match for economic growth made in heaven. 9. THAT SHORT-TERM AND LONG-TERM BUSINESS EXPECTATIONS FOLLOW EACH OTHER

Keynes defines “short-term” projections as those an entrepreneur makes of the prices of the completed goods “at the time when he commits himself to starting the process which will produce [them].” (2008: 46) He differentiates these projections from those an entrepreneur makes when deciding how to re-invest his profits or attract new capital, calling them “long-term” expectations. Keynes may be thinking that short-term expectations take place within a production cycle, and long-term expectations do so from one cycle to the next. This is because “commitment” is expressed in the action of buying and hiring factor services. The difference is that if expectations change in the middle of a cycle, then losses are inevitable, because the old plan has been proven faulty. But if entrepreneur Smith believes that keeping doing the same old thing in the future rounds of production has ceased to be a good idea, then no losses need to be taken: all that has been shown is that evenly rotating is no longer an option. Several alternatives come to be possible. Smith can make changes to the way the business is run; he can innovate; he can sell the entire business or factory to someone who thinks that he can turn it around and be free of all worries and either (a) start a new company or (b) retire altogether; or, with similar results, he can shut down operations, lay off every factor, and sell off his non-specific durable capital. Again, let short-term actions be adjustments of a plan within a production period; medium-term actions concern the costs of production and revenues from selling the output, i.e., take care of a single whole

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cycle; and long-term actions regard investment decisions in between production periods. For example, when a manager moves Jones from one department to another where he anticipates Jones will successfully assist a team that has fallen behind schedule, the manager is acting in the shortterm. When a CEO has approved a plan to construct a new factory, the wheels are set in motion according to his medium-term expectations. Finally, when an owner is deciding whether to switch from producing widgets to producing trinkets in the future, he is thinking long-term. These expectations affect different entrepreneurial decisions. The short run begins as soon as the money capital has been spent and keeps ticking until the final output is generated. The initial capital goods have been purchased; factor services, hired; and production, begun and revved up. Let me call “physical stages” – in the structure of production contained within an individual firm – those stages of a good being transformed from the state received from previous capitalists to the final good to be sold to succeeding capitalists or to the consumers, that are formed by application of distinct efforts of labor or machines. Physical stages are snapshots of the good taken in its various conditions on its way to completeness, such that each transformation costs some amount of money (either for labor or as a result of capital consumption and depreciation5 or even solely due to passage of time). These may be distinguished from “temporal stages” of such a good defined as all the time periods necessary to complete production within a firm from the beginning physical stage to the final physical stage that require payments of interest. (This definition will prove useful later.) Now at every physical stage, the entrepreneur has the power to decide whether to proceed to the next stage. Every new transformation is subject to the approval of the business leader. If expectations change, then production even of partially completed goods can be quashed in order to minimize losses, including losses due to interest payments. Now if one is forced by changed market conditions to rethink his business plan so soon after buying factors of production, then he may also need to rethink whether he should be in business in the first place. At the same time, it is better to be apprised of one’s error sooner rather than later. 5

Capital consumption entails an opportunity cost: if capital is used here, then it cannot be used there. Capital depreciation is an additional cost: in being used here, there, or anywhere, most durable capital goods are slowly destroyed.

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Adjusting the plan of production can and should be done at any moment, whenever the situation calls for it. Short-term expectations can then be formed by projecting the revenue and, the entrepreneur hopes, the profits from any physical stage, from the most remote to the penultimate one. There is an aspect of definiteness to the short-term horizons of the entrepreneur’s life. It is “all in: all bridges are burned; let’s get this sucker done and into the stores for all it is worth.” Medium-term expectations involve a different, lessened but still considerable, commitment: the entrepreneur (or his lender) has saved enough money to finance one production cycle but has not yet spent any of it. Many capital goods are specific, sometimes even custom-built; and usually all sales are final; there are no returns for them. Labor and rent require other immediate expenses. As long as production has not yet been started, the potential entrepreneur has some degree of freedom. At the same time, if the medium-term expectation change, the previous saving may be rendered a mistake. The entrepreneur deprived himself of immediate consumption and now finds himself with a wad of cash he does quite know what to do with. Long-term expectations may need to be made because durable capital goods owned by Smith span multiple rounds of production. These expectations are the most hazy and error-prone, because they introduce still another variable: the actions of other entrepreneurs who respond to the public unveiling of the goods produced in the first round of production. It is possible to keep one’s work under wraps until the very end; but in making its fruit available to the consumers and in fact, in advertising it to the whole world for this very purpose, one cannot avoid drawing attention of competitors to it, as well. On pp. 48-51 of General Theory Keynes describes how employment of factors in a single company can change upon changing profit expectations. Let us outline what happens when long-term expectations change. If existing production processes are foreseen to call for greater investment on account of greater profits anticipated, then employment within the firm will increase gradually: first at the highest-level physical stages and then at the lower-level stages, as new goods percolate there in a more finished condition after a period of time. I also agree with Keynes that sometimes employment can “increase at some stage to a higher level than the new long period employment. For the process of building up capital to satisfy the new state of expectation may lead to more employment and also to more current consumption than will occur when the long period position has been reached. Thus the change in

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expectation may lead to a gradual crescendo in the level of employment, rising to a peak and then declining to the new long period level.” (2008: 49) I interpret this as meaning that such a thing may happen when one or more stages of production require investments into expensive producer durables, such as machines. Capitalist spending increases greatly at first, if these goods are purchased outright (rather than rented) but then diminishes, as capital slowly depreciates and is also, perhaps, slowly regenerated. Alternatively, Keynes may be talking about the “accelerator principle” which, though not found in General Theory, is Keynesian in spirit. I will deal with the accelerator principle in (II, 4). If production is being redirected from how it was originally planned, so that factors come to be employed in the production of different goods or services (e.g., due to saving), then we are faced with two possibilities, namely, whether the production of old goods, according to the old business plan, is being shut down quickly or slowly. If quickly, that is, if old investments including the unfinished goods are briskly liquidated, then employment in those old processes will decline sharply yet will increase in the new processes slowly, as described. Overall employment will dip and then gradually rise to a new long-term level. (This level may be higher or lower than the old one, depending on whether more or less money has been set aside for the process of redirection.) If slowly, then the diminution of factor services employed in the old processes will be more or less offset by the slow increase in the factors employed in the new processes, most likely generating a steady rise or fall. 10. HOW ENTREPRENEURIAL EXPECTATIONS AFFECT PRICES, PART I Keynes may be up to something else with his mention of expectations. As his teacher Marshall argued, in the short term, prices are determined by consumer demand, while in the long term, they are determined by costs of production. This is entirely true but must be properly understood. In an interesting article, Jörg Guido Hülsmann (2000) considers various approaches to equilibrium analysis. Now the whole reason for why a factor may be valued less than its discounted marginal value product even in general equilibrium is that people are not omniscient and do not possess perfect foresight, but neither is it sensible to say that they err. It is simply that profitable new ways of producing the same or different things have to be discovered and are discovered every day through

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an arduous process. It is simply not true that an acting person “always chooses the most important project”; he chooses the most important project from among those few that happened to occur to him or that presented themselves to him. He does not choose from the infinity of all possibilities. In other words, some factor may be undervalued or priced below its DMVP, but no entrepreneur may as yet have noticed that. As long as this state of global ignorance persists, we can have an equilibrium and what may be termed “false prices.” They are false because transient. Ignorance is characterized by at least two failures to know: first, one does not know how to improve and make more efficient his own conduct; and second, he does not know how other people up to this very moment have labored to improve their own efficiency in serving the consumers. In noticing an opportunity and acting on it, one subjects the economy to a disequilibrating jolt. An entrepreneur is first of all anyone who breaks the mold, who explodes a comfortable and predictable ERE. It is necessary to distinguish between disequilibrating entrepreneurship, by means of which profits go up; and equilibrating entrepreneurship, by means of which profits go down. The latter (e) is imitation of both existing production processes and existing products; the former is inventive and can escape being imitated by coming up with (de1) new and more efficient methods of production, thereby making the stuff that is already being manufactured cheaper and more plentiful, or (de2) new and better goods and services. (In addition, one can cut costs while using the same technology, e.g., by organizing the business better; or generate extra enthusiasm among the consumers for the same product, such as by re-branding it.) One can, therefore, disequilibrate the economy in two ways, namely, by lowering costs of production (while maintaining the same or higher output) and by creating all-new goods and services. One can dash and confound the imitators by innovating in either direction. We have dealt with the four paths of creative advance already. In the case of (de1), the entrepreneur obtains market permission to slide down the curve of the demand for his product anywhere between (A) the old point, on which it rested before the modernization of his production methods, above and (B) the point of zero profits, at which marginal costs equal marginal revenues, below. That new price / quantity combination will be chosen that maximizes the company’s profits. (de2) is similar: each innovator tests essentially his conception of the consumer demand for his product. Arbitrage, such as buying commodities low in one country and selling high in another, is a special case, because one unites two previously separate and unconnected markets. There is an aspect of

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disequilibration within each market, as the arbitrageur profits from his alertness and audacity; the companies operating in one market (where the arbitrageur buys) experience an increased demand and also profit; and the companies operating in the other market (where he sells) are faced with a higher supply and lose. And there is an aspect of equilibration within the now unified market, insofar as the whole thing is poised to be balanced, with similar prices for similar goods and services popping up over its entire territory. The equilibrating process is a creature of unmitigated theory: it is an abstraction from reality resorted to in order to grasp the unstable nature of profits and the forces that tug on the economy to bring to toward an ERE. No one is a pure imitator: in practice, entrepreneurship always incorporates both equilibrating and disequilibrating aspects. The reason is that in imitating, one is sabotaging his own profits as much as those of the innovator and moreover, signaling other entrepreneurs to imitate them both. Therefore, if one is imitating a widget, then he will likely aim to manufacture not the exact same product but a slightly better one (anticipating that the consumers will agree with his judgment) or invent a cheaper and more efficient production technique or both. Equilibration is “virtually included” into disequilibration. It is an important strand of thought in economics that no businessman can rest of his laurels or become complacent. Unless he continues to win every day anew, sooner or later he will be outcompeted and supplanted: his profits will be reduced to zero by the equilibrators and turned into losses by other disequilibrators. The entropic law is fully at work here: untended to enterprises get worse with time. To give a real-world example, Chattem apparently pioneered ACT Restoring Mouthwash which, unlike its competitors, “remineralizes soft spots” in teeth and “strengthens enamel to prevent tooth decay.” Other rinses at the time fought bad breath, plaque, tartar, gingivitis, and everything under the sun, but none were, as ACT was, anti-cavity. The ACT’s sales pitch was: “When you use an ordinary, non-fluoride mouthwash after brushing and flossing you may actually negate the fluoride efficacy of toothpaste.” But flossing and brushing would accomplish everything that those rinses did anyway. In my opinion, the most irritating part of going to the dentist is learning that one has cavities. Fixing them is expensive, painful, and unworkable in the long run. Other consumers must have reasoned likewise, and ACT became more and more popular. A few months later, Johnson & Johnson introduced Listerine Total Care Anticavity Mouthwash which “helps prevent cavities,” “restores minerals to enamel,” and “strengthens teeth,” while also fighting plaque and all that. ACT’s own Total Care quickly followed, but as of

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June 10, 2010, Listerine cost $5 per bottle, while ACT cost $6. Listerine looks slicker than ACT, has a lower price, and is a more trusted brand. Here we can observe both kinds of entrepreneurship in action. Successful disequilibrating entrepreneurship is an act of “transcendence” of the supposedly perfect yet actually illusory static conditions into a new and higher state. Once the economy is there, it begins its march toward a new equilibrium again. Yet this march is repeatedly disrupted by novel entrepreneurial action. The general equilibrium, if such could exist, for a Stone Age society would be very different from the general equilibrium for 2010 America, but in order to get from the former to the latter, numerous disequilibrating acts of aufhebung, “negation” or here “lifting up,” had to be performed. Hülsmann himself writes: “And, when it comes to real life, there are unlimited possible but unknown strategies, for human creativity constantly overthrows old patterns, adding new strategies previously unimagined. This fact prevents the identification of something like a timeless solution to problems of human life. Game theory can handle only those strategies the analyst himself can imagine.” The theme of a genuine if still relatively crude breakthrough which overturns the established status quo followed by the process of perfecting the breakthrough is immanent in all human affairs.6 To deny disequilibration is to side with the robotic neoclassicals; to deny equilibration is to tie one’s intellectual life with the nihilism of Ludwig M. Lachmann. We must assuredly avoid both extremes. Disequilibrating entrepreneurship banks on global ignorance not on human error. To be unaware of opportunities is something other than to err. Being blind is not the same as seeing illusions. For example, having a blank canvas rather than a beautiful painting is not an evil. The painting is under no necessity to exist; it is not something that ought to be; therefore, its absence cannot be called evil. But creating a painting does improve the global state of affairs and is, therefore, good. Similarly, it is not the case that various types of market knowledge ought to be had by men; therefore, ignorance is not an evil as error is an evil; though, again, discovery of truth is good. Saying that entrepreneurial 6 In human actions, there are no infinitesimal steps. There are smaller breakthroughs that build on momentous breakthroughs in the past; there are less significant paradigm shifts within larger paradigms. Just as an exchange of a pair of shoes for four clocks is discreet and does not mean that a quarter of a shoe costs half a clock, so any human contribution to technological advance is also a jump. An improvement in a technical system, however modest, is not really imitation, as economic equilibration is. But the general pattern indicated still holds.

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profits are made possible by errors in human actions condemns our entire civilization to be a gigantic mistake, because things can always be better. But that I am enjoying a cup of coffee does not seem to me to be a lamentable sin for which I should scold myself and resolve never to do likewise, just because in a decade, the quality of coffee will improve. There is a sense in which errors can be attributed to entrepreneurs, and that is in the context of competition. Loss of money in the market is always a loss to someone. Smith who is evenly rotating is attacked by Jones and fails to defend; or Smith himself attacks but is countered elegantly. There is a chess game of wits and nerves, and Smith lost the battle. He thereby erred; he could have overcome Jones, if he had done better but could not. If one could predict how others would respond to him in the competition, then he would obtain tremendous advantages against his opponents. All action depends upon other people’s countermeasures being weak responses to it. Smith might be tempted to “give up” at the outset, if Jones always responded powerfully. Victory in a competition is contingent on someone’s making a mistake. In coming up with a possible business plan that serves to enhance consumer welfare, one has conquered ignorance; in putting this plan into action and reaping profits, one has won the fight due to other people’s flaws as entrepreneurs. Prices do not “tell the truth… about how resources can and ought to be allocated.” (Leijonhufvud 1968: 85) The momentary price system represents a consensus of the market. But a businessman can only “secure profit from knowing better than the market what the future will bring forth.” (Keynes 2008: 170) In acting on his profit expectations, the entrepreneur alters the prices, imparts new truth into the system, re-allocates resources. The present prices are a status quo, to be upset by human actions delivering the creative advance. In order to draw an important further contrast, we must distinguish between being surprised through error and taking a risk through ignorance. Both make the course of human events uncertain. The former will be discussed shortly; it arises out of the impossibility of making precise predictions of human actions, in particular, of how other entrepreneurs will change the state of the market during one’s period of production, i.e., while one is busy constructing his own product. It is not generally possible to know what upgrades competitors are now developing that might outshine one’s own. The latter is due to the fact that one produces not for himself but for other people, and he can never be fully sure what the consumers will perceive as an improvement. The difference is twofold. First, a definite probability can be assigned to risk; no such thing

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can be done for surprising events. Second, perfect knowledge of the situation, such as the state of the consumers’ minds, permits unfailing prediction of their behavior right now. On the other hand, even perfect knowledge of today’s market is not sufficient to respond adequately to novel events. In order to get a handle on risk, it may help to consider two extremes of consumer behavior. On the one hand, there is entertainment. The key property of entertainment goods is novelty for novelty’s sake. New shows, movies, and songs do not satisfy a desire for a diversion better than the previous product; they are merely different though not necessarily better (as in, more beautiful, more stirring) than what has been created before. There can easily be degeneration of taste in entertainment from previous products to the new one, but all is forgiven, as long as it is new. It is a common phenomenon that show C, according even to moderately refined sensibilities, is inferior to previous show B (which itself may have been a great improvement over some A still earlier), but C is still preferred, because it is different from B. And just as B fell out of favor, because it got old, so will C, even quicker than it. Entertainers have to keep reinventing themselves and coming up with new things, regardless of whether those new things are any better than the old things. This causes them to tire of the race for novelty much quicker than regular manufacturers do, who can be assured that their product will keep selling, unless a genuine improvement has been unveiled. (Mises even attributes “anticapitalistic mentality” to people in show business – actors, novelists, movie directors – because their fame is so fleeting that they dream of having the government prop them up permanently. (1994: 24)) In other words, normally, if Smith has product X out, then it can be made obsolete by Jones’ product Y down the line. But in entertainment, X becomes obsolete not because a competitor has come up with a better mousetrap but entirely on its own, simply by losing its piquantness due to passage of time. A late night comedy show host cannot use the same jokes the second time; he has to come up with new ones every day. In show business, then, the risk is enormous, yet the capacity of each moment to deliver unpleasant surprises is low, because, as long as the product a novelty, it matters little how it will compare with the competition in the future, even if it takes years to make it. The only real fears are (1) that other entrepreneurs will “steal one’s ideas” and rob the new production of originality and freshness; and (2) that there will be “too many” new things happening at the same time, in which case some may slip through the cracks and fail, because people’s attention is occupied with their rivals. Present chaos causes anxiety; but it is a certainty that

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chaos will reign in the future, as well, meaning that the success of an entertainment venture depends largely on how bold and radical it is a departure from the traditional, not on how good it is in itself as critics or connoisseurs might judge. There are people with talents to thrive in this environment. On the other hand, some goods are “iconic.” A standard example is the adventures of the Coca-Cola company after in 1985 it released the “New Coke,” an update to the same drink it had turned out for decades. The public’s reaction to it was poor, and the old version of CocaCola was reintroduced less than three months after being discontinued. The conventional interpretation is that the company had failed to consider the people’s “attachment” to the brand and to the old taste. Even if marketing research shows that people prefer the new taste within the confines of the consumer survey room, the public at large, when confronted with the new product, may vote against it. A product that within the company is deemed clearly superior may be rejected by the consumers for a variety of reasons. In some lines of business, then, novelty is everything; in others, the executives had better make sure that their brand name is not adulterated with unwelcome “improvements”; and still others are in between, having to balance both demands. Therefore, strictly speaking and contra Kirzner, only e- and de1entrepreneurs make “discoveries” – de2s make “hypotheses” which can be called discoveries only in hindsight, after they have been actually proven profitable, and this is the sense in which I will use this term henceforth. Surprise threatens all three kinds of entrepreneurs; but risk hangs only over those disequilibrators who dare to promote new products or market existing ones differently. The risk would exist even if the product were ready now; surprises come up precisely because the product is not ready now. Risk pertains to reading the consumers’ minds; surprise, to reading the minds of other entrepreneurs, one’s competitors. Moreover, just as creation is paired with its concomitant destruction, so discovery must be paired with forgetting. As superior production processes come online, old ways of doing business are discarded. (I have wondered sometimes what role “conservatives” should play in the scheme of things, and it is probably to conserve the knowledge of past failures, from which we could all learn.) On the one hand, then, that Jones who is a Guardian worker drone at a dead-end job does not know how to beat the flamboyant Artisan entrepreneur Smith in the fashion industry should be regarded as Jones’ ignorance. But that Smith is resting contentedly while an even

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more flamboyant Robinson is designing what is destined, upon its unveiling, to be perceived a superior line of dresses is Smith’s error. One is ignorant in not noticing what would be better (for himself or others), as well as not knowing how to build that better thing; but one errs in failing to sneak the envisioned improvement past the enemy’s guards. Entrepreneurs change the market, but “on average,” entrepreneurs themselves do not change. Whether we pick the world now or twenty years from now, there will be entrepreneurs in it, and their quality and artistic prowess need not change predictably. What will be different are the state of capital accumulation and technological knowledge. These are responsible for increases in prosperity. Now entrepreneurs not only find uses for things previously unowned but also imbue the same objects with novel usefulness; they carry out production based upon new combinations of factors. In this sense, entrepreneurs are creators of capital; they turn objects into capital goods in the very process of acting. At the same time, few things can be done with prime matter; hence, entrepreneurial skill is paired with technological forming. Stated differently, entrepreneurs are efficient causes of prosperity (in the sense of suffusing objects with purpose and sustaining capital one round of production after another), but capital and technology are its material causes. Society’s entrepreneurial power is a political issue. It depends on the freedoms and restraints that the laws bring to bear on creative human actions. It may, perhaps, be a “eugenic” issue, as well. For Kirzner, entrepreneurs are indispensable but interchangeable. Opportunities for profit just kind of sit there, waiting to be discovered. If not today, then tomorrow; if not by Smith, then by Jones. I disagree: the role of personality in business is crucial. If Smith fails to notice an opportunity and shepherd it toward success and profit, then no one else need come to the rescue. Smith may be uniquely positioned to take advantage of the situation. Now I admit that our point of contention is empirically perfectly unverifiable. For every opportunity, we see the person who noticed it and led it to a happy end. We do not see how other people failed to perceive their chance at all; and we can barely learn of how other people did perceive it yet lost in the game. Failed projects tell no tales. We would need a possible world in which Smith was presented with an opportunity (whatever that means), failed to notice it, and then just a few days later, Jones figured it out and successfully guided it to fruition. Given enough such worlds, we could test who is right. Of course, that is impossible. Nevertheless, there is a reason to believe that Kirzner is mistaken. It is usually argued that the source of division of labor is twofold:

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(1) the diversity of land (power of nature) and distribution of natural resources over the face of the earth and (2) diversity of personal nature and nurture (human talents, training, etc.) Yet in discussing entrepreneurs, Kirzner eliminates (2) altogether. Every entrepreneur is like or almost like everyone else. All businessmen are equally capable. Jones was just randomly lucky. This seems deeply untrue. When Mises argues that, unlike a manager, an entrepreneur cannot be trained, he does not mean by it that the entrepreneur is a monkey banging away on a typewriter. Steven Landsburg asks what would happen if “we could identify the top 1% of the population in terms of gumption, and exclude them from participation in economic activity.” His guess is that “if you’d done this starting in, say, the year 1000 A.D., we’d still be living in the Middle Ages.” (1997: 126) I think he gets it. With respect to bodily height, the more people one piles up, the less the sample will deviate from the overall average and the less each individual’s contribution will matter. In entrepreneurship, quite on the contrary, more people will increasingly enhance the whole, and individual achievement will count more and more for the society’s economic status. Giants in height add little to the average height; giants in achievement mean everything for the standard of living of the average person. Call it the yin and yang of statistics: the equilibrating yin diminishes and puts out individual differences; the disequilibrating yang magnifies and glorifies them. An entrepreneur is a hero who changes the world; a very tall person is strange aberration to be ignored. I suggest, therefore, that “opportunity,” like “capital,” has both objective aspects and mind- and heart-dependent aspects. Opportunities are such only in retrospect, when a successful entrepreneur in his golden years recounts how he got an epiphany about some great product, and what he did to realize his dream. The creative entrepreneurial process operates within the context of the Hayekian “dispersed knowledge.” I have seen several interpretations of this notion. Permit me to offer four of my own. First, the present price system is continuously synthesized from the price system of the immediate past, the values scale of the consumers, and entrepreneurial competition. The information used to construct this system is dispersed among every single market actor. Second, consider that most entrepreneurs go into business already in possession of specialized technical know-how about some slice of a particular industry. They have specific notions on how to attract customers away from their competitors by offering them a better and cheaper product relative to what those competitors are (or will be when

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the product is out) selling. Other people may have no idea of the present state of the market, as contained in the natures of the production processes in use by the established firms and individuals. This technological knowledge is dispersed among various market actors. Third, even if people are aware of what is going on inside different firms, they may not be as innovative as these inventor-entrepreneurs. The ideas of how to improve consumer well-being, such as the quality or quantity supplied and price of final output, are dispersed among the potential and actual disequilibrators. Fourth, the knowledge of who out there are making profits and how and are ripe for being imitated is also initially concentrated among certain particularly attentive entrepreneurs, whose actions constitute the equilibrating process, though it eventually spreads throughout the economy. (2) can be duplicated by a socialist central planner. Even under socialism there can exist division of labor, with different managers and technicians attending to various machinery and factories. In principle, all that scattered knowledge can be presented to the central planner in a digestible form. In discussing the socialist calculation problem, Mises assumes that the director has at his disposal all the technological knowledge of his age. Moreover, he has a complete inventory of all the material factors of production available and a roster enumerating all manpower employable. In these respects the crowd of experts and specialists which he assembles in his offices provide him with perfect information and answer correctly all questions he may ask them. Their voluminous reports accumulate in huge piles on his desk. (1996: 696) Mises does not consider the “intellectual division of labor” to be a fundamental obstacle to socialism. Note a subtlety: workers labor but do not produce, because almost every worker’s activities are submarginal: there are usually numerous workers per any firm, and each of them contributes only a small part to the final product. On the other hand, firms produce but do not labor, being abstract entities, even “legal persons.” Even if a firm is identified with its entrepreneur-owner, the entrepreneur commands and directs; he can speak without laboring himself. Hence, we must distinguish between division of labor, i.e., original input or what goes in, within firms and division of productive activities, i.e., produced output or what comes out, in between firms. The former increases the productivity of overall

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labor; the latter permits the price system and market to emerge. A socialist society then has division of labor but no division of productive activities; all production is undertaken by the single state firm. With respect to (1), just as within a firm resources are not bought and sold by different profit centers, neither would producer resources be bought and sold in a socialist society, and prices would lose all meaning. We need prices in order to rank the methods of production in the order of their efficiency. At the same time, socialism, if it could work, would proffer two intriguing advantages over the free market. First, (4) can be made more efficient under socialism, as compared with the free market. The reason is that all production decisions and everything going on within firms would be fully transparent to the planners, so that equilibration does not depend on the slow, fickle, and irregular process of entrepreneurs’ sniffing out arbitrage opportunities, but is instantaneous. Innovators and imitators are mortal enemies, always at each other’s throats. The equilibrating process is a battle, in which some entrepreneurs try to hold on to their private trade secrets, and others try to wrest these secrets away from them (e.g., by reverseengineering their products) and imitate them. (They imitate, because it is easier than innovating themselves, yet it still serves a social purpose.) Imagine how efficient the economy could be if all such secret knowledge could be made public. At the same time, imitators are very vulnerable to both new products and cost reductions which cause them to suffer losses and discombobulate them for a short while. If the imitators were able to foresee these improvements, then they could adjust their productive efforts and avoid losses, and a central planner can arrange that. A socialist who appeals to this argument is in the position of an advocate of the repeal of intellectual property laws, except that he goes much further. He demands that no secrets at all be kept by any individual or factory in the economy. Every production recipe is to be made public knowledge, to be copied and used at will. For each product, its list of ingredients is to be recorded in a database accessible to all, and every method of production is to be “open-sourced.” Second, with respect to (3), socialism would dispense with entrepreneurial errors. On the market, it is extremely common for Smith to start a business that in a way is already condemned to losing to Jones who, unbeknownst to Smith, has come up with a better product or cheaper shopping list of factors. If Smith and Jones are planning to launch their respective products at approximately the same time, then Smith’s efforts will have been completely wasted. A central planner could make sure that such competition does not occur. He could order

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Smith to cut back production without waiting for the market to signal him to do so. These would be attractive possibilities, if it were not the case that for any product, there exist numerous methods of crafting it. In order to enable Jones to produce, the planner must decide which design or contrivance is the most economic. He must know for each method, which other state-run firms in the economy that use the same complementary factors of production in the course of their operation must be denied these factors, so that Jones could do his thing. But his search is predictably ruined by the fact that each of these firms, too, can use numerous technological formulas for producing practically anything. Even if he could find the least costly alternative for each method under consideration, he would still need to compare them with each other in order to choose prudently among the methods. And this he cannot do. Sans money prices, there is no way to add and subtract heterogeneous goods. Even if the planner is intending to put out a brand-new product, he still needs to apprehend when the profits of producing it are higher than the profits of producing the old article, and by what route they are made to be highest. In the absence of prices, the planner has no access to costs of production. This can be called the “too many possibilities” problem of socialism. It is each person’s struggling after profits and avoidance of losses on the market that causes resources reliably to be withdrawn from those occupations where they are needed least in order to actuate those branches of production that are projected by entrepreneurs to satisfy more urgent, in comparison, consumer desires. It is clear now why socialists lament both “monopoly” and “dog-eat-dog competition.” They are to be understood as holding that monopoly prices will be abolished due to instant equilibration, and entrepreneurial errors caused by competition will be abolished due to flawlessly harmonized growth. Consider a firm X. Let us pretend that we know nothing of whether it is making profits or suffering losses. But we do notice that if we take worker Smith and move him from department A within the company to department B, then more can be produced. As soon as we do that, we raise Smith’s real wage to cover the new efficiency gains. This change involves a certain amount of creativity or ingenuity yet seems to be fully equilibrating: Smith is made better off without anyone else being made worse off. Call this move ASB. However, in the real world, when Smith is re-deployed in such a manner, the immediate beneficiary is not him but the company owner. The company’s profits increase (or losses decrease). This we will name

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move ES (tongue in cheek for “Exploiting” Smith). This is a disequilibrating act, insofar as Smith is moved away from full employment. He contributes more to society but does not receive the full product of his labor. (It is neither known nor of any relevance whether he works “harder” than before.) In addition, the inter-firm economic system is afflicted with a measure of instability: when other businessmen notice X’s profits, they will wonder whether they can arbitrage them away by imitating X’s production process, call moves of this sort IXP. They can even seek to do not what X is doing exactly but develop various small improvements to the stuff X sells, thereby making their reactions to the seemingly innocuous ES have both equilibrating and disequilibrating aspects. Those businessmen feel “uneasiness” (Mises’ somewhat awkward term), pain from watching X succeed at their expense and are themselves thrust into action. Neoclassical economists fail to distinguish between the two points of view just laid out. They think that economic progress consists in “Pareto-superior” moves like ASB rather than in combinations of moves like ES and IXP. Ultimately, ASB does actualize, but it does not arrive immediately but after the dance of numerous simultaneous ES and IXP initiated by different companies has commenced and concluded. There is no such thing as an instant jump in the market economy from one equilibrium to another, as performed within a company by the company’s owner or within a socialist society by the central planner. Rather, an increase in efficiency comes through the process of entrepreneurial competition. There is innovation in ES and imitation in IXP. The advantage of inserting ES + IXP in between equilibria is that, as we will see, this way, the rate of economic improvement can be vastly speeded up. I have reached the conclusion that since disequilibrating entrepreneurship works only within the market, we have no choice but to entrust equilibration to the market, as well. The two kinds of entrepreneurship are at odds with each other: promoting one serves to depress the other. The market strikes a balance between the social functions of innovators and imitators. Profits can be had but not for “too” long. Sadly, the pendulum of public opinion swings between ossified socialism which is all yin and no yang and interventionist capitalism with its agitated and feverish chaotic business cycles which is all yang and no yin, without ever arriving at the golden mean of laissez-faire. It is almost as if the devil unleashed his two avatars, wolves in sheep’s clothing: Marx onto the more idealistic East in order to devastate its yang, and Keynes onto the more pragmatic West in order to sabotage

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its yin. As Marx deified the state to crush any dissident, so Keynes, who described himself as a homosexual “immoralist,” embraced anarchy, also achieved, oddly enough, by using the state, only this time with perverse laws that regulate money and banking. I continue the discussion in (I, 13), (I, 48), and (II, 27). The entrepreneur ideal type can be split into two aspects: the (a) risk-fighter and (b) chief manager. The former is concerned with selling the output or with maximizing revenues; the latter, with locating and combining the inputs or with minimizing costs. In small companies, the proprietor has to perform all the functions of leadership, including creating the product, marketing, inventing the production process, accounting, managing both the business as a whole and the departments within it, and dealing with individual customers. On the one hand, this close contact with every aspect of the business allows the owner to save on communication costs. One need not schedule meetings with himself. On the other hand, large corporations take advantage of specialization and division of labor even in leadership and gain an efficiency bonus over their smaller counterparts. This is the reason why large companies have the offices of both (a’) CEO who looks “outward,” as it were, seeking to attract new customers and retain existing ones and (b’) President who looks inward, seeking internal efficiency of operation. The two leaders’ tasks are not unconnected, of course: an expense can be justified if it leads to higher revenues and to profits; so, there has be constant dialog between the CEO and President about what to do. As a manager, the entrepreneur directs the company’s activities, and he can do so by expending an arbitrarily small amount of energy. The owner of a company can direct production simply by commanding his subordinates. The manager manipulates, arranges, orders, informs, imparts information into the factors of production; yet he is also a factor of production himself. A business owner, then, can obtain two kinds of income: wages for his work as President and profits for his entrepreneurial alertness, foresight, imagination, and courage. His total income will remain unchanged whatever wage he pays himself, of course, but the reason to distinguish between the several sources of income is to grasp whence profit, once purified from interest expenses, managerial income, and all the rest, comes. 11. EXPECTATIONS, PART II

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Welfare economics is only in part concerned with equilibrium analysis. It is also a measure of the perfection or ideality of an economic system. The term “ideality” comes from the TRIZ framework, TRIZ being a Russian acronym that stands for “the Theory of Inventive Problem Solving.” According to its developer Genrich Altshuller: The Law of Ideality states that any technical system throughout its lifetime, tends to become more reliable, simple, effective – more ideal. Every time we improve a natural system, we nudge that system closer to Ideality. It costs less, requires less space, wastes less energy, etc. Ideality always reflects the maximum utilization of existing resources, both internal and external to the system. The more free or readily available the resources utilized, the more ideal the system will be. … What happens when a system reaches Ideality? The mechanism disappears, while the function is performed. (2002: 16) This last bit does not describe any sort of divine ex nihilo technology; Altshuller gives real-world examples in which this actually occurs. Although Altshuller writes that “the further an invention is from its Ideal state, the more complex the system will be,” the key indicator of ideality here is not so much simplicity as internal unity. A system may be very complex, like the modern economy, yet exhibit a great deal of unity, such that it functions smoothly and efficiently, and all of its parts work as one. That an ideal machine will make use of as much of its environment as possible does not mean that it should devour scarce resources; nor that a profit due to high revenues exceeding high costs is better than the same profit due to low revenues exceeding low costs by the same amount. Rather, an ideal machine will not leave a resource idle when it can profitably bring it into the fold. In this case, the relevant meaning of TRIZ is that an economy attains higher ideality when an ever greater number of factors are well-utilized in ever more projects. The economy, of course, is a natural not man-made system which nowadays encompasses the entire world. There is no such thing as “labor economics” or “agricultural economics”; the economist must look at the whole system, in which every part is influenced by every other part. Nonetheless, the degree of economic ideality is not an intractable notion. TRIZ is primarily concerned not with “routine” problems, as a result of solving which a system evolves, but with “inventive” problems, such that to solve them is to push the system up

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into a new, improved, and different state, “sublating” it, to use a Hegel’s term. The economic equivalent of routine problem solving is equilibrating entrepreneurship or imitation; and of inventive problem solving, disequilibrating entrepreneurship as described in the previous chapter. We can now adopt two criteria for the level of economic ideality: (1) coordination of plans and (2) total consumer preferences satisfied. Consumer sovereignty characterizes the unhampered market, as distinguished from both interventionism and socialism. In both of the latter, the government usurps consumer supremacy: under interventionism, with taxes; and under socialism, by owning all output. In addition, under interventionism, production is explicitly redirected by decrees into uneconomic channels via a myriad of regulations; and under socialism, production lacks any rationality at all. The issue is not resolved with allowing a consumer goods market under socialism; the point is that consumers are not in a strong position to evaluate production attempts. For example, a society can be relatively wealthy but suffer from trade cycle, which means that it is poorly coordinated with respect to the time market. Alternatively, an economy may be very free, as it was in the US in the 18th century, but only in early stages of development. (1) corresponds to “local perfection” or an equilibrium with global ignorance of possibilities for improvement; (2) corresponds to a movement toward “global perfection” and may violate (1) temporarily by means of disequilibrating entrepreneurship. Coordination of plans entails unity and harmony: all resources are at full employment and receiving their DMVP, and no “businessman,” such as he is in an ERE, is losing money because of someone else’s routine-busting actions. For example, the point of the SEQ is to ensure that there are in society as few losers and as many winners as possible. If a widget’s price is below equilibrium, then which buyer will get the widget depends more or less on luck. Some other buyer would, too, have gotten the widget at that price; unfortunately, his intentions were frustrated by the existence and actions of the first lucky buyer. We want to avoid the situation of people getting in each other’s way like this. Therefore, if the widget’s price is raised to the SEQ price, then the first buyer will voluntarily prefer to spend his money on something else, and there will be no competition for the widget. The SEQ does not mean that Jones who agreed to pay $10 for the widget feels “more joy” from owning it, even if such things could be measured, than Smith – who is willing to sacrifice for the widget no more than $5 worth of other goods – would feel if he were to get it. It means merely that “everyone is a

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winner”. This is good enough ethically to justify (1) the equilibrium as a local ideal and (2) the tendency in an economy toward an ERE for all goods and services. At the same time, though there is no doubt certain beauty to such a construction, this beauty is deceptive, because something still better can always be created. Beauty is a real if subjective property, unless one does not want to treat such imperfect knowledge equilibriums as containing an aspect of perfection. A true final equilibrium, then, would be a “heavenly” society, where there cannot in principle be any improvement. It is next to impossible to imagine such a thing, but that is exactly the implication of Kirzner’s (2000) strange artifice of treating even an ERE as still discoordinated, because it can develop further. This is paradoxical, for an inventor’s action could be coordinative in Kirzner’s sense with regard to a previous state of affairs but discoordinative with regard to some succeeding state. As a result, the term “coordination” comes to mean “closeness to absolute perfection” which is entirely unhelpful. Again, if entrepreneur B invents a mousetrap that is better than the sort produced by entrepreneur A, and A’s plans are thereby disrupted, then according to Kirzner, even then, B is not a discoordinating entrepreneur, because in some sense A was always mistaken. B nudges the economy just a little closer to “heaven.” But then when later on C improves upon the mousetrap still more and proves B wrong (by causing losses to him), it turns out that B, too, after all fouled up his business calculations. Is the entire economy always and at every moment a horrible blunder? There are parallels between biological evolution and entrepreneurship. Disequilibrating entrepreneurship corresponds to a favorable mutation; and equilibrating entrepreneurship is analogous to the offspring of the mutant surviving and reproducing better than other members of their species and slowly, one generation after another, supplanting their less favored fellows. The difference is that a mutation has numerous generations of animals to work itself out; while the marginal unit in human civilization building is far shorter in duration: a human plan and a connected series of human actions imitating the success of some disequilibrator. An equilibrium evokes the idea of a world “already possessed,” an “evenly rotating ecosystem,” and a mutation must be clever enough to help the organism wrest resources by force from those who would otherwise claim them as their birthright. Another point of comparison is that an entrepreneur gathers for himself a variety of factors of production, many of which are employed

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in other tasks elsewhere in the economy, hoping to profit from his foresight which he deems superior to the weaker foresight of the factor owners. Similarly, for evolution to succeed, it must be the case that for any irreducibly complex (IC) system in a cell or organ in a body, all of its components were previously parts of other subsystems; and a multiple mutation that, like our entrepreneur, collected these parts into a single molecular robot, creatively destroyed those other subsystems yet overall without harm to (and in fact, to the advantage of) the entire organism. An obvious difference is that an entrepreneur can move factors of production from other locations into his own factory; but parts of old biological machines cannot really float to the right location all by themselves and assemble themselves there. It is true that their arrangement is programmed into the DNA; but the DNA, then, too, must simulate knowing where to install the entire new structure. The complexity of the organ is mimicked by the complexity of the DNA program guiding its construction. This is a point that has not received much attention in the controversy: biomechanical complexity entails the ability not only to (a) generate IC integrated wholes and (b) sustain a minimal function in the system but also (c) effect super-precise, fine, delicate, and accurate to the nanometer positioning and alignment of parts in space and time. Thus, looking at the chemistry of the cell, we are struck by what appears to be expert design. We say such things as that part A “wraps around” part B or that part B “transfers energy to” part C. Molecules are arranged into an order marked by specified complexity in close proximity to each other and intimately dependent on each other. Behe (1996) comments that in some biological structures, such as the cilia and the flagellum of various bacteria, there are “dozens or even hundreds of precisely tailored parts.” (73) Other instances of apparent design include blood clotting, described as “a very complex, intricately woven system consisting of a score of interdependent protein parts” (78); and vesicular transport, called “a mind-boggling process, no less complex than the completely automated delivery of vaccine from a storage area to a clinic a thousand miles away.” (115) A tiniest failure in balance or proportion or symmetry or mutual anticipation, then, and the entire machine is destroyed. Of course, with this, a staunch supporter of evolution’s power may find himself in full agreement. His case, too, depends on the very fact that a badly constructed machine or malware in the DNA will kill the organism with an unlucky mutation which will leave no descendants. Occasionally, however, a chance mutation will get a job done. Since we know nothing about the history of organisms, stretching billions of years into the past, we cannot be decisively sure that such a thing did not happen.

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Another difference lies in the fact that evolution may be stuck at a dead-end equilibrium, because in order to move to a state higher in complexity, the organism must suffer a number of individually debilitating (though jointly creative) mutations that, in the meantime, hobble it in the competition of life. In evolutionary theory, this is a no-no. Entrepreneurs, on the other hand, can find a way out of any equilibrium. The present state of the market does reveal the relative importance of every resource in the order of things, but the status quo is no obstacle to an acting man: even highly valued resources will be reallocated, if the anticipated profits are high enough. An entrepreneur can grab any factor from anywhere on earth that is for sale or unowned and insert it into a production process however he chooses. Every resource, whether already employed or still an unappropriated part of nature, is ripe for the plucking, if profit expectations will bear. The economic entrepreneurship may be likened to evolution; but human businessmen arrange factors of production into production processes though by secondary causes, not primarily by physical causes but via intelligent design; the evolutionary technique is entirely mechanical and random. Still, human civilization is at most 10 thousand years old. Life has been on Earth for on the order of 10 billion years. We do not know whether the time allotted to evolution, namely, 1,000,000 years of random trial-and-error for every 1 year of human technological and economic intelligent trial-and-error, is not sufficient quite without intelligent design to do the work claimed as its merit, i.e., to simulate the efforts of human inventors and entrepreneurs. Nature “tries” the mutations, and those found “erroneous” are ruthlessly eliminated; the consumers try the entrepreneurs, and entrepreneurs both act ignorantly and err, because they could not predict their success or failure prior to being tried due to both risk and surprises. In other words, the intelligent variation in the economy consists in four facts: businessmen deliberately seek to (1) lower costs, (2) increase revenues, (3) design the end product, and (4) invent and set up a method of production. Moreover, humans deliberately maneuver so as to win in the competition and profit. They want to outfox their opponents who, in their turn, are trying to beat them. These take intelligence, as well. We must not make the mistake of denying the possibility of intelligent design, but we must be humble in accepting that we can rarely know whether a particular biological machine has been improved with intelligent design at any time during its existence. This injunction is fully in accord with St. Thomas’ opinion in (ST, II-I, 112, 5): “no one can know whether he has sanctifying grace” by reason alone. In other words,

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knowing that one has grace “with certainty” is itself a grace-infused private revelation. Grace does what nature cannot; but nature must exhaust and prove itself first. At the same time, though it is difficult to estimate the precise limits of evolution, it is permissible to judge “conjecturally by signs” whether ID is likely to have occurred or not. The fundamental puzzle of entrepreneurship can now be expressed as follows. As in (I, 1), let Crusoe exchange his fish for Friday’s berries in an ERE. Let Crusoe sell 1 fish to Friday for 100 berries. Smith enters the Crusoe-Friday economy and offers Friday a fish for 50 berries. He thereby puts Crusoe (at least partially) out of business. Similarly, in a real economy, if an entrepreneur, Smith, has decided to disturb an ERE, then he bids away both the factors of production and the consumer money away from some Jones who is evenly rotating without care. This results in a loss to Jones. An instance of a monetary profit to one entrepreneur, therefore, often enough entails at least one instance of a monetary loss to another one. The puzzle is: Why do both Crusoe and Friday profit from association; Smith profits at the expense of Crusoe / Jones; yet both situations seem perfectly legitimate? The answer has to do with the distinction between (1) and (2) above. At first, Crusoe and Friday are perfectly coordinated, with each person supplying what the other demands and being seemingly happy. Smith introduces discoordination into the economy, but that is not a bad thing, because he improves the situation of the consumers. Even when the consumer is Friday alone, nevertheless, Smith frees Crusoe, a human resource, to try to produce something else. Crusoe has to re-specialize, but when he does, and a new ERE is created, all three people will be richer for that. The puzzle can be further re-worded thusly. Given that, upon disequilibration, workers’ nominal wages fall as compared with a previously prevailing ERE, with some of those wages metamorphosing into profits, how can it be that the standard of living (and therefore, real wages) rises? It may certainly be that the new ERE that will eventually be established will be superior to the old one in terms of general welfare, but is the intervening disequilibrium also superior to it? The answer is yes, because Jones’ function as an entrepreneur is at least as valuable as the functions of those factors working for his competitor Smith which have diminished in importance. The consumers, around whom the economy revolves, no longer think as highly about Smith’s workers’ contributions to their happiness as before. They prefer to do business with Jones who is fully justified to be a consumer of his profits. Curiously, Hayek argues that

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the concept of equilibrium merely means that the foresight of the different members of the society is in a special sense correct. It must be correct in the sense that every person’s plan is based on the expectation of just those actions of other people which those other people intend to perform and that all these plans are based on the expectation of the same set of external facts, so that under certain conditions nobody will have any reason to change his plans. Correct foresight… is the defining characteristic of a state of equilibrium. (1948: 42) Given the distinction proposed here, the term “foresight” has two meanings. The first and Hayekian meaning is that all participants in social cooperation receive psychic profits from association (specialization, division of labor, and trade) in every round of their economy’s even rotation. The profits are relative to the alternatives of (a) autarky and (b) losses due to entrepreneurial errors. No one’s efforts are seemingly wasted. Of course, (b) is absent, not because everyone enjoys perfect happiness but because of how we define the ERE. The second, my own, meaning consists especially starkly in the reception of monetary profits in a real economy. Correct foresight means “more correct than the foresight of other entrepreneurs.” Some participants in social cooperation foresee that their stuff will be accepted by the consumers and succeed, while others are left in the dust, suffering losses in the competition. Disequilibration is not guided by a provident hand as within the firm by the CEO; coordination is accomplished by signaling in the market via changes in supply and demand. Losses are suffered when an entrepreneur has not anticipated the changes in demand or costs for his own product correctly. Profits are enjoyed when an entrepreneur has perceived future high demand, while others, including both factors of production and his competitors, remain unaware of the opportunity. This understanding sheds light on the problem of patents. They are usually justified by the argument that they promote innovation. That they might, but innovation is not the only kind of entrepreneurship. Even if patents encourage innovation and disequilibrating entrepreneurship, they discourage imitation or equilibrating entrepreneurship. It cannot be decided a priori whether the good of the former effect outweighs the evil of the latter one. “The fact that my fellow man wants to acquire shoes as I do,” Mises writes, “does not make it harder for me to get shoes, but easier.”

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(1996: 673) Why? First, there are economies of scale. But second, because the shoe market is so large, with everyone having at least a couple of pairs and usually many more and replacing them every so often, that innovating within the industry, e.g., Nike Free and Vibram FiveFingers running shoes being new offerings in 2010, even if it allows an entrepreneur to capture a comparatively small segment of the market, can still translate into very high revenues. Hence, the competition among firms is fierce, making it easy to obtain ever better and cheaper shoes. How this is relevant to the subject at hand is that it matters whether one is the first seller to the market. In this case, all he needs is his predicted consumer demand curve. Given that curve, one needs only to set that price / quantity supplied combination which maximizes his profit.7 As imitators-arbitrageurs begin to appear one after another shortly after the initial inventor’s success, however, prices of the good (say, widgets) being produced begin to head down, and prices of the factors entering into the making of those goods begin to rise, as the imitators bid them up. Consider R.F. Harrod’s opinion: The elimination of net gains at the margin does not eliminate but maximizes profit. It makes the total revenue from the machines exceed the total cost of hiring labor by the greatest possible amount. … The principle is analogous to that by which Crusoe does so much work that marginal utility is equal to marginal disutility; so long as the utility of what he gets by work exceeds its irksomeness he should go on, but as soon as the irksomeness is felt fully to offset the advantages reaped he should stop. (1936: 26-7) One must know where Crusoe economics illuminates, and where it obscures. For Crusoe, indeed, the first good produced is put to its highest valued end, and the first hour of work is the least “irksome.” The profit obtained in this first hour is, thus, the greatest. The second good produced is put to the second most valued end, and we may reasonably suppose that the second hour of work has more disutility that the first. Crusoe still profits, I will assume, but somewhat less before. And on he goes working until the marginal disutility of labor exceeds the marginal value 7

Of course, the businessman may have only a vague idea of the shape of this curve and initially make a mistake. In this case, this monopolistic price discovery will be guided by a competitive market process.

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product of his labor. Harrod may be thinking about the case in which Smith owns a machine and hires labor to operate it. Equating the machine’s depreciation per week with its marginal product would seem to be the best strategy. I answer, however, that (1) if the problem is to find the best monopoly price, then it is not obvious that increasing employment of factors will always be more profitable, because as quantity supplied rises, the price must needs drop. Further, equating marginal revenue (MR) and marginal cost (MC) may involve buying more machines and therefore, paying more for each. If at the monopoly price, the machine is not forced to yield so much product that MR = MC, then Smith may be able to rent it out to other enterprises for an even higher return. The profitability of higher supply depends, therefore, on the elasticity of demand and the precise behavior of costs. (2) In a real economy, where Smith and Jones are competing at producing widgets, things are also different. In such a market, a single price dominates. Smith cannot hire a worker for one hour for pennies, make a single widget, sell it for $1,000,000, and reap the highest gain like Crusoe does. He cannot further hire the same worker for slightly more and sell the second widget for $900,000, reaping the gain which is second highest, as compared with the first. Suppose that Jones has an advantage over Smith. The two men will bid the price down to that value, at which Smith’s marginal revenue equals his marginal costs. Since Smith must sell all of his widgets at the same price (equal to the marginal revenue) and must pay the factors in his employ the same wages, rents, etc. (the sum of which is equal to the marginal costs), his total revenue equals total costs; he receives no profit and drops out of competition. Jones must set the price to at most that value, at which Smith’s marginal revenue equals Smith’s marginal costs. Jones’ actual price and output will be determined by the consumer demand, but they for sure will be such that his marginal revenue is greater than his marginal costs, because of his greater efficiency (e.g., his marginal costs are lower). Assuming from now on that the imitators are no worse and no better than the first seller, at some point, barring further disequilibrating shocks – an unlikely scenario in any more or less advanced economy – the state of equilibrium will be reached, in which all money profits are gone, the costs of production equal revenues, and the price is such-andsuch. This will be the price at which any existing imitator will have to sell the same widgets: he will not sell lower, because he will suffer losses, and he cannot sell higher, because everyone else will outcompete

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him on price. Such an imitator is a price taker, and the price that he takes will be equal to costs. In this situation, nobody either enters or leaves the market. (1) Any new imitator will be a price reducer and cost increaser, making production of the widgets for everyone, himself included, unprofitable. On the other hand, (2) every entrepreneur is reluctant to exit the market, because why should he be the one who blinks and allows others to profit? Of course, such a deadlock is implausible, because profit opportunities in other industries will draw the imitators away from the widgets, but here it is, anyway. To illustrate, consider a special case of constant returns, in which the price in the short term fluctuates, due to changes in demand, around a long-term price. Let the demand for widgets increase from D to D’, as pictured in Figure I.11.1(a).

FIGURE I.11.1. WHEN PRICES ARE DETERMINED BY COSTS OF PRODUCTION

In the short run, the price will go from p1 at point K to p2 at point L. Point M, between L and O, is what the price would become under monopoly, and this is the price any producer would like to set. A highly “competitive” market will yield some point N: competition favors noncooperation in a prisoner’s dilemma, engendering a race to the bottom, i.e., fast expansion until marginal costs equal marginal revenues and a price war. Now the laws of increasing marginal cost (LIMC) and diminishing marginal utility (LDMU) say that expanding production is like moving up the supply curve and at the same time, down the demand curve toward equilibrium. The price at which Smith must sell all of his

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output to come out even rises; and the price at which he can sell his output drops. Ex hypothesi, we assume that the LIMC is not applicable to a business. The average cost of producing 10 widgets is the same as the average cost of producing 1,000,000 widgets. If this law is suspended, then N becomes O, and the supply curve S is horizontal, as per Figure I.11.1(b). Then any new imitator who has set up shop in response to the higher demand will pick up the slack of Δq = q’ – q and be able to sell it at p1. Contra Marshall, an economist should not be excused for holding that the “normal” price is the long-term price. There is no normal price, as distinct from the irritating “abnormal” oscillation around the normal (i.e., just? efficient?) price. Every price is perfectly OK, and the only use for the medium-term price of perfect competition is to illustrate the equilibrating tendencies in the economy. The medium-term price is never reached in any actual market. There are numerous disturbances in the economy other than weekly or monthly demand fluctuations that somehow cancel each other out. Moreover, constant returns, when the LIMC does not apply, are unstable, because it is too lucrative an opportunity for others. If one can get as many factors of production from anywhere in the economy as he wants and not suffer increasing average costs of doing business, then imitators are bound to notice and try to do the same, eventually restoring the authority of the LIMC. The normal prices are those prices that would eventually be reached if all disequilibration ceased. But the normal prices in the SEQ some time in the future depend on actual prices right now. Since the latter are updated every minute, so are the former. Hence, there is nothing special about the normal prices as dreamed of today, as distinct from probably very different such prices as imagined tomorrow. In any event, Marshall is right vs. Murray Rothbard who does not seem to do him justice (2004: 357-362). Rothbard would be correct, however, if he were to assert that, even in the long run, both the price and the costs of production are determined by the market process working itself out roughly as just described. To summarize, a successful initial disequilibration for product P results in monopoly profits due in the short run to consumer demand for P. Later on, equilibrating imitation results in the disappearance of profits with price and quantity supplied of P being determined in the medium run by costs of production. To be more precise, the actions of equilibrating imitators cause the two values to converge. The closer they come together, the less lucrative imitation becomes, and the more disequilibrating creative advance is encouraged. Finally, innovation and

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imitation elsewhere in the economy for goods Q, R, … cause losses to even rotators producing P, with P’s price and quantity being caused in the long run by technology and consumer demand for all other goods. Regarding individual firms, equilibrating forces reduce profits to zero; regarding whole industries (comprising things like P and its imitated substitutes), they equalize the average rate of return in them. The Post-Keynesian Paul Davidson (described as “the keeper of the Keynesian flame”), too, fails to grasp the LDMU and LIMC. As I argue in (I, 4), the reason why production suffers from “diminishing returns” is that as one hires resources, those resources are bid away from more and more valuable uses in other firms, and costs (that is, prices of the factors of production) are determined by the most valued such use; and as one produces output, the price of the output drops, because the marginal widget is put to less and less valuable ends, and prices are determined by the least valued such end. He writes: “Expansion of the flow of production in our economy often involves the hiring of less-skilled workers and the utilization of older, less-efficient equipment and therefore, adds to diminishing returns. This phenomenon, which may be labeled hiring path diminishing returns, was emphasized by Keynes as a main reason ‘for rising supply prices before full employment’.” (1978: 341) But of course, the two laws assume that one cannot differentiate between workers, that labor is non-specific. If one worker is more efficient than another and can be seen as such, both by their present employer and also by other entrepreneurs, then their wages can differ. Recall from (I, 7) my argument about the reducibility of labor to human capital. A more highly skilled worker is going to receive a higher wage than his less productive fellow. In this case, labor costs need not necessarily increase, as more workers are hired, but only because labor productivity falls. It follows that Davidson’s observation is an addition to the two laws of diminishing returns, not an exception to them. Davidson’s kind of diminishing returns makes a firm less productive on the margin, as it expands. As a SEQ is being reached, “supply prices,” indeed, do not fall as fast as before. We should not be upset, however, because even in hiring the services of an inferior worker or machine, a company takes this resource away from what is hopefully a less valued use, thereby increasing its return and enhancing the value of its employment. Keynes imagines a society in which the “marginal efficiency” of all capital goods – essentially, that discount rate at which the cost of a marginal capital good is equal to the sum of that good’s discounted product over its lifetime – is zero “and would be negative with any additional investment.” He argues that positive net savings are poisonous

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in such a society, because “entrepreneurs will necessarily make losses if they continue to offer employment on a scale which will utilize the whole of the existing stock of capital.” (2008: 217) It is plain that this would be so only if no disequilibrating entrepreneurship were possible, in which case any new investment due to these savings would, indeed, only lead us away from perfection. But any equilibrium Nirvana is only apparent and only to dull minds who cannot envisage any improvement to it. This is how it is possible to reconcile (1) indeterminacy and shocking nature of competition, (2) entrepreneurial discovery, and (3) a tendency of the economy toward equilibrium. For with respect to (1), losses are self-penalizing; a person who continuously loses to the competition will sooner or later cease to be an entrepreneur. As I will have occasion to repeat several times, entrepreneurs compete amongst themselves. They do not seek success which is a relationship between a person and his chosen goal but victory over others. If N% of all restaurant businesses fail, then one needs only to be among the top (100 – N)% of best restaurateurs. Everyone’s starting position is equal vis-à-vis unwelcome surprises; tactical incursions are both a weapon of all and an obstacle to all. I will have much more to say on this in the next chapter. (2) represents innovation and disequilibrating entrepreneurship, while (3) represents imitation that inaugurates a procession toward equilibrium. For this reason, the term “efficiency” has two meanings: one applicable to equilibrating entrepreneurship; the other, to disequilibrating entrepreneurship. Capitalism is efficient in “allocating resources” in the first sense, in that arbitrageurs invest capital into those lines of production that have already proven profitable, thereby bringing every resource closer to full employment, locally understood. (Discoordination is precisely lack of full employment of all resources directed by all entrepreneurs, but only as far as our arbitrageurs can tell.) They are attracted to the showing of profits by others, as bugs are to the light, almost instinctively. But efficiency is very relative. It is precisely novel, intelligent, and disequilibrating human actions that make previously efficient manners of living and doing business obsolete and manifestly inefficient and open the door to possibilities that no one ever considered. At the same time, a disequilibrator can err, thereby failing to increase global happiness. The market quickly punishes such a bumbler, and it is in these things in which it is efficient in the second sense. The market is efficient, because it harmonizes individual creative initiative and the common good. Consider that neoclassical economics assumes that firms

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maximize profits. What can possibly be meant by this, when this school is preoccupied with the state of equilibrium, in which there are no profits? Again the distinction between psychic and monetary profit is relevant. When a farmer exchanges cows for horses until it is no longer profitable to trade a marginal cow for a marginal horse, every cow and horse are put to their most valued uses, as subjectively determined by the parties to the exchange. This is one sense of efficiency. Another sense is evoked by a barroom brawl: in a free-for-all “anarchic production,” the objective is to inflict maximum damage on others while receiving minimum damage oneself. That person is efficient who knocks out the most teeth or more pertinently, makes the most money, perhaps, at the expense of others. Fighters, too, can be more or less efficient. This dichotomy has often been misinterpreted (1) in the business world as that there is a limited “pie,” over which people fight to the death. It is true that the money supply (under laissez-faire) is highly inelastic, and one man’s profit in terms of money entails another man’s loss. However, that does not mean that the “pie” in terms of consumer and capital goods per capita and therefore, general welfare do not increase precisely as a consequence of entrepreneurial competition. Entrepreneurs are recruited into service to society through the cunning of the economists. It has been misinterpreted (2) in economic science as the purpose of economics: to shove resources to where they appear to the economist to be most wanted. This neglects the fact that people constantly find new and better uses for things, uses that surely stupefy our generic economist. Note that it is entrepreneurs – not technicians or managers – who do that, and they are able to, because the market permits them to calculate costs and expected revenues. Under socialism, only the dictator “plans”; on the free market, numerous entrepreneurs do. Though both do it rationally, as in informed by the consequences of their actions, the market allows economic improvement to proceed in parallel. Economists find themselves perpetually flabbergasted by the fact that entrepreneurs escape the straightjacket of boring equilibrating economizing. The idea behind the neoclassical Kaldor-Hicks “efficiency” is simply obscene. As an imaginary construction, it is amusing. In the real world, however, there are no compensations from winners to losers. A person who invents and markets a better mousetrap has no duty to share his profits with his competitors. There is no flood of lawsuits from

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people who have been made “worse off” by some change to claim their rightful property from the more successful. It is not the judges who allocate income to entrepreneurs but the consumers. Now perhaps, it might be objected, such ought not to be the case. But the ES + IXP moves described in the previous chapter and the cash flows in the economy require that for every winner there be losers, either workers or other entrepreneurs. A law stipulating that compensation be paid to the losers abolishes human action as such. Enforcing distributive “efficiency” regarding psychic profits is, to say the least, impracticable for a variety of reasons, such as an effective end to consumer sovereignty, the complexity of the economy, the virtual impossibility of tracking counterfactuals (“If it were not for Smith, Friday would have bought his fish from Crusoe.” How would we know?), the no doubt fantastic cost of investigations and arbitration, and the difficulty quantifying and comparing happiness intersubjectively. There is no such thing as cosmic efficiency any more than cosmic justice; moreover, if we re-focus from the cosmos down onto earth, we see that basic justice in buying and selling permits Friday to forsake Crusoe and do business with Smith. Hardly anyone would dare argue that Friday has a moral duty not to make Crusoe worse off upon the appearance of Smith. Economists must deal with rules not acts. Their welfare economics or ethical outlook is rule not act utilitarian. Is it a happy society in which entrepreneurs are allowed to innovate and imitate in many various ways and profit from their troubles? Economists cannot say that this is OK for Smith yet bad for Jones. They must, by answering this question, lay down a definitive praxeological and then positive law. Kaldor-Hicks efficiency may be relevant for firm governance (in which case it seems trivial: of course, funding should be shifted from department A to department B within a company, if B is expected to bring in higher revenues) but has many fewer applications in a capitalist economy. The key point is that both senses of efficiency are attached to entrepreneurship, that is, to the market process. They are properties of something moving or changing – in fact, developing, not of any static and unreachable “general equilibrium.” For example, Schumpeter (2008) is at pains to declare that the procedure of taking a point in time in this process and judging the competitive state of some industry or slice of the market at it is completely invalid. Rothbard (2004) pointed out even more radically that a mere observation that right now a widget sells for $5 is not sufficient to determine whether this market price is a monopoly price, competitive price, or anything in between. One must

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observe the market process work for a period of time, and if one actually does that, then, Schumpeter implores, he will likely come away with very different conclusions about the market’s efficiency. The yang and yin of creative destruction are best fully enabled and well balanced. In creating profits and jobs, the disequilibrating yang butchers the deer-in-the-headlights even rotators; in destroying profits, the equilibrating yin like some bloodthirsty goddess Kali (remember that the female archetype is both receptive and destructive in its various guises: e.g., if you do not take the opportunity to plant your crops in the summer when nature is pliable, the same nature will starve and kill you in the winter) creates new opportunities for growth; both benefit economy as a whole. Yin and yang, in joining together, produce fruit, in this case, economic progress. Under unhampered capitalism, society tends to become more ideal in the most efficient ways possible. 12. THAT HUMAN PRACTICAL WISDOM AND “ANIMAL SPIRITS,” WHEN COMBINED, COMPOSE HUMAN ACTION, PART I An entrepreneur has before him an array of prices of potential factors of production. In this, he is different from a central planner of a socialist economy who does not have access to such prices. The entrepreneur has to project or predict only the prices of finished products (from the point of view of the firm producing them). Before beginning each round of production, the costs and benefits of evenly rotating are evaluated anew. Numerous things can cause a businessman to rein in or shut down the production of a particular article: changes in wages, rents, and interest rates; changes in government policy, behavior of competitors, behavior of suppliers, and general economic conditions; and changes in consumer tastes. However, to the extent that these can be predicted, the businessman gets a leg up: he can with some assurance stay in business for longer than a single round of production. It is certainly true that human sagacity and predictive powers are limited. Suppose that some person, Smith, has invested his life, fortune, and sacred honor in some enterprise. Then prudence, which is also called practical wisdom, will allow him to calculate precisely the danger or risk he is facing and determine whether he can overcome the odds. Given these calculations, he need not hesitate. Either he determines that he will succeed, perhaps with high probability, or he decides that the risk is unacceptable and refrains from acting. In either case, Smith stands in no need of battling any possibly paralyzing feelings of dread or apprehension inside him. This is because, again, the outcome or the relevant

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odds is known beforehand, and therefore, Smith will either execute his plan and reach fruition with a definite probability or decide against doing so and retain his starting capital. Either way, Smith can calmly make a rational decision, that is, a decision supported by more-or-less exact calculations of the consequences of his actions for an arbitrary number of people and lying arbitrarily far in the future. Fortitude, on the other hand, is a character trait that defies all calculations. It is essential when one is dealing with momentary surprises, when one does not know how things will turn out. Continuing the discussion in ethical terms which seem apropos here, fortitude, therefore, is a profoundly entrepreneurial virtue. It lets a person go through with a plan of action when he is not sure of his chances of success. It lets him overcome the fear he may be suffering of obstacles of whose existence and difficulty he is as yet unaware or aware only vaguely. Fortitude is required when facing the unknown and unpredictable, precisely when prudence is helpless. St. Thomas indicates that fortitude “deals chiefly with sudden occurrences” (ST, II-II, 123, 9) and insofar as he connects magnanimity and magnificence to fortitude, is often about “goods of fortune” (129, 8; 134, 3). When one is in danger, and uncertain of whether he can overcome it, and fearful, with courage (a close relative of fortitude) he can nevertheless achieve victory. Courage and tactical intelligence can ensure triumph when all strategic calculations predict disaster. Keynes seems quite aware of the distinction: contrasting “short-term” speculation with long-term “enterprise,” he writes that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death. (2008: 162) Prudence and courage complement each other in all human action. One may think of prudence as the virtue that helps one to achieve a well-defined goal. Whatever obstacles stand in the way, they are directly surmounted. Every milestone is dutifully reached. No matter what contingencies occur, they have been anticipated and planned for; the end is kept clearly in mind, with eyes, as it were, on the prize; and every hindrance is brushed away, overcome, perhaps, with great ingenuity. Technical problems get solved one by one, relentlessly, resolutely, with iron self-control and willpower, and removed from the path

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to success, the key to which is faithful no-improvisations-allowed following a perfectly conceived plan. One is on his own, autonomous, manipulating the world with wizard-like competence and cold control over the elements. Fortitude, on the other hand, concerns victory over one’s competitors. There is no specific end to be attained; the end depends on what other people do and how one will react to their actions in order to counter them, obtain an edge, and dominate the situation. What goal is had in mind changes all the time, depending on how the competitors position themselves. The key is to adapt to constantly changing environment. There is no inexorable march toward a goal far in the future but deft maneuvering, veering back and forth gracefully and artistically so as not to destroy obstacles but to avoid and evade them. It is as if one is engaged in a boxing match: the key is to best the other player who in turn is trying to best oneself. Far from being autonomous and self-sufficient, one is constantly measuring himself against other people. Visionary thinking and planning for the long-term give way to opportunistic and agile negotiating whatever the world throws at one in the next moment. Courage is a “hot” virtue, the opposite of self-control, in that one must free his creativity from all inhibitions and hang-ups. A man whose chief virtue is courage aspires to be a virtuoso tactician, a master of technique and style. While prudence eliminates chance and the unforeseen or tries to, fortitude revels in them and seeks to take advantage of them, shrugging off and even conquering the slings and arrows of outrageous fortune. Prudence is the art of avoiding lemons in the first place; fortitude is the art of turning them into lemonade. Marshall summarizes the entrepreneurial imperative as that one “must be able to judge cautiously and undertake risks boldly.” (1964: 248) The weakness of the strategic intellect is that the goal is relative to one’s own power and may be trivial and nothing special, if many other people achieve similar or greater things. One needs to see what others have done in order to form a true opinion of himself. The weakness of the tactical intellect is that one can be a champion but really a big fish in a small pond, yet he does not realize this, because he is seemingly king of his world. One has to look inside himself and orient the goal away from beating ineffectual unworthy opponents to finding the limits of his own strength, regardless of which other people he is better than.8 8

A communication breakdown is depicted in the movie The Rock (Hollywood Pictures, 1996). Goodspeed says: “I’ll do my best,” to which Mason replies: “Your ‘best’? Losers always whine about their best. Winners go

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It is, of course, not the case that competition must arouse in one feelings of hatred or envy or contempt for one’s rivals. As one race car driver noted, “I love my competitors, but I’d hate to let them win.” All great entrepreneurs, like all great athletes, display a profound sense of good sportsmanship. Market competition often brings the best out of people. Erikson points out that “a combination of early prevention and alleviation of hatred and guilt in the growing being, and the consequent handling of hatred in the free collaboration of people who feel equal in worth although different in kind or function or age, permits a peaceful cultivation of initiative, a truly free sense of enterprise.” (1980: 86) The economic analogy is that in the perpetual market conflict between established companies and newcomers eager to challenge them, neither the “old” nor the “young” must be privileged by the state with subsidies, monopoly grants, favorable regulation, credit expansion, or any of the rest of the economic monstrosities. Free competition that actuates the market process is both a means to prosperity, a legal ideal, and an individual virtue, insofar as business owners voluntarily abstain from corrupting the legislators, even when they feel they might succeed at something so seedy. The tendency of the universe to throw surprises at a person may be called part of the “human condition.” But it is not the case that human beings as a species were thrown into a world in which such surprises were already present. It is precisely the planning and acting of other people that make the world surprising for any particular individual. Events can, therefore, be divided into three categories: (1) actually known; (2) potentially known but actually unknown because of the complexity of the situation or some actual limitation on human predictive powers; and (3) surprising due to creative human action. The difference between strategy and tactics is that strategy is the method used to minimize risk by dealing with (2); and tactics is the method used to defeat sneak attacks and the enemies who engender them under (3). Uncertainty of the future arises out of a combination of (2) and (3). The most crucial reason why Smith’s future is uncertain is that Jones and Robinson and billions of other human beings are present in his environment, acting on their own accord. Uncomprehending, Skidelsky writes: “If… there is bound to be irreducible uncertainty in financial operations, the state has an additional duty, which is to protect society as a whole against the consequences of bets which go wrong.” (2010: 170) home and f--- the prom queen.” Not that Nicolas Cage or his character is a Rational, but in general, an NT person is not a “loser,” any more than an SP person is a “failure”; they just have different kinds of destinies.

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This really is outrageous. Uncertainty is a metaphysical feature of the world, up there with scarcity and sin. If the state has a duty, then it is not to lower uncertainty (how? by killing Jones and Robinson? with autarky at the level of individuals, destroying the division of labor? with socialism?) but to protect the property rights of the customers of financial institutions which are violated in the process of fractional-reserve banking. Our economic woes are due to government and Central Bank activism, not to the human pursuit of happiness. This pursuit does need to be coordinated, but that can only be done via unfettered laissez-faire. Another crucial distinction is that between knowledge and understanding. While knowledge – also called “science” in older philosophy – is the first of the three intellectual virtues and describes the causes and effects to which physical entities are subject, understanding is traditionally the second such virtue and is used specifically in dealings with rational beings. The way to grasp human actions, whether past or future, is by means of understanding. I will expound on it more fully in (I, 26; 27). Understanding can be elucidated in terms of the distinction between class and case probability. The former is a standard type of probability, amenable to mathematical analysis. If there are in an urn 10 balls, 3 of which are red, and the others are blue, then the probability of taking out a red ball from the urn is 0.3. The latter is very different. Precisely in understanding the situation, one must consider the various human interests involved and estimate their relevance, strength, and direction, often on a hunch. E.g., how important to the Republican gain of the House in the 2010 election was the passage of the Democrat-sponsored health care legislation? Then one must sum them up in order to reach a conclusion. For case probability, one can form opinions about the course of future events and defend those opinions by adducing reasons for them. For class probability, any “opinion” will be merely a restatement of the value of the event’s numerical probability. Class probabilities cannot be assigned to human events at all; even betting, say, that the Republicans would gain the House before the election is unfitting. Smith might think it likely; Jones, unlikely; but the actual odds (such as 9:1 “in favor”) cannot be determined. Class probability is determined by dividing the number of favorable outcomes (FO) over the number of all possible outcomes (AO). But people choose to act by considering reasons for their actions. Choices are non-random; when contemplating decisions, people do not conceive of several courses of action and pick one randomly. These decisions are not FO vs. AO but pros vs. cons. Moreover, each human

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choice is a unique non-repeatable event, because the valuations, plans, and powers of the chooser change precisely as a result of the choices made. That is why there are not even relative frequencies of actions and no experimentation with the market. If one could know Smith and his reasons inside and out, then one could foretell his choice, eliminating risk. If one could know how Smith would change with time, then one could avoid surprises from him. This lack of definite knowledge about the evolution of humanity, such as, as Keynes put it, “the prospect of a European war…, or the price of copper and the rate of interest 20 years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970,” is called uncertainty. Prudence requires both physical causality provided by knowledge and teleology provided by understanding. One understands human actions; since present understanding, no matter how deep, does not allow perfect prediction of future human actions, these actions create a surprising world; and one must be courageous, as well as adaptable, confident, quick-witted, and in possession of presence of mind in order not to be dismayed by any sudden development, come what may. If it is an opportunity, then one must seize it before others catch on; if it is a disaster, then one must minimize the damage and turn things around ASAP. Regarding knowledge, one may know something with 100% certainty or be completely ignorant. In between, there are probabilities. Persons who count on their power to estimate probabilities accurately and use them in their favor to obtain profits are called gamblers. Regarding understanding, things are analogous yet different. One either understands another human being very well and can surmise his next moves, or that other person is a complete stranger. In between, there is “discernment of spirits,” insight into another’s soul, his character, motivations, aptitude, etc. Whenever one is counting on his spiritual insight to guide him toward profits, whatever he is doing, it cannot be called gambling. One who counts in addition on his emotional intelligence and acuity to help him deal with his customers and beat his rivals is not a gambler but an entrepreneur. Now it will immediately be pointed out that an entrepreneur performs a social function: he rearranges production in such a way as to improve consumer well-being. That is correct, but in order to do that, the entrepreneur must have precisely insight into the moods and mental states of both his customers and his competitors. It is his deep understanding that makes an entrepreneur successful and a servant to the people at the same time. We can see that speculation on the stock market and suchlike can in no wise be called gambling but must rather be labeled

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entrepreneurship. How many entrepreneurs do “we” need? Even Crusoe risks that his preferences will change, or that he will find a superior tool that will give him a reason to abandon production in midstream; every entrepreneur risks that he will be outdone in ways he cannot at the moment fathom. But given large markets, there is room in the world for more than one entrepreneur, even though all markets are connected. Rothbard suggested that the socialist calculation problem (which I have rephrased as the “too many production possibilities” problem) limits the size of the firm: too big a company will have trouble deciding to which projects it should allocate which resources, putting it at a stark competitive disadvantage relative to smaller enterprises. Though all entrepreneurs compete not only with established businesses but also amongst themselves, numerous disequilibrating entrepreneurs can succeed at the expense of many even rotators. But “too many” entrepreneurs with “too few” capital goods to make all their plans viable, which is a situation that is begotten during a business cycle, as we will see later, spell trouble. Remember our four ways of disrupting an ERE with creative advance. One can (1) manage better; (2) use a superior technology; (3) come up with a more satisfying product; or (4) make an old product more appealing through advertising and suchlike. Entrepreneurs are rightly concerned with all of these. If we want, we may incorporate luck or serendipity into this schema, as well. An entrepreneur looks here, then looks under there, and perhaps stumbles upon something useful. But even in this case, those people tend to be lucky who know where and how to look. Skill and luck for acting men are intertwined inextricably. There are other causes of profit. Lower costs of production can be achieved also by means of cheapening of machines, raw materials, and human capital that enter into production by existing methods. Demand can be stimulated by breaking into new markets with the old product, e.g., by establishing offices and factories in other countries. What happens when an entrepreneur disturbs in one of these ways not an evenly rotating economy but a previously discoordinated system? If yang is in ascendance, that is, if there are too many disequilibrators, then too many surprising things are all happening at the same time. As a result, innovating or contributing to creative advance is not necessarily the smartest thing to do, since one’s own product will be competing with a lot of other people’s inventions. It is inevitable that many innovators will make mistakes. Pushing yang is subject to diminishing returns. On the other hand, imitating or helping oneself to other people’s monopoly profits seems like a natural choice and is profitable.

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If yin is in ascendance, that is, the closer an economic system is to an ERE, i.e., the less lucky and shrewd other people are, the greater the opportunities for profit. This is because an ERE signifies absence of surprises which means that the spineless multitude of even rotators can be outcompeted easily. Innovation is lucrative which means that yang flares up naturally; while there are increasingly fewer entrepreneurs left to imitate: there are diminishing returns to greater dominance of yin. This way, a balance is struck between the coordinating and discoordinating forces. The business cycle breaks this balance radically, because during its boom segment there occurs too much disequilibration which leads to far greater discoordination than the economy can handle profitably. The yang / yin duality under analysis here is essentially catallactic in scope or limited to the operation of the market. We must be careful not to confuse it with other, true or merely apparent, complementarities in nature. For example, it is only with heroic effort that we can conclude that the two major parties in the United States “balance each other.” The welfare-warfare state is not a happy political union. Neither are there any yin and yang in government interventionism: the “Third Way” between capitalism and socialism, marked by “public-private partnerships,” a vast number of regulations, and other horrors, is not in any sense a golden mean or complementary opposites completing each other. It may be asked both, ethically, (1) how profits can be justified and (2) how disappearance of profits via equilibrating entrepreneurship can be justified. (1) Profits and losses arise as a result of entrepreneurial competition. Some win; others lose. Therefore, it is this competition that needs to be justified in the first place. But doing that is easy: society craves catallactic competition, because this is the only way rationally to bring about both incremental and revolutionary improvements in consumer welfare. If it is suggested that entrepreneurs are duty-bound to give away their profits to the factors in their employ without waiting for equilibrators to arbitrage away these profits, then my reply is (a) that this is markedly unfair: if Smith loses, then he loses; if he wins, then he merely breaks even; and (b) that this will destroy the economy, based as it is on self-interested human search for happiness.9 Moral ideals generated by 9

An employee who requests “profit-sharing” from his boss can be rebuked with a simple “You can share the profits, only if you agree to share the losses, as well.”

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the virtue of justice may demand that some 1st-order desires be despised and eventually be suppressed for the sake of spiritual health; but it does not touch many or even most non-pathological desires. In addition, successful entrepreneurs, like artists, make the world more beautiful and deserve to be compensated for that. (2) That the process of arbitraging away of profits is just is not self-evident: as indicated in the previous chapter, the idea of intellectual property has it that imitation ought to be explicitly outlawed. Normally, however, justifying imitation is simple enough: it leads the economy toward local perfection (on a higher global level) and is to that extent good. 13. PRUDENCE AND COURAGE, PART II In one sentence, Schumpeter presents an intriguing scenario: “A firm specializing in paper labels for beer bottles may be so circumstanced – potential competitors realizing that what seem to be good profits would be immediately destroyed by their entering the field – that it can move at pleasure on a moderate but still finite stretch of the demand curve, at least until the metal label smashes that demand curve to pieces.” (2008: 102) So, we have that Jones might think it a great idea to arbitrage away Smith’s profits, but he figures that, as he will be entering the paper labels industry, others will do likewise, and he will not gain anything. Notice that I have defined an entrepreneur as fundamentally someone who faces competition or threat thereof and therefore, surprises, 7 days a week. It may seem, however, that equilibrating entrepreneurship garners certain profits: is it not obvious exactly what an entrepreneur needs to do in order to copy another? The answer is that the surprises for equilibrators lie not in the fact that by selling the same product for less they will not definitely get consumer attention – that they will is quite certain, indeed, or rather riskless – but in how fast each of them can notice and act on an arbitrage opportunity, before (a) the rest of the horde of wannabe imitators barge in and (b) the firm being imitated in its turn makes a new and unexpected move. In bringing bottled water to a disaster area and making a tidy sum, Jones is still counting on his superior foresight (prudence) and quickness (courage), and he may well be wrong or slow. Thus, equilibrators are true entrepreneurs after all. In (I, 3), I mentioned a reason for price stickiness originating in fast-paced innovation and quality competition. In such a case, equilibrating tendencies have little time to work themselves out. The moment

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someone thinks about duplicating some consumer electronic device (say, LCD HDTVs) and selling it for less, the device mutates into a superior form (say, LED HDTVs). Though each such transformation is disequilibrating, having tempted the entrepreneur with a possibility of evanescent profits, it also equilibrates virtually, destroying old technologies and ruining the prospects of those companies that display less inventiveness. Discoordination is not thereby increased but is merely reinforced or thrown back to the same level again and again, even as pure equilibrators – who do exist – try franticly to orient themselves. Schumpeter even speculates that a market leader enjoying a temporary advantage by virtue of a superior product or production methods may be, for psychological reasons, in a better position to innovate still further than a firm laboring under perfect competition in an ERE. “Perfect competition is not only impossible but inferior, and has no title to being set up as a model of ideal efficiency.” (2008: 106) Hayek calls the consequences of the preoccupation with perfect competition “antisocial.” (1948: 102) Even Marshall argues that it is not the case that “the amount produced under a monopoly is always less and its price to the consumer always higher than if there were no monopoly.” (1964: 400) The neoclassical ergodic assumption of their models to the effect that the future is predictable and can be found out by means of statistical analysis of the past is judged outrageous upon even mild reflection. It is true that trends can sometimes be discerned in a society, but trends do not last, and neither do the predictions of even the most sophisticated models. In order to realize the impotence of the fully mechanical view of human beings used in computer modeling, it is enough to ask whether a model can predict which consumer good will hit the market next, which new technology will find itself into the halls of factories and offices, or whether it can predict a political revolution like the fall of the Soviet Union or the Republican revolution of 1994. The established routine of production and consumption may have some claim on the world, but any entrepreneurial novelty-generating action deviates from such a routine, which is why the further into the future a model pretends to look, the more erroneous it will be. The market is ceaseless agitation of its every participant aimed at improving his well-being. The future cannot be like the past, because it is the intention of every human being for the future to be better, as he judges it, than the past. One cannot substitute either entrepreneurship or economic reasoning with number crunching. Why is that? It is nothing if not empirical to notice that the actual market under “study” is extremely complex. A billion things are

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happening all at once at any single moment. But perhaps, an experiment could be conducted. Very well, what is the general nature of an experiment? A scientist has a process, and he wants to learn something new. He alters a single variable, re-runs the slightly modified process, and observes the results. Having done this a number of times in different ways, he is bound to have discovered something. The case against empirical economic theory consists of two observations, both based on the idea, obvious to all but philosophers, that people are not things. First, they have personalities, those upsetting aspects of humanity that make Smith at time t1 in set of circumstances C behave differently from Jones at t1 in C and from Smith himself at t2. Therefore, any conclusion allegedly arrived at by an empirical economist must also answer two extra questions that need not bother a genuine naturalist: for whom did you make your prediction and for that person, when? It would be unhelpful if after a laborious series of experiments, a scientist has deduced that only this atom or this pendulum would have behaved in a certain way and only then. For example, people themselves change, sometimes consciously, sometimes not. A person may be animated by a vision of how he wants himself to be. For example, he may strive to become “holy,” thereby losing some desires and gaining others. Or, as Cary Grant said, explaining his suave magnetic appeal, “I pretended to be somebody I wanted to be, and, finally, I became that person.” No model can foresee that. This is the meaning of Mises’ point that empirical economics is only nomically inert economic history. “The study of history makes a man wise and judicious,” says Mises. (1996: 30) Why? Becker (1932) quotes an 18th century historian: “We see on the theater of the world a certain number of scenes which succeed each other in endless repetition: where we see the same faults followed regularly by the same misfortunes, we may reasonably think that if we could have known the first, we might have avoided the others. The past should enlighten us on the future: knowledge of history is no more than an anticipated experience.” (95) Suppose I say, “I have come to realize that of the sex, drugs, and rock ‘n’ roll, at least two are overrated.” This may be a fine maxim. Nevertheless, that it seems plausible does not absolve any other human being from personally testing it on himself. Second, people are intelligent and so learn from their mistakes and their successes, ensuring that even in similar situations they will act differently. An interesting connection between these two properties is that entrepreneurs try to figure each other out, i.e., to use their (2)

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intelligence to grasp each other’s (1) personalities. In so doing they may be able to identify trends. Toy experiments designed by some economists to find out how people will respond to incentives suffer from the problem that people will change their behavior or lie in order to look “better,” when they know they are being observed. Some people may take being watched so seriously that they will experience stage fright, further confusing the experiments. As a final example, someone once complained to me that it seemed like the moment she started to enjoy some product in the supermarket, it disappeared. The reason for this phenomenon is twofold. First, many people are temperamentally inclined to novelty as such. The routine bores them, and companies cater to that preference, a major source, as already pointed out, of the usual roiling in show business. Second, every entrepreneur, “Smith,” who has product X out realizes that other entrepreneurs are at this very moment inventing ways of beating him in the competition, and they are explicitly taking the present state of the market, including X, into consideration. They are planning to put out something that they hope will be superior, from the consumers’ point of view, to X. Smith cannot sit there and wait inevitably to be replaced. He must continuously improve, so as himself to surprise his rivals. (Again we see how crucial tactics is to entrepreneurship.) A scientist who imagines himself capable of predicting economic future is a slave to his own temperament. The “NT Rational” temperament is the least mutable and adaptable of all. A person who likes to control every aspect of his life cannot imagine that there is such a thing as spontaneous human action. He thinks that he can calculate the destiny of mankind from now till kingdom come. This is the delusion of a central planner. The Rational temperament excels in active life at making masterful plans and needs autonomy. The “SP Artisan” temperament excels at masterful execution and needs freedom. The Hayek-Mises knowledge / calculation debate regarding socialism can now be seen in a new light. Hayek argues that if everyone were a perfect Rational, having a complete and infallible plan of his life and the lives his descendants, even then a central planner could not gather all the dispersed knowledge of each individual’s own personal plan. A socialist can reply to that that human plans by necessity conflict, that this friction is entirely unnecessary, and that the development of a command economy will be perfectly coordinated. Hayek’s defense would seem to be to argue that the enormous state conglomerate that tries to produce everything would be too

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complex for any one central planner to run successfully. Nor, he would continue, could the planner delegate some of his work to lower managers; as Mises argues, “the managerial system, i.e., the assignment of ancillary tasks in the conduct of business to responsible helpers to whom a certain amount of discretion can be granted, is possible only within the frame of the profit system. … In a socialist system… there is no room left for managerial activities either.” (1996: 859-60) An alleged manager under socialism would rather be a bureaucrat, with the result that any freedom granted to him would impair the central plan and sabotage its execution. Regarding the “calculation problem,” the vastness and interconnectedness of the economy ruled by the central planner would necessitate that improvements to this economy be made sequentially, one successful new project after another. On the other hand, the market improves in parallel, that is, many orders of magnitude faster. If the planner attempts multiple changes in resource allocation at the same time, the result is straightforward “planned chaos”; the planner is lost in too many possibilities. The market utilizes persons of the Artisan temperament wielding their unpredictable yet intelligent entrepreneurial powers in competition with each other.10 It is true that such competition will make each moment surprising and dumbfounding for all concerned, possibly upsetting their best laid schemes. But it will also determine the fastest way of satisfying consumer welfare, as everyone tests himself against everyone else. This mutual adjustment, innovation, and imitation make up the awe-inspiring market process. In the free market, an entrepreneur is still 10

It is an intolerable state of affairs how poorly people of different temperaments understand and appreciate each other. While Mises also refers to “ideal types,” Keirsey’s (1998) disquisition on the four temperaments, from which the terminology in this chapter is taken, is generally unparalleled in quality and detail. In other words, the old Greeks who thought that everything in the world was made up of four elements, earth, air, water, and fire; Aristotle who identified the four types of causation, material, final, efficient, and formal; the four cardinal moral virtues; Ez 1:10; St. Irenaeus who suggested that “the living creatures are quadriform, and the Gospel is quadriform” (Against Heresies, III, 11, 8); Thomas Morris’ understanding of the four “dimensions of human experience,” moral, spiritual, intellectual, aesthetic (1999: 101); the present-day personality theory that argues that individuals are born already specialized in one of these four dimensions; and numerous other references, both ancient and modern, to the number 4, are clearly on to something.

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under the necessity of projecting his future revenues, but he can calculate the present costs. Under socialism, the planner has no access to present costs, because the price system can arise only out of entrepreneurial competition. The price system is an emergent property of the market. Joseph Salerno explains: “In this competitive process, … there thus comes into being the market’s monetary price structure, a genuinely ‘social’ phenomenon in which every unit of exchangeable goods and services is assigned a socially significant cardinal number and which has its roots in the minds of every single member of society yet must forever transcend the contribution of the individual human mind.” (1990) In stressing that the market is a process, I argue that it is in a flux, moving from some state A to state B. But the price system can be thought of as the market’s “identity,” the “soul” of the market, its actuality, what it really is at any given moment. This makes socialism “spiritual death.” Hayek may have adopted the neoclassical viewpoint that any improvement is already part of someone’s plan and foreseen in advance. For Hayek, the future is written, and the only difficulty is getting reliable information on who is planning what. Perhaps, both approaches can be combined with each other, delivering a death blow to the socialist idea. Since both the Rational and Artisan aspects of entrepreneurship are enjoyed, there are two distinct kinds of pleasures or optimal experiences. For Rationals, the pleasure is called “success”; for Artisans, it is called in modern psychology “flow.” The former is rooted in a timeless plan, wherein the achievement and profit are contemplated even in midstream, with the costs in the past, and the benefits still in the future. The latter is a self-forgetful activity that is performed and enjoyed for its own sake with no external goal attaching to it, that requires maximum utilization of one’s powers, intense concentration, rapt attention to the task at hand, and full self-giving. Flow is the state athletes call “being in the zone.” It is a conscious, almost perfectly self-controlled of both one’s thoughts and body yet allowing one’s training and “muscle memory” to guide action, low anxiety (i.e., fearless) feeling. It is an act of competent playing. Sometimes flow takes the form of a calm and dreamlike yet intently focused state. Other times, one is able to act and react lightning fast and make split-second decisions correctly yet often not even remember the details of the performance afterward. Rationals see the entire algorithm from beginning to end. Artisans live in the moment. An NT person can accuse an SP of not seeing the forest for the trees; a counter-accusation might be that the NT will fold the moment something that he did not anticipate arises and ruins his plans. But a team of NT and SP business leaders together can

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do wonders. The Artisan-Rational complementarity at work is due to the distinction between creativity and ingenuity. The essence of the former is breaking the rules. The essence of the latter is discovering more rules, according to which the world works, and putting them to use. The Rational motto is: “Nature, in order to be commanded, must be obeyed.” The Artisan motto is: “I make my own nature.” For Artisans, the moment lasts forever, so to speak, and they tend to enjoy life to the fullest. But enjoyment of an action requires its mastery. And achieving mastery takes a large amount of practice. That Artisans are mindless “sensation-seekers” is a grotesque calumny; they seek joy in perfected activity. The end is pleasure in action; the means is practice. For any temperament, there is motion from what is, such as incompetence, to what ought to be, such as mastery. But here, the means, practice, is simply performance of action when it is not yet fully mastered. Thus, at the beginning, practice is painful, because the Artisan often fails. He is clumsy, unartistic, awkward. But as he progresses, even practice becomes pleasurable, insofar as it comes to resemble fully perfected skill. For the Artisan temperament, the distinction between means and ends does not exist; means morph into ends smoothly and imperceptibly. A Rational person may thus assume that in climbing a mountain, getting to the top is the end, and the efforts and danger and trials and tribulations of getting there is a costly means. An Artisan would laugh at this blind misapprehension. For him, the process of climbing is the end, the fun part, an exercise of graceful power right here, right now; arriving to the top is a disappointing termination of a joyful activity, a rush, an exciting virtuoso performance and expression. Therefore, Mises’ “human action” is only (temperamentally) Rational action. This is not to impugn the theory but to acknowledge its limitations. We may think of it this way: every challenge presents one with opportunities for self- and world-making. In doing so, one must pay two kinds of opportunity costs. First, in becoming A and enjoying α, one forgoes becoming B and enjoying β. Second, one forgoes just sitting there and quickly dying, figuring that life is not worth the effort. Thus, Crusoe labors to produce basket of goods {A, B, C} and in so doing, decides against both producing baskets {B, Q, P}, {L, M, N}, etc. and not suffering the exertion of work at all. We should thank our lucky stars that, remarkably, the world is structured in such a way as to allow one not to notice the disutilities of a) labor, b) waiting, c) fear of surprises, as one works toward achieving

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a goal, by means of enjoying the work or “being one” with the work, self-forgetfulness, loss of self-consciousness, and like properties of flow. Work still has disutility: it is a cost to be minimized; but given that, it is joyful. The second opportunity cost need not, with proper training, be paid at all. If not admitting Artisan courage impels the mind toward socialism, then a contrary fallacy might hold it that people are woefully imprudent (or irRational) when it comes to investing. Some economists theorize that, like lemmings, people follow each other’s lead. Others charge that in the presence of a promising new technology, folks become like maniacal wildmen in throes of “irrational exuberance.” Such contemptuous views of human nature have little to do with reality. It is true that during the boom phase of the business cycle, people seem to abandon common sense, but they can scarcely help it, given that the economy is overflowing with cheap credit. An exciting new technology is merely icing on the cake. Normally, however, the market quickly dispatches the “lemmings.” A more apt metaphor would be that such investors resemble half-blind rabbits who venture into the forest full of wolves who see the slightest move in the dark. They will never know what hit them, as the more perspicacious fellows leave them utterly confused as to what is going on. Their capital will be lost in foolish projects that would never have attracted the attention of superior entrepreneurs and speculators. In fact, in speculating, the greatest error is to do what everyone else is doing. Entrepreneurs are the driving force of the market. They lead; they do not follow. They foresee the future better than their duller fellows and uncover profitable opportunities of which no one is yet aware. Rabbits had better stay in their holes. Consider that, stripped of all details, Schumpeter’s theory of business cycles centers on a new technology inciting the appearance of numerous entrepreneurs. There is no doubt that this occurs. However, the fractal-like spread of new entrepreneurs and new production endeavors in the economy coincides with a parallel spread of losses, bankruptcies, and declining production elsewhere. In all likelihood, the expectations of higher profits similarly will be counterbalanced with expectations of losses: most entrepreneurs can smell threat easily. It is true that old businesses may not shut down immediately, being in possession of quasi-rents for capital goods that are owned, specific, and hard to sell, accumulated cash, and access to credit.11 But these will not last long

11

Quasi-rent is income derived by an entrepreneur from employing a machine in production in excess of the machine’s opportunity cost, that is, what

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(e.g., quasi-rents will subside, as machines are not maintained; credit will dry up, as investors seek higher capital gains with the newcomers); and at any rate, losses are seen immediately: first, from the draining of factors, and second, by a shift in demand. There is no deadly illusion that scores of entrepreneurs can all succeed at the same time. Therefore, Paul Davidson’s (2009) belief that the free market “works,” only when people are assumed, as per the ergodic hypothesis, to be omniscient, is absurd. This hypothesis is, indeed, a sign of the neoclassical economists’ disdain for reality, and defenders of the market have no need to resort to it. They are fully aware that the market does not protect from misfortune, sickness, death, and so forth, and most important, entrepreneurial errors. It is not the case that the market works because all humans employ perfect reasoning. I would argue the opposite: that to err is human, but the free market provides the best and quickest feedback to those who have made mistakes. Hayek illustrates this point by calling the “true” individualism, “the antirationalistic approach, which regards man not as a highly rational and intelligent but as a very irrational and fallible being, whose individual errors are corrected only in the course of a social process, and which aims at making the best of a very imperfect material.” (1948: 89) In order for there to be society, it is sufficient that people be endowed with ordinary prudence. Superhuman prudence would be useful but is not required. In addition, the market does not “solve” “economic problems,” let alone “all” economic problems. The free market is a process of entrepreneurial discovery, competition, and local and global improvement. A “problem” is a thorn in the flesh of an otherwise coherent system. Without the market, there is no system in the first place. One might praise a city ordinance mandating minimally effective procedures for trash disposal in every community for solving the problem the market lets fall through the cracks, namely, negative externalities to every citizen from garbage that piles up in an improper location. The externality its owner can get by selling the machine or renting it out to another entrepreneur. Quasi-rent is not yet profit, because profit is obtained by tallying up all the costs and revenues. A good may yield an MVP well above its cost to the businessman, but overall, the company may be taking a loss. It may easily happen that if the money spent on a machine is counted, then by remaining in business the entrepreneur will lose money; but if it is viewed as a sunk cost, then profits can be made; and finally, keeping producing will yield a higher return than attempting to liquidate the assets. In such a case, the owner of the machine will continue operating despite losses.

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is a tiny flaw in an otherwise fully serviceable process of present production and future improvement in production. Without the market, there is no trash, but only because there are no goods which generate trash. There are scarcely people who have to dispose of trash, because only the market allows human population to grow exponentially. The market is not even a “system,” as if it could be tinkered with at the economist’s will, but an organism, a living process of social cooperation. We either have the whole thing or nothing at all. A market sickened with government interventions eventually dies. Davidson makes it appear as if advocates of freedom are unhinged utopians, thinking that perfect happiness awaits all people the moment the market is fully enabled. It must be satisfying for our author to fight against such scandalous straw men. What await all people under unhampered free market are merely rationality in economic calculation, a non-self-contradictory government policy, if we admit the need for government on some level, and the fastest possible rate of advance in the standard of living. It is only if the “problem” is phrased very generally as “locate the best system of social organization” that “laissez-faire” can be the answer to it. Entrepreneurship, thus, incorporates both strategy or long-term planning and tactics or thinking on one’s feet. What can be predicted (or assigned probabilities to), one ought to predict; what cannot be predicted, one ought to handle with the opportunism of a champion football player, the effortless quickness and grace of a predator, and the instinctive skill of an intrepid master hunter, as it comes upon him and better than his competitors handle it. The live-in-the-moment, on the edge mentality which is able to take account of one’s surroundings instantly and accurately and make decisions on the spot belongs to the genus of the virtue of fortitude. There is in the economy both risk, tractable though knowledge and understanding, and scary surprises that the fickle fate can throw at a person at any time. Prudence and its related virtues and acts cope with the former (whatever the scope of prudence is for any given entrepreneur, it covers everything that might affect his business either positively or negatively); fortitude, with the latter. 14. OF THE STRANGE CASE OF NEOCLASSICAL “RATIONALITY” In his book Price Theory: An Intermediate Text, my favorite neoclassical David Friedman defines “rationality” as application of correct means to human ends. He further assumes that people are

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“mostly rational.” Using incorrect means, Friedman argues, often results in personal misery or death, e.g., for a person who fails to realize that refusing to eat will kill him. Similarly, entrepreneurs who do not correctly satisfy consumer desires lose money and eventually go out of business. There is an evolutionary selection process at work which causes individuals who err often to gravitate toward the margins of society or disappear altogether. The usefulness of this assumption is alleged to lie in the ability to predict human behavior. This is because there are, Friedman writes, only a few correct means to any given end and a veritable infinity of means that fail to lead to the end sought. Assuming that people are rational is a good idea, because we eliminate from consideration the multitude of irrational actions. For example, let it be that a person makes correct decisions half the time. If we assume that he is rational, then we will be able to predict his behavior 50% of the time (supposing that there exists only one best means to his end; the other half the time he will do something unpredictably shocking). If, on the other hand, we assume him to be irrational, then we still will not know which irrational thing he will do next. Is Friedman’s assumption of rationality justified? I reckon that it is neither true nor useful. Acting individuals and entrepreneurs do make mistakes, because each moment offers a variety of unpleasant surprises to them from their rivals, and lose in the competition. The nature of reality, indeed, is such that errors are penalized. But the disincentive to making errors does not eliminate errors entirely. Nor is it possible a priori to predict who will act successfully and at what endeavors. Further, as argued in previous chapters, there is no such thing as absolute efficiency. It is the essence of entrepreneurial ventures to discover new ways of attaining monetary or psychic profit. What is efficient at one time will be revealed to be inefficient at another. Once a new plant opens, or a new technological process begins operating, everyone will see that the old way of doing things is surely inefficient and requires adjusting. It would appear, then, that just prior to the introduction of the innovation that is destined to be successful (though we cannot know that beforehand), everyone was acting irrationally. Friedman’s economics leaves no room for entrepreneurial action and therefore, for (quite unpredictable) changes in what is efficient. In other words, in our dynamic reality, it is actually easier to predict how one will err, namely, by sticking to the same routine, than to predict how others will succeed, namely, the innovations that are in the works. The Austrian concept of rationality as purposive behavior is more reasonable, because even if the means chosen are not the most

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efficient ones or fail to secure the end at all, the economic consequences of an attempt to use such means do not change. Suppose that the shaman of a primitive tribe is doing a ritual dance, hoping to procure rain. That his actions are futile is irrelevant for the determination of the barter price of the special garb that he buys from the tribe’s tailor that the shaman feels he needs to execute his dance properly. Or that a businessman buys an expensive piece of equipment which turns out to be useless to him makes no difference to the fact that he may have bid up the price of this equipment on the free market. Or, again, Friedman makes no provision for the frequent phenomenon of entrepreneurial failure, one of the economic consequences of which is that the labor and capital tied up in unsuccessful projects are freed up to be used elsewhere in the economy. For such a failure must be a consequence of “irrational” actions, yet it happens all the time. In other words, within market competition, those entrepreneurs who win will turn out to be more “rational” that the others who lose. What is rational to do depends on what other people are doing or planning. Market rationality is not a method of production, in which combining factors 7L + 4M + 10N successfully yields product P, predictably and mechanically; but making provisions for future needs which other entrepreneurs have to their own ruin overlooked. The only way of making a profit is precisely to foresee the future better than “the market,” to be more rational than most other market agents. Even Keynes says as much on p. 170 of General Theory. Assuming that all people are rational in some overarching sense is profoundly unscientific. The same goes, of course, for taking this understanding too far and calling everyone “irrational.” Mises points out: if the mere fact that a man shares erroneous views and acts according to his errors qualifies him as mentally disabled [or “irrational”], it would be very hard to discover an individual to which the epithet sane or normal could be attributed. Then we are bound to call the past generations lunatic because their ideas about the problems of the natural sciences and concomitantly their techniques differed from ours. Coming generations will call us lunatics for the same reason. Man is liable to error. If to err were the characteristic feature of mental disability, then everybody should be called mentally disabled. (1996: 185-6) Humans are rational insofar as they seek their own happiness.

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Whether or not they seek it “to the best of their ability” or “efficiently” or “wisely” is not for the economic science to inquire or assume. A second surprising assumption Friedman makes is that human ends or preferences or purposes, in order for economic analysis to proceed, have to be “simple.” Why is that? The answer, similar to my previous considerations, is that easily grasped preferences allow one to predict how human actions will be shaped by incentives. Thus, if the government wants people to have more children, then they assume that subsidies to parents in the form of money will, indeed, cause more children to be born, rather than some crazy result like that people will go out into the sea and kill more walruses for their meat. Or, if the government wants to create a boom-bust cycle, then it will depress the interest level below its natural value for a prolonged period of time. As a result, entrepreneurs will invest more money into early production stages, rather than, say, go out into the sea and kill more whales for their blubber. That is the point of the assumption of simple preferences in neoclassical economics, because, otherwise, we cannot predict how each person’s or a group of people’s behavior will react to marginal incentive changes. This reflects the neoclassicals’ empirical bent. There are two grounds for admitting only simple preferences. First is to be able to reason like this: “People want money; therefore, if I want them to do anything for me, I’d better offer them some cash.” Second is to be more precise: “If I give Smith $100, then he will agree to do for me this and that.” In both cases, Friedman is stuck in the 19th century, when “political economy remained a science of the ‘economic’ aspects of human action, a theory of wealth and selfishness. It dealt with human action only to the extent that it is actuated by what was – very unsatisfactorily – described as the profit motive, and it asserted that there is in addition other human action whose treatment is the task of other disciplines.” (Mises 1996: 2-3) For Friedman, “simply” stuffing one’s face with lard (or perhaps, only with that amount of lard that Friedman himself consumes) is the only rational thing to do. Insofar as men want other things, their strange interests are outside the domain of economics. But quantitative relationships are economic history unfit for predicting the future with any precision. Even economic history must be enlightened and interpreted by theory; otherwise, the data will shed no light on the events which the historian wants to explain. This is because the data must be appropriately selected, and even then multiple and often mutually incompatible accounts may seem to fit it. Conversely, the most economic

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history can do is illustrate economic theory. No theoretical conclusions can be drawn from statistical or econometric analyses. I can imagine Friedman’s encountering an unusual sexual preference in lady Smith. Now normally, our author is in awe of his own cleverness (e.g., to teaching people economics, he prefers to teach them to “think like an economist,” apparently aiming to mold the hapless students’ minds in his own image and likeness). This time, however, as he is trying to wrap his mind over this complex outrage, asking Smith to explain to him the meaning of her behavior, she rebukes him with “Don’t knock it till you’ve tried it, honey.” The idea of simple preferences may have emerged due to the penchant of neoclassicals for using indifference curves and cardinal utilities. This obscures the distinction between entrepreneurship and economics. As an entrepreneur, one is perfectly able and, in fact, required to distill utility juice from goods and satisfactions. If A is preferred to X, and Y to B, then which package is preferable, (A, B) or (X, Y)? One may have to reduce each combination to some common denominator. In other words, one would find the marginal pleasure of upgrading first, X into A and second, B into Y and compare them. And one can do this both for oneself (e.g., a traveler may need to decide between a better airplane seat or better hotel room at the same price) and for his customers (e.g., a businessman needs to figure out whether spending an extra month on polishing the product is justified by the expected revenues). But this is one calculation that economists – as cold scientists – are not allowed to perform. They deal with human nature not with individual human beings. They have general insight into what make man as a species tick. They offer no insight on what makes Smith or Jones each with his unique personality and intelligence tick. Economists start with the proposition that man makes choices, and choice is expressed in ordinal notation: A is preferred to X, etc. By how much A is preferred to X is different for each person, unknowable without the ability to see individual souls, a kind of discernment of spirits, and incommensurable without love. But in his capacity as an economist, one does not spend his time peering into people’s souls or perfecting his charity. For that reason, cardinal utilities are disallowed in economics but are the stuff of life for entrepreneurs. Friedman neglects the obvious point that entrepreneurs continuously synthesize new products and services and make old ones more affordable. This allows consumers to discover new preferences in their hearts. The very process of growing up involves finding out one’s interests and building up one’s taste and discernment. Who could be so vain and arrogant as to demand that people fit into the Friedman’s

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Procrustean bed? It may be objected that in private lives, too, we try to guess people’s ends and seek to change their behavior through incentives. A credit card company imposes a penalty for late payments; this is a way for it not of making money but of getting people to pay their bills on time. A parent tells his child that if he misbehaves, then he will be grounded, another incentive. Fine. But that is not what economics is all about. Economics aspires to discover certain immutable laws that are valid everywhere and at all times, derivable from self-evident axioms, though with some extra empirical premises thrown in. The law of returns does not change with the passage of time. The Austrian business cycle theory, the law of comparative advantage, the consequences of price controls and other government interventions have little to do with empirical studies of how incentives affect human behavior. The theorems of economics are deduced from a priori premises. E.g., the problem of socialism is not just what incentives the central planners will need to institute to get people to take out the trash. It is also the impossibility of calculating profit and loss and therefore, of knowing whether the planners’ actions do or do not fulfill the most urgent desires of the consumers. Even if all the proper incentives are magically put in place, socialism still will not work. Consider that basic economics assumes that property rights are fully enforced; in fact, no one cheats. If Smith exchanges a cow for a Jones’ horse, then both get their goods. But this assumption is false in the real world. Justice is expensive; trustworthiness needs to be signaled; etc. Economists sometimes argue as follows. Why do banks charge higher interest for loans to people with poorer credit ratings? After all, paying off borrowed money is a contract breaking which constitutes fraud, a social injustice. One ought to pay his debts, whether he likes it or not. Well, some people default or declare bankruptcy, thereby being unjust. What are the banks to do? In a similar vein, why do (or did under sound money) banks invest into beautiful facades of their branch offices? Economists reason, in order to persuade the potential customers that they are rooted and respectable members of the community, that they expect to stick around for a long time, that they will not take their money and run. Notice, however, that these economists did not invent or predict these practices. Entrepreneurs invented them, and the economists merely retrodicted them, showed how they are in the interest of certain market actors. In so doing, they liken themselves to Darwinists who “explain” every biological machine by calling it “well adapted.” For such

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economists, whatever is, is ipso facto efficient. Now obviously, this is absurd. Even on its own terms, any social or business practice could actually be a destructive “mutation,” a maladjustment on its way out. Moreover, unlike biological organisms, social and economic institutions “evolve” extremely fast, and we can observe this evolution happen, such that the current practices will probably be replaced with something much more “efficient” down the line in the coming months or years. If economic retrodictions are merely amusing diversions, and if economists are too shut in their ivory towers to advise actual businessmen, then what should economists do? An economist can note that trust is scarce, but he can only point to how banks try to signal their stability and honesty as a present imperfect example of such signaling. So, first of all, economists should show the ability of entrepreneurs to solve their problems and improve their ways of doing business without any input from the economists some respect. Economics is empirical, insofar as economists almost never devise brand-new forms of social cooperation with the help of their own mental powers (building up utopias from ground up is no longer respectable) but rather observe them in society and study what they thereby uncover; but it is a priori, because the economist proceeds to prove that one such form A is less efficient than form B by following economic logic with his mind’s eye wherever it leads. Once the strict separation between economics and entrepreneurship has been established, our science should be confined to cataloging precisely errors, practices, whether business or especially governmental, that do not work or have been revealed as comparatively inefficient. A great deal of economic theory and policy counsels draws upon a record of failures enlightened by rigorous explanations for why these failures occurred and would occur again if tried. Economists should have very long memories and should bear grudges against bad ideas. Solving puzzles that require one correctly to assess the incentives to actors is, indeed, useful for optimizing punishments for crimes for governments, making sales projections in business, and any endeavor that depends on good understanding of actual people. But these things are far from the whole of economics. In imagining humans to be rational, Friedman fails to grasp entrepreneurship; in imagining preferences to be simple and predictable, he confuses economics with entrepreneurship! Even in the latter, divining consumer preferences is a nontrivial task. Risk of disappointing one’s customers always hangs over the heads of entrepreneurs, and there is no simple way of eliminating it. But does not Austrian economics assume also that, for example,

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if the price of a good goes down, then the quantity demanded will rise rather than fall? The regularity just asserted holds, but it is not at all an assumption. Rather, it is a derivation from the law of marginal utility. I will have more money in my hands due to the fall of the price at the old quantity demanded. So, I now have the job of allocating this extra cash. I can buy more of the same good, or I can spend my money elsewhere. My lower-ranked desires will now be satisfied. And we do not have to assume that these desires are “simple.” They can be anything. I may want to give the money to charity; I can rent a boat and go out into the sea and kill some walruses and whales; I can burn the money on the front yard, if I so choose; only if I think of money as an economic bad, will I be glad to pay more for less, but even this preference, still on my values scale, is not exempt from any economic laws. In a debate, Friedman attempted to counter this analysis as follows: Suppose that consumers dislike the idea of consuming the services of low paid workers – tastes, after all, are neither rational or irrational. Further suppose that consumers have no low cost way of determining how much a particular worker, say a waiter in a restaurant, is being paid, so individual employers don’t have the option of paying their workers more in order to appeal to their customers’ preferences. The minimum wage is increased. Customers now know that workers in various low skill industries are being paid more. So the demand for the output of those industries goes up. Employment goes up instead of down. It doesn’t strike me as a very likely story, but it isn’t logically impossible and without knowing some facts about people’s tastes you can show it isn’t true. That’s one example of my more general point. As long as you are completely agnostic about utility functions and production functions, neither of which is given by economic theory, any behavior can be explained by some assumption, possibly an implausible one, about what those functions are. The particular example of the effects of minimum wages that Friedman uses is illegitimate. The reason is that economics presupposes that people neither hate nor love each other as perhaps some ends in themselves. Instead, each person considers every other person and by extension society as a whole to be a special tool that he can use to further his “self”-interest. In making use of other people, one (Smith) realizes

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two things. First, that human nature is distinct from the nature of rocks and machines. Second, that other people think of him in turn as their own tool and would not allow Smith to privilege himself in such a way that Smith can use them but they cannot similarly use Smith. E.g., this symmetry means that any exchange benefits not only Smith but the other exchanger, as well. Insofar as Smith derives pleasure from watching low paid workers get higher wages, he ceases to treat other people wholly as means to his own ends. We can speculate why he holds such valuations. He might consider it a holy moral duty on the part of the employer to pay his workers more. He might prefer greater equality. He may be an advocate of a “living wage.” But any answer will betray in him (in our case illusorily) a higher humanity in a manner of speaking in which other people are now more than merely some peculiar devices whose most efficient use is described by economic theory. In other words, economics is a science of social cooperation. But the cooperators are equal in status and indifferent to each other’s welfare. Friedman’s example violates this last assumption. Let Smith give Jones a gift G. Smith agrees to let Jones allocate G according to Jones’ own values. Jones decides what to do with G. But why would Smith part with the item, unless Jones’ pleasure were in some way his own, unless Jones’ values were his, also? Only if Smith loved Jones. Love’s effects are union, mutual spiritual indwelling, or, in economics-speak, a merging of individual values scales. Jones is part of Smith. When Smith loves, the beloved’s values are his, and vice versa if the love is requited. There is an intertwinement of wills. (Such a union obviously does not entail that property ought to be communized.) It follows that if we allow love of friendship in economics, where people’s values are shared, then we have to ditch methodological individualism. And that is far more trouble than it is worth. Hence, the assumption. Regarding Friedman’s general argument, notice how his mechanical view of humans – everyone responds to incentives the same way, namely, “rationally,” whatever that means – coexists with unbridled psychologism, namely, a belief that there is “behavior” out there that calls out to an economist to be “explained.” At times, the latter is true, as with my example of banks and their facades. In (I, 18), I retrodict Bitcoin in an attempt to show how it managed to stake an initial claim to being a medium of exchange, an invention I could never have foreseen beforehand. Or, I have heard it suggested that the cruelty of medieval Japan could be explained as a form of institutionalized population control in an isolated pre-capitalistic

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island civilization where scarcity of resources was felt particularly pointedly. I agree that all these can be entertaining and instructive exercises. These, however, is all they are; they are not economics. The Austrian school falls prey to neither of these errors. People “respond to incentives,” i.e., act, in a kaleidoscopic variety of ways which it is unfitting and presumptuous to classify into “rational” and “irrational.” Our definition of rationality is again more general. Economics studies purposeful actions that combine as if in a package (1) a desire to be satisfied or an end to be pursued, (2) a plan, and (3) the plan’s execution; and refrains from studying anything that is missing at least one of these components. “It is the merit of psychoanalysis,” proposes Mises, “that it has demonstrated that even the behavior of neurotics and psychopaths is meaningful, that they too act and aim at ends, although we who consider ourselves normal and sane call the reasoning determining their choice of ends nonsensical and the means they choose for the attainment of these ends contrary to purpose.” (1996: 12) If economic laws are to fulfill their nomological function, i.e., if they are to be laws, then they must describe a wide variety of situations that involve humans who “economize.” But each human being has an interesting personality that causes him to act differently from the rest of his fellows. (Sometimes a personality is an integrated whole; other times it is chaotic heap or swarm of arbitrary desires; regardless, it is unique.) Economic laws then cannot be expressed in reference to any particular personality. Friedman the neoclassical dimly understands that but, unable to let go of his empiricism, reduces the influences of personality on actions by considering only “rational” personalities and “simple” people, affirming after all that all people are pretty much the same. The Austrian school avoids both the disease of wild psychologizing and the grotesque cure for it, namely, the flattening of human individuality and dismissal of the contributions of actual psychology in all its complexity and controversy as a full-fledged science distinct from economics. If I were to psychoanalyze Friedman, I would test for whether he was a narcissist who, unable to understand other people or reconcile himself to human diversity, desired that everyone shall become just like himself. After all, not only is Friedman a “rational” individual himself, but he studies human rationality and is therefore a kind of “scholar of scholars” who is superior even to a run-of-the-mill “rational” person in much the same way as a civilized anthropologist is superior to the people of a more primitive culture he dispassionately – yet with certain inevitable slight contempt – scrutinizes. Who wouldn’t want to be Friedman! There are other consequences of neoclassicism, whether tragic

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or comic is for you to decide. In the novel The Phoenix and the Mirror by Avram Davidson, the main protagonist Vergil is considering his day as he is falling asleep. One of his thoughts is: “What did the proconsul hope to find in Egypt – rest? Plunder? Wisdom?” I remember finding this a memorable sentence: at least some fiction, I reflected, had characters whose motivations were more interesting than those of typical cardboard “heroes.” Friedman’s economics trivializes not only actual life in all its complexity but good works of art, as well. Second, the simple desires are shared by all of Friedman’s Homo economici, and no non-simple desires are admitted. In order to make use of these desires in teaching economics, it is necessary to assume that they can be satisfied through exchange. But that entails that everything – and by extension everyone – has a price. No wonder economists are stigmatized as people who know “the price of everything and the value of nothing.” A notion of such cynicism is another reason why I am not a neoclassical. In sum, economics is not quantitative prediction. Nor is it a game or puzzle-solving. Hence, neither of the Friedman’s two assumptions, viz., of “rationality” of economic agents, whatever that means, and of the simplicity of preferences, is necessary. 15. THAT HOARDING IS DISTINCT FROM CONSUMPTION AND INVESTMENT

The distribution of both money and real wealth in the market economy is not arbitrary but reflects consumer decisions of which entrepreneurs and factor owners should profit, and therefore, (1) which entrepreneurs should own the means of production, and (2) which factors should be remunerated and how much. The pattern of ownership of cash is past-oriented. It can be used to find out who up till now has been successful at making consumers happy, and who has not. Remember that personal wealth is a consequence of superior service to the people in their capacity as consumers. I wonder whether the most successful people who have devoted their lives to business view the money they earn as sort of achievement points. They will not refuse themselves luxury goods, but increasing their net worth is almost a game to them. As far as games go, this one is profoundly socially virtuous. It is a curious fact, however, that all times have relevance for the distribution of money and non-money goods. Insofar as entrepreneurs save or take out loans for investment purposes and advance present goods to factors, there is a future-oriented

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aspect to possession of money capital and goods. The arrangement of ownership rights reflects entrepreneurial expectations of future prices. The reason why one owns money and goods is not because he “deserves” it (that is, has earned it but not yet spent it), but because he is hoping to make a profit in the future. Ownership provides information about people’s plans of organizing productive activities. Since the execution of any action takes place in the present, and since any pleasure is momentary, in the here and now, the ownership of wealth in the wide sense of the term as store of value is also presentoriented. It is a consequence of (a) who is enjoying now (b) what goods (including financial security from hoarded money); and the supply of and demand for these goods in the immediate past. Finally, the entire money supply is at every moment owned in various amounts by different people. (α) Money need not be produced, since any amount of money is socially optimal; though changes in the money supply have diverse consequences. (β) Money stays “in circulation” for no more than a moment and is then redeposited into the seller’s bank account. From the point of view of the entire economy, money ownership is timeless. Here be dragons, for the monetary authority, such as a Central Bank, may imagine that, on this stance, one pattern is as good as any other. It may derive from this timeless facet of money the false idea that money is economically neutral and use it as a pretext to justify its manipulation of the purchasing power of cash balances. It will be useful to consider three scenarios. The first will involve Robinson Crusoe alone on his island. Suppose that Crusoe wants to make a boat. However, at present, he cannot devote all of his efforts to this task, as a more urgent need, namely, to feed himself, is pressing on him. What he can do to solve this problem is catch more fish than is necessary to assuage his hunger and save some of them. The work can proceed in two ways. One possibility is that every day Crusoe dries a few fish and eventually stockpiles enough of this consumer good to sustain him through the project. Then he abandons fishing altogether for the duration of the time necessary to build the boat. In this case, there are two time periods that must elapse, before a future good is produced: the time it takes to save, and the time it takes for the good to mature or be created with the help of the savings. This distinction will be crucial in the discussion of interest rates which begins in (I, 40). Alternatively, Crusoe can split each day between fishing and working on the boat. Regardless of how he chooses to proceed, he is sacrificing present consumption, whether of fish or of leisure. Crusoe may decide to consume so few fish that he goes to sleep still hungry, all in order to speed up his boat-building or shorten the time he has to wait before starting work.

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Schumpeter puts it this way: for Crusoe “the function of his saving is to raise him above the necessity of submitting to daily drudgery for the sake of his daily bread and to give him breathing space in order to look around, to develop his plans, and to secure cooperation.” (2008: 16) This is close, but no cigar. Crusoe had better formulate his plans before he begins saving (and an entrepreneur in a real economy, before he takes out a loan and subjects himself to interest expenses); otherwise, if no opportunities can be detected, then Crusoe will find his efforts wasted. The way to salvage Schumpeter’s proposition is to call the savings a “hoard,” while they are being accumulated, and an “investment,” after some kind of plan is worked out. Hoarded money is insurance, to be spent for an undetermined purpose at an undetermined time. When these potentialities harden into something real, the money may well be invested. An implication in a real economy of Smith’s buying a hammer and other tools and using them to build a ship and then selling the ship to a customer at a monetary profit is that the hammer, etc. were undervalued. This is very similar to Crusoe’s reallocating the hammer from busting open oyster shells to building the boat. Crusoe realizes that he has not been using his resources in the best possible manner, that only now has he perceived an opportunity to make himself better off, and that a more urgent goal can be achieved with the same means (namely, the hammer), and therefore, greater profit, realized. Of course, Crusoe judges his own ends, whereas an entrepreneur within a sophisticated economy must judge the ends of other people, the consumers, but this difference is conceptually minor, having to do with the amount of risk involved. Let me emphasize the following proposition: [I] when Crusoe saves, he saves actual consumer (or capital) goods which have full usevalue for him. By the time he is ready to invest, he has accumulated real wealth. The second scenario is direct exchange between Crusoe and Friday. Both men specialize and produce both for themselves and for each other. Suppose (again) that they exchange fish for berries. Here a part of the Crusoe’s supply of fish has no use-value but only exchange-value. [II] He accumulates wealth, but it is no longer wealth that he can himself exploit. Suppose that Friday has been consuming Crusoe’s fish for a year in exchange for his prize pig. Crusoe had demanded that Friday fatten up the pig during all that time. What happens if, when the time comes to part with the pig, Friday refuses to let go of it? To be sure, that is fraud on his part. But it also means that social cooperation has broken down and may easily harm Friday in the long run. The benefits of the division of labor are not exhausted with a single exchange, which means that it

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may be in Friday’s interest to pay up. Crusoe and Friday benefit from continuous association, despite the fact that their actions must now be coordinated, inasmuch as they take one another into account in their plans. Life is more complicated, but they eat better. The third scenario is a modern economy with indirect exchange. Here, the difference between Crusoe economics and real economics becomes evident. [III] For Crusoe saves wealth, while Smith, if he saves, saves money. But money is not wealth; it does not represent wealth, etc. What is going on? It seems at first glance that I might argue as follows. There is in the first place symmetry between Crusoe and Smith in their capacity as savers. They sacrifice first and benefit later. It looks, however, as though by the time enough savings have been accumulated, Crusoe has his fish, while no new goods seem to be present in the monetary economy: they have all been consumed! It is true that the matter partially comes down to justice: Smith has so far sacrificed and allowed other people to benefit from his frugality; so, now Smith “deserves” to reap the benefits of his prudence by purchasing some expensive item with the cash he has amassed. In this process, other people are “hurt,” because he takes something valuable off the market, but they were compensated for that in the past. Saving in an economy with indirect exchange may be construed as a property rights issue. It effects redistribution of wealth that nonsavers enjoy from the future into the present, for as long as saving is going on. Smith’s accumulating a cash balance results in more goods per consumers that might otherwise have gone to Smith, until the savings are spent. But what is the social purpose of saving? To put it another way, when I produce and receive income but save some or most of it, the same amount of goods produced during the time while I engage in saving accrues to fewer consumers, precisely because my saving is abstention from my consumption. (The number of consumers is fewer by exactly one.) This means that the prices of those goods were lower than they would have been, if I had decided instead to stop saving and spend and compete for those goods on the market, thereby bidding up their prices. Supply is high (because I keep producing), while demand is low (because I am not spending the money I earn), resulting in lower prices. The more is saved, the smaller the amount of money that is chasing the same number of goods, resulting in perpetually lower prices, until the savings are unloaded. This reasoning is sound, if the savings are simply hoarded. Keynes writes that when there is saving, there is “a transference of consumption from the savers to the general body of consumers, and a

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transference of wealth to the savers from the general body of producers, both total consumption remaining unchanged.” He obviously means that goods are transferred to consumers, and money is transferred to savers. “There is no increase of wealth in any shape or form corresponding to the increase in saving; – the saving has resulted in nothing whatever except a change and change-about between those who consume and between those who own titles to wealth.” (1935: 174) Hoarding, indeed, does not increase real wealth, but it does not decrease real wealth, either. It may be asked what happens when there is unforeseen by most entrepreneurs mass hoarding. This has important effects, indeed; however, the rate of confidence (to be examined in (I, 47)) which determines hoarding decisions is fairly stable on average, except for periods of government- and Central Bank-caused booms and busts. Large and unpredictable changes in the confidence rate are rare under laissez-faire. I do not mean that such changes cannot occur – for they are outcome of individual initiative – only that they do not actually occur. Hoarding presents few problems under unhampered market, which is why I am postponing considerations of this sort until the discussion of business cycles. Hoarding, therefore, ordinarily makes little difference from the point of view of society as a whole; but individually, (1) the non-hoarders were able to consume more, as I have indicated, and (2) the risk preferences (to be defined and explicated in (I, 46)) of the savers have been satisfied, and total happiness, therefore, increased. If the savings are earmarked for a particular purpose and slated to be spent on a specific date, then Keynes is wrong, and the economic (as opposed to legal) problem I have posed is only apparent. Suppose that instead of waiting for a year to save the $50,000 necessary to start a business, every week Smith takes $1,000, buys some capital good that he knows he will need, and puts it in a futuristic stasis field, where it does not spoil. Then, by the end of the year, Smith will have real wealth stored up. If, on the other hand, Smith saves $50,000 directly and only upon having saved that much, spends it during a single shopping spree, then it was the task of other entrepreneurs to foresee that the goods he now wants shall be available in the economy at prices he finds acceptable. While Smith is saving, those other entrepreneurs are stockpiling goods in anticipation of increased demand on his part on some particular future date. They stand ready to deliver these goods (e.g., capital goods), when his saving is finished, and he is all set, say, to go into business, buy factors of production, and all the rest. Smith, indeed, is accumulating only money, but goods are created anyway, though not by him but

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by other people. Those entrepreneurs have expended their labor and time in order to prepare these goods for Smith to buy. That is, just as they have used Smith so far, he now uses them and in fact, has been using them for a while (because the period of production of any good is nonzero), though as per the essence of indirect exchange, the acts of selling and buying are separated in time. On the market, we are each other’s “human resources.” People participate in indirect exchange, even though they exchange real wealth for money, because it is in their interest to be integrated into a large economy; failure to do so means retreating to autarkic production which for most people would be suicide. As a result, in this case, consumers receive no benefit from Smith’s abstention from consumption, even while he is saving, because resources are still diverted from production of present goods to production of future goods. An act of capitalist saving redirects production from the consumer goods that Smith would normally enjoy to capital goods that Smith believes will make him more productive and garner him profits. Keynes is so eager to condemn hoarding as socially vicious that he does not realize that people save for other reasons, as well. It may be objected that I am ascribing too much power to entrepreneurs. Can they really read a person’s mind and predict what he will want? The reply is first, consumers select only among those goods and services that the batch of all entrepreneurs together have offered to them. Some of the latter have to get lucky. Second, the collective state of the minds of the consumers is expressed in the momentary state of the market. Before Smith started saving, there already had existed a determinate range of his choices. He has some idea of what he wants, though he is open to still better offers. Third, in order to attract Smith’s attention to one such offer, while his bank account is growing, any entrepreneur contemplating satisfying his desires needs only to come up with an original marginal improvement to the present state of affairs. Competition keeps every entrepreneur on his toes, such that it will not work for him to produce junk and expect the consumers to buy it, because anything is better than money with no use-value. A consumer will normally have a vast number of goods and services from which to choose. There are the period of saving and period of production. By saving fish, Crusoe buys himself time, his own labor, and say, the trees on Friday’s property that yield the most suitable material for the boat that Crusoe wants to build. Thus, Crusoe buys original factors of production separately. When Smith saves money, he impels other entrepreneurs, such as Jones, to produce capital goods for him. But such goods are packages,

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stored-up labor / land, natural resources, and time. Smith buys some factors of production already combined. Why is there a division of labor between different entrepreneurs Smith and Jones, such that first, Jones builds capital goods up to level 20 in the production structure, and then second, Smith buys these goods and advances them further down to level 12 in the production structure? This happens because of entrepreneurial profit expectations. Both Jones and Smith profit from their localized knowledge of the market conditions for these particular goods. The producer loan market allows Smith to economize on the time spent saving, though not on the time spent producing. John F. Henry correctly describes the entrepreneur as buying factors of production with money and selling the completed product for money. (King 2003: 344) Profit arises when in the M-C-M’ (Money spent – Consumer goods produced – Money received) sequence of events, M’ > M. It is certainly not true, however, that the “economy” is “driven by aggregate spending.” It is impossible for all entrepreneurs to profit. Even if M’ remains the same, economic progress can proceed sprightly. Entrepreneurs do not hope that in the aggregate “M’ exceeds M and debt can be cleared.” They hope they their own personal M’ exceeds their own M, and it can well be at the expense of this relation for other entrepreneurs. In short, they hope to beat their competitors. Henry goes on to say that “the production process in a monetary economy must begin with debt, because workers must be paid and capital goods purchased before income-yielding output is produced.” This is emphatically not true, because still more primal than debt are savings. That is what any production process must begin with. In fact, the loan market is merely an efficiency-enhancing institution; it is useful but not fundamental to the functioning of capitalism. In an early work, Schumpeter (2010) propounds a similarly strange thesis. His argument is as follows: 1. Entrepreneurs and only they drive the market. 2. Therefore, the market or an evenly rotating economy cannot change unless disturbed by creative entrepreneurial actions. 3. Entrepreneurs act by setting up novel production processes. 4. In order to act, they need to withdraw factors of production from other occupations elsewhere in the economy. 5. But in an ERE they have no profits to serve as start-up capital. Moreover, workers consume everything they get. Thus: 6. Only entrepreneurs can change an equilibrated economy. 7. In order to be agents of change, they need money.

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Summa Against the Keynesians 8. But an evenly rotating economy cannot provide them with money. 9. This is a catch-22. 10. Therefore, the only way to endow entrepreneurs with “purchasing power” to bid on factors presently employed in other, inferior from the point of view of these entrepreneurs, lines of production is by means of new money or new credit. 11. This is a virtuous task, because the entrepreneurs will end up improving the economic conditions of the consumers. 12. Hence, the need for inflation and credit expansion.

Against this, I must once more object that voluntary private saving by means of abstention from both immediate consumption and hoarding is part of any entrepreneurial plan of production. The plan begins with saving, and an ERE is shattered the moment the first $100 is stuffed under the mattress. Any income whatsoever, wages, interest, dividends, and not just profits, can be built up and eventually redirected from personal consumption to slurping up factors of production and arranging them into a business enterprise. Demand for the consumer goods Smith would normally buy drops which causes the factors employed in the making of those goods to be released from their task and redeployed into making the capital goods Smith is planning to buy in the future. Of course, the workers Smith unemploys by lessening his consumption while he is saving are in all probability distinct from the workers he overemploys by increasing demand for the new capital goods that he is planning to buy after the process of saving is complete. This is because the factors, including human capital, are not perfectly non-specific. Under free markets, my saving hurts those workers who are employed in businesses that now experience more anemic demand. Under Schumpeter’s scheme, when prices rise due to inflation, and wages lag behind them, again, because of specificity of workers’ skills, imperfect mobility of labor, and suchlike, numerous other workers’ standard of living is impaired. At any rate, issuance of debt under honest banking does not increase the money supply: the ownership titles to present money are transferred from one person to another. What Smith gets to spend, because he borrowed money, Jones cannot spend, because he lent to Smith. Debt and credit cannot in a laissez-faire economy with sound money increase M’. Normally, we want money to sediment in the pockets of the most productive people. Must we expropriate all cash and give it to

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them? Not at all. First, entrepreneurs prove themselves anew every day. Success is only in hindsight, when a company finds itself well in the black. Second, that is exactly what happens in an unhampered market, anyway: people who delight the consumers more than the competition increase their net worth and have an option to expand their businesses still more. The government can intervene to alter the purchasing power of savings or cash balances. (“Purchasing power” and “price level” are two terms used to describe the same thing.) This is the most important macroeconomic difference between commodity money and fiat-and-credit money. A classic intervention is inflation, produced today by cooperative action of the Central Bank and commercial banks, whose effects run deep. True to its nature of being incapable of producing any useful goods, the government, in a paroxysm of fruitless action, enjoys producing money. If this were merely pointless, then no one would care. Unfortunately, this harms the economy and society in a number of ways. It undermines the institution of private property. It disturbs economic calculation of profits and losses. It affects the cash balances’ utility as a store of value. A government in control of money has grabbed a serious power. On the other hand, economic progress that is not sabotaged by the government makes one’s savings more valuable to him. 16. THAT, IN CONTRAST WITH ENTREPRENEURS, A WORKER IS A COMBINATION OF THE GUARDIAN AND IDEALIST IDEAL TYPES The entrepreneur-factors of production union within the firm is like the union of soul and body – necessary and unavoidable. The ideal types – entrepreneur, capitalist-saver, worker, and landowner – are distinguishable in the intellect, but that most people are of only a single ideal type is, perhaps, a newer development in the history of civilization. In the previous chapter, I described two ways for Crusoe to organize his saving and investment. If, however, he hires Friday as a worker, then he can only proceed in the first way, namely, by saving first and investing later. Again, in catching and storing fish, Crusoe expends extra labor. He experiences waiting, both until enough fish has been accumulated, and until the end product is ready. Risk and possible surprises have already been mentioned. In being free from these lies the essence of the privilege of being a worker. The worker need not exert himself any more or harder than is necessary to live paycheck to paycheck. He receives payment immediately and on agreed upon dates and is under no necessity to abstain from present consumption. And he

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does not care what becomes of the product on which he is working: even if Crusoe errs in forecasting the item’s utility, Friday will still get paid. If a worker quits mid-project, then he retains all of his earnings; the employer, on the other hand, gets stuck with a half-finished product, in order to bring which to completion he must now secure the services of someone else. The deck is stacked heavily in favor of workers in a capitalist society, also because a businessman may not be able to avoid the expense of training his workforce, whose members will then unceremoniously use their new skills to find better jobs elsewhere. Though there may be little reason for beating dead horses, I have a theory why Marx considered it the fate of capitalism to tend toward “immiseration” of the working class. In the beginning of Marx’s story, numerous feudal artisans possess various real and human capital and are to an extent their own masters: they are both workers, capitalists, and entrepreneurs rolled into one. But after feudalism, by means of the inexorable march of history (or some such alleged cause), has been transformed into capitalism, a fundamental change occurs in society, within factories and the like, namely, the separation of the three roles. Each person is now either a worker or a capitalist or an entrepreneur. (At this point, the absurdity of “assuming” that workers do not save and that capitalists do becomes plain. Workers do not save, but who is a worker? Someone who does not save. This is entirely circular. Therefore, if “he who does not save” is a definition of the word “worker”; and “he who saves and invests, in addition, perhaps, also to working” is a definition of the word “capitalist,” then that is fine. But these things cannot be assumptions.) Marx’s argument consists of three moves. First, exactly like Keynes is shown in (I, 6) to have done, he must have reasoned that human capital is fully expendable or replaceable by machinery or if he lived today, then perhaps by robots and computers and Microsoft PowerPoint presentations. This entails the inevitable separation of the economic roles. That is why Marx so stressed technological determinism. Second, most people will gravitate toward being workers. Third, capital by definition belongs to the capitalists, not to the workers. Normally, one would say that capital goods make labor more productive and increase its DMPV and ultimately real wages. Not so for Marx. He jumped to the paradoxical conclusion that as capitalism advances, workers would become less and less useful and receive less and less real income: “in proportion as capital accumulates, the situation of the worker, be his payment high or low, must grow worse.” (1990: 799) Genuine artisans would die out, and capital would be slowly transferred from the workers to the capitalists, until none remained in the former’s hands. Workers do not save and for that reason will eventually end up

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with no capital at all, whether real or human. Nor do they direct selfproduction. All their skills are sucked out of them, turned into machines, and wind up as property of capitalists. Hence, in the darkness before socialist dawn, the workers will be bringing to the market merely coarse bodily powers, the demand for which is negligible, and the supply of which is growing with the increase in population. Hence, the impoverishment of the vast majority of non-capitalists. An alarming prediction, to be sure. But it has not come true and will not, for two reasons. First, because the human mind is not fully or even essentially material. There are things that machines will never be able to do, and for now, I am going to leave it at that. There is no such thing as pure worker whose contribution to production consists of mere expenditure of life energy; all workers retain their capacity to save and invest into skills and to own and govern themselves. Workers can not only study hard, building on their existing training, and use the newly acquired knowledge to solve new problems; but also be first to solve a problem and teach others how to do likewise. People are both inventive and creative. We can make use of the science of the four temperaments in yet another way. In setting up production, Guardians manage the factors; Rationals invent a technological process; Artisans design and fashion the product; and Idealists market the finished good. Robots can do none of these things. It is in this sense that labor may be considered to be the scarcest factor of production. There are never enough geniuses. Second, the world of our feudal artisans was characterized by very little capital accumulation, lack of consumer sovereignty, and a large measure of autarky, in which private property served the owner but not his fellow men. Capitalism at the beginning, therefore, was marked by profound importance of human labor and low importance of entrepreneurship. It was not too difficult to outcompete the artisans. Consider now what happens when a machine displaces a worker. This particular input has been released from its task in the economy and can now re-specialize. The worker has become an entrepreneur who has to decide how to invest his time and effort in order to find another position where he can contribute to society. He can choose to become a workerentrepreneur, training himself again to become an employee doing something that machines cannot yet do or something to produce the machines for which people are unwilling to wait. Or he can choose to become a businessman-entrepreneur, directing other laborers and “creating jobs.” Either way, there are now fewer workers but more entrepreneurs. In the extreme case, even if ultrasophisticated robots can abolish human labor as a factor of production by excelling over humans at every aspect of production, requiring no rest or sleep, and by being able to

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replicate and even improve at little cost, then former workers will all turn into robot owners. They will all, as one, become capital-owning entrepreneurs using as many robots as they please to produce anything they pleased, and scarcity of capital and even consumer goods will be eliminated, resulting in paradise on earth, hardly “immiseration.” Allow me to bring into the discussion the vulgar Soviet hierarchy of social orders. First, there was the (1) Stone Age communal order in which there were no economic distinctions. Next came the (2) slaveowning society, where the worker was a slave. Then (3) feudalism, at which point the worker was a serf, a definite improvement. (4) Capitalism arose next, transforming the worker into a free mercenary. He worked hard for the man, but he played hard, as well. The current (from the point of view of the Soviet intellectuals, such as they were) stage, (5) socialism, has elevated the worker into master of productive activities. The pinnacle of wonder, (6) communism, will abolish work as such; instead of enduring disutility of labor, people will play in pure bliss. I like hierarchies; there are a few in this book, as well. They give you the big picture. They help ensure that the details cohere. But great care must be taken when charting the outlines of the universe as whole: pitfalls await at every turn. In this case, the socialist theorizers decided to abolish the real world. There is no higher stage after capitalism, except for each individual as he enters glory in the afterlife. With this mistake corrected, this particular hierarchy turns out to be rather illuminating. We can expand on it, regarding war and exploitation. First, the communal era featured total war. The conquering tribe annihilated its prey. As under the vulgar anarcho-capitalism discussed in (Introduction, 2), they killed everyone and took everything. The slave-owning society arose when the victors got the bright idea that they would benefit by sparing some people in the community they pillaged and making them their slaves. People can be useful this way. Widespread slave-owning was later on replaced by serfdom in the feudal era. It turned out more profitable for the exploiters not to enslave people and thereby reduce their output to that similar to of dumb beasts of burden but to allow them to keep some fruits of their labor and tax the rest. Wealth creation was to that extent given a huge boost. Capitalism is a much more recent invention. It “reduced the prestige of conquerors and expropriators and demonstrated the social benefits derived from business activity.” (Mises 1996: 8) Under laissezfaire, the worker is a free man, obligated to do nothing he contractually did not agree to. Under capitalism, institutional exploitation does not exist.

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One consequence is that taxation according to this scheme is an atavism, a feudal remnant which has not been surmounted only because of the influence of the 20th century’s destructive socialist and “progressive” movements. Humanity’s most wholesome work of building a just and prosperous society, i.e., laissez-faire capitalism, was tragically waylaid for a hundred years! Another is a theory of social change: revolutions that are (a) lasting and (b) improve things almost never come about from the “bottom” but always from the “top,” as the ruling class after perhaps centuries gets an epiphany that a relaxation of exploitation up to and including no-exploitation-at-all-under-laissez-faire serves its own interests. A trip up through the “stages” of social orders then is simply technological progress, as people learn (eventually by discovering economic laws) how to use each other increasingly more efficiently. Still further, left-liberalism in America can be understood a social auto-immune disease, in which the leftists uncover injustices and inefficiencies in capitalism where in fact there are none. Thusly deceived, the left finds itself perfectly at peace with the contemporary conservative American fascism, because they view the retreat from laissez-faire capitalism back to theocratic feudalism of the ancien régime as a stepping stone toward their own ultimate goal of the still more comprehensive devolution into socialist slavery. But I want to suggest that in postulating immiseration – a conclusion also reached by the alleged iron law of wages – Marx was confused on his own terms. First, he mixed up (4) with (2). A slave owner can afford to spend on his chattel just enough to keep them in reasonable health and force them to work under threat of punishment. The iron law describes this situation adequately. Second, Marx imagined (5) to have features that are not present in (4). He failed to realize that workers in the free market are the masters of production, directing the conduct of the entrepreneurs, guiding their endeavors, in their capacity as the preeminent consumers in the marketplace. They are far from the cheap pieces of meaty capital equipment that Marx made them out to be. Marshall argues that “wages tend to retain a… relation with the cost of rearing, training and sustaining the energy of efficient labor.” (1964: 442) This could be interpreted in a few ways. First, consider Crusoe again, only this time he is left on an almost barren island by pirates who provided him with a pistol and a single bullet in it. Crusoe surveys his surroundings and realizes that he can gather at most a handful of berries each day. This is not enough to stay alive for long. Crusoe decides to shoot himself, thereby dying with dignity. Here we see that labor that is not sufficient to sustain the bare life of the worker is not supplied and is withdrawn from the market. I am not sure what the relevance of

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this scenario is, however, since in an any real capitalist society such an event has probably never occurred, despite the impression one might get after hearing the coercive “living wage” advocates. If wages behaved according to the famed iron law, then we would expect that they should dip below subsistence level so often that we would be confronted with a barrage of suicides. Second, there could be the possibility that if acquiring human capital has disutility, then under some circumstances, it may not be acquired which lowers the supply of labor in the corresponding skilled occupations. Usually, however, disutility of training oneself takes the form of being too slothful, stupid, or clumsy to be trained. There is not much that can be done about that. Third, Marshall may be reasoning that the happier a worker is, the more productive he is. If true, then this only means that rising prosperity has a positive feedback built into it. There is no implication that employers can boost productivity simply by paying people more money. Remember the worker-capitalist-entrepreneur in (I, 7)? I insist that all workers resemble to a greater or lesser degree this complex archetype. Nevertheless, it is incumbent on me to present my vision of the temperament of a pure worker. Consider that the worker’s SJ Guardian part makes him obedient, cheerful, someone who never complains, eager to take on more work and work overtime, pleasant with customers, and honest to a fault. An ideal worker is someone who does not despise dirty or humble work, agrees to start at low pay and as contract-to-hire (i.e., essentially as an apprentice), does not presume himself better than what he is, works within the system, does more than is asked for; is responsible, reliable, dependable, and punctual. Such a worker makes the business owner’s life easy. His virtues include the dutiful need to work hard, self-reliance, self-control, modesty, politeness, sportsmanship, and considerateness. He will extend his loyalty for job security and predictable routine, another reason for sticky wages. Guardians at work are cautious, methodical, orderly, patient, steady and unimpulsive, rule-following, and rule-enforcing. If Rationals are driven by success, and Artisans, by flow, then Guardians are driven by duty. They would rather rise slowly and steadily within the ranks than opportunistically go where the action is. The NF Idealist component of a worker’s personality is the direct opposite of his Guardian component. It is manifested in the worker’s “standing up for his rights.” All that loyalty and cheerful obedience and hard work come at a price. The worker demands that he be recognized for his faithful service in two ways. First, by being promoted to executive ranks. (Keirsey (1998) points out that most Guardians aspire to be

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executives.) Second, by watching his employer carefully and seeking to benefit by diminishing his profits. For the very existence of profits indicates that factor owners did not receive their full DMVP. Of course, being ignorant of opportunities is not a fault for the Guardians. They do not blame the entrepreneurs for their sly and attentive to prospects profit-seeking. They know their own limitations. But in their Idealist capacity, workers can ask for raises in the next period of their company’s production, to the extent that imitators have appeared by then, offering higher wages. Marx had no use for entrepreneurs, not realizing that only their actions introduce progress to society. He untenably insisted that workers always receive the full product of their labor. It is true that Idealism calls for full employment, but only as a goal to aspire to, not a permanent state of affairs. The worker must (G) be meek in not asking for more than his DMVP but (I) be willing to stir things up at some point in order not to be left with less than his DMVP. A worker in the first place is fearful to transgress the moral law by being so vainglorious that he asks for things that do not belong to him. Far be it from him to fancy that the world owes him a living. But in the second place, he is uncompromising by insisting on justice: he is to be paid what he is worth. I have arrived at the simple but true platitude that an idealized worker strives to receive an honest day’s pay for honest day’s work. Leadership at work, too, borrows from the quadriform understanding. The outer active part of any business part lies in the ArtisanIdealist nexus and consists in making the product appealing and estimating revenues by means of empathetic vicarious experiencing the feelings and thoughts of one’s customers. The inner passive part is the Rational-Guardian nexus, putting together the technological process and calculating costs with an eye toward running the company such that every resource and factor pulls its weight. One’s product and customers are outside the company; technology and cost accounting are inside the company. The passive yin is an essential drag on the yang’s excitement and enthusiasm, always saying that something “cannot be done” or warning about budgets. Now risk is handled by prudence which is the Rational cardinal virtue; and surprise, by courage, the Artisan one. Quadriformity is everywhere in the world; so, we have to be careful and add that uncertainty of the future (defined as the combination of risk and surprise) is distinct from these four aspects of a firm and correspond to human action simpliciter. Risk has a wide meaning of something intellectually tractable and narrow economic meaning of the problem of assessing consumer preferences. Surprises’ wide meaning is handling

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fear and flawless execution of a tricky action, and its narrow meaning is dealing with competitors. The connections between ideal types are shown in Tables I.16.1 and 2. Outside Artisan Idealist

Good Money

Inside Rational Guardian

TABLE I.16.1. SOME TYPE CONNECTIONS

Artisan

Guardian

Idealist

freedom and responsibility active

profit

Rational

output

passive

Idealist

Rational

Artisan Guardian

head and heart

TABLE I.16.2. MORE TYPE CONNECTIONS

The types in the “Good” row are concerned with what should be produced and how; the types in the “Money” row are concerned with the bottom line (costs and revenues). For example, the task of the Idealist is to inspire and rally the customers. The Guardian strength is logistics, organization, and making sure that the business functions smoothly, with every task supplied and attended to properly. Consider again that a worker realizes that his efforts are disconnected from the result. He does not make art which is an expression of himself but a product of which he may not even be aware and may not even see. As one among many workers, his contribution to the business may be minimal. And if the business fails, then the owner may be devastated, while the worker will find a new job somewhere else. The job of the Guardian manager, therefore, is to strike fear into the hearts of the human resources, consultants, contractors, and suppliers and make sure that no one is playing solitaire at work. 17. THAT MONEY IS USEFUL TO BOTH SOCIETY AND THE INDIVIDUAL IN NUMEROUS WAYS

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Money in its capacity as a medium of exchange (MoE) is designed to solve two problems of barter, namely, of (1) double coincidence of wants and (2) indivisibility of goods. Under barter, if a person has fish and wants to acquire strawberries, then he has to find that one person who both has strawberries and wants to exchange them for fish. With money in the picture, all he has to do is find one person, Smith, who just wants to buy fish, exchange it for money, and then find another person, Jones, who just wants to sell strawberries, again, in exchange for money. This makes exchanges far easier to procure. Secondly, if Smith has a car and wants to exchange it for a computer, some clothes, and university tuition, then he cannot divide the car into units in order to pay the people who presently own the goods that he wants. It would mean destroying the car. But a medium of exchange is highly divisible and can be used in trading unified and valuable objects for a number of less valuable ones. If Smith could always find someone who wanted the car and was willing and able to exchange for it all the goods that Smith wanted, then there would be no need for a MoE. Money also plays the role of a unit of account (UoA). It is essential to the functioning of any business to be able to calculate revenues and costs. Calculation can proceed under barter, as well, but in an exceedingly laborious manner and only for the simplest chains of exchanges. If, however, all goods and services are assigned money prices in terms of some common unit, then one can suddenly engage in economic calculation. The need for a UoA comes about due to (a) the variety of types of factors of production (labor, time, rent, capital goods); (b) the variety and number of the actual factors involved in an enterprise; (c) uncertainty at the beginning of production regarding the price of the factors bought when the later parts of the production structure are reached; (d) variety and number of different products made by a company; (e) the fact that finished goods may sit in inventory for a while before they are sold; and (f) uncertainty regarding the revenue from the final products built. Some business models require only rudimentary calculation, such as speculating and arbitrage. Speculating involves buying low now and selling high later; arbitrage involves buying low here and selling high there. They combine goods with either time or delivery. Though goods are reallocated to their most valued uses, nothing “new” gets produced as a result of either speculation or arbitrage. That may be why Keynes distinguishes between the “speculative motive” and “finance motive” for holding money: the former is for the sake of rationing

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existing goods; the latter, for the sake of producing new goods. Economic calculation is assisted by relative stability in the purchasing power of money. This pertains to the third function of money, namely, store of value. At the same time, money does not “measure” values; monetary calculation is always an ordering according to rank, an act of grading: first, second, third; not an act of measuring: one, two, three. With the help of money, each item is assigned a cardinal number that reflects how well that item contributes to consumer welfare (or how productive it is of human happiness) as compared with every other item. All prices are, therefore, relative and not absolute; they allow for comparisons or ranking of an enormous variety of sets of goods, but that is all they do. For example, business calculation can reveal whether a car is worth more or less than the set S = {computer, clothes, tuition}. If more, then the desires satisfied by the car rank higher on the people’s values scales than the desires satisfied with the help of S. There can, thus, come into being a global structure of production of arbitrary complexity. The final social utility of money arises from its capacity to act as a store of value (SoV) which is a corollary of its function as medium of exchange. Here, money is a shield against uncertain future. Interestingly, in A Treatise on Money, Keynes privileges the unit of account function of money: “Something which is merely used as a convenient medium of exchange on the spot may approach to being Money… But if this is all, we have scarcely emerged from the stage of Barter.” (1935: 3) It is true that the cause of low utility of money as a unit of account could be due to the fact that the economy is in the embryonic stage of development. It is only an advanced economy which involves at least thousands of people, and in which numerous firms operate, that so completely depends upon a reliable way of calculating profit and loss. But even a primitive economy with a well-established medium of exchange has “money” in its most primal sense. It has not “scarcely emerged” from a barter economy. It is a fully monetary economy, developing though it is. The reason is that a MoE is needed to deal with the most basic problem of double coincidence of wants. The three functions of money may be classified as follows. The medium of exchange is a social notion. It has no meaning for an isolated individual. The store of value, on the other hand, makes perfect sense when applied to an individual’s hoard of goods. Even Crusoe would likely have on his island dried fish and berries and spare tools and what have you in storage, waiting to be used at the right time. The unit of account function of money is in between or rather spans both of the above: the concepts of profit and loss, for whose sake economic

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calculation is performed, take two forms: (1) psychic profit requiring only an individual and (2) monetary profit requiring a money-using community. We can further relate the three functions of money to the three uses of money: money acts as a medium of exchange when it is consumed; as a unit of account when it is invested (allowing calculations of profit and loss); and as a store of value when it is hoarded. (Hoarding in a barter economy is done by collecting actual consumer and capital goods; hoarding under indirect exchange in order to keep more cash for a rainy day is done by varying the supply of money.) Gold is said to have exchange-value in its capacity as money and use-value in consumer and industrial applications. But pure money itself has use-value, as well, manifested in its utility as a SoV. Money then is demanded for three reasons: (1) for exchange, (2) as present vs. future money, and (3) as cash balances. Keynes seems reasonably aware of this correspondence; for example, he proposes as the reasons for demanding money “(i) the transactions-motive, i.e., the need of cash for the current transaction of personal and business exchanges; (iii) the precautionary-motive, i.e., the desire for security as to the future cash equivalent of a certain proportion of total resources; and (ii) the speculative-motive, i.e., the object of securing profit from knowing better than the market what the future will bring forth.” (2008: 170) All cash balances were acquired in the past; the transaction-motive for having money is to spend in the present; the speculative-motive is for the sake of the future (indeed, an entrepreneur supplies present money and demands future money); and hoards are “timeless,” meaning that their potential to be used is stretched throughout all tenses. As we move from (1) to (2) to (3), the function of money under consideration can be fulfilled by more and more things. Thus, a country’s fiat money is the only medium of exchange on its territory. But any country’s money can be used as a unit of account. And numerous things, such as precious metals, collectibles, securities, capital goods, real estate can be used as stores of value. Rothbard speculated that if the future were certain, then no one would want to keep cash balances, because every person would try to loan out all of his money to be returned to him on the exact date when he needed to spend it. There can be no monetary system without uncertainty: no one would be willing to keep cash balances at all. Perfect foresight then seems incompatible with indirect exchange. The idea is that if life offers no surprises, then everyone knows exactly when he will need any particular amount of money to pay the bills. Then everyone has a reason to lend his money out upon contracting to receive it back at

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the very day and time when the bills are due. Consequently, no one will want to hold cash. It is true that the entire money supply will be at all times available for borrowing, with actual borrowers arising sporadically and spending their newfound money instantly. The flaw in this reasoning is precisely the assumption that there will always be people who will want to borrow. And that is not obvious. One may have no choice but to keep his money even if he has to pay for storage, if he can find no one to lend it to. Moreover, even if certainty obviates the need for money as a SoV, it does not touch money’s utility as a MoE and UoA. Even if money has no use-value, it will still retain its exchange-value and calculation-value. Therefore, it will still be advantageous to use money and keep cash balances, though no longer hoarding them. But money has utility to an individual and not just to society as a whole. First, speaking precisely, money should not be thought of as a claim on society. Without legal tender laws, anyone can refuse to sell his goods for the generally used medium of exchange and demand something else for them in return. Under legal tender laws, money is de jure a claim on society, because everyone is required by law to accept the particular medium of exchange for his goods. Smith’s money represents society’s debt to Smith. Regardless, if one has money, then most of the time, the state of affairs is as if everyone else owed him goods for that money. All kinds of money, whether commodity or fiat, have exchangevalue, calculation-value, and use-value. (i) It is “disrespectful” in a sense to argue that money is “only” useful for exchanges. Far better is to recognize that money is an exclusive means to all goods and services on the market. Now plenty of things have an exchange value: again, if Crusoe has fish, then he can exchange it for Friday’s strawberries; so, fish for Crusoe is a means to the strawberries. What makes money unique is that it works even in a global market by virtue of its being a universal and international medium of exchange. It is as though in exchange for money (especially when it is gold), the whole world – and not merely the fish-loving strawberries dealers – owed to the money-holder stuff: (1) all available merchandise, (2) in whatever combination he chose, (3) in whatever amount, (4a) at any time and (4b) however apportioned through time, (5) on demand. In this lies money’s preeminent utility as money, over and above the utility of any other good, for an individual human being. Indeed, as pointed out above, any MoE is a social construct but useful to individuals. (ii) Money to an individual entrepreneur is useful as a UoA. He

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can now make his business as intricate as he wishes and still know when he is in the black or in the red. But society, too, benefits from this, in that private enterprise is duly enabled and freed. Both the individual and social utilities of money as UoA are on equal footing. (iii) Lastly, we must make a distinction between the use-value of the materials (Au, Ag) out of which money is made and the use value of money itself in its capacity as a SoV. The former is manifested in the use of these metals for industrial purposes, in jewelry and ornaments, or even as protection against inflation, in which case it is used as its own store of value. Again, the SoV applies to individuals, but is useful precisely to society which is spared the necessity to produce numerous consumer and capital goods and keep them idle in hoards. Only money needs to be hoarded; hence no actual resources are wasted. Astonishingly, Dillard (1948) reverses this understanding, describing the pure liquidity preference theory of interest in the following way: “those who hold surplus money must be bribed before they will surrender it to those who will put it to a socially beneficial use, that is, will use the money for mobilizing labor, material, and machines for the production of goods and services.” But it is the same with any good. Money produces the pleasure of security when serving as a SoV; a bicycle produces the pleasure of riding. In order to forgo both, their owner must be “bribed.” Dillard continues: “Those who receive interest income are performing no socially useful function.” Perhaps not, but neither do those who enjoy their personal properties like TVs and books and cars. Are the consumers beyond the pale, too, for Keynes and Dillard? Most useful items, including means of production, are owned by somebody. If Smith owns a capital good, then in order for Jones to use it, he has to pay rent to Smith. Opposition to “rentiers” and a desire to “euthanize” them is tantamount to condemning private property. We will encounter more evidence that Keynes was ultimately a socialist later. Our author seems to imagine that the economy underperforms due to scarcity of money. In addition, Keynes “rejects the idea that capital is productive.” (194-6) This is surely grotesque: money is productive, while capital goods are not! Rothbard counters wisely that “the change [in the money supply] does not – unlike other goods – confer a social benefit. … it doesn’t matter what the supply of money is. Any supply will do as well as any other supply.” (2010: 29, italics removed) Let me suggest that for Keynes, the pure LP theory amounts to the pernicious – as he sees matters – choice of the public to hold banknotes instead of depositing their money into banks. Interest is that

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“reward” that entices a person to take his cash from under his mattress and deposit it, making it possible for the bank to pyramid credit on top of the new reserves. LP explains the interest that banks pay to depositors, not the interest that banks charge on their own loans. The rentiers’ intransigence is the only thing that allows “capital” to remain scarce. Please distinguish between at least three kinds of debt. First, a bank may owe gold to Smith upon his showing a valid banknote. This is simply the recognition that the bank is merely a glorified warehouse, a storage silo, that the gold belongs to Smith by right, and that the bankers have not perverted justice by lending this gold out. Second, there is the “social” credit, i.e., money. Though it is no crime in a free society to refuse to sell one’s goods for money, the market incentives ensure that this rarely happens. Self-interest substitutes for justice in making money valuable. The disutility of owning money is that even as makes a person society’s creditor, it earns no interest. That is why it is called “non-interest bearing debt.” The cash in one’s pocket does not earn interest for its owner. Third, there is a normal transaction of Smith’s lending money to Jones. There is no longer an “on demand” aspect to Smith’s claim: he contracts to get his money back only on a determinate future date, but he is compensated for this inconvenience with interest income. That is why if a person is asked whether he wants fish or an equivalent amount of money to be used in exchange, then he will likely choose money, because he will be able to cut out one step, namely, finding a buyer for the fish, in the acquisition of what he wants. In the language of older philosophy, money is a potentiality, situated between actuality (goods bought with its help) and non-existence (insofar as one cannot eat money). Such a potentiality is useful, precisely because it lacks a full-blown identity, and because of its fluid protean nature. The pleasures that money can buy are almost endless. 18. THAT FIAT MONEY MUST HAVE ITS ORIGIN IN COMMODITY MONEY

The Post Keynesian economist L. Randall Wray advances an incredible proposition. He is partial to the view that money originated not from a pre-money market system but rather from the penal system. … An elaborate system of fines for transgressions was developed and, over time, authorities transformed this system of fines paid to victims for crimes

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to a system that generated payments to the state. … Why would the population accept otherwise “worthless” sticks, clay, base metal, leather, or paper? Because the state agreed to accept the same “worthless” items in payment of obligation (fees, fines, and taxes) to the state. (King 2003: 2623) Is Wray not noticing an infinite regress? The state accepts fiat paper money because the public uses it; and the public uses it because the state accepts it. What boots up the whole process? The state is just one consumer on the market. Why should it want paper, if other market agents are still bartering for their goods and services? What will the state be able to buy from the public with the “worthless” paper? Under barter, any Smith would be happy to pay taxes to the state in paper. He would print some himself. Ah, Wray might interject, but the state could designate paper as legal tender and prohibit private counterfeiting. It sure could try, but how will it determine the prices of all goods and services in terms of the nascent money, when there are only barter exchange ratios? Is the price of a gallon of gas or bushel of wheat 2 “sticks,” 0.02 sticks, or 200 sticks? This problem is insoluble, which is why neither commodity money nor fiat money could be imposed on a society by a state “from a pre-money market system.” In addition, there is no record of fiat money coming into existence without commodity money preceding it. Commodity money originates according to the monetary regression theorem. A piece of gold has two sources of demand: demand for use in consumer and industrial applications and demand for exchange. In other words, gold, to reiterate, has both use-value (understood as the value of the chemical element gold and of the actual objects made of this material, not the financial security from hoarded gold-as-store-of-value, because the latter is contingent on gold’s becoming a medium of exchange first which at this juncture in the argument it has not yet done) and exchange-value. Now the present prices are determined with the help of the prices of the immediate past. All entrepreneurial actions that bring novelty into the market deviate from the economy that just existed and therefore, take that economy and the prices in it as their starting point. As we regress into the past, we finally reach a point in which a given commodity now used as a medium of exchange had only usevalue and no exchange-value at all. Moving from that moment in the ancient past again to the future, we observe the commodity slowly acquiring exchange-value, until the latter comes so to dominate its usevalue as to make the use-value pale in comparison with the exchange-

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value. The regression theorem shows how a monetary price system can emerge from a barter economy. The emergence of money is subject to the phenomenon of network effects. As the use of gold as medium of exchange spreads, gold’s utility as money increases approximately in proportion to the square of the number of people who accept gold as payment for their goods and services. The greater the market in which gold is monetized, the greater the benefits to each individual of using gold, and the greater the incentive to those groups of people yet unincorporated into gold-based production and exchange to join the network. When they do so, the size of the network is increased which makes the network still more valuable to its members. Having reached a certain critical mass, gold is poised to become international money, accepted all over the civilized world. This is the original essence of the term “gold standard”: a universal custom generated privately by the market, that is, by human action (i.e., of individuals acting in their own pecuniary interest as buyers and sellers of goods and services) not human design (i.e., by an armchair economist-philosopher of social institutions or government). This gold standard precedes any national currency or fiduciary media. Other meanings, such as a state of affairs in which government paper money is redeemable in gold, are strictly derivative and must be used with care. The question, then, is how fiat money displaces commodity money. Let us consider a few scenarios. (1) The government has 1 million ounces of gold in its treasury and issues 10 million $100 bills, promising to exchange $1,000 for 1 gold ounce and vice versa. This does not count as introduction of fiat money at all but is a perfectly innocuous use of money-substitutes. No new money is created, and all money is still gold. (2) Same as the above, but the government inflates by printing more paper tickets than is backed by gold in its stock. This is a clear example of a lawless political regime, in which the government thinks it can get away with a crime. Inflation of this sort sooner or later triggers devaluation; so, it is unsustainable. Perhaps, the government has allowed banks to maintain fractional reserves solely in order to destroy honesty in the monetary system and inure the public to the idea that money is not anything stable and secure but can be created at the state’s will. (3) The government owns no gold but prints fiat money and sets an exchange ratio between paper and gold. If the state insisted on being paid in paper, then on April 10th, Smith would buy the amount of bills equal to the tax from the government for gold; and on April 15th, he would mail the tickets back to the IRS. This makes little sense: why be redundant and not fix the taxes, fees, etc. in gold directly?

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(4) Same as the above, but the state orders that its paper money be accepted on par with gold everywhere. This is politically impossible, entailing that the people must have given the state the ability to expropriate any and all goods at its pleasure, bypassing the tax system. A transition that drastic from free markets to government omnipotence could never be allowed. If the state is already sufficiently powerful, and the subjects are sufficiently subhuman, then the state does not have resort to such a subterfuge; it can plunder any merchant of his goods directly. No, if fiat money is to be introduced, then it must somehow cleverly co-opt commodity money, on whose emergence and function it will be parasitic. The process starts with money-substitutes, claims on commodity money which may be stored in banks in their capacity as gold warehouses. The public may become used to using paper currency exclusively. Then, even if the link between paper and gold is severed, say, by a government decree that frees banks from their obligation to produce gold on demand upon being showed a valid paper ticket, then prices are already quoted in terms of “dollars” and not gold ounces. In addition, people’s relative wealths are unchanged, given that the ratio of Smith’s cash balance to Jones’ cash balance is the same before and after the decree, even if all the gold in the banks’ vaults is quietly transferred into some government storage facility. The present prices in terms of inconvertible currency are set by means of the prices of the immediate past in terms of gold. Here is an approximate sequence of events. (1) There is an acknowledged deficiency in the free-banking industry plagued by government interventionism. Though the state is wholly responsible for it by allowing banks to keep fractional reserves and “suspend specie payments” at their discretion, so that it could benefit from inflation, the free market is predictably blamed. (2) Combined with an ideological pressure to institute a more “scientific” monetary regime, this leads to the passage of a law requiring banks to grant deposits in Central Bank (such as the US Federal Reserve) notes, not in gold. The notes are still redeemable in gold, but only the Central Bank is allowed to own gold in any quantity. The idea is that the Bank would be too big to fail and can be trusted always to endure. (3) The banknotes of individual banks become redeemable only in Federal Reserve notes, which the banks obtain from the Fed by exchanging their gold for them. Eventually, all gold is transported into the vaults of the Fed. (4) The government outlaws the issue of banknotes by commercial banks entirely. Though banknotes are scarcely any different from checks and serve the exact same purpose, this move serves to solidify

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the impression that the people must trust only the state to manage currency. In order further to cement its grasp on money, the government declares the Fed notes legal tender. As a mock show of good will, it, indeed, accepts them as payment for “fees, fines, and taxes.” (5) The state insures deposits of small balance holders, indicating that banks will not be allowed to fail and that deposits are “safe.” They are not safe from inflation, but calmness ensues, and the state is even more trusted with administering monetary policy. (6) The government can now inflate at will, but its power to do so is limited by the gold standard that is still being maintained. Devaluing the currency is an unfortunate measure, damaging the state’s prestige both at home and abroad, to which the government does not want to resort. Far better every so often to suspend specie payments now on the level of the nation as a whole. After the condemnations of gold users as antisocial miscreants have gone on long enough, the final act is by law to restrict the convertibility of Fed notes into gold, such as to international traders only, and then abolish it altogether. A fully fiat currency is now born. This is an illustration of how the government cures interventionism with socialism. We will have occasions to observe a dynamics like this again later on. It is clear that the “taxes-drive-money” theory, according to which that thing becomes money which the non-totalitarian state accepts for payments of taxes, does not pass muster with economic reasoning. There is yet a grain of truth in Wray’s understanding. For a currency that the state accepts in payment of taxes and fines has the ability to save a citizen from government violence. If one fails to pay taxes, then he runs the risk of being found out and punished. Now paying taxes is not really an “exchange,” since we reserve this term for non-coerced market transactions. Thus, besides use-value and exchange-value, money has “protection-value” that helps to render the state harmless to a person. But neither the use-value nor exchange-value of a commodity arises out of protection-value. For example, taxes in medieval Japan were set in rice, something that had obvious use-value. Later on, taxes came to be set in cash, i.e., something that had acquired exchange-value. It may be true, however, that protection-value strengthens the overall value of a currency. But our author is not done. He considers the “the one-nationone-currency rule” to be an “extraordinary coincidence.” (2003: 262) Let me take a shot at a solution. First, a currency can be driven out according to Gresham’s law. Consider that a 1-ounce American Gold Eagle (a gold coin minted by the US government) has the face value of

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$50. As of May 2010, it is worth over $1,200. When faced with a choice to pay for a pair of shoes with the gold coin or with a $50 Federal Reserve note, I would without hesitation use the latter. This behavior keeps gold coins out of circulation, hoarded, and encourages the use of fiat money “for all debts, public and private.” In regard to that, there are three individually necessary and jointly sufficient conditions. First, merchants want to deal with dollar-holding customers. Second, dollars are legal tender, such that creditors are not allowed to discriminate between media labeled “dollars.” Third, some media are artificially undervalued relative to others, such as gold coins are undervalued relative to paper dollars; they are worth much more than the amount stamped on them. Second, a nation is a very extended family unified by language, common law, and customs. In America, it was a custom that the word “dollar” meant one weight of gold; and in France, the word “franc,” though also meaning a certain weight of gold, stipulated a different weight. Keynesism as an ideology supported by its economic theory has triumphed throughout the world, but its implementation, as though every nation embraced its own “Keynesism in One Country,” has been carried out by each nation individually. Each nation is governed by a state which could introduce its own Central Bank and conveniently – deviously – use the name of the old currency for something brand-new, fiat money unconnected with gold. “Scientific” management of money has replaced the international gold and silver standard which has been fractured, broken into pieces on the level of nation-states which now administer their own fiat currencies, though Keynesians still talk about a world fiat currency now and again. That is the ideological part of the solution to our puzzle. It remains to suggest that if two currencies, say dollar and Euro, are similar in quality and are accepted on a large enough territory, then people do not find it convenient to belong to more than one network. Even a manifestly superior currency, such as the US dollar as compared with the Russian ruble, may not be able to supplant the inferior currency, because people still want to do business with those who own rubles. At the very least, it will take a while for the better currency first to overcome and then to take advantage of the network effects. It would seem that a money network, once it exists, is “sticky,” i.e., tends to endure despite its troubles. The end result is the perfectly ordinary situation of “one nation, one currency.” The case of Bitcoin is interesting, as it seems at first glance to offer a counterexample to the present theory. Now as of 2014, Bitcoin cannot reasonably be called “money,”

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because the network of people using is too small. The greatest hurdle to Bitcoin’s becoming money is this. If I am a business owner, then how do I price my goods in bitcoins? Do I set the price of BTC 1 for a pair of shoes, BTC 0.001, or BTC 1,000? There is no answer to this question within Bitcoin’s own universe. That all prices are relative is economics’ own relativity theory; any individual price acquires meaning only within a large network of other prices; but the network itself is created as one price is set after another. This is what the Monetary Regression Theorem essentially states. Bitcoin cannot have recourse to the progression process. A good cannot “slowly acquire” positive exchange-value from zero use-value. How then can prices be determined for goods in bitcoins? The upper limit on the bitcoin’s price in terms of other currencies is set by the marginal cost of mining. Suppose it costs $1 to mine BTC 0.001 in terms of the energy and computing resources spent. If the price on a currency exchange is $5k / BTC 1, then it will pay to mine, then exchange bitcoins for dollars. This will bid down the price of bitcoins. What about the lower limit? There is none. It is completely arbitrary. But now we can use a trick. People have set up Bitcoin as a currency speculator’s money used easily to convert one type of currency into another. This is the non-monetary value / use of bitcoins. The initial actual price is arbitrary, as long as it is below the marginal cost. Any person running an exchange can pick such an arbitrary price, say $200 / BTC 1 or $20 / BTC 1 and say that dollars will be exchanged for Euros, pounds, etc. via this “messenger boy” or “envelope.” If this conversion rate is high enough, then early Bitcoin adopters will profit handsomely by selling their hoards. But that is no skin off the nose of later adopters. As long as they can use Bitcoin to convert currencies into each other with greater ease than before, they, too, are satisfied. Exchange owners do not really care, either: as long as they feel their bitcoins will be bought (and that is an entrepreneurial risk they are taking), they can make a living off the exchange fees. The very first currency exchange thereby set up will govern the bitcoin prices for all competing exchanges that would come later. Thus, the bitcoin has acquired a price, and piggybacked on present prices in terms of dollars. Now it is entirely true that when people quote the prices of their goods, they derive the bitcoin prices from their dollar prices. But that means that the chief problem with bitcoins – the establishment of an exchange rate with dollars – has been solved! That people still use dollars for economic calculation has to do with the size of the network of

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dollars users vs bitcoins users. But even a large network is not invincible. It has an initial advantage but can be, with time, replaced. There is also the matter of money’s serving as a unit of account and store of value. When grandma goes shopping, she sees prices quoted in dollars, and those are meaningful to her. She sees a box of cookies priced at $5.00 and says, “No, these are too expensive.” If the price is also quoted in bitcoins, such as BTC 0.032, then she cannot yet tell whether this is expensive, or cheap, or affordable. She cannot use this price to choose between consumer bundles. The store may post prices is bitcoins, but either they or grandma will have to convert them into dollars to make heads or tails of them. Businesses may find it easier to calculate with the help of computers which could convert currencies into each other on the fly. Nevertheless, the conversion would seem to be a necessary step. Additionally, Bitcoin, while it remains a small network, has a volatile price. It functions poorly as a store of value. However, these are only corollaries of the general barrier of network effects. Since Bitcoin is not yet money, can it be an investment? Why would people buy bitcoins and hoard them at the now “market” price? In anticipation that bitcoins will become real money, that the size of the network of people transacting in bitcoins will grow due to the perceived advantages of this cryptocurrency. They hope that the demand for bitcoins-as-money will skyrocket, which will raise its price in terms of dollars, since supply is capped and mining becomes increasingly more expensive with time. They hope that bitcoins will outcompete dollars, such that perhaps 20 years later, we will all be converting dollars and Euros into bitcoins when calculating costs and revenues. Again, now that the price of bitcoins in terms of dollars and every other currency has been established (thanks to the clever device of Bitcoin’s usefulness for currency exchanges), it is immaterial whether prices for goods are quoted in terms of dollars or bitcoins. That they are quoted in dollars is an artifact of history, of Bitcoin’s newness, and tradition. It is true that the price of Bitcoin is volatile, but that is only precisely because most prices are not quoted in terms of it! In other words, Bitcoin is volatile, because it is not yet a genuine medium of exchange, and it is not yet a genuine medium of exchange (despite its proffered advantages over dollars), because it is a volatile currency. To be more precise, Bitcoin is volatile, because people’s opinions about its future prospects as a medium of exchange change all the time.

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This catch-22 is just another way of presenting the (potentially surmountable) obstacle to Bitcoin of network effects. 19. HOW THE NOTION OF NEUTRALITY OF MONEY IS TO BE UNDERSTOOD

There is in the economy the speculative-theoretical aspect and the active-practical aspect. The former is all the economic laws according to which it functions. It is comparison of economic systems like capitalism vs. socialism. It is all the ways in which the economy is affected by government interventions, from prohibitionism to child labor laws; e.g., it is the answer to the question “What kind of incentives does the new health care legislation create for the market agents?” It is analysis of institutions, such as, what is the best way of structuring a firm? The latter corresponds to answers to questions like the following: Which products are being offered for sale to the consumers? How is the production of all these goods being executed? What is the share price of IBM? What is the CEO of Ford doing right now to attract new customers? Should I invest in the S&P 500 index mutual fund? The speculative part is described by economic theory. The active life of the economy is the work of the hands of actual entrepreneurs. These are very different aspects of the economy, requiring different skills to construct; that is why economists generally make poor entrepreneurs, and why entrepreneurs generally make poor economists. Nassim Taleb’s entire book Black Swan is essentially an extended attack on economics vitiated, however, by the author’s lamentable misapprehension of the scope and method of economic science. Taleb thinks that economists predict the future and chastises them for doing a bad job at it. This is a ridiculous straw man; entrepreneurs predict the future; economists deduce universal laws of social cooperation – as well as what happens when people try to break those laws. If it is useful for entrepreneurs to use powerful computers to help them make educated guesses about future states of the market, then more power to them. Of course, if everyone uses these machines, then their utility to each entrepreneur declines, though society may or may not benefit. Still, some model builders and programmers will be smarter than others, which will grant a competitive advantage to the former and disadvantage to the latter. Further, it is certainly possible that a person with a PhD in economics can learn computer programming and write a piece of software to help his firm make money. But he will be doing that in his capacity not as an economist but as an entrepreneur.

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To ask whether money is neutral is to ask whether changes in the money supply have implication for (a) the theory and (b) the practice of the economy in (1) the short run and (2) the long run. The reason why I single out the supply of and not the demand for money is that in most industrialized countries, the state-supported Central Bank manages the money supply; and the question of the neutrality of money arises precisely in the context of the Central Bank’s monetary policy. Under a free-market international commodity money standard (such as gold and silver), the money supply would increase so slowly and imperceptibly that the subject of money’s neutrality would have no practical significance. This problem comes up only under inflationary fiat currency regimes. It is especially interesting to interventionist economists who want to know with what depredations their employer the state can get away. They want to know to what extent the state can inflate without damaging the economy and its popularity with the masses too much. The demand for money, too, rarely changes abruptly, and ignoring government spending (which we can do under “small government”), is due entirely to individual choices of the market agents, which in economics are ultimate givens not subject to any judgment, which means that it is also under normal circumstances a fully free-market phenomenon. In the short run, money is not neutral either for the speculative or for the practical aspect of the economy. Credit expansion, administered by the Central Bank and the fractional-reserve banks, has consequences for the unfolding of the market process that are highly peculiar and are vastly different from the consequences of sound money and honest finance. As to theory, economic theory can demonstrate the inevitability of business cycles as a result of the inflation conducted by the monetary authority in conspiracy with the banks. It can describe the threat to consumer sovereignty from Keynesism-inspired government spending. It can throw light on the interaction of the public’s time and risk preferences with the state’s monetary and fiscal policies. As to practice, new money enters any economy from different points, raising prices unevenly (another conclusion of pure theory), resulting in consumer products and businesses actually operating being quite different from their counterparts in a non-inflationary economic monetary system.12 The size of one’s income, what one can buy with 12

“Though the high price of commodities be a necessary consequence of the increase of gold and silver, yet it follows not immediately upon that increase; but some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people.

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that income, which technologies are being used in which production processes, who the captains of industry are, which businesses are growing and which are shrinking are all different, given different money regimes and different monetary policies of governments and Central Banks, wherever they have control over the money supply. In the long run, money is neutral for the speculative aspect and not neutral for the practical aspect of the economy. Theoretically, once a particular instance of credit expansion has worked itself out, the price level fully adjusts, and the recession after the boom is over, the situation is no different from that which existed before the expansion was launched. The new money supply is capable of serving the needs of society and individuals just as well as the old money supply. The economy, barring further government interventions, will be working exactly as it did in the beginning of its story, that is, resulting in similar consequences given similar nudges to it. But the practice of the economy is another story altogether. For the credit expansion will have drastically rearranged the actual structure of production and thereby the kinds, quantities, and prices of the consumer goods available on the market. Since the business cycle is destructive of prosperity, people will likely be poorer after all is said and done than they could have been under, say, a full-bodied gold standard. In other words, different firms will be operating, producing different things, using different means and techniques. The economy will function similarly, but it will have different content. To this, I must add that if credit expansion and contraction, bank reserve requirements changes, or fiat money creation do not stop after the first business cycle is over, then even in the long run, the cycle will keep re-occurring. In that case, money supply changes will not be neutral speculatively in the long run, but only because the sequence of similar to each other short-run intervals will compose that long run. Paul Davidson (2009) argues that what causes neoclassical economists to take money supply inflation to be a reliable cause of price inflation is their belief that money is neutral. (While I judge Keynes and the Keynesians to be often wrong, as this book testifies, I am with Davidson in finding the mainstream economic theory to be just plain strange, even alien.) I agree, of course, that money is not neutral in the senses just described. But the connection between printing money and decrease in that money’s purchasing power does not thereby disappear. “At first, no alteration is perceived; by degrees the price rises, first of one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom.” (Hume, “Of Money”)

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In philosophy of causation, money supply inflation would be called an INUS cause of the rise in the price level, or an insufficient but necessary part of a condition which is itself unnecessary but sufficient for the result. (The term originates with John L. Mackie.) For example, there is a set of conditions, such as creation of fiat and credit money coupled with no increase in productivity, no trade deficit, and so on which is sufficient to raise the general price level. At the same time it is not necessary, because price inflation can be caused by other events, such as decrease in the demand for money, voluntary dishoarding, or a disastrous war that results in impoverishment of the general population. But given the specific complex condition just mentioned and in the absence of other sufficient sets of conditions, money supply inflation is necessary for price inflation, because without it, the other conditions in the set will not do the trick.13 Neoclassicals thus correctly affirm the effect yet mistake its cause; Davidson denies even that the effect need occur. The reason is that Davidson favors wage controls in a futile hope to prevent price inflation from following on the heels of money supply inflation. The idea of neutrality of money would never have been entertained if money had remained a privately minted commodity. For that is the shape that normal money takes. It has its own supply and demand; it is produced, usually by being mined out the ground; consumed, when it is spent, invested, hoarded, or used directly for purposes other than exchange; and depreciates due to wear and tear. Money is not an existential condition of human existence, forbidding and unassailable, imposed upon men by a mighty state “for their own good,” as a kind of eternal and immutable measure for economic calculation. It is not any ghostly oil that lubricates the economy as an unmoved mover, affecting nothing in operating and remaining unaffected itself. It is a tool for securing success of numerous human endeavors, and it is enmeshed into human valuations and actions and life. Fiat money is not some “ideal” money purified of its embarrassing roots in something tangible. State control of money is a catastrophe. Gold and silver money is not a fetish or some primitive relic of the past; it is on the contrary one of the most important human inventions ever made. Government control of the money supply is not an improvement over commodity money. It is not a better mousetrap; it is worse – much, much worse; a sign of degenerate – anti-intellectual and immoral – times. 13

The quantity theory of money presents an INUS cause of the rise in the global price level obtained through time-consuming branching spread of rises in prices of numerous goods due to money supply inflation.

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Ask a man on the street why we want the state in control of money supply, and he will tell you that coins are clumsy to use, that physically moving gold from one bank to another seems dangerous and wasteful, and that society is spared the cost of mining precious metals. The first two are purely technical issues, to which enterprising individuals will assuredly find brilliant solutions, if given a chance, especially in a digital age. How can they possibly be decisive? The last one, gold mining, as we will see, makes laissez-faire work much smoother regarding the part that money plays in economic calculation than printing money and credit expansion do for a socialist regime. In short, money is a thing which happens to be extremely useful and marketable. Properties of money change with the growth of civilization. And civilizations are, in turn, influenced by the adventures of commodities that act as money. 20. THAT SAVING OCCURS FOR A VARIETY OF REASONS, AND THAT SAVING DIFFERS FROM INVESTMENT

There are numerous reasons why a person might want to abstain from immediate consumption and save his pennies. All of them, however, fall under consumption [C], investment [I], or hoarding [H]. [H] The first reason is to insure himself against uncertain future. One can do so both in his capacity as a consumer and in his capacity as a producer; and one can do so to deal with both troubles and opportunities. For example, for troubles as a consumer, one may keep a cash balance in order to survive a possible loss of a job. It may take a while to find another job, and, in order to carry out his own personal reservation wage policy, one will be able to draw upon his savings in the meantime. Note that during this time, his unemployment will be voluntary, as per the arguments in (I, 7). Let me additionally point out that it is an insult to workers ever to call them involuntarily unemployed in the free market. For that suggests that workers are disabled and supported by their employers’ charity. If the employer changes his mind, then the worker is cast out into a hostile world, helpless and confused. However, entrepreneurs are not their workers’ servants; nor are the latter incapable of foreseeing and preparing for troubles ahead. As a producer, a person may need to preserve his business from failure during an unexpected fall in the demand for his product. For opportunities as a consumer, one may be thinking of buying a house and taking his time in choosing the right one. He will need the

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cash in order to snatch a suitable house as soon as an opportunity presents itself. And as producer, he may want cash on hands in order to invest quickly into a new prospect that comes his way. “Troubles” and “opportunities” are similar in that missing an opportunity may reasonably be likened to getting in trouble. The demand for cash balances for this purpose can be affected by changes in both (a) the perceived uncertainty of the future and (b) the serviceability of money to protect one against this uncertainty. Thus, people’s levels of “confidence” and “optimism” about the future will affect (a), and inflation (deflation) will undermine (strengthen) (b). To paraphrase Paul Davidson, hoarding “transfers purchasing power over time to an unspecified date for an unspecified use.” (1978: 60) This corresponds to Keynes’ own subjective factors for saving (i), “To build up a reserve against unforeseen contingencies,” and (vi), “To secure a masse de manœuvre to carry out speculative or business projects,” (2008: 107-108) The definition of uncertainty is risk and surprises applied to human affairs and actions, combining the difficulties with both calculation and execution. Being outcompeted and losing money is a threat that uncertainty poses to an entrepreneur. And hoarding money is how people choose to protect themselves in the face of this threat. [C – Arbitrage] The second reason for saving is to provide for a (not unpredictable) time, when one does not expect to have any income at all, such as during old age. In addition, one might save if he has a “feast and famine” income pattern. Various kinds of consulting, construction, seasonal jobs are the lines of work exhibiting this quality: sometimes, there is more work than one can handle, even if he works 60 hours per week; other times, there is no work at all. One may also save in order to facilitate a career change. Thus, a man who works as a middle manager for an insurance company has an ambition of being an actor. He saves money in order to provide himself with income to take classes and with time to rise up in the acting profession. In short, saving is useful for “smoothing out” consumption over both good times and bad. Keynes lists this as subjective factor number (ii). [C] The third reason is to either (1) purchase an expensive consumer good (in which case while the appropriate balance is being accumulated, it should be considered as part of consumption, even as if “already consumed,” rather than as part of investments or hoards), (2) give a gift, (3) discharge an obligation. The effects of (1) were described in (I, 15). An example of (2) might be education of or inheritance for

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children, and of (3), the payment of taxes. Keynes himself proposes “(vii) To bequeath a fortune” which is similar to my (2). [I – Loan Market] The fourth reason to save is in order to profit from one’s low time preference, if the equilibrium interest rate is high enough to outweigh the disutility of waiting. (I will deal with these concepts in detail in (I, 41-45).) This coincides with (iii) in Keynes. [I – Arbitrage] The fifth reason has to do with expectations of price movements. If a person expects prices to fall or quality of goods to rise sufficiently quickly, then he may abstain from immediate consumption and endure the disutility of waiting, believing that he can satisfy his desires more successfully at a later date. This phenomenon is endemic in highly innovative industries, such as the computer and electronics industry at the present time (2010), wherein a product may become obsolete mere weeks or months after being bought. Those people who waited until high-definition Blu-ray DVDs appeared on the market to start their DVD collections may have made a smarter move than those who bought regular DVDs right away. I label this [I], because it is an investment “in money” and in its increasing purchasing power. [C] The sixth reason is to enjoy the instant gratification of impulse buying. When one is rich, one does not have to watch every penny; one does not think of money or budgets in day-to-day life, and that is a source of pleasure. This may have some relation to Keynes’ (v), “To enjoy a sense of independence and the power to do things, though without a clear idea or definite intention of specific action.” [I – Stock Market] Finally, one might save is in order to invest, that is, to buy underpriced and undercapitalized, as he figures it, factors or production, including intermediate goods, in order to profit by producing something the consumers will value. It is useful to make a distinction between (an individual’s) demand for money and demand for a cash balance. Smith’s demand for money consists of all the sets of goods and services that he is willing to give up in order to acquire $N for all N. It is all the things he (1) has or can obtain that he (2) would agree to part with for various amounts of money. Demand for money is not, as the Post-Keynesian Nicholas Kaldor would have it, “nothing else but the reciprocal of the velocity of circulation of money.” (1982: 9) Demand describes what one would be willing to give up for a marginal dollar. Velocity measures how often a dollar bill changes hands. Clearly, these are different notions in meaning. It can easily be shown that they are different in reference, as well. Consider the monetarist equation MV = PT, where M is the supply of money, V is the velocity of circulation of money, P is the price level, and T is society’s wealth in terms of goods being produced and sold in

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stores. If M and T are held constant, then if demand for money D increases, then the purchasing power of money increases, too; P goes down; and V must go down, as well. We see that D is, indeed, inversely proportional to V. But that is not all. For let M and V be held constant, and T increase. The equation can be rewritten as (M / T)V = P, where M / T is the relative abundance of money with respect to goods. If T increases, then demand for money increases which again raises the money’s purchasing power which, in turn, is equivalent to a falling price level. In this case, demand for money is an intermediate term in the causal chain between a change in T and a change in P. Since D has now been shown to be proportionate at least to T / V, it cannot be said that demand for money is simply 1 / V. As a result, the equation can be again rewritten as P = M / (T / V) or “P is proportional to M / D,” reflecting the influences of the supply of and demand for money on the price level. Changes in V are generally a short-term influence on P; changes in T (i.e., the standard of living of the mass of the consumers), longterm. A “demand” for cash balances is not really demand for money Smith does not yet have but a choice on how to allocate the money he already possesses, namely, by putting it into his savings account. There are a lot of ways for Smith to distribute his income among competing ends, and saving some money is one such way. Smith might have demand-for-money-to-be-used-for-buying-apples. He demands money for, say, his labor and demands apples for the money. In this case, I can dispense with money altogether and consider Smith’s demand for apples in terms of his labor (forgetting for the moment that he sells labor to one person and buys apples from another). Similarly, one can consider Smith’s demand-for-money-to-be-put-in-a-hoard. The savings are, in a certain sense, a consumer good, insofar as Smith derives utility (such as due to security) from it. For example, Smith’s deflationary expectations can accelerate the fall of prices due to an increase in the (a) demand for money. Smith might actually sell more of his goods in order to acquire money that he expects to appreciate in value. If this money goes into a savings account, then we have an instance of reason for saving #1 (or perhaps #5), namely, a (b) demand to keep a cash balance on hand in order to make a purchase, precisely when it seems that prices have hit bottom. Demand for money cannot be aggregated, since it is impossible to sum up everything from soup to nuts that people are willing to exchange for money. Demand for cash balances, on the other hand, is easily aggregated: take a look at the entire money supply and see how much

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of it is kept by its owners for the precautionary reason. Saving can be construed in the wide sense or in the narrow sense. In the wide sense, saving is any accumulation of a cash balance for reasons #1 through 7. It is clear, as per the reasoning above, that investment is not identical to saving widely understood but is rather a form of using the resources saved. In the narrow sense, saving is any abstention from consumption and hoarding with the purpose of investing the money saved. Keynes says in his Treatise on Money that “saving is an act of the individual consumer and consists in the negative act of refraining from spending the whole of his current income on consumption. Investment, on the other hand, is the act of the entrepreneur… [which] consists in the positive act of starting or maintaining some process of production.” (I, 172) On the other hand, in General Theory, Keynes takes “saving” in the narrow sense. Thus, he is right in holding in General Theory that saving and investment are the same with regard to the amount saved and invested and in holding in Treatise on Money that the meanings of the two terms are different. Keynes writes that classical economists, such as Marshall, thought that S(aving) = I(nvestment) (2008: 177-8), but it seems to me that they held this because they neglected to take into account hoarding. Keynes makes no such mistake but also equates saving and investment. He does so, however, for a very different reason. Chapter 15 of General Theory leaves no doubt that he presupposes the modern central banking in all his arguments. In Chapter 17, for example, Keynes argues that “there is a different natural rate of interest for each hypothetical level of employment.” (242) He must have in mind the stimulation of business activity by the manipulation of the rate of interest via monetary policy. Again, in Chapter 18, he takes the interest rate to depend “partly on the state of liquidity-preference… and partly on the quantity of money.” (246) Quantity of money here substitutes for time preference. Nothing in Keynes makes sense apart from the assumption, running throughout General Theory, that creation of money lies under government control. Under sound finance, saving or supply of credit precedes investment or demand for present money. A person saves a certain amount of cash and then looks for suitable entrepreneurs to grace with “time” (i.e., with the privilege not to wait or abstain from present consumption themselves) for a price called interest. But under fractional-reserve banking, demand for credit from consumers or entrepreneurs comes first and elicits creation of credit out of thin air by the banks. Before one has decided

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to invest, the money does not exist. It is created instantly in the bank’s computer upon the entrepreneur’s request. This reversal is an abomination, as we will see in the course of this book. Keynes took this unfortunate state of affairs, namely that investment is financed through fractional-reserve banks with the help of their miraculous money-creating power, to entail an identity between saving and investment. There is no market for individual loans, in which Smith abstains from consumption and explicitly lends the funds thereby generated to Jones for investing. Hence, saving and investment are not equilibrated to yield an interest rate, wherein preferences for present goods versus future goods are balanced, as Austrian economics teaches. (More precisely, a “center of gravity” in the form of the interest rate is found for the constellation of people’s time preferences on the loan market.) Rather, they are one and the same thing, with investment producing savings as “needed.” Since money is now superabundant, investment is seemingly not traded off against consumption, and the only limit to the amount of cash invested is the people’s liquidity preferences or decisions regarding hoarding. It will be proved later that people’s time preferences would not be defied, and the lack of a sufficiently inelastic supply of money is a cause of business cycles that are destructive of wealth. Keynes argues that the amount saved or invested depends on the level of “income” by which he means money income to the members of society. But this income is “a function of the rate of the investment.” The classical understanding, at best, can tell us “what the level of income will be, given… the rate of interest; and alternatively, what the rate of interest will have to be, if the level of income is to be maintained at a given figure.” (2008: 180-1) It is clear that he is again thinking about the inflation ushered in by credit expansion. This inflation alters money incomes to people and changes the amounts of savings. The amount of forced savings injected into the loan market affects voluntary savings. A certain amount of money is Smith’s savings at t1, if at any later time t2, Smith directly invests this money, i.e., attempts to profit with it by spending it on factors of production. As a corollary, it follows that I could not find out the amount of aggregate savings in the narrow sense in the economy until moment t2 comes to be. According to this definition, investment at t2 was savings at t1. The savings represent a sacrifice of that present consumption, etc. that could have been enjoyed at t2 or earlier but was not because of the decision to invest. Thus, Crusoe may be saving some of the fish he catches, but I am not concerned with the state of his mind while he is doing this. Only when he starts building a boat, while using the saved fish to sustain himself while he works, can

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the fish be called his (narrow) savings. The reason is that he is always free to change his mind as to how to utilize his extra fish. Like so many other things, saving is revealed in and made definite by human action. For the sake of clarity, I want to point out that only money kept for reason [H] and not the total money supply is considered to be a “hoard.” Besides reasons for saving, there are also the forms of saving. One need not stockpile money but may keep various securities or items. Money shares with bonds, stocks, gold, other commodities, artwork, certain kinds of capital goods, and various other valuables one property: liquidity. Therefore, all these things can function as a store of value easily convertible into the medium of exchange. Investments, on the other hand, are extensions of money to factors of production, since investments depend intimately on the ability of the businessman to calculate costs and revenues. Again we see that the two mean completely different things. People do not accumulate money the way roads accumulate falling snow, mechanically and pointlessly. Saving is always “saving up for something,” for some more or less explicit purpose, or some forms of consumption, investment, and hoarding. The loan market disconnects saving from investing. If I loan my money to someone at a (psychic) profit, I am by law guaranteed the return or ought to be. Therefore, I do not care how this money is invested or even if it is altogether lost. The loan market brings together lenders and borrowers, not strictly speaking savers and investors. E.g., during a credit expansion banks can hardly be called “savers,” and the borrowers can use the money to buy houses, hardly “investments.” Even regarding production, saving is performed by capitalists who earn interest; and investment, by entrepreneurs who earn both interest and profit (hopefully), another theoretical difference. However, under interventionism, saving and investment are actually united in a perverse sense that the only way to prevent one’s savings from gradually losing their purchasing power over time due to inflation is to invest them, even at risk of losing them. The Wall Street adores inflation partly for that reason. (Appendix, 9) deconstructs the stock market. Lastly, when a man has saved a certain amount of money or has purchased assets such as stocks or precious metals, these things, though part of his net worth, are not his wealth. Wealth consists always of (actually) consumer goods obtained and the enjoyment therein and (potentially) in the business firms active in the market. A hoarder, who has millions in the bank yet lives in squalor, unless he derives extraordinary

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pleasure from the financial security afforded by the hoard, is not rich. 21. THAT KEYNES’ “PSYCHOLOGICAL LAW” DOES NOT HOLD The “law” claims that “men are disposed, as a rule and on the average, to increase their consumption as their income increases, but not as much as the increase in their income.” (2008: 96). This law is a truism, if we assume that the absolute amounts of consumption and investment do not decline from the time before the increase in income. Suppose that Smith’s income was $5,000 / month, and he spent $3,000 and saved (in the wide sense) $2,000. If his income increases by $500, then this $500 will be allocated between consumption and saving, e.g., $175 spent and $325 saved. Consumption has, indeed, increased by $175 which is, indeed, less than $500. That surely is a trivially deduced result. Why, however, must the assumption hold true? Perhaps, Smith decided to buy a house the very month he received his raise and in order to achieve his goal, started saving a lot more. In this case, he might now be spending only $1,500 per month and saving $4,000. His immediate consumption this month has thereby declined considerably. On the other hand, perhaps, Smith has decided to “die broke.” This end induced him to spend $6,500 and dissave $1,000 per month. Here his consumption has increased but by more than $500. Again, Smith may consider a new car to be unaffordable under old income and suddenly within reach under the new income. The $500 / month raise will now result in a huge spending spree, far more than the mere $175. The only way in which consumption can reasonably be considered to be a predictable “function” of income is that it cannot exceed income; and even that is manifestly false, since a person may borrow money and spend it. There is further a difference between nominal and real income. The latter may be defined as that amount of money received in a given period that can be spent without lessening one’s net worth. But the whole point of net worth is to be able to convert it into real income, i.e., consumer goods and pleasure. Consumption, therefore, can be “autonomous,” that is, independent of income and funded by cashing hoards and investments and also by borrowing. The simple reality is that at any moment, it is open to a person to redistribute his income, net worth, and borrowed money toward consumption and saving however he chooses. No one is bound robotically to follow Keynes’ formula during his life. A consumer does not need to evenly rotate any more than an entrepreneur does. The same reasoning applies if Keynes means real rather than money income. There is a

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greater abundance of both consumer and capital goods at lower prices in the economy relative to a previous state of affairs. Must Smith increase both consumption and investment at the same time? Not at all. He can reallocate his money in any way whatsoever in response to the greater prosperity. The “law” is nothing of the sort. Keynes seems aware of all this. Aside from the “subjective” factors influencing the savings rate enumerated in (I, 20), there are, Keynes argues, “objective” factors, as well, such as changes in the purchasing power of money and changes in time preferences (2008: 91-95). But “since… the main background of subjective and social incentives changes slowly, whilst the short-period influence of changes in the rate of interest and the other objective factors is often of secondary importance, we are left with the conclusion that short-period changes in consumption largely depend on changes in the rate at which income… is being earned.” (110) But then, still, the “law” is merely an empirical generalization. “People will not change their base rate of consumption and saving in the face of fluctuations of their incomes, unless they decide to” hardly qualifies for the status of a law of human nature. In a similar vein, it is true that investment drives saving, to the extent that people save for the sake of investing (though they may save for other reasons, as well); investing is the end, and saving is a means to that end. But it is certainly not true that the present level of investment determines the future level of saving, because at any time people are free to change their ratio of present vs. future consumption. Moreover, saving takes time, and by the time one saves enough to invest, the opportunity he is contemplating may easily evaporate. To be sure, one can borrow, but this only means that other people have in the past saved enough in the hope that there will arise entrepreneurs who will find these savings useful. In other words, the goal of investing follows the act of saving, insofar as the former is a motive for the latter, giving a person a reason, via teleological “effecting,” to save. If Keynes means that economic growth continues even as a society becomes richer, i.e., that people continue to save, or that growth is split between creative advance in the quantity and quality of both consumer and capital goods, then he is right, but this seems like a trivial point. I want, however, to interpret Keynes’ idea as charitably as I can. Perhaps, what our author means is that rich people tend to save a higher percentage of their income than poor people do. We can consider either (1) individuals, in which case wealth equals their net worth expressed in money; or (2) society as a whole, where wealth means consumer goods and pleasures available now and the production processes replenishing

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them. For (1), whether one is rich or poor depends both on one’s income and on one’s rate of saving. A person with high income can easily spend himself into bankruptcy, while a person with low income can, through a high savings rate and prudent investments, join the upper class. In one sense, the tendency holds by definition: rich people, indeed, save more; or better, have been saving more up till now, and that is precisely why they are rich (in terms of their net worth). Poor people, on the contrary, spend almost everything they earn, and that is why they are poor. This is a reason why (a) those who save a higher proportion of their income tend to be richer. But there is also a reason why (b) those who are richer tend to save a higher proportion of their income. Let Smith’s income be $200 / month. He invests $10 and a month later obtains $20 in profit. This is a 200% return on investment and a 10% increase in his income with the savings / income ratio equal to 5%. Once all such high-yield investments are realized, in order to continue the same level of economic growth in the next period, namely, 10%, Smith will need to save more that $220 * 0.05 = $11, because the return will be smaller than 200%. Say, he saves $15. His return is $22 / 15 = 147%, and the ratio of savings to income is 6.8% which is greater than 5%. In order to grow his wealth at the same rate, our now richer Smith has to sacrifice increasingly more personal consumption. Investment by an individual thus is subject to diminishing returns. It is no doubt true that new investment opportunities arise all the time, and moreover, the economy is so large that it dwarfs any single investor’s personal wealth, but the point is still that given an array of such opportunities at any moment, the marginal dollar is put into increasingly less lucrative business firms. As a result, the poor get richer faster than the rich get richer. With respect to (2), each new production endeavor satisfies in the hearts of the people less and less urgent needs. In order to “keep up” with previous increases in human happiness, the number of projects started and successfully completed needs to be on the perpetual increase. First of all, the more capital and consumer goods there are in the economy, and the more lines of production are in operation, the greater the amount of time and effort, and therefore, real capital, needed to maintain the existing economy. It is true, of course, that the addition of capital good A to a particular production process can make labor so much more efficient at maintaining capital good B within that process that the cost of maintaining both A and B together will be smaller than the cost of maintaining B alone without A. Thus, a durable and easily replaceable sharpening stone can reduce the time it takes for Crusoe to

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sharpen his axe every day from 2 hours to 2 minutes. The longer physical structure of production has resulted in a shorter temporal structure. I only note that multiplication of processes will require more savings. Second, richer communities have more capital accumulated per person and therefore, longer production processes online. Now the most profitable investments are taken advantage of first. What remain, assuming no technological progress, are less and less valuable uses of capital. However, to reiterate the point made in (I, 6), the consumption sacrificed in order to finance economic expansion is no greater in a rich society than in a poor one. A poor Crusoe is tending to 5 projects; in order to find the time to do a 6th one, he has to postpone the satisfactions derived from 2 projects he judges least important out of those 5. A rich Crusoe cares for 25 enterprises; in order to devote his efforts to 7 more, he has to postpone 9 least important of them. There is not enough information to deduce, if Crusoe had to choose between those 2 or 9 jobs, which combination he would consider to be more valuable. Dillard argues that Keynes favored “socialization of investment” on the grounds of “the secular decline in the marginal efficiency of capital.” (MEC) (1948: 156) The more abundant capital is, the less each capital good contributes to production. Now futurists always predict gloom and doom and are usually wrong. Keynes is no exception in this case. For the positive MEC of a capital good is due to different entrepreneurial valuations of the good’s prospective yield. The consuming public will probably never be satisfied with what it has, and winners in the competition improve consumer welfare. But there is always room for improvement; therefore, for profits; therefore, for positive MEC. It is true that the impact of any individual machine on (i) consumer happiness declines; but the number of such machines increases. Even if (ii) the money value of quasi-rents (i.e., the discounted marginal value product or DMVP) of a piece of capital decreases, as well, this development is offset by (1) general price deflation, such that all goods cost less and (2) the size and number of enterprises which grow with economic progress. Paul Samuelson points out that “the leaders in the growth race invest at least 20 percent of output in capital formation. By contrast, the poorest agrarian countries are often able to save only 5 percent of national income. Moreover, much of the low level of saving goes to provide the growing population with housing and simple tools.” (2005: 241) One reason why this is plausible is the failure of the citizens of poor nations to exercise birth control, i.e., their lack of what Malthus and Mises called “moral restraint,” such that the population always presses on the means of subsistence.

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The key points are (1) that the money is invested always in new capital formation, i.e., capital that did not exist before and which is expected to make production more efficient in terms of quality and quantity of consumer goods. (2) That the leaders in the growth rate are leaders precisely because they spurn present pleasures in order to provide for the future. (3) That it is not the case that the poorest countries are not “able” to save more, as if they were up against a malevolent force that checked their capital accumulation; rather, they choose to save little for their own reasons. Rich people and communities save more, insofar as they may have taken the lesson to heart on how to stay rich and become richer still. However, regardless of this interpretation, economics is not psychology. Psychology describes the actual ends that people have and their reasons for those ends. But economics takes preferences as given or as ultimate givens and teaches how to satisfy as many of them as possible. We do not have to know the content of the ends in order to do economics. So, the “psychological law” is out of place in an economics treatise. 22. THAT THE SHARE PRICE OF A PUBLIC COMPANY IS INFLUENCED BY CAPITAL OWNED AND ENTREPRENEURIAL DIRECTION

In order to grasp Keynes’ attack on a particular form of saving, it will be useful to examine the problem of how corporate shares are priced and what determines the worth of a company. Questions abound. Does the company benefit from, or is it hurt by, any particular trade? If a person buys more shares with his dividends, then his money does not go “into the company”; it goes to the shares’ seller. Suppose a small company going public issues 1,000 shares. Can it price them at a million dollars each? If not, why not? In what follows, I explain how shares are priced. In order to understand the dynamics of the stock market, it is useful to start with an ERE. In such an economy, investing into a company is entirely equivalent to loaning money to that company. Suppose that 10 people, Q1, …, Q10, each own 100 shares of company A, each share costing $1. Let A also borrow $1,000 from lender P. A’s assets are now $2,000. It uses these funds to buy inputs to production, arrange them into a technological process, create output, and advance that output down the production structure by selling it to the lower-order capitalists or the consumers.

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Now a question: How much must A’s revenue be, if the equilibrium interest rate is 5%? In order to continue evenly rotating the next day or next year, A must make at least $2,000. But it also has to pay interest to P which is $50. Moreover, if A distributes less than $5 in interest-equivalent income to each of its shareholders, then these shareholders would be better off dumping their investment and loaning the money to some better-performing company B. (Since in an ERE, there are no losses, B’s return would be guaranteed.) In order to keep the investors happy, A must also give them at least 5% above the $100 in revenue it generates every year for each investor or $5. But since we are not allowing company A to profit, it cannot generate more than $5 per investor income. Overall, A must make $2,100. We can see that the definition of the ERE causes there is no conceptual difference between investing and lending money for productive activities. Now let us permit profit to enter into the picture. Suppose that in a certain year company A made $2,300. It decides to give out dividends to each owner. Note that P is not eligible for the dividends; all he receives is interest. How at this point do we distinguish between interest income to Q1 and profit consumed by Q1? By counting as profit everything above the interest income. (We will examine the problem of how interest rates are determined later.) How will the share price change given the profits? The share price is a sum of two components. The first component is the capital owned by the company, that is, A’s assets minus A’s liabilities. That number is C = $1,000, and so, the initial value of a share of A is $1. The price of a share can never fall below that value, because then it would be profitable to buy the whole company, take it out of business, carve it up, sell its capital, and profit thereby. Of course, in order to ascertain the total value of the capital owned by the company, it is necessary to have well-developed spot markets for these goods. To the extent that obtaining a market price of and finding buyers for specialized or even unique machines and raw materials are difficult, the net worth of the capital is reduced or even simply uncertain. In that case, this component of the share’s price, C, will vary with people’s differing estimations of the company’s material wealth. The second component is the expected discounted future profits of the company. We have to discount, because $200 received 10 years from now is equivalent to $200 / (1.0510) right now. The reason is that $122.78 today will safely generate exactly $200 in 10 years at 5% interest. Thus, if the profit is expected to be $200 / year every year for all eternity, then the total dividends will be D = 200*(1 + 0.952 + 0.9522 + …) = $4,200. This, of course, is an idealized calculation. In real life, profit expectations and the discount rate will fluctuate, and the series

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will not be infinite, because no one can foresee the future very far ahead. The point merely is that the series converges, even under the most favorable for the company circumstances, and a fortiori, in every other case. The share price will increase to 1 + 4.20 = $5.20. Materially, every company is a basket of capital goods it owns; while formally, it is entrepreneurial direction of that basket. The share price reflects both matter and form. For example, profits are not guaranteed by high investments. In fact, the more one invests, the more he can lose. Mises points out that “reality does not reward toil and trouble. If toil and trouble is expended according to well-conceived plans, its outcome increases the means available for want-satisfaction.” (1996: 396) Similarly, nature does not automatically reward one for the capital goods one owns. The capital goods must be paired with slick entrepreneurship in order to yield anything useful. Now if the share price were equal only to C or $1, then by buying 100 shares of the stock at $1 / share, one would immediately gain $420 in pure profit; at the same time, one can at any time sell the stock and get his $100 back, pocketing the profit. It is true that my calculations assume that one’s possession of the stock is everlasting; so, it seems at first glance that one never actually gets a chance of selling it. That, however, does not matter, because one is compensated for this interminable waiting with the interest income: remember the $100 / year interest accruing to all the owners and creditors of the company. Profit is over and above the interest income. What can a company do with its profit? First, it can distribute it to the investors for consumption. Note that it is expectations of future dividends that change the value of each share, not the dividends that have already been given out. Second, it can reinvest the profits into itself or “plow the profits back into the business.” This causes the company to grow, where by “growth” I mean capital gains. Instead of buying $2,000 worth of producer goods, as it did last year, A buys $2,150 worth of them. The share price goes up, because its first component, C, increases. If in a certain year the company was expected to produce dividends but instead decided to reinvest the profits, then what happens to the share price is unclear: on the one hand, the expectations were disappointed, which is why D will be lower; on the other hand, the company has grown. (With more capital A has a chance to attain higher revenues in the years ahead. This may increase D relatively: instead of going down to $4,000, the second component may decrease only to D’ = 205*(0 + 0.952 + …) = 4,100.) The share price, then, is an effect not a cause of the corporation’s adventures in the market. It is entirely a

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reflection, a sign of the present and expected future state of the company. So, if it is asked: For what reason is the company interested in making its share price as high as possible? the answer is: Because the price is formed as a result of adding (1) the company’s capital and (2) its discounted expected future dividend stream, and the higher the share is, the richer the company owners are: the higher the value of the “stuff” they own in the form of producer goods now, and the higher its value they expect to come to own in the future, once the output is produced and sold. This combination can be traded for cold hard cash with other people. Paul Davidson distinguishes between what I will call investorsavers and hoarder-savers. The former are interested in the dividends or in consuming the profits. The latter are interested in capital gains which are profits reinvested or in preservation and enhancement of their assets. Thus, stocks for the hoarders are a store of value. Davidson goes on to state the opinion of “neoclassical economists” that in such a case, the wealth is stored in durable capital goods. (1978: 66-7) Our author’s distinction is untenable. (1) For profits are indispensable for both kinds of savers. The stock of company Q that is losing money will fail to serve either the investors or the hoarders. The investors are receiving no income from Q and will have to be content with diminished income from other companies, if they sell the investment for less than they bought it and put the money into something else. The hoarders’ assets in Q will lose value. Both, therefore, want to buy stocks prudently, and both will be guided in their choices of assets by exactly the same considerations. It is wrongheaded to argue that the hoarders are concerned with the material cause of a company, while the investors are concerned with its formal cause. For as long as a company lives, its form and matter are an inseparable unity. What Davidson is trying to argue is that the hoarders are enabled by the existence of the stock market which makes their assets liquid, i.e., easily convertible into cash. (2) But the investors are enabled by the same thing! Without the ability to get rid of an investment that has gone sour, or capitalize on superior knowledge that profits will diminish in the future, or invest still better, investors are hamstrung. An investor also wants to be able, easily, with a click of a button, to unload a bad stock on one unsuspecting simpleton, and buy a good stock from another such. What is more, Mises famously identified the presence of a stock market as the litmus test for whether a country is capitalist or socialist. Without this market, or if people cannot trade stocks easily, the world’s production structure and processes would be exceedingly primitive, decimating the purchasing power of both the hoards and the income from dividends.

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Once again, the allegedly different kinds of savers are shown to be exactly the same. (3) Furthermore, the hoarders do not purchase random durable capital goods. They buy these goods via the intermediary of publicly traded firms. This way, all capital goods remain under some entrepreneur’s direction. That is what makes them goods. In addition, a firm has assets other than machines. It may possess land, a trained workforce, steady relationships with suppliers of raw materials, good will and recognizable brand names, superior managers, and so on. In buying stock, a hoarder-saver, just like an investor-saver, buys not only capital goods but all these auxiliary factors of production and more. What happens to the shares, if the shareholders expect the company to keep losing money for the foreseeable future? They may try to dispose of the shares at bargain rates, given that, in their estimation, there will be no dividends, and the company’s capital will shrink. The shares now may cost less than A’s total capital. They (or the new owners) may try to make changes to the company, such as replace the senior management, seeding the vacant position with better leaders, thereby changing profit expectations. They can, finally, shut the company down, sell the assets, pay off the debts, and distribute the proceeds. Trading shares on the stock market happens for two reasons. First, when the traders discount differently which means that their time preference rates differ, so as to permit a mutually beneficial exchange. If Smith discounts by 5%, then D for him will be equal to $4,200, as calculated above. If Jones discounts by 20%, then D for him is only $1,200. If I may be colloquial and allow interpersonal utility comparisons, then Jones needs the money “right now” more urgently than Smith does. He can then sell the shares to Smith for, say, $3,000 for mutual profit. Second, whenever two people disagree in their estimation of the company’s prospects. The first component of the share price can at any moment be relatively easily ascertained by taking stock of the company’s assets and liabilities. But people can have widely divergent views of how profitable the company is going to be in the future, or even whether it will have a future at all. So, when shares change hands, it is not a normal trade, as in the case of Smith’s trading his apple for Jones’ orange. In the latter situation, there is a double inequality of wants: Smith prefers Jones’ orange to his own apple; Jones prefers Smith’s apple to his own orange. But in trading shares, only one of them will be revealed to be right as the future unfolds. The share that, were there no uncertainly, would cost $5.20, instead cost $3, when Smith bought 50 of them. Hence, he profited or will have when the money comes in. One of

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them is wrong as to the company’s outlook and therefore, is a poor entrepreneur. Stock market trades are aspects of competition and are socially valuable inasmuch as resources are guided into the hands of those shareholders who think they can use them best. Finally, let me say a few words about how a company raises money in an initial public offering (IPO). Let Smith’s company be worth, in his judgment, $800,000. He predicts or estimates that his company can become quite larger – in fact, larger by $1 million and still profit considerably. Smith knows how to use $1,800,000 well, though he is less confident about how he could use still more money. Moreover, he knows that other people will be reluctant to commit too large of an amount into the hands of an untested CEO (Smith, in this example). To attract capital, Smith issues 180,000 shares, slaps a $10 price tag on each, and retains 80,000 of them. The rest he offers for sale. At this moment, Smith owns all the shares, but they cost only $4.44 apiece. He raises capital by selling them for more than that, with the condition that all the money received has to become the starting capital. Now suppose that other people overestimate Smith’s leadership skills. In that case, they might be willing to buy each share for more than $10 each, raising its price once the IPO is over. Even a smaller share of the future profit (which translates into dividends and capital gains) may be valuable, if the profit is expected to be large. On the other hand, if folks think that Smith is less alert than he imagines himself to be, then the share price is likely to fall, allowing people to buy the right to a greater share of the capital and profits for less money. Smith’s own wealth will fluctuate as a result, as well. Once the IPO is over, a company can increase the amount of capital it owns by reinvesting the profits, borrowing money, and even – though this is rare – issuing more shares at the market price to new investors. 23. THAT SINKING FUNDS ARE NOT A VICIOUS FORM OF SAVING Depreciation of long-lived assets is a consequence of capital consumption. (I am aware that things can deteriorate solely due to passage of time, but an idle object that is just sitting there rusting is not really a capital good. Practically all depreciation of equipment occurs as a result of using it.) Let the landlord of an apartment building rent it for, say, $10,000 / month income. But the building suffers wear and tear every month. Therefore, the landlord must either (1) spend a certain amount of money, say, $1,000, every month on upkeep, (2) let the building

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deteriorate without providing for its replacement after it becomes unrentable, or (3) again let it deteriorate yet set up a “sinking fund.” In the first case, the capital value of the building will stay the same, yet its profitability will suffer. This corresponds in (I, 22) to C staying the same and D decreasing. In the second case, D is higher yet C is slowly falling. The total worth of the building is the same in both cases, although we must limit our series to the number of months the building will stay in working order as opposed to infinity, as in the original example. Now the way it is presented, this statement must be qualified. Any durable item used in production, such as a machine but even a house, will not conveniently depreciate by a set amount year in and year out. The remaining value of a machine depends on the surprising happenings that will alter the future states of the market. In all likelihood, a changing economy will devalue the machine far quicker than its purely physical properties may suggest, because technological progress and capital accumulation will allow competitors to use machines that are more efficient in the years ahead and steal one’s customers away. The chance or expectation of some bizarre turn of events in and of itself diminishes the capital value of the machine, because the very possibility of its coming to be outshone by competitors, as time goes on, makes its potential buyers more wary. On the other hand, a house may benefit greatly from the gentrification of its neighborhood and even become more expensive next year than it was last. Depreciation is an accounting trick; it is useful for determining whether evenly rotating in the future for the durable goods owner is advised; but it has no economic meaning. Set depreciation is an ERE concept and not an outcome of human action. The third case may arise, if it is impossible to make repairs to the asset. Then, every month $1,000 might be saved into a sinking fund, such that when the building is no longer serviceable, there is enough cash to buy or build a brand-new one. Keynes is worried that this money, while it is being accumulated, will be hoarded which may produce unemployment, since if we no longer consider the hoard to be genuinely part of the money supply. This entails permanent monetary deflation, and prices and wages may fail to keep adjusting downward speedily enough to preserve full employment. “Financial prudence” or depreciating on the books by a greater amount than what the assets actually lose is condemned as being part of the problem. Keynes goes so far as to attribute the Great Depression to this phenomenon, saying that “by 1929 after rapid capital expansion,” much of new investment went into sinking funds (2008: 100). This argument is a variant of the underconsumptionist theories of the business cycle which I will examine in (II, 15).

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The first reaction to Keynes’ idea is the incredulous: “Should people not have maintained capital?” If Keynes wanted still more “rapid capital expansion,” then even more money would have gone into capital formation, and present consumption would have declined to a still greater extent. It is equally implausible to believe that people made errors en masse and saved so much as to trigger the deepest depression in the US history. Saving more than the amount by which an asset would depreciate in a certain world is simply a normal and socially non-malignant reaction to the non-ERE reality. A judicious bit of insurance never hurt anybody. Herein lies the beginning of the Keynesian censure of money’s function as a store of value. It is a preview of hot reproofs of “liquidity preference” among the people that seems to cause them neither to consume nor to invest. For example, it is conceivable that there may be a sudden and seemingly uncaused fit of fear among the investors, such that money supply deflation due to hoarding into sinking funds results in losses to some entrepreneurs in a given round of production. As we will see, however, such a one-time convulsion is economically irrelevant. Unless deflation comes to be expected, production and job creation will not subside. Even if there is some kind of hyper-deflation during an especially severe bust, this deflation will exhaust itself in a very short order, restoring normalcy. Under gold standard, in addition, gold mining will be stimulated; and price deflation, quickly undone. At any rate, Keynes does not give enough credit to entrepreneurs which should be given to them according to (I, 15). In the case of (2), a businessman will simply engage in an accounting procedure designed to give him an idea of his profit or loss. Has more been earned from sales than lost in capital consumption? No money is hoarded. Now by saving, a man brings a definite future good closer to solid reality. The more he saves, thereby foregoing immediate consumption, the less he waits. In the case of (3), we can distinguish between (a) waiting to resume consumption by spending one’s principal plus interest income at some future date (which generates a normal upward-sloping supply of present goods line), (b) waiting for the right moment known in advance (which yields a vertical supply line), and (c) waiting for the right moment not known in advance (hoarding).

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Saving for retirement, say, involves (b) or wanting to consume at the right moment, i.e., when one is old, as versus before, when the timing would be wrong. Entrepreneurs can still predict what things the saver will want after he retires and produce them. He can receive interest both while he is accumulating and even afterward, if he decides to get an annuity with his cash. Smith can loan his money both as he increases the stash, and as he draws it down. Hence, it is in the interest of the landlord to invest the money into bonds or even stocks, keeping it from being “idle.” It is contrary to reason to expect hoarding. What is more, if depreciation is calculated correctly, then the future loses its uncertainty, and the money can be loaned out with the provision that all of it is returned on the very day when the asset loses all value. Even if accumulation of money does occur, entrepreneurs will foresee the state of future demand and keep producing to such an extent as to enable the property owner to buy a new building (or enable a businessman to buy a new machine), as soon as the old one is no longer functional, and the sinking fund is ready to be spent. This corresponds to reason #3 for saving in (I, 20). Production does not subside but is merely redirected from cheaper goods to more expensive ones; or from consumer goods to capital goods; and therefore, Keynes’ concerns are unfounded. 24. THAT CHANGES IN THE RATE OF INTEREST CAN AFFECT THE RATE OF SAVING IN CONTRARY WAYS

Pp. 110-111 of General Theory lend themselves to several interpretations. The first of these is that Keynes simply confuses supply of loanable funds with quantity supplied of loanable funds. He writes: “The influence of changes in the rate of interest on the amount actually saved is of paramount importance, but in the opposite direction to that usually supposed.” If (i) the supply of and demand for present goods are not in equilibrium with the price below it, then an increase in the interest rate which is the price of time (I will have opportunity to examine these issues in (I, 41-45)), corresponding to the move from A to B in Figure I.24.1, will cause there to be, generally speaking, more lenders and fewer borrowers. This means that consumption of the lenders will decline, and their savings, rise, in order to bestow the necessary and sufficient funds on the demanders of present goods, as equilibrium is being attained. But if (ii) the rates of time preference go up, leading to a shift

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of the supply curve leftward and to a rise in the equilibrium interest rate (a move from B to C), then lenders will need more inducement in order to part with their money. Borrowing (and quantity of the present goods supplied) will decline concomitantly, and consumption will increase at the expense of saving and investment. If Keynes has (ii) in mind, then he is right, but there is no reason to denigrate (i); both cases are of equal dignity.

FIGURE I.24.1. THE SUPPLY OF AND DEMAND FOR LOANABLE FUNDS

Keynes goes on in his concluding chapter: “The justification for a moderately high rate of interest has been found hitherto in the necessity of providing a sufficient inducement to save. But we have shown that the extent of effective saving is necessarily determined by the scale of investment and that the scale of investment is promoted by a low rate of interest…” (2008: 375) Again it appears that Keynes has fallen victim to an elementary error. We can get an increased quantity of money loaned and borrowed in at least three ways. First, by means of a higher demand for present money. Second, by an equilibrating move, just discussed, from A to B, in which case the interest rate rises. Third, by a move from C to B which corresponds to an increased supply of savings, in which case the interest rate falls. (This is equivalent to saying that people are willing to sacrifice more consumption here and now for the same price. NB: An increase in the supply of present money on the loan market usually comes with a decrease in the demand for money, because at any interest rate some former demanders turn into

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suppliers.) The greater the supply of savings-to-be-borrowed, the lower, indeed, the rate of interest. But during a shortage of savings, the interest rate must needs increase, so that the market can clear. In other words, a low interest rate will stimulate investment, only if it comes about due to an increase in the supply of loanable funds or present goods, as opposed to either a disequilibrium situation of abnormally low quantity supplied or a decrease in the demand. Once again Keynes privileges C → B at the expense of A → B, obviously because the former can be achieved by inflationary credit expansion, a favorite Keynesian trick. The second interpretation is that this argument is a precursor to Keynes’ later bitter, though, as I will show, unjustified, denunciation of high interest rates. An increase in the interest rate diminishes (1) investment, he says; therefore, (2) incomes to the factors of production; therefore, (3) both consumption and saving, even if saving increases in proportion to the now lower overall income. That is why Keynes believes that “even if it is the case that a rise in the rate of interest would [I] cause the community to save more out of a given income, we can be quite sure that a rise in the rate of interest… will [II] decrease the actual aggregate of savings.” (2008: 111) On the supply of loanable funds curve, each interest rate determines how much savings will be forthcoming at this rate. But the equilibrium interest rate is that value at which quantity lent equals quantity borrowed; it is itself determined by the intersection of supply of and demand for loanable funds. One possibility is to take Keynes to mean that [II] corresponds to a move from S1 to S2, and [I] corresponds to a subsequent move from D to C in Figure I.24.1. More plausibly, Keynes thought that though it is true that a low interest rate provides little incentive to the public to postpone consumption or part with liquidity, nevertheless, the entire reason why the interest rates are low is because of credit expansion by commercial banks on top of their fractional reserves. “Forced” savings have been injected into the economy, and the fact that voluntary savings are now more scarce is a mere symptom and irrelevant. Restraining creation of money out of thin air may cause more voluntary lending to take place, but the interest rate will still be higher and quantity borrowed, lower than otherwise. Another possibility is to reconstruct the main argument, which Keynes proposes on the same pages in Chapter 9, as follows: (1) People often save for the sake of investing. (2) A higher interest rate caused by lower savings will diminish investment. (3) But lower investment will decrease incomes.

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Summa Against the Keynesians (4) If the psychological law, which I dissect in (I, 21), holds, then incomes will fall by a greater amount than investments. (5) Assume that it holds. (6) Therefore, consumption will decrease, as well.

The reasoning is unimpeachable, if we are dealing with (a) real incomes / consumption / investment (b) in the long run. If (a) does not hold (and (b) does), then (3) is false: money incomes need not alter predictably as a result of higher time preferences. For example, a firm can acquire funds in two ways: though borrowing or attracting investment or through sale of its products. Both of these can change in a variety of ways for different companies. If (b) does not hold (and (a) does), then (3) is false again: in the short run, investment will decrease, and consumption will pick up. As compared with the counterfactual situation in which time preferences are lower, and there is more investment right now, at some point in the future, there will be fewer of both capital and consumer goods. In other words, it is true that if the social rate of time preference rises, then there will be fewer goods in the future to consume. This would explain why real income would decrease in the long-run, impoverishing a community by causing a drop both in consumption and in accumulation of actual capital goods. But in the short-run, i.e., in the meantime, capital formation will suffer, while immediate consumption will be given a boost, something of which Keynes is apparently none the wiser. Once again, my argument applies to honest banking. Keynes asserts (2), probably because under modern banking, a desire to invest, if the investor is at all creditworthy, conjures up new bank money or “savings.” Given in addition the multiplier, reducing the rate of interest can, with a high enough marginal propensity to consume, bring about full employment. Interestingly, higher savings, too, are treated with suspicion. Keynes does not locate the source of interest in time preferences which are consumer choices on how to allocate their money between consumption now and production now for the sake of consumption in the future. For him, not-consuming is tantamount to hoarding. In some cases, this is true. But surely, there are such things as investments; it is just that the market cannot be trusted with supplying enough savings to drive the interest rate close to zero. In his vision, as we will see, only an economy in which the time needed to produce goods was of no consequence to the people could render employment full in the absolute sense. Keynes may not have been a thoroughgoing socialist, saying, for example, that “I see no reason to suppose that the existing system

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seriously misdeploys the factors of production which are on use. … It is in determining volume, not the direction, of actual employment that the existing system has broken down.” (2008: 379) But he still favored interventionism and inflation: as long as we are stuck with capitalism, at the very least, monetary policy should be utilized in order to stimulate, i.e., increase the “volume” of, private investment. 25. THE PHILOSOPHY OF ECONOMICS: THAT THERE ARE THREE GRADES OF BEING

I am going to start from afar in approaching the problem of capital. It may prove difficult to understand ideas such as “production structure,” or “temporal distortions in the network of capital,” or even what economists mean by “good” without a solid philosophical grounding. Now one may not need philosophy in order to find these concepts natural and intuitive. But too many of even great economists have fallen into grave errors here, and I want to take no chances. [I] The first “grade” of being is described by natural sciences such as physics and chemistry. It comprises all those things that strictly obey natural laws, coupled with randomness. There are two kinds of randomness in the material world: quasiand true randomness. Quasi-randomness is connection of secondary causes so complex that it precludes prediction by finite intellects. It is still fully determined and hence predictable by God whose intellect is presumably allpowerful. As our power over nature grows, what was once quasi-random becomes lawlike. True randomness cannot be predicted at all. No one can foresee beforehand when and whether a virtual particle will pop in and out of existence, regardless of the sophistication of our instruments. Its actions are not determined by any secondary cause. However, the particle proposes, but God disposes. God retains the power either to allow it to appear or to prevent this from happening. Such a divine intervention cannot be classified as a miracle, because God does not coerce nature but simply determines a truly random event. He constrains the possibilities to either a yes or no, true or false, something that would happen anyway even without His involvement, except that He does intelligently what would otherwise happen randomly. As a result, true randomness should be understood as an act of the first cause within the allowable parameters built into the world. As a result, we obtain that “God does not play dice with the

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universe.” Chance is best thought of as an attempt to build into unaided by reason nature a primitive way of solving certain easy problems by trailand-error. Randomness is the intelligence of merely material objects. Biological evolution is precisely such a process, combining (both quasi- and truly) random mutations and a natural law, according to which fitter organisms tend to survive and prosper. Plants generate copious amounts of seeds, such that though most die, some are statistically expected to survive and take root. A bug flies into a room through the open door, and starts fluttering about wildly, obviously hoping that these (mostly) random motions will, with a bit of luck, allow it to find the door and get back outside. If the bug were smarter, then it might be able to find its way out by thinking. But it is stupid; so it relies on the primitive random path generator to escape the trap of the room. Yet for all that, it may nevertheless succeed. If intelligence is the ability to learn, then randomness is its opposite. Nevertheless, randomness solves problems and “gets stuff done” and can for that reason be called analogically “intelligence,” however low-level and crude. The bug in the example was programmed by whatever process or entity to engage its RNG routines to escape from danger. In short, even a blind watchmaker has some IQ. Some scientists have maintained, however, that numerous cellular biochemical “robots” and perhaps larger structures such as organs, as well, far exceed the capabilities of this makeshift.14 William Dembski suggests that insofar as biological systems not only evolve but are in addition intelligently designed (such that art completes what even perfected nature cannot bring to a finish), their designer, if sufficiently powerful, may, in order to succeed at reaching his goals, choose to flip random events one way or another. (2004: Chapter 20, “Nature’s Receptivity to Information”) This idea is particularly pleasant philosophically, because the integrity, dignity, and autonomy of nature are preserved against “too many” miracles. Now I have seen atheists declaring miracles to be “God-magic.” But this is unjust. Magic is an attempt to get something from nothing. If in a fantasy movie, a man who falls from a castle wall is held in the air and safely brought to the ground by a human wizard who utters a few words, then we attribute the effect to magic, because we know that mere speaking has no power to alter laws of nature. Words can persuade, not coerce. But if the rescue is done by God, then it is due to a perfectly 14

See, for example, Behe 1996; 2007.

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adequate cause, namely, God’s omnipotence. The fact that God is not embodied does not make it impossible for Him to act, and a miracle should be understood as another type of act of the first cause in the world. Now it is true that miracles are problematic for several reasons. Frequent unpredictable miracles would destroy the orderliness of the world. A natural scientist is normally able to isolate causes and effects in his lab experiments. Though humans are unpredictable, too, the scientist can minimize the interference of human action with his research. For example, he can lock the doors to the lab and not let anyone in while he works. But he cannot keep God out in this manner. Frequent predictable miracles, including those that would occur with a definite probability, would end up being yet another natural law, and humans would adapt to them. If God always responded to any utterance “Abracadabra, homework be done!” by completing the student’s homework, then we can be sure that people would exploit this regularity. This new law would be especially strange, because it could be revoked at any time at God’s will rather than being rooted in the measure of permanence and stability of things’ natures, thus enslaving man to God’s caprices once again. Some atheists wonder whether it would be a better world, if God prevented murders by vaporizing bullets as they traveled from the gun to the victim. They do not envision the nightmare this would create, as people adapted to this rule, tried to circumvent it by finding loopholes (of which there would be a vast number), argued with God whether any particular shot should be stopped by Him and even dragged God into court, or switched to knives. Natural laws would turn out to be orders of magnitude more horribly convoluted than the US tax law. Either people can purposively kill each other or not. If they can, then individual miraculous interventions are out of the question. If this is to be a law-bound world, then there cannot be many miraculous exceptions to it, lest our predicament would be likened to Wile E. Coyote’s tumultuous relationship with laws of physics. If they cannot, then the law forbidding this should be placed deep into the human nature, such as by causing malice in one’s heart to be impossible. But the latter solution is not practicable either, because often human interests conflict or seem to. Learning to love other people despite obstacles is part of the human mission to the world. In any event, a miracle is a situation in which nature wants to do X, according to God’s own laws, and God checks its natural disposition and forces it to do Y instead. God suspends the very laws that He Himself instituted; at the very least, God effectively counteracts the

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power of nature with His own power, making it unclear why He needed the former in the first place. Since “things are not good by the divine goodness, but by their own goodness” (ST, I, 6, 4), the power to do miracles is the power to destroy the world. Constant miraculous corrections would be an admission that nature is inadequate, and that God created poorly. On the other hand, bestowing grace is a very different act: 1stgrade nature is not determined at all, whether to X or Y; the outcome is randomly generated. Where nature would choose randomly, God chooses intelligently by constraining nature either to X or Y, according to His design. God does miracles only to give a sign of His power and presence, when it is profitable that they be demonstrated to all concerned. We must proudly refuse to consider miracle-working to be God’s day-to-day modus operandi, while still apportioning to Him the fitting power non-coercively to manipulate physical entities. Another problem with miracles is that they disconnect a natural entity from its past. What a thing is now is a consequence of the unfolding of the workings of nature and grace for billions of years. My core being is linked with my actions yesterday, my parents 25 years ago, my grandparents 50 years ago, the first humans, and ultimately trilobites and bacteria billions of years in the past. My nature has been honed and perfected throughout a vast time span by survival of my ancestors. I can handle whatever life throws at me; I have fought for and earned my place in the world. Life and humanity have apparently been stress-tested for a very long time. But a miracle is always special creation. Something just pops into being right now, untried and arbitrary. A person who counts on a miracle to help him refuses to be part of the circle of life. The first grade is world-as-matter-and-motion. It comprises everything mechanical, all machines, all inanimate objects and events that have come about as a result of or function in accordance with chance and necessity. [II] The second grade begins with mere life and ends with consciousness. The perfection of the second grade lies in rationality. At this summit are the sphere of the will and its moral virtues, the intellect, and self-motion, what is commonly called the “soul.” It is world-as-subjective-experience. It is the “trinity within”: the essence or human powers, the word of the intellect proceeding from it, and the love of the will spirating from both, though without injury to the soul’s unified nature. Or we can define the human trinity simply as intellect plus will plus control over the body. In a manner of speaking, I am “me, myself, and I.” The trinity within is the nature that cradles the individual

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personality, and what the word “personality” means cannot be explained by reference to the material world. The reason why no arrangement of elementary particles in the brain or elsewhere will produce a personality is that “who one is” has an internal aspect and an external aspect. A robot someday, perhaps, can be programmed to simulate human behavior and learn to operate around people, being so human-like in daily interactions as to confuse people as to what they are dealing with. But the robot will have no desires, no beliefs, no phantasms produced by the imagination, and no states of mind. Since personality proper is a combination of the two aspects, no machine can have a personality. “Value,” “truth,” “virtue” apparently have nothing to do with the physical realm. The world-of-matter-and-energy is categorically different from the worldas-subjective-experience. These worlds are irreducible to each other. On the one hand, sensation and action are bridges between the 1st-grade world and the 2nd-grade world – the former converting the world-of-matter into experience; the latter, experience into pushing around particles of matter. The soul = the will + ½ intellect; the body = the other ½ of the intellect + the physical body. Sensations impinge upon the body and percolate through the attention of the composite intellect into the will; actions originate in desires and again through making plans in the intellect end up causing events in the physical world. On the other hand, the 2nd-grade world is causally isolated from st the 1 -grade world, though not vice versa. The intellect is fundamentally (though not, unlike the will, in every respect) immaterial. The mind is more primal than matter, such that all physical events in the brain and body are inputs to a human being, variables based on which he choose how to act. “The unconscious behavior of the bodily organs and cells,” writes Mises, “is for the acting ego no less a datum than any other fact of the external world. Acting man must take into account all that goes on within his own body as well as other data, e.g., the weather or the attitudes of his neighbors.” (1996: 11) It is impermissible, for example, to say things like “drinking coffee caused Smith to get to work.” All the physical and biological effects of drinking coffee, just as all (outer) sensations and (inner) reflections, are materials out of which Smith constructs a decision what to do. Drinking coffee provided some kind of inducement for him to get to work, a lure, but he was the one who decided to give in to that inducement. Decision-making is part of any human action. Though an action can fail, at least an attempt to succeed is part of the triple. Sensing is passive; acting is, well, active. As a general

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rule, the active is master over the passive. Thus, sensations influence the soul but do not determine action. But the reverse, “actions influence the body but do not determine sensation,” is false: an action is often undertaken precisely in order to induce or block a sensation. In order to get a handle on our species, it is useful to accept the following two points. First, that the combined whole HA of any instance of willing, deciding, and acting is a real event. It has a definition, an essence; it means something; it has a variety of important consequences, especially for the originator of the HA. It is not an “illusion” or “a maelstrom of events distributed across the brain [that] compete for attention; and as one process outshoots the others, the brain rationalizes the outcome after the fact and concocts the impression that a single self was in charge all along,” (Kluger 1/29/2007) whatever that means. Second, that material events influence HAs but do not determine them. It follows that “mind” could not have arisen from “matter” by “evolution” or any other means. Matter exists for the sake of and is used by the mind; matter constrains the mind; but within those constraints, the mind is autonomous and supreme. It is impossible to read a person’s mind by reading his brain. One may have better luck trying to divine the will of the gods by studying the entrails of a chicken. The idea seems strange; for example, the contents of thoughts, such as the propositions that can be expressed by thoughts, are infinitely varied: 2 + 2 = 4, 3 + 3 = 6, …, even uncountable, but the number of possible brain states is finite. Even if, per impossibile, it could be done, we would further need to know where thoughts determined brain states, and where brain states determined thoughts. For example, it is indisputable that a human subject can be aware of other things, objects. Can he be aware of himself? Can he be both subject and object at the same time? Life experience certainly suggests so. In any non-divine being, the object-self is always less than the subject as a whole, but there is a parity between the two, insofar as those aspects of the subject that are not known (and therefore, not loved) are as if they did not exist. Such subconscious aspects are instinctive and even necessitated, being “unexamined” and belonging not really to the 2nd level but to 1st level. But 1st-level traits do not count for much in the human personality. The better one’s self-knowledge and the stronger one’s self-love (because aspects of oneself, of which one is aware but which he hates and rejects, are not really part of oneself either), the bigger human being he is and the more happiness he can “contain.” If the subject is an illusion, then so are, of course, its awareness and love of oneself. But if the subject is real, then I think it will be accepted that one can “know” oneself (and therefore, be aware of oneself

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and have a self-conception) and “love” oneself (and therefore, affirm and seek to preserve one’s existence). Hence, the human trinity within. Again, today some people who call themselves “evolutionary biologists” make bold claims about the “origin of species.” First, they argue, billions of years ago, primitive nano-replicators (a placeholder of a word, since no information is provided on how these replicators worked) arose, by an unknown process, from the primordial soup, whose content is also left unspecified. Step by tiny step, exclusively by way of the Darwinian evolution – an unverifiable in principle and improbable in practice hypothesis – these replicators clothed themselves with more and more complex biological garb, and though these outer shells seemed (or perhaps not for the “evolutionary biologists,” I do not know) to have acquired interesting functions, the replicators, now called genes, have remained in full control. The human body and soul, despite their fantastic complexity, are mere vehicles for gene reproduction. In short, we, along with all other living beings, are used by genes in order for these genes to spread themselves. When Homer was composing the Odyssey, or when the Wright brothers were inventing the airplane, they, without their knowledge or conscious consent, were in fact furthering the continuation of their genetic patterns – in short, attracting girls.15 A cruder metaphysics could scarcely be imagined. The worst scientific failing of evolutionary theory is its refusal to admit both the possibility of inventive problems that are too difficult for blind trial-and-error to solve and the actual likelihood of such problems’ having existed in at least several well-publicized cases (such as the bacterial flagellum), similar to what is outlined in (I, 11). Genetic determinism may be able to explain why a young person wants to have sex; it cannot explain why that young person goes on to found Google, Inc., or why some people choose to renounce sex and become Catholic priests. It is not as if those who fail to found a successful company are disadvantaged in the alleged red in tooth and claw competition in the world. Sex may be explained, but why do people fall in love with their sexual partners? Biologically, love seems deeply superfluous. Every animal seems to do fine without it. Could it be a uniquely human spiritual phenomenon that lifts us up to deiform joy rather than an evolutionary subterfuge to ensure that men stay loyal to their mates? Genes, being simple replicators, have apparently contrived to reproduce themselves in astonishingly roundabout ways. As George in Seinfeld muses, “I’d like to have a kid. Of course, you have to have a date first.” Reproduction for humans seems to begin with a dinner and 15

See, for example, Dawkins 2006.

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a movie. Did genes create the computers which were used to make special effects in this action movie our couple is now watching? They had to, as this must have been part of their wildly circuitous scheme to get them to mate. Every accouterment of civilization is designed to encourage sex and care for the children by human parents. Skipping past a couple of mysterious break-ups, several miscarriages, a possible abortion, the strange artifice of a Catholic sacrament, a life-threatening birth, we have a newborn. It is completely helpless and demands years of attention in order to reach puberty and itself reproduce. Is the child studying math? Is he playing catch? These, too, are part of the genes’ grand master plan to propagate themselves. Perhaps, playing is a gene-ordered exercise that keeps the sexual organs in good health. When the child grows up, technology will have advanced, and he and his girlfriend will enjoy a dinner and a video game, which apparently make reproduction so much more efficient. Nothing human beings do, unless caused by a destructive random mutation, falls outside the imperative of their genes to spread themselves, including the Darwinians’ making arguments in favor of the adequacy of evolution. These arguments, too, are tools that genes cunningly use to make the Darwinians more popular with the opposite sex. It seems that we are brains-in-vats, and if genes are not gods, then they are at least evil geniuses controlling and defining our life experiences. This is surely a depressing picture, but if the price of truth is unyielding despair, then so be it. See David Stove (1995) for a different opinion. Stove supplies an entertaining and thorough demolition of the idea that Darwinism applies to humans or ever did. I once was in a park with my uncle and saw some beavers swimming around in the lake. I asked, “What do you think they are doing?” And my uncle replied, “They are enjoying life.” Could that be the purpose of genes? To specify the bodily make-up of creatures who might seek and perhaps, find some kind of happiness in life, of which offspring is an important but strictly subordinate part? Assume that any non-divine object must have all four causes. What is the final cause of a beaver? Many people answer, its progeny. The reason why the beaver was made and lives is so that it could make little baby beavers. Very well, what is the final cause of those baby beavers? Apparently, also to reproduce and make the first beaver a grandfather. And so on, ad infinitum. The obvious problem is that the chain of final causes does not terminate. A is for the sake of B; B is for the sake of C, … Every creature is instrumental, existing for the sake of something else; no creature is intrinsically valuable. Therefore, this answer cannot be right. The final cause of a beaver, the reason why it was made, most plausibly, is its own enjoyment of its

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own life. We might also argue that animals exist for the sake of human happiness, insofar as we are the sort of creatures who naturally and cleverly use animals for our own ends, which also terminates the final causation properly. Animals exist for the sake of their own pleasure per se, and for the sake of human pleasure per accidens. Another anecdote: my cousin’s family owns three cats. I was at their house once, and saw one of the cats sitting by the entrance door; my cousin opened the door, and the cat slunk out. I asked, “What’s she doing out there?” He replied, “She’s chillin’.” I stood enlightened. Plants and many animals do not exercise any care for their young, leaving them to fend for themselves. Animals mate, driven by a powerful instinct, and birth occurs naturally as an afterthought. Surely, we can argue that in such cases, animals purposively seek the pleasures of orgasm? Perhaps, their genes have programmed them to do so, but the teleological causation cannot be dispensed with. Animals want sex, and they will go to many hardships in order to obtain this good. It is certainly lucky for the species that sexual delight leads to conception and birth of a new generation, but why should fish and spiders care? Again, they do not want children but sex. (How many humans would agree?) What of the animals who expend a lot of energy caring for the young, like cheetahs and penguins? Perhaps, they do enjoy having cubs around. But those animals do not care about what sort of “persons” their offspring become. If asked, “What do you want of your kids?” they might, indeed, say, if they could talk: “Survive and reproduce,” although I see no reason why a cheetah may not wish that her cubs have some fun, too. But ask a human father what he would want of his son, and he would probably say, “To make me proud.” or “To achieve the things I never had.” or “To do greater things than I did in life.” Greatness is scarcely measured by how many children one has. He probably would not say, “Have as many children as you can physically beget.” Reproduction is a part of a human life but not nearly as overpowering as the Darwinists would have it. It seems self-evident that human beings seek happiness, not vast numbers of children, and moreover, they seek happiness in ways that “evolution” has not anticipated. We may have evolved in a jungle but it was a real jungle not an urban one. In the writings of evolutionary determinists, we repeatedly see sentences like “evolution did not prepare us” for such and such modern environment. If it did not prepare us, then how were we able to create that environment and find comfort in it? How is the writer who has identified evolution as inadequate or “sloppy”

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able himself to overcome the limitations that supposedly plague mankind as a whole? If the evolution failed to prepare everyone, then why is the writer making an exception for himself? Goleman (2006) writes about his feeling fear during a sudden snowstorm that prompted him to stop and wait it out: The caution fear forced on me that day may have saved my life. Like a rabbit frozen in terror at the hint of a passing fox – or a protomammal hiding from a marauding dinosaur – I was overtaken by an internal state that compelled me to stop, pay attention and take heed of a coming danger. (6) Notice first how evolutionists are believers in mythical creatures, like “protomammals.” No one has ever seen a protomammal, nor even explained exactly what sort of thing a protomammal is, but such things had to have existed, because evolution, if it occurred, the fanatics believe, proceeded, as per Darwin, via “numerous, successive, slight modifications.” But it did occur, obviously. Hence, there must have been plenty of protomammals and in fact, proto-everything around in the past. Second, let a sophisticated robot drive the car. The robot senses a snowstorm and stops. You might say, it “feared” an accident. Even here, there is no feeling, no teleological causation. Goleman makes it appear as if the point of fear is to be a subjective intermediary between objective danger and objective action. The “purpose” of this passion that evolution has implanted into us is to keep us safe. But from the evolutionary point of view, why have this mystical go-between? It’s a clear waste of resources. A robot for which there is a direct physical link between storm and stopping seems far more efficient and simple and would have an evolutionary advantage over humans. Now let the robot successfully avoid all problems on the road and get to its destination. Goleman may have felt happy at that point. The robot would not feel anything; it is a machine. Our author can no longer even say that the subjective happiness is for the sake of anything objective, such as survival and reproduction. This is because happiness is the final end of all human endeavors. All objective human action is entirely for the sake of subjective happiness. How could evolution of matter – atoms, molecules, chemical elements – have resulted into the elevation of happiness to the ultimate relative given? With anger blood flows to the hands, making it easier to grasp a weapon or strike at a foe; heart rate increases, and a rush of hormones such as adrenaline generates a pulse of energy

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strong enough for vigorous action. (6) I am sure this is a real connection. But anger both is a different referent and has a different meaning than “blood flows.” Anger is not “really” a rush of hormones. It is a spiritual phenomenon unique to higher animals and in its specific form to humans. It is a subjective private feeling not objective public action. Nor does anger mean in common speech “rush of hormones.” It means “antagonism, outrage,” etc. I suppose that for Goleman, love, too, is “overrated; biochemically no different than eating large quantities of chocolate,” to quote from the movie Devil’s Advocate (Warner Bros. Pictures, 1997). (This is true enough: biochemically it may well be no different; both sensual and intellectual love and pleasure may be implemented the same way in the body. But there is more to love than biochemistry.) He does not disappoint: Love, tender feelings, and sexual satisfaction entail parasympathetic arousal – the physiological opposite of the “fightor-flight” mobilization shared by fear and anger. The parasympathetic pattern, dubbed the “relaxation response,” is a bodywide set of reactions that generates a general state of calm and contentment, facilitating cooperation. (7) Love, too, then, is for the sake of survival and reproduction. It is an intermediate emotion that compels actions beneficial to the organism. What a strange device. But of course, it compels nothing. Going back to fear, Goleman explicitly recounts his emotions. He was not pushed by them ineluctably but considered them to be inputs to his mind that had to be contemplated and weighed along with every other like input, such as perhaps the fact that he was going to be late. Stopping was a choice, a conscious decision. Goleman allowed his fear to influence him. At any rate, the word “benefit” has a teleological meaning. It cannot be decoupled from happiness or pleasure of some kind. Dawkins is consistent in this regard, denying that there is any such thing as the science of final causes. Viruses “are here because they are here because they are here. … Flowers and elephants are ‘for’ the same thing as everything else in the living kingdoms, for spreading Duplicate Me programs written in DNA language. Flowers are for spreading copies of instructions for making more flowers. Elephants are for spreading copies of instructions for making more elephants.” (1997: 272) Of course, that is just another way of saying that neither flowers nor elephants are for anything. Thus, to my proposal that the cat’s body suggested to her a

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pleasure, namely, to cool off, which is an ultimate given, Goleman (and Dawkins) would retort that the feeling was for the sake of the promotion of optimal metabolism, and the sophistication of the body itself is explained as that if the cat were constructed poorly, then it would have died long before reproducing, and so its species would not exist now in the first place. The ultimate given then is the evolutionary process. Call it a conflict of visions, one of which, however, as Raymond Smullyan might put it, is sane, and the other, not. Try to guess which one is which. Calling our capacities and skills “side effects” of the evolutionary process becomes more implausible, the more powers human beings acquire over the world. Behaviorism, Mises writes, “seeks to investigate reflexes and instincts, automatisms and unconscious reactions. But it has told us nothing about the reflexes that have built cathedrals, railroads, and fortresses, the instincts that have produced philosophies, poems, and legal systems, the automatisms that have resulted in the growth and decline of empires, the unconscious reactions that are splitting atoms.” (2007: 245–46) Neither has genetic determinism. The Darwinians find themselves with an argument like the following. 1. Genes replicate. 2. Human beings are complex robots controlled by the genes, so that the genes may replicate. 3. But humans seek happiness in life. 4. Happiness is an illusion foisted on people by genes, when people behave in a manner that promotes gene replication. 5. Therefore, for example, when a child in one family is snatched by another family, the first family always rejoices, because this frees them from their duty to care for that child and therefore, to reproduce and spread their genes still more. Even when pointed out that (5) is obviously false, the Darwinians never quite realize that this throws (4) and (2) into question. Some people commit suicide. Why do they do that, contrary to their genetic program to survive and reproduce? Presumably, because for them, life is no fun. A certain decent amount of present happiness or hope for future happiness then is essential to survival. Already this seems senseless from the point of view of genes. Why saddle existence with something so fabulous and difficult as search for happiness which may consist in, get this: studying economics! It is plain that for humans, survival (in the widest sense of doing the things that constitute living) conflicts with reproduction. The Catholic Church even finds a cause for

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concern over this: human reproduction, it says, is properly in the hands of God, because it benefits the species often at the expense (both figurative and literal) of the individual. Too much narrow selfishness on the part of the existing humans, and there will be no new generation at all. Hence, the strictures against birth control and such. Now suppose, as many people reasonably believe, that human beings have immortal souls. In that case, spiritual survival which yields eternal life and beatitude takes center stage. Physical survival is now purely instrumental, inasmuch as it assists soul-making: the creation of human nature, personality, and happiness. As Wallace says in Braveheart (Icon Entertainment, 1995), “Every man dies; not every man really lives.” Finally, reproduction becomes a mere addendum, resorted to insofar as a person thinks that association with and rearing of children will enrich his life. Most people plan their families and limit the number of children they give life to, precisely so that their standard of living is not impaired too much. They thereby explicitly privilege their happiness over their reproductive capacity. The wealthy do not necessarily have more children than the poor, suggesting that caring for children is such a demanding job that they would rather do something else that is more exciting. Etc., with no end in sight. Where does all this leave Darwinism? In any case, genes are merely physical molecules, whereas humans are ultimately spirits. 1st-level events generally do not determine 2nd-level ones. Teleological causality cannot evolve from physical causality, any more than life can come from non-life. Expressions such as that men are “ghosts in the machine” or that they are “spiritual machines” are misleading. The “machine” is subservient to and is an aspect of the “ghost,”16 a way of looking at the spirit that emphasizes the spirit’s mechanical properties. We are not at all spiritual machines but machine-like spirits or spirits whose operation depends to an extent upon laws of physics, chemistry, biology, and the rest, even though, more fundamentally, the spirits have wills and intellects and control rather than are controlled by their bodies. Though 2nd-grade creatures, human beings have 1st-level characteristics. It is proper to man, i.e., his nature, to have power over the physical world. This power is exercised through the body which via a mysterious link connects to the mind, and the latter, no less enigmatically, to the will. That power is not the whole of man. For example, humans virtually convert power into pleasure, the cost of bodily exertion into the 16

I owe this expression to Callahan 9/7/2002.

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revenue of delight or joy or both, what we call psychic profit. Subjective experience is all we humans have. To say that is not to deny the reality of human nature which hosts the experience or of human habits and character which shape the experience, but to point out that experience, the process of living, completes and expresses those things. Of course, if there is any experiencing going on, then something distinct from the experience must be doing the experiencing. And the same stimuli will be reacted to differently by different people. However, a person enjoying a dreamless sleep retains his nature and personality, but he is not at that time being truly human. Sleep is a sacrifice imposed on us by our bodies, but if it were converted into a coma that would last until the person died, then we would consider that to be in a sense a fate worse than death. Such a person is alive neither here nor in the hereafter. Abstractions from experience, such as reductions of it to bodily states governed by mechanically tractable forces, are only one of many ways of viewing experience. It is not just “I think, therefore, I am.” but “I think, I feel, and I act, and my thoughts and feelings and pursuits are, together with my humanity and personality, me or the whole me.” The “whole me” is not the “mechanical aspect of me.” Some reductions of the whole to a part I have encountered in the wilds of the Internet are truly amazing; thus, one person opined that humans are “really” “nothing more” than “electrical impulses miraculously held together in incredibly complex patterned arrays.” I replied to him with a few of my own in a, well, reductio: Humans are actually “nothing more” than inefficient computers. Wait, that is not right, they are “nothing more” than waste-producing factories. No, no, no, they are “nothing more” than bags of chemicals. So much more tough-minded, aren’t I?17 I will even strengthen my claim: that a certain brain activity is correlated with those thoughts and feelings does not detract from the point that this fact is merely a – no doubt to the utmost degree curious and important – accident of our nature. It is conceivable that the same experiences and even whole lives could have been produced by vastly different designs of the human body and its environment. The body is a 17 The intellectual power of synthesis, as distinct from analysis, induction, and deduction, allows us to grasp a real object from a multitude of its appearances. Thus, the brain, etc. are just one of the numerous ways in which the soul is present to us. What we have here then is failure to “synthesize a manifold.” Of note is the fact that synthesis is performed by the mind, and unless the mind itself were one, it could not unify anything. The unity of the soul is the cause of the unity of concrete objects in the understanding.

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handmaiden to the soul, highly useful but nothing beyond that. For example, a possible case against the government’s drinking and driving laws consists in the fact that a scientific oddity, namely, the blood alcohol level, a fully 1st-grade property, is alleged to cause poor driving or a 2nd-grade property. The reasoning is that alcohol causes the mind to be clouded, and the drunk to be disconnected from reality, which in turn causes poor driving. In other words, things are as if a bottle of vodka were driving the car, maliciously doing a poor job at it. But in fact, there is no causation either way; at most, there is correlation. Alcohol need not impair the driver’s thinking and driving ability; and even a drunken haze need not automatically output a “kill that pedestrian” instruction. But in order to be guilty of a crime, a man must cause or threaten to cause injury to another. If a motorist is driving erratically, then he can be ticketed as a threat to public safety, whether he is drunk or not, in order to deter such behavior. But if he is driving fine, then it is a travesty of justice to punish him for a physiological condition.18 The second grade is the grade of self-interest. I do not believe that progress of natural sciences will ever show praxeology or economics to be superfluous. But even if one is so obstinate that he denies the separation between the grades or metaphysical dualism (or “triplism,” in this case), one cannot deny at least that in the present condition of our knowledge, he must adopt in social sciences methodological dualism. One must study man, while assuming that he is fully physical, as if he were not merely physical, as if he were above the nature of the material world. (This terminology originates with Morris (2001).) Mises used to give an example of the motion of people and subway trains each morning at Grand Central station in New York. To a physicist unenlightened by knowledge of human nature, the happenings there would be utterly mysterious. What explains the hustle and bustle of these strange beings? Our physicist would investigate all the possible material and biological causes of these events. Could each person be an automaton, programmed to move in such an unpredictable manner? Is their motion random, as if they were gas molecules? Are humans moving hither and thither, because they are like bees? Fortunately, we know better: his project is futile. If only the physicist understood that there was a reason for each person to descend into the subway, namely, to get to where they want, such as to work, and that the purpose of that would be to exchange labor for money, and so forth, then he would solve the problem. Admitting the 2nd grade of being and with it, purposive action and teleology, is at the very least scientifically fruitful. 18

Cf. Rockwell 11/3/2000.

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Confident assertions of metaphysical monism or panphysicalism can be deflected with a simple argument to the following effect: 1. We do not know, nor are we even close to finding out, how the soul and the body are linked, i.e., the nature of the dual connection of the intellect to (1) the body and (2) the will. It is not in vain dubbed in philosophy “the hard problem.” 2. Suppose the contrary: tough-minded monism is true. “There ain’t no such thing as soul.”19 3. But then the mind and body are connected in the most intimate way possible, namely, by being numerically identical to each other. 4. Therefore, the monist claims to know exactly how the soul and the body are connected. 5. Which contradicts (1). 6. Therefore, monism is only an opinion, a metaphysical hypothesis, nothing more. It is at best a starting point in our investigation rather than a dogmatic foregone conclusion. Of course, a dualist would not be stymied by this argument, because he is free to maintain that the soul and body have both different meanings (which the monist may admit) and different referents (which the monist cannot admit), while disclaiming any knowledge of how the two are united.20 It will not do for a monist to reply that he, too, is unsure how the brain “gives rise” to the mind. For if the brain produces the mind, yet the mind is identical with the brain, then we have it that the part, i.e., 19

People sometimes say this, because they feel they do not understand the meaning of the term “soul.” Here, the meaning is given above as the will combined with the immaterial half of the intellect. 20 I am using the all-important distinction in philosophy between meaning and reference. Even if two things have different meanings, they can still point to the same object. “Evening Star” means something other than “Morning Star” and again something other than “Smith’s favorite heavenly body,” but they pick out the same thing, namely, the planet Venus. On the other hand, in the proposition “Smith trades with Jones,” Smith and Jones mean the same thing: an arbitrary person. But they refer to different things. Or, in “This card is magenta, and that one is fuchsia,” the two color names specify the same color but refer to two different patches. Therefore, materialism cannot be dismissed simply by pointing out that the terms “mind” and “brain” mean different things, though they certainly do that.

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the mind, is identical to the whole, i.e., the brain and its byproduct, the mind, which is absurd. One might argue that the mind is an “emergent property” of the brain. Perhaps, the relationship of mind to brain is like the relationship of high heat to a complex machine: the motion of each part of the machine generates a bit of heat, yet on the whole, the machine generates a lot of heat, perhaps enough to interfere with its operation. Here the high heat is not found in any part, in the motion of any part, or in the stationary machine as a whole but only in the working machine as a whole. But though high heat, indeed, is an emergent property of the machine in this sense, it belongs to the machine. Perhaps, the high heat is concentrated in the box in which the machine is housed, as mind seems to go no farther than the skull. Since matter and energy are part of the same 1st-grade world, and temperature is mean molecular kinetic energy, high heat is simply part of the machine. This is very different from the metaphysical status of will and intellect, for which the materialist’s (impossible in my view) task is to show how the highly peculiar to human beings phenomena can be accounted by the travails of matter and energy. Perhaps, the mind lurks, as A.N. Whitehead with sort of idiotic earnestness thought, in the “interstices of the brain,” just as the hot air permeates the space in between the machine parts. It is obvious that this is mere wordplay; the point is, according to the monist, that there is some pound of flesh occupying some part of 3-dimensional space in the human body to which the soul is identical. And that is too ambitious a statement to flaunt casually. Insoluble problems appear, even if the mind is admitted to be real and immaterial but is claimed to be a mysterious “side effect” of the goings-on in the brain (supervenience). As Mises points out in a striking example, “for a doctrine asserting that thoughts are in the same relation to the brain in which gall is to the liver, it is not more permissible to distinguish between true and untrue ideas than between true and untrue gall.” (1962 [2]: 30) Supervenience is self-defeating21, in that it holds beliefs to depend solely on the motions of atoms (or suchlike) in the brain, i.e., non-rational forces, which make beliefs unjustified regardless of their content and denude reason of its ability to support even non-

21

Note the difference between a self-defeating and self-refuting proposition. The latter entails something that contradicts the proposition, which proves its falsity. The former merely undercuts all reasons for believing the proposition to be true. The self-defeating belief may nevertheless be true; it is just that we cannot tell.

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reductionist materialism.22 Aside from that point, it is yet another hypothesis, and an odd one, since we get no details about how a mind is supposed to pop out of the brain. Materialists are witches and warlocks who chant: “Eye of newt, and toe of frog, Wool of bat, and tongue of dog,” etc., and spirits are magically conjured up. Materialists seem to confuse the material and formal causes of the mind. When asked: “Of what is the intellect made?” it would undoubtedly be correct to answer: “In part of the brain and its constituents.” But when asked: “What is the intellect?” i.e., “What does it do?” it does not take a philosopher to see that answering “The brain.” or “Sends electrical signals to and from the body.” is not particularly helpful. A house is built out of bricks and cement and wood and roof tiles, but a house is not a brick or even a set of bricks. A house is a place where human beings live. Similarly, the mind is a thinking thing; it consists of C-fibers occasionally firing; but it is hardly the C-fibers. It pleases me greatly to see the über-materialist Daniel Dennett averring that he is a zombie and has no soul. In his The Name of the Rose, Umberto Eco suggests that tough-minded scholars “are very sure of their errors,” and that is, indeed, an occupational hazard of being tough-minded. Here, in addition, we have a man who applies his own errors in practice, possibly even in his own personal life. Since only souls or minds can have the property of being sane or insane, I cannot call Dennett insane by his own standards; on the other hand, far be it from me to attempt to refute him; I am quite content to call him literally “dumb as a doorknob” and ignore him as befits an inanimate object so uninteresting. Of course, in regard to this diagnosis, I may be charged with making a rhetorical point. Would I be similarly uninterested, an objector would ask, in a computer or airplane? Indeed, no, for those are fascinating machines, but I would be interested in those things solely for sake of their function and utility to me. On the other hand, consider the idea of human presence. Presence in general is a kind of awareness. A man can be aware of an object, in which case that object would be “close” to him; of another subject, and now that subject is “closer” still; or of himself, and one would be “closest” to himself. People seem to be present to one in the way that merely physical things are not. Persons are “here”; things are “there.” Presence is a special way of attracting attention to oneself, a power to command being noticed which are absent in a thing or a non-human animal. One cannot use people the way he uses things without paying attention to the 22

Reppert (2003) has a full discussion of this and similar arguments.

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person’s well-being or desires. Smith is present to Jones in the sense that Jones stands ready to recognize Smith for any contribution to the world, no matter how small, and is himself in need of similar treatment. There may be a bond of affection between them, a union of minds and hearts, or, at the very least, recognition of each other’s humanity, rationality, specialness, enormous value and delicacy, a unique kind of mutual usefulness perhaps, possibility of friendship, possibility of admiring the person present, and suchlike. To adapt an understanding of Richard Weaver (who, after all, is not all bad), presence entails that “one separates man out from other beings and regards his destiny as something no member of human kind should be indifferent to.” (1964: 150) Philosophers will begin making progress in this area, as soon as they realize what most people figure out by the time they are four years old, namely, that human beings are by their essence precisely not doorknobs.23 While grace for 1st-grade objects consists in collapsing probabilities of random events, grace for 2nd-grace objects takes the form of uniting the wills of men and God through charity into a single spirit, connecting the branches to the vine and to each other, or merging the values scales; as well as making this soul of God everlasting. Let me weaken (i.e., make more modest, content with defending a smaller claim) the arguments in favor of the existence of the 2nd grade of being presented so far. With respect to the intellect (though, I maintain, not the will), the materialist and spiritualist may want to meet each other halfway, and this in two senses. It is possible for an effect to have completely different properties from its cause. Thus, bakers produce delicious bread but are not themselves delicious; a man who fattens oxen need not himself be fat; a murderer is not dead; etc. Similarly, perhaps, the non-rational events in the brain can produce thoughts that have the property of being true or false. What do we really know about matter? Leave a primordial soup alone for a few billion years, and who knows what disgusting things will come to inhabit it. Likewise, put together an outrageous amount of different kinds of cells and organs and whatnot, zap the resulting cadaver with a lot of electricity, and maybe we would get to yell: “It’s alive!” Or 23

Acknowledging presence is not yet feeling love, because a person may respond to the presence of other human beings with hatred or contempt, but it is necessary for love. One cannot love doorknobs as himself. The moral rule “Do not treat human beings as things” must be lost on the materialist philosopher, making him essentially a lunatic, out of touch with reality.

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so we ignorant humans tend to imagine matters.24 Far be it from me to confuse matter with form; just because the mind is made up of atoms does not logically entail that the mind is as impotent at thinking as an atom; maybe the whole is somehow greater than the sum of its parts. A spiritualist may admit for the sake of argument, then, that materialism might not be metaphysically impossible. But a materialist must concurrently admit his complete and utter ignorance about the mechanism according to which such thought-generation allegedly happens. I am even tempted to declare this issue an impenetrable mystery. As we go on with our learning and conversation, our understanding of both the mind and body will increase, and the dialog will become ever more sophisticated, but the solution to the “hard problem” will ultimately forever elude us. Secondly, both parties to the discussion ought to concede that it is actually implausible both that the mind is pure spirit and that it is pure matter. They should meet each other halfway by agreeing that the human intellect is a “psychosomatic unity,” though with a bias toward the spirit as master over matter, being served by it, and metaphysically one grade higher than it. It is fashionable nowadays to compare the mind to a computer. Such statements are typically made by people whom neuroscientists imagine to be good computer programmers and whom programmers imagine to be good neuroscientists. Suppose that a computer has been programmed to “understand” a few simple commands and can calculate and articulate the result. Both the computer and a human subject stand in the same room and are told to calculate 2 + 2. Both respond by uttering “four,” the computer in its robotic monotone, the human in normal voice. Both are formally the same; but different in material, efficient, and even final causes. The reason why there is such thing as computer science at all as distinct from electrical engineering is that computer folks deal with numerous levels of abstraction piled up on top of each other. Any piece of software is a stack. Where engineers see only electrical signals, programmers see logic, math, “if… else” statements, classes, software components, operating systems, algorithms, and all that. Even a distinction as primal as instructions vs. data is already logical. The lowest level of 24

This reminds me of the movie Monsters vs. Aliens (DreamWorks, 2009), in which a monster introduced as follows: “A genetically altered tomato was combined with a chemically altered ranch-flavored dessert topping at a snack food plant. The resulting goop gained consciousness…” Materialist and evolutionary explanations, such as they are, are equally comedic.

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abstraction available to one qua computer scientist and the building block of every processor is a gate. The simplest gate is a transistor with two inputs and one output. One of two kinds of electrical current can flow through each input. If one type of current is interpreted as “true,” and the other as “false,” and the transistor is so constructed as to mechanically output “true,” whenever both inputs are true, and “false” otherwise, then we have a gate that simulates the AND logical operation. (Again, strip away the human interpretations, and there is nothing but physical events going on in the computer.) But nothing like this in found the brain. The brain is not made up of logic gates. Not even the most enthusiastic proponents of the “mind is a computer” theory have compared the eye to a graphics card. The brain is materially completely unlike a typical PC. Efficiently, at the very least, the computer is a machine, while the brain is a living organ. The way the brain works, insofar as we know anything about it, does not at all resemble the functioning of the arithmetic logic unit in a processor. The only point of comparison is that the brain, like the computer, seems to have areas that are somewhat specialized. This part deals with speech, this one with emotions, this function is equivocally called “memory,” etc. But this means even less than it seems at first glance. Is there any material object in the world that performs a function whose parts are not specialized? Regarding the final cause, the brain’s job is not to aid thinking, let alone think on its own, but to limit the human power to think. Thinking is more difficult for an embodied human being than for a separated soul, but not too difficult. The brain is a hindrance to thought not its enabler, though a healthy brain is less a hindrance than a sick brain. Given that the 3 out of 4 causes of the brain and computer are so completely different, it is the height of rashness to pronounce casually that both are actually reducible to each other in form. The body is the soul’s prison, but it is exceeding intricately designed. The spiritual powers that need to shine through are permitted, and those that need to be curbed are shut off. The reason for the body’s enormous and stupefying complexity is that both kinds of sets of faculties are extremely varied: from the ability to drive a car to appreciation of music, from playing tennis to mother-love; and the most important power denied to humans in this life is to see the spiritual light: to observe souls and God directly. (Descartes was enabled by this fact to write: “I do not fail to say that I see the men themselves, just as I say that I see the wax; and yet what do I see from the window beyond hats and cloaks that might cover artificial machines, whose motions might be determined by springs?” (Meditations on First Philosophy, II, 13) Barnbaum

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(2008) suggests that autistic persons lack the capacity to infer that other people have souls or minds.) This complexity reflects the truly epic number of vulnerabilities and defenses that a human being is endowed with in this fight of his life. For example, people who have undergone near-death experiences sometimes report hearing wonderful music in the otherworldly environment they visit. Earthly music should be able to be beautiful, too, but not comparable to heavenly music; composing such music needs to be possible but cannot be effortless and must require great talent and hard work. And so forth with the nonpareil technical ingenuity and compromises and hacks in constructing the body able to host thousands (or millions) of aspects of human existence in their suitable and intended forms. We should at least be able to agree that “0V applied to input A of a transistor coupled with 5V applied to input B yields output 0V” and thinking “false AND true = false” are different phenomena. Now the will’s desires are “subjective and arbitrary,” but the mind works according to laws of logic, evidence, probability, scientific method, etc. But a machine is also law-bound. Hence, it can simulate certain aspects of the search for truth. But not replace it. Why not? Suppose Smith calls himself a “freethinker.” A materialist objects at once: the mind is the brain is matter and therefore, not free at all! There is no such thing as free thought. But Smith replies that he unmistakably can survey possibilities. He can explore ideas. He can regard counterfactuals. He can even write an original novel. In short, he can imagine and contemplate possible worlds. Unlike machines. The intellect’s key ability is to learn, to derive outputs from inputs. The inputs for machines are finite in number. Their “premises,” based on which they “reason,” are pre-programmed into them. The inputs for humans are infinite; we can assume anything we like. See (Appendix, 7) for more on this. Then there is such thing as intuition, defined by Merriam-Webster as “the power or faculty of attaining to direct knowledge or cognition without evident rational thought and inference.” Things like that do happen, if we have a word for it! Computers are “too” logical. [III] The third grade is first cause, understood as communication of being, creativity, and is realized only in God. I will explain what this means for the sake of completeness in (I, 27-29). The grades may be classified as follows. Man is a thing-in-himself who has, thinks for, and directs himself and loves himself for his goodness. He exists for his own sake. Man, indeed, loves others, but he does not seek their good, except insofar as it is part of his conception of

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his own good. 1st-grade rocks may be called things-alone-and-without-secrets. God is fundamentally a thing-unto-others. Its nature and imperative are to create things that are not it and do so with utter exhaustion and abundance, even, as we will see, unto death. Consider that the physical light traverses the finite universe at great but finite speed. The light of human reason on the one hand traverses the finite universe at infinite speed: one can go from contemplating a faraway galaxy to thinking about the stock market in a blink of an eye; this means that no matter how physically big the universe becomes, the mind will remain capable of grasping it in its entirety. On the other hand, it learns the infinite number of truths discursively, proceeding from A to B to C step by step. God’s goodness traverses the infinitude of possibilities at infinite speed, meaning that God intuitively comprehends everything, that is, Himself, fully and in a single act of knowing. There is a sense, then, in which the 1st-grade world is finite; the nd 2 -grade world is potentially infinite; and the 3rd-grade world is actually infinite. 26. THAT THE 1ST GRADE AND THE 2ND GRADE OF BEING ARE NOT THE SAME

Permit me to adduce a few other differences between the first two grades. First, every creature exists in some sense for itself. Its purpose is its own life and happiness. Happiness for a human being may consist in one thing, whereas happiness for, say, a tiger or amoeba may be something else entirely. Nonetheless, every life-form will be eager to avoid pain and death and will strive toward its last end for its own sake, whether instinctively or purposively. Even purely biologically, everything that lives is carefully separated from the external environment by anything from the membrane in a cell to skin in a human being and maintains an internal ecology and equilibrium. A machine, on the other hand, has no purpose other than to serve man by performing a useful function. Its “goals” do not differ from those of its creator. It wants nothing for itself. It is a perfect slave. A human slave might try to hide his abilities so as not to be swamped with hard work; a machine would not “think” of anything so clever. Or, a master must make sure that the slave will prefer to comply with the master’s orders over rebelling; a machine does not in this manner calculate

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benefits and opportunity costs. A machine has no internal life or experiences that are inaccessible to anyone but itself. Where the machine ends and raw materials and the environment begin is an arbitrary decision. These are the most primordial differences between the two grades. In irrational animals, there is only the sensual appetite, such that their hearts are in their stomachs; in man, there are both senses and the will which is the heart of hearts, the fifth element, the quintessence of man. 1st-grade beings lack the “appetite” – or let us be careful and say “full-featured” appetite, because I do not know “what it is like” to be a rock: perhaps, rocks “like” to have energy and to bounce around. Of course, what is interesting about the human spirit is that it’s a one; it has a unity of experience. A car is a fairly unified object, too, but it is an extension of the human body without a will of its own. Like “capital good,” the car is a mind- and heart-dependent object. As a result, it lacks the unity of experience that humans and higher animals have. I am “one”; like the demon-possessed man in Mk 5:2-13, a car is “legion.” That the will is wholly immaterial can be shown as follows: (1) As will be argued in (I, 31), “the will and the free-will are selfsame powers but have different connotations.” (2) In other words, “will” and “free-will” mean or emphasize different things but refer to the same object. (3) Insofar as the will is free, it weighs its options. (4) Though each choice has a sufficient cause, the weighing cannot be dispensed with, as it is precisely the process by which the decision is determined. (5) But a thing is material, if and only if it is subject to necessity in the process of operation; only if it cannot choose its course of action. A rock does not contemplate whether falling on the ground will be more or less pleasant for it than floating in midair. (6) One who objects that, perhaps, the rock does contemplate this but always chooses the same is asked whether the rock can choose differently in some possible world with the same properties of matter as the actual world. If it cannot, then its alleged ability to contemplate is extraneous and should be cut by Occam’s razor. (7) Random “choices” are admitted but do not change the essence of the argument. We have already seen the profound difference between gamblers and entrepreneurs.

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(8) Therefore, since no will is ever unfree, the will is immaterial. Further, in merely material objects, there is no distinction between what is and what (morally) ought to be. A rock is everything it has ever been and ever will be; unlike men, whose character not only changes but is subject to judgment of holy or unholy, just or unjust, good or evil. It may be that a rock is here and is moving there; that it is spinning but will soon stop doing so. However, changes in a 1st-grade object or its environment make no difference to that object: its future state is in no sense “better” than the present state. Also, personality is neither nature nor act but accident. All the adventures of a rock are acts. 1st-grade things lack the intellect, as well. That is why in the previous chapter, I called them “things alone.” I am “my own thing”; I “belong to myself”; I “love myself through myself”; not so for a rock. Therefore, even if happiness can be predicated of rocks, the latter do not seek it: they do not know how. To be more precise, an ersatz intellect, i.e., the capacity to apprehend, consider, and choose between possibilities, is simulated in them by means of chance in the world, whatever its exact source. The human intellect is a remarkable entity. The first thing that is characteristic of minds is knowledge. Even as creators of natural science, we start with experience and try to abstract from the booming, buzzing confusion some kind of order and regularity in the world. Scientific discovery aims at knowledge, and knowledge, which at some point requires beliefs, is a 2nd-grade phenomenon. Machines, though they can manipulate information, have no beliefs. A computer’s gate or series of gates cascaded simulates logic, if a human being assigns the appropriate meanings to its inputs and outputs; but the computer itself is not logical. Knowledge is a posteriori and is divided into analytic and inductive. Perhaps the intellect’s most revealing power is interpretation or finding meanings of things. Each thing is not only itself but also a sign pointing to something else. To understand something is to find and grasp its signified. Understanding is a priori and is divided into synthetic and deductive. Neither knowledge not understanding can go on forever. Analysis must stop when a part, such as an elementary particle, can no longer be broken into further components. Induction ends when the sample reaches 100%. Synthesis quits when the final product is fully serviceable. And one must terminate a deductive process when the area under investigation (such as geometry) has been fully developed and understood.

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Things get interesting when we apply these to God. Regarding God, knowing and understanding Him at the same time (a) cannot get off the ground yet (b) go on forever. For the time being, think of the following paradoxes as koans. God is simple, i.e., has no real parts, yet is also infinitely complex. As C.S. Lewis argued, “Your soul has a curious shape because it is a hollow made to fit a particular swelling in the infinite contours of the Divine substance, or a key to unlock one of the doors in the house with many mansions.” (2002: 428; The Problem of Pain, “Heaven”) God is 100% free, as in obeys no laws that are prior to Him and define His operation, yet is also unchanging. Pure chaos and pure order somehow co-exist. God is one and is perfectly happy yet is forever exploring His infinite self, as though in search of new pleasures. Again, pure act and pure potency are both aspects of God. In addition, God is not only one but triune, as well, which presents its own complications. God is maximally well-defined, constituting a unique particular thing, even the full reality, such that His formal cause, ”what God is,” includes in itself also His concrete individuality and His very existence, yet God cannot be defined through any genus and difference, including “being” and “substance.” We will see how to resolve some of these paradoxes later. Regarding the material cause, for example, we can say either that an elementary particle does not consist of anything (has no material cause) or that it consists of itself (is its own material cause). Somewhat similarly, God and His Aristotelian causes can be called one and selfsame. It is finally necessary to acknowledge wisdom which is the power of judgment: of good and evil, beauty and ugliness, truth and falsehood, and unity and dissolution. The following example of a modus ponens is illustrative: (1) I am late for work. (2) The boss yells at people who are late. Therefore, (3) The boss is going to yell at me. Of the three intellectual virtues, knowledge entails, to use its traditional definition, having a justified true belief in (1) and (2).25 25

In philosophy of science, knowledge is any proposition that is welljustified, so far as we can tell; in epistemology, knowledge is simply true belief.

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(1a) Induction as a means of obtaining empirical knowledge starts with sense data like (1) and abstracts from them regularities like (2). The result is grasp of “permanent things” or universals26. Other universals include laws of nature, the methods of natural sciences, first principles, such as “what is red all over is not green all over,” propositions that are true or false necessarily, essential properties (“All men are essentially rational.”) and proper accidents27, and others. Now the senses, with whose help empirical data are gathered, as per my quote of St. Thomas in (Introduction, 1), cannot give any information beyond the here and now. I do not know that laws of nature do not change, and that in natural sciences the past can be a guide to the future. But I can have reasons for believing these things, and understand why I believe. Causality is a praxeological a priori category. Of this we can satisfy ourselves by means of the following argument: (1) In order to live, man must act; therefore, plan; therefore, form connections between means and ends; therefore, have knowledge of causality. (2) In order to permit human action, the world must be sufficiently orderly. (3) If I believe that the world is chaotic, and I am right, then I will not be around to say “I told you so”; I will be dead. (4) Even if I believe that the world is chaotic (at t1), and I am wrong, I am also likely to die (soon at some t2) from despair through failure to act in my own interest. (5) Even if I am merely afraid (at t0) that the world will become chaotic (at t1), this fear is certain to produce anguish. (6) A healthy man puts away the idea of failure and death, including failure (from t1 to t2) and death (at t2) caused by, for all he believes, chaotically changing natural laws, and fear of both (at t0). (7) Therefore, for the sake of (a) optimal psychological balance, (b) success and happiness, and (c) outright continuation of life, it is best to hold that natural laws are immutable. (8) In other words, I am happiest, when I trust the world not to be See (Appendix, 1) for more on this bombshell. 26 A universal is that which applies to many. 27 That all men are rational is true in all possible worlds; but that all men have the faculty of laughing is true merely in the actual world, though, indeed, for all men who have ever lived, live now, and will live in the future. The faculty of laughing is, hence, a “proper accident” of a man, situated between essential properties and purely accidental ones like being six feet tall.

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or become chaotic. (9) And this is my reason for holding that induction in sciences is a valid procedure. In short, (10) I do not know that the sun will rise tomorrow, but I understand why I believe it; I understand myself. It is very convenient for us to assume that laws of nature exist, and very inconvenient for us to doubt them. In fact, we will seriously harm ourselves, if we doubt them. Induction then is a survival technique. Praxeological reflection counsels us not to worry about the universe’s suddenly turning into chaos. As we can see, this is not exactly Santayana’s “animal faith” – animals do not have a choice instinctively not to “believe” – but a reasoned conclusion, as befits rational animals.28 Consider the “grue” paradox. Call a thing grue if it is examined before t1 = April 1, 2099 and found green or examined after t1 and found blue. Now there are two reasons why we might declare that (a) “All emeralds are green” (or “All ravens are black” or whatever). First, suppose there are 1 million emeralds in the world. We randomly pick 990,000 of them, and they all turn out to be green. Simple calculations show that the probability that all of them are green is high, because if even one out of the 1 million was blue, say, then it would very likely have found its way into the sample, and we would have detected it. The probability of a non-green emerald drops with every green emerald we inspect. (The sample has to be really random; it will not do to conclude that “All swans are white” by looking everywhere except Australia however thoroughly.) Second, because an emerald is a stable natural kind, and its internal structure necessarily causes it to appear green. Induction works for (a) at all times but fails to work for (b) “All emeralds are grue” at t1, because both reasons for (a) are present; however, for (b), only the first reason is valid. But why cannot a grue emerald be a natural kind? Precisely for the same reason why no natural law is likely to change on April 1, 2099. In fact, a law of nature can be 28

It might be objected that this is the complacency of a turkey who thinks it will be fed forever, while the Thanksgiving Day is fast approaching. The reply is simply that the turkey is right not to worry and be happy, because it can do nothing to alter its fate. Even if God plans to pull the rug out from under our feet by changing a few natural laws, we are powerless to prevent or adapt to this and may as well relax and get comfortable within our present surroundings.

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interpreted not only as a must-have regularity but also as a permanent “deep-seated” ingrained causal disposition. The latter construal has one advantage: it considers causal powers to be part of objects’ definitions or essences, as if written directly on their hearts or programmed into them. It endows all things with a measure of dignity and selfhood. We see that the “old” and “new” riddles of induction are exactly the same, as are their resolutions. (2a) Understanding refers specifically to human nature, psychology, and action. For Taleb (2010), a “Black Swan” event is one that disconfirms what was previously thought to be a law of nature, such as “all swans are white.” He tackles the problem as a “skeptical empiricist,” not quite realizing, unfortunately, that this is the wrong way to be either an entrepreneur (who deals with real people not mathematical entities) or an economist. In a sense, however, every act of entrepreneurial disequilibration is a Black Swan, something which buckles a trend or practice thought eternal by the dull multitudes or “the way things have always been,” surprises rivals. But suppose I tell you: “A number is divisible by 9 if and only if the sum of its digits is divisible by 9.” When you express doubts, I present you with a proof. When you continue doubting, I jokingly advise you to spend your life searching for a counterexample. If economic theory is deductive a priori, and entrepreneurship is synthetic a priori, as we will see in the next chapter, then empiricism, skeptical or not, is precisely the mistaken way to approach both. (3a) Wisdom is making value judgments, ranking things, evaluating them. Here we need to consider the wisdom’s aspect of truth. It is through wisdom that we assign a value to (3), either true or false. Once we have done that, the truth or falsity of (3) becomes knowledge. And this cycle repeats indefinitely. Thus, a. I know the truth value of “I am late for work.” b. I understand that the reason why the boss is upset is my being late for work, because he wants me to justify my salary, that is, contribute to his business more than I am paid, not miss an important meeting, etc. c. I judge that “The boss is going to yell at me” is true. In this example, wisdom is the grasp of how the three propositions “fit together.” It is small wisdom, to be sure, but perhaps one should think globally about how the entire universe fits together but solve problems locally. “It is the part of a wise man to arrange and to judge,” says St. Thomas. (ST, I, 1, 6) “It belongs to wisdom to set things in order.” (ST,

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II-II, 45, 6) All this is surely far from the world-as-matter-and-energy.29 So much for the outline of the will and intellect. What of power? Indeed, man is an acting agent. He does not merely react to external stimuli; he takes initiative and acts with the purpose of changing both himself and the world according to his design. Similarly, no life-form, not even the most primitive one, is entirely at the mercy of its environment. It, too, acts on instinct, as if propelled by a powerful force to use natural resources to sustain its life and pursue happiness. At our present level of technology, no machine can in a highly complex environment do things like (a) find food and convert it into energy, (b) procreate and care for the young, (c) regenerate itself, (d) help its fellows in need, (e) effortlessly walk over broken ground, navigate, and so on; no machine’s complexity even approaches that of a single-celled organism; no machine as of now is a self-sufficient miniature productive factory that can perform the vast variety of functions (and even has the ability to develop new functions) that human beings can perform. The sheer enormity of human outward manifestations of life is enough to bury any attempt to think of humans merely as machines. When in the movie Gladiator, Juba says, upon beholding the Colosseum for the first time, “I didn’t know men could build such things,” he is giving glory to human beings, not machines. Until a robot can pass every Turing test imaginable, life will be fundamentally different from nonlife. In other words, while man-made machines can be very sophisticated, perhaps only what I in the previous chapter called “machine-like spirits” can exhibit the stunning mechanical complexity that they have. To end this argument on a humorous note, in an episode 29

The semi-public nature of the intellect furnishes us with a solution to the puzzle of solipsism: how do I know that there are other human beings out there? I know, because I could not have become an actually rational animal, including acquired language, without engaging in conversations with other people. No man is powerful enough to figure out the world on his own; without the assistance of his fellows, he is helpless. In short, everyone must be “peer reviewed,” lest they remain infants all their lives. To the objection that other people may be intelligent cyborgs disguised as men, I reply that in that case, I may well be a cyborg myself. Solipsism is eliminated regardless; if I am human, then there are other humans out there; if I am a cyborg, then there are clearly cyborgs galore in the world, as well; finally, if I am one and everyone else is the other, then, since I cannot tell our species apart, intelligence is intelligence, whoever it blesses, and it is good enough for me.

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of the TV show Family Guy (20th Century Fox, 1999-), Peter Griffin is filming a plastic bag being moved to and fro by the wind and saying that there is so much beauty in the world, obviously in reference to the movie American Beauty (DreamWorks, 1999). Then there is a shot of God on a cloud yelling at him: “It’s just a piece of trash blowing in the wind! Do you have any idea how complex your circulatory system is?!” Again, perhaps the phrase “only God can make a tree” in the Joyce Kilmer’s poem means that life has never been observed to come from non-life. (This, even if true, in no way supports theism, because it can be countered that living things may always have existed and therefore, were never “made.”) I suggest that its second meaning could be that even the design of matter in a tree must come from on high. By way of another example, consider the metaphysics of secondary qualities, such as the question of whether my desk is “really” brown. [I] Let me first propose that the desk is brown because it produces in me a certain experience, a feeling that feels this particular way. Brownness is a subjective experience. The desk is brown, if it presents itself to me thusly. I can express this property counterfactually: the desk is brown if: if it were exposed to the sight of a human being, then it would look like this. (Alternatively, and better, “if a desk is exposed to the sight of a human being, then it is brown, if and only if it looks like this.”) [II] But another meaning of the term “brown” can be constructed from a scientific analysis of the desk’s molecular structure. A desk is brown, if its surface absorbs all of those wavelengths of light, except for these wavelengths of light, which it reflects. [III] That is not all. For between the desk and the experience there is a material medium, consisting of things like: the light being shone on the desk; the air through which the reflected light travels; the physical, chemical, and biological structure of my eyes and my brain; and so forth. Unless these are, so to speak, “proper,” the desk may not appear brown at all. Therefore, I can argue that the desk is brown, if the medium connecting the desk and my seeing brownness is such-andsuch. These three aspects of brownness are definitions. They explain the meaning of a term. None of the three definitions needs to be privileged, but whenever one asserts that something has a particular color, one must state which definition of “color” he is using. Now of course, color is normally defined by ostension (i.e., pointing it out); so, in the process of giving such a definition, one uses all three of the above. One says: “brown is what (2) this thing (1) looks

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like (to me) (3) under these conditions.” Let me aggregate (2) the molecular structure of the desk and (3) the material medium, through which that structure reaches the mind, as “everything physical,” and (1) the experience of the color brown as “everything spiritual.” For me, since I am acquainted with brownness, color would be “everything spiritual.” But if I tried to explain to another person what the color brown was, I would not be able to express my experience in words, the experience being simple or atomic. I would have to define “brown” as “what I think you are going to feel by your sense of sight, given some particular combination of ‘everything physical’.” Even that is inadequate, because particular constraints on “everything spiritual” must also be satisfied. This is because there is only a correlation between the physical and the spiritual; there is no causation, no causal crossing between what in the next chapter I will call the two “levels” of the 2nd grade. E.g., one must be paying attention to the color rather than “looking but not seeing.” He must be willing to learn the truth about the color brown rather than trying to deceive himself. Etc. Thus, the phenomenology of brownness is categorical, while descriptions of brownness are dispositional. However, it is awkward to define brown as what a “normal” person would see, if he is “paying attention” under “standard” conditions. For a person instructed in this manner may miss instances of the color that would appear to him in a manner not specified by this definition. The definition is, no doubt, useful, because most of us are normal, awake, and active during daylight, but pedagogically, it is better to create some conditions (both everything physical and everything spiritual), whether they are “normal” or not, under which brown is definitely felt, point the color out, and let the newly enlightened person discover the rest of brownness in the world for himself. At the same time, the question often asked by undergraduates, “How can I know that my experience of brownness is the same as yours?” must be answered as “You cannot,” because of the appetite-intellect-power trinity, the perceptions and feelings of both the will and the senses are fully private and inaccessible to anyone else. (Bodily actions are fully public, and the mind and thoughts are in between.) We cannot intersubjectively compare experiences. Our best hope lies in our shared human nature, but it is still grasping at straws. 27. THAT THE TOP LEVEL OF EACH GRADE DEFINES THAT GRADE I have suggested that grade 2 is one level higher than grade 1, and that grade 3 is one level higher than grade 2. Table I.27.1 illustrates.

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1, rocks

3 2 1

matter

Grade 2, humans spirit organized matter

3, God goodness perfect spirit simple matter

TABLE I.27.1. THE LEVELS OF OBJECTS OF DIFFERENT GRADES

An electron is simple as a point particle, and God is simple, but in contrary ways. A thing’s complexity ranges from 0 to infinity; its unity ranges from 0 to 1. An election has zero unity but thankfully also zero complexity, so that there is nothing to unify in the first place. God is simple with respect to real parts but infinitely complex regarding His thoughts; at the same time, in God there is no separation between the concrete and the abstract; hence, God’s thoughts are fully real. (This solves one of our paradoxes.) Further, God’s unity is 1. Intermediate things like humans have high but finite (or potentially infinite) complexity and unity somewhere within the (0, 1) interval. I am one yet also many. Objects that are merely physical and are consigned to the 1st grade are composed of two aspects: nature and act, as shown in Table I.27.2. Notice that momentum entails velocity which means motion in a particular direction. The potentiality of matter is the actuality of energy. Why? The Nature Duality matter (e.g., particles)

Actuality Potency

The Act Duality position momentum

energy (e.g., waves)

motion transfer of energy

TABLE I.27.2. OF WHAT THE 1ST LEVEL IS COMPOSED

Let me make a subtle analogy that illustrates how the physical world imitates the spiritual one. The essence of life is struggle, attempting to change the world, to take control of one’s destiny. Life consists in improving, in moving from bad to better, from potency to act,

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from suffering to pleasure. Life is a process of (a) employing one’s powers to (b) make oneself better off. On the one hand, one needs to have enough “momentum” to move from a less satisfactory “position” to a more satisfactory one. On the other hand, the very use of one’s energies during the execution of this task is in itself a pleasure. Robert E. Howard’s nihilistic Conan reflects: “I live, I burn with life, I love, I slay, and I am content.” This attitude is present in phenomena as distinct as the Artisan temperament’s creative flow and Georges Sorel’s destructive violence for the sake of myths.30 2nd-grade objects are made up of three aspects: nature, habits, and happiness, as summarized by Tables I.27.3. As we can see, the 2x2 grid for rocks has been replaced with a 3x3 grid for humans. The distinction between the grades then is that unlike rocks, humans have (a) accidents and (b) intellect. Now many universals have accidents, whether the things they describe are material or spiritual. Thus, “wall” is a universal: this is a wall, and that, and here is another one. A wall in general, as a term that applies to many things, can turn from red to blue, from tall to short, from wooden to brick to metal, and remain a wall. Almost every conceivable “nominal” universal has accidental properties, because the things that it signifies can vary in properties or qualities and remain describable by the universal. This penny is shiny, and that one is dull, yet both are 30

Sorel (1916) sharply distinguished a mass movement, such as of workers for socialism, from intellectual disputes about ideologies that do or do not justify the movement. According to him, the masses of common people do not respond to ideas that engage the mind. In order to sustain a mass movement, one needs something that rather stirs the heart. That thing Sorel called a “myth.” What sorts of things stir the heart of an average person? Sorel answered, violence. (Both on its own and as entertainment.) Hence, any mass movement requires its prophets to offer the people an opportunity for murder and torture on a colossal scale. In other words, Sorel thought that it was the essence of humans to fight and wanted to tap into that instinct to realize his socialist visions. As an intellectual, he must have had some “Utopia” in mind (though he is contemptuous of its older versions), but he did not consider it a sufficient energizing force and so placed his hopes in “myths” (abundant with “glory which will be attached to [the proletariat’s] historical role and of the heroism of its militant attitude” (189)) that would drive the masses to action. The masses would kill and destroy for the sheer fun of it but at the same time be carefully guided by the likes of Sorel toward the explicit end of socialism. Sorel’s own contributions to the socialist cause were the myth of “general strike” and defense of worker violence “enlightened” by this idea.

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pennies. General Power (selfIntellect motion)

Part

Procession Visibility Union Possible?

Part, Pursuit Part, Enjoyment

Virtue

words (persuasion) semi-public in part, through a conversation

body (force) public no, bodies are private properties

The Nature Trinity (Objective) discovery of exsocial acternal law ceptance society “leads the willing, ability to care drags along the for oneself reluctant” from non-interference to wisdom works of mercy

Will feelings (on their own causally inefficacious) private yes, through love

escaping the beast within from hatred to indifference 3rd-order love of friendship

TABLE I.27.3A. THE HUMAN “TRINITIES WITHIN,” PART I

My desk and couch are both essentially pieces of furniture but only accidentally brown. However, suppose that the couch and chair form a matching set that I have personally chosen. This time, they are essentially brown (or at least essentially “of the same color”), and their brownness is a kind. If they were not brown, I would not have bought them. It is true that some universals do not admit accidents. Consider a penny again. Call UniquePenny any object that is qualitatively identical to it but quantitatively distinct from it. If we do not consider spatial location to be an accident, then “UniquePenny” will not have accidents. “Electron” may lack accidents for another reason: it is too simple. On the other hand, for particulars, merely physical entities will not have accidents; while spiritual entities will. This wall, the one I am pointing to, is fully defined. If anything about it changed, then the wall

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would corrupt, and possibly another brand new wall would be generated. Not so for humans. This man was Rothbard yesterday and is Rothbard today, despite the fact that yesterday’s Rothbard thought that blackmail ought not to be legal, and today’s Rothbard has changed his mind. The Virtue Trinity (Intersubjective) doing one’s moral ideal Part, Pursuit duty conformance to the ideal, seeing oneself in Part, Enjoyself-ownerthe true light ment ship fear of the Cardinal Virjustice law tue

2nd-order desire “to be” contentment with oneself 2nd-order selflove

The (Narrow) Happiness Trinity (Subjective) 1st-order desire plan execution Part, Pursuit “to have” contemplation of possession of contentment Part, Enjoywhat one has, viit, comprewith the world, ment sion hension fruition 1st-order love Cardinal Virof concupisprudence courage tue cence TABLE I.27.3B. THE HUMAN “TRINITIES WITHIN,” PART II

An objection to this understanding can readily be raised. For every property, there is a corresponding proposition identical to it in meaning. For example, let X be a certain table. Its (P) 4-legged-ness can be converted to (P’) “X has 4 legs.” The reverse conversion is less natural: consider the proposition (Q’) “The cat is on the mat & X has 4 legs.” The parallel property would be a somewhat unhelpful (Q) “X is such that (Q’).” A similarly puzzling case is property (R) “X is such that 2 + 2 = 4.” (P) seems essential: If X were rebuilt with 3 legs, then it would straightforwardly change; the old table X would disappear, and some new table Y would come into being. Suppose now that (Q’) is true. The cat leaves the mat. (Q’) becomes false, but we are reluctant to say that the table has changed at all. Must we conclude that (Q) is an accident of X? (R’) “2 + 2 = 4” is a necessarily true proposition and cannot

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change in truth value at all. How can (R) be essential to X, when it is in no way about X – in fact, has nothing to do with X? An important property of many objects is “owned by” or simply “owner.” (Similar with “priced at” or “price.”) If I own X and sell it to Smith, yet the table has not moved or anything like that, is it the same table? “Owner” can be described as a relation as well as property, but this only indicates how close various types of abstracta (properties, propositions, relations, universals, kinds, possible worlds, etc.) are to each other. What about “X is 30 miles south of Cleveland” or “X began to exist after the death of Julius Caesar”? My solution is to bite the bullet and declare all the above properties essential to X. We then note that a table is a mind-dependent construction of an individual rational creature. It is part of his own personal world which he rules as he sees fit. Now Thomas Reid argues: All bodies, as they consist of innumerable parts that may be disjoined from them by a great variety of causes, are subject to continual changes of their substance, increasing, diminishing, changing insensibly. When such alterations are gradual, because language could not afford a different name for every different state of such a changeable being, it retains the same name, and is considered the same thing. (1852: 246) Each person chooses for himself at his own pleasure which properties to count as essential or accidental. Though there are interpersonal conventions, there is no right answer here. “The question is which is to be master – that’s all.” Thus, merely material particulars do not have accidents in themselves but may have them considered as for “convenience of speech.” In availing himself of such a convenience, however, each person remains in control of his own definitions. Car, oil, human, brownness, be they artificial or natural kinds, are prototypical universals, applying to a variety of things quite independent of anyone’s wishes and hopes. But how to regard a particular table’s identity through time is very much one’s own decision which may legitimately differ from other people’s. A materialist would have to deny the distinction so far maintained. He will hold that Smith calls a certain person the same name “Jones” today, tomorrow, and the next day, just as with all material particulars, simply for the convenience of speech. However, Jones may object to being constructed in this manner. He feels he remains the same person despite changes both to his body and to his personality. Let us

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just suggest that Jones is entitled to his skepticism over Smith’s alleged powers over him. Universals, material particulars, and spiritual particulars then end up having accidents, but all for completely different reasons. A 2nd- or higher-order desire is defined as a desire to begin or stop desiring something. A person may want to change his own psyche. The core difference between virtue and happiness is that happiness involves satisfaction of 1st-order desires, whereas becoming virtuous entails a “righting of oneself,” cleansing one’s 1st-order desires. In attaining virtue, one is not concerned with satisfying his desires but with becoming the person one wants to be with the (1st-order) desires he approves of. The 2nd-order desire may also be a desire freely to choose to satisfy a given 1st-order desire. For example, Smith who is an alcoholic is contemplating whether to go on a bender or not. He chooses the latter. Good for him! Suppose now that he chooses the former but despises his choice and wants be a “good” person who is not interested in drinking at all. It may be that his 2nd-order desire to do his duty to himself outweighs his 1storder desire. Doing the “right” thing, i.e., not drinking right now is a means to his transformation, though it will take teetotaling for a long time actually to transform. If Smith wants to drink but stops himself with moral suasion without changing the self, then (a) his willpower will probably not last for very long; and (b) it is pointless, because his soul is still corrupt. Smith does not just want to avoid the indignity of getting wasted today and tomorrow but to change his very personality, such that when presented with a similar opportunity to drink in the future, he will be straightforwardly happier abstaining from drinking. Addiction psychologically is inability to make a choice. Normally, an option X that is set aside is forgotten, as the chooser focuses fully on achieving or enjoying the option Y picked. A person addicted to X, however, cannot forget. Even as he is doing Y, all his thoughts are with X. Laboring on Y is tedious for him, making him, in Mises’ words, a “rancorous, quarrelsome, and wrathful malcontent” (1996: 592); whereas there is persistent regret for not enjoying X. Such a person does not approve of what he enjoys and does not enjoy what he approves of. Notice how seeking narrow happiness by a vicious person is nugatory. For if later on in life Smith decides to “become a better person,” whatever exactly that entails for him, then he may have to reject, abandon, and purge those very desires that he struggled so valiantly to satisfy, making all his previous efforts entirely vain. I can express this point in Freudian terms. The Id, which I

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interpret as the will or human appetite in general, is circumscribed by two boundaries. First, by the Ego, which I take to be prudence and courage or the need to choose, plan, act, pay the costs of action, adapt on the fly; in short, to make oneself happy. Second, by the Superego or the 2nd-order desires, together with justice and fear, to keep oneself on the straight and narrow. Thus, the Ego will point out to Smith’s Id that he cannot travel to the Andromeda galaxy despite his ardent desire to do so; and the Superego will point out to the Id that even though Smith can rob a bank, doing so would be morally wrong. Ego connects to Id as reality to desires; Superego connects to Id as morality to desires. Freudians make much, even too much, of the truth that the Id is split into sensual and intellectual. Suppose a person has “sadistic” sexual impulses but is ashamed of them. He does nothing to satisfy his sadism. To a desire that is not being pursued, I refer as a hollow desire. On the other hand, he wants to feel, instead of sadism, compassion for people. He actually does not but thinks he ought to. To achieve his end, he “strives to love his neighbor actively and indefatigably,” as Dostoyevsky put it. To a desire that a person seeks to create through planning and execution, I refer to as an unfelt desire. It is a bit like Pascal’s remedy for atheism through his wager: one can, if we take him seriously, engender a genuine belief in God by “taking holy water, having Masses said, and so on.” Perhaps, hollow desires can be snuffed out through ignoring them, and unfelt desires can arise through acting as if they existed. As some desires are hollowed out, the Ego is unpleasantly traumatized and inhibited; as other desires remain unfelt, the Superego, on the contrary, goes into overdrive. This is normally a temporary state of affairs. The problem is that both hollow and unfelt desires, because painful and like a grain of sand trapped within a mollusk, can be in the “unconscious.” Psychoanalysis should make the patient aware of them, so that conflicts can be resolved consciously and rationally. Or so I understand. Table I.27.3c links the human trinities with temperaments. If I were to get mystical, then I might postulate (or fantasize?) that humans have more than one life and that in each incarnation, as it were, a man progresses one step horizontally from yin to yang to fruit and vertically from nature to virtue to happiness. Hence, I suppose, the “7th” heaven, representing graduation from Artisan-ship. If so, then we obtain two surprising results. First, that not everyone has a Keirseyan temperament. Some folks are so low in their level of development, still learning what they are and not to hate other people, that their souls are not yet defined this way. Second, that the temperaments are unequal in dignity. In (I, 34) I will describe three kinds of goods: physical, moral,

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and metaphysical. Evaluations of things’ goodness are arrived at by judging. Judging physical good or happiness corresponds to the (both moral and intellectual) virtue of prudence; moral good or virtue, to the (moral) virtue of justice, and metaphysical good or nature, to the (intellectual) virtue of wisdom. Nature Part Pre-temperament Gender

Part Temperament Gender

Barely Human yang

power (higher) humanity fruit

Virtue character duty (approved of) Guardian personality fruit yin Narrow Happiness plan execution

Part Temperament Gender

intellect

Rational

Artisan

yin

yang

will Monster yin

ideal Idealist yang

pleasure (true) happiness fruit

TABLE I.27.3C. TEMPERAMENTS AND HUMAN BECOMING

“Narrow” happiness means satisfaction of 1st-order desires, whatever they happen to be. Narrow happiness is the human last end; it is both an end and an act, viz., an act of self-forgetful playing without care. Before one can steel himself to pursue this last end, however, there are two other ends to be attained first. The first end is nature: one needs to connect himself as a “branch” to the “vine” of divinity and other branches of humanity. No lonely person is happy. But the brotherhood of men is disrupted especially with crimes against person and property. Aristotle argues that “he who is unable to live in society, or who has no need because he is sufficient for himself, must either be a beast of a god.” And Monsters are no gods. Or again, “he who by nature and not by mere accident is without a state, is either a bad man or above humanity; he is like the tribeless, lawless, hearthless one, whom Homer denounces.” (1253a1)

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Almost the same conclusion prevails for Barely Humans: they must come to realize that people are more than odd-behaving machines to be used at will. Barely Humans are the prototypical Homo economici, arch-selfish, responding only to promises of reward and threats of punishment to them personally. They will usually avoid violence but will easily lie, betray, and cheat if it suits them. This sort of people is of particular note to us, as they are precisely the object of study of economics! Monsters then sin by violence; Barely Humans, by deception. Unjust violence and fraud are crimes. St. Thomas calls them “beginners.” The fruit of advancement through nature is being accepted into society as a productive member thereof and the ability (a gift of power), now that the person is no longer threatened with prison time, to care for oneself. The second end is virtue: one needs to make his own soul lovable; he needs to acquire a character. The judgment that virtue is its own reward, and vice, its own punishment is entirely correct. The Guardians’ occasional sin is accusation; the Idealists’, temptation. These are merely vices, and, as the saying goes, vices are not crimes. These temperaments are “proficient.” The fruit of advancement through virtue is comprehensive selfknowledge. One accepts oneself for who he is and becomes free, being satisfied with his personality and therefore, with the pleasures unique to him, to seek narrow happiness. It is a gift of the intellect, because one already owns and loves himself; but man is wolf to himself until he finds out who he really is. Narrow happiness is the third and last end. The combination of all three ends successfully attained may be called true happiness. Rationals and Artisans generally do not sin, enjoying a completed personality with good traits, and are “perfect,” though they do not always succeed in their pursuit of happiness (the ultimate gift of the will). In finding nature, one reconciles oneself with fellow men; virtue, with God; and narrow happiness, with oneself. There are two kinds of duty: metaphysical, toward other human beings, as fruit in the nature trinity; and moral, toward oneself, as yin in the virtue trinity; they are often called other-regarding and self-regarding virtues. For example, punishment for a crime may be called “metaphysical justice.” There are also two kinds of vision: moral, of oneself, as fruit in the virtue trinity; and physical, of the world in its complexity, as yin in

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the happiness trinity; and we may call them self-knowledge and knowledge of the other. The last three temperaments are masters over the first three. Thus, Idealists guide Guardians away from perpetuating a mere dutiful routine in their daily lives to, through its help, building a permanent and stable personality. Rationals, further, as lawgivers (and law discoverers) command Barely Humans by shaping their behavior through incentives. The difference between them is that BHs on the inside are a swirling mishmash of unrelated ends and cravings, whereas a Rational’s (and especially Artisan’s) soul is a piece of work: a multifaceted yet unified and integrated identity, reflecting perhaps some coherent aspect of the divine. In their turn, Artisans are masters of self-defense, keeping the Monsters in check. This requires more responsibility than even the Rationals’ task. Note that Monsters do not respond to incentives like Barely Humans; they are fearless, with the caveat that this fearlessness comes not through courage but through despair. Overcoming that despair and earning a kind of right to exist is part of the Monsters’ mission in life. Punishments for crimes and sins are usually symmetrically retaliatory. For example, for Monsters, Artisan self-defense is complemented with judicial condemnation, as though a cancerous cell is cut off from the social body and burned. “Do you, Monster, hate others?” an Artisan declares. “Society hates you back. No mercy shall be given.” The Rational’s making general laws and setting and promulgating punishments for breaking them find their match in particular deterrence through a criminal trial. Rationals say: “Are you, Barely Human, indifferent to your fellow man, caring only about yourself? Have you used people unjustly for your own ends? Society shall be just as indifferent to you and sacrifice you to make other potential con artists afraid.” Idealists punish Guardians by retribution; and are themselves punished to be rehabilitated. Comparable evil is returned for evil. Rationals and Artisans as ideal types do not get explicitly punished, but they can be incompetent, in which case reality itself will hurt them in the form of broken plans and failed executions. While punishments are not exceedingly subtle, they can certainly be effective. For human beings there are three kinds of love. First is love of concupiscence which corresponds to actions and happiness; second is love of self which corresponds to habits and virtue; third is love of friendship for others which corresponds to human nature and powers. The ultimate and clearest manifestation of power is to affect things other than oneself, i.e., other than one’s own happiness and character.

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When Thomas Jefferson advises to “love your neighbor as yourself, and your country more than yourself” (1984: 1499), he has in mind the human nature’s love of friendship. The three aspects of love have already been mentioned: (1) to whom a good is willed; (2) what appropriate good is willed; and (3) how intensely love is felt, both absolutely and relatively. Thus, one may (3’) suffer much in order to inform (1’) society as a whole with (2’) just law and efficient order, such that for example, individually, people may be expected to seek government protections for their businesses; however, society and government would function in such a way as to make such efforts futile. As we have seen, the Rational function is to modify the behavior of Barely Humans through incentives, both in legislation and trials, in order to steer their actions into socially beneficial outlets. There is a clear difference between “you shall not steal” addressed to a citizen and “you shall punish stealing” addressed from the judicial and legislative branches of the government to the police. The former concerns the morality of a act; the latter, its legality. Not every vice ought to be criminalized; as a result, we may formulate a concept of libertarian tolerance that morally objectionable practices, such as homosexual sex, are not punished by force of law. We do not mean that one needs to approve of or champion those objectionable practices. In the case of stealing, however, both commands are valid. A good person seeks his own good without damaging but in fact, with promoting his neighbor’s or overall good. A good society encourages such behavior in individuals. Consider again the idea of the masses’ looting the elites by violence or votes. On the one hand, mass looting will “harm the economy.” As a member of society, any Smith has an interest in preventing others from looting the rich by exercising moral or legal pressure on them, e.g., by electing “conservative” congressmen who will not raise taxes. On the other hand, Smith may want to be able personally to loot the rich himself. The ideal for Smith situation would be that no one loots except him: the harm to the social body is minimal, while Smith is growing fat and happy. Unfortunately for Smith, often this is not possible. Smith cannot avoid including others into his nefarious schemes. Everyone will want to get in on the action, and Smith will need their support to make plunder legal, anyway. Either he steals and let everyone else steal; or no one is permitted to steal. Either both Smith and others are unbound; or both are bound. He cannot have one without the other. Everybody thinks this way, and a shifting equilibrium is eventually established, wherein the “good” ideological forces enforcing social equity are counterbalanced

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by the “vicious” self-interested forces impelling individuals to commit legal plunder. In the end, a moderate amount of looting occurs, sufficient to qualify for the label “welfare state.”31 This suggests a general solution to electoral politics. Mises sets up the problem as follows: Representative democracy cannot subsist if a great part of the voters are on the government payroll. If the members of parliament no longer consider themselves mandatories of the taxpayers but deputies of those receiving salaries, wages, subsidies, doles, and other benefits from the treasury, democracy is done for. (1946: 81) Mises is being more dreary than needed. Let us say Smith is a welfare bum who wants welfare to continue for selfish reasons. In that case, it is irrational for him to bother to vote for the familiar reason that no single vote matters. He is wasting his time; he would be better off spending the time it took to learn about the candidates, the issues, register to vote, drive to the voting place, etc., drinking beer in his yard instead (or whatever it is that welfare bums do). On the other hand, if he wants welfare to other people to stop, thereby helping the economy or promoting social justice, then it makes perfect sense to vote to affirm his ideology, to make his voice heard regarding the common good. One is master of himself but scarcely master 31

Some pundits have observed that Americans are “ideologically conservative but operationally liberal” which is a glorified way of saying that Americans disapprove of other people’s plundering society but are quite eager themselves to plunder when an opportunity to do so happens to come their way. Americans do not like taxes as a matter of principle; as a matter of actual practice, they very much enjoy taxes imposed on people who are not them. The arch-leftist William Blum has complained that Americans “don’t want more government, or less government; they don’t want big government, or small government; they want government on their side.” Blum has clearly despaired of finding a way out of a war of all against all. But he is 50% right. Americans do want small government but cannot resist using said government to make others pay for their own pleasures, in the process making the government bigger. Harry Browne, who twice was a Libertarian candidate for US President, had an ingenious catchphrase: “Would you be willing to give up your favorite federal government program, if it meant never having to pay income tax again?” He was presenting to the people a choice between everyone’s stealing, including the voter he is addressing, and no one’s stealing, also including the same voter. It is too bad that Americans keep choosing the former.

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of the universe. He is not pursuing his self-interest by means of a futile act like voting but being a solid citizen and pursuing the common interest, such as the best legal environment for society as a whole, in the only – and therefore the most efficient – way possible. It follows that the conventional wisdom that people “vote their own wallets” is false or at least ought to be. People, if they have any prudence in them, vote their ideology. According to this, if Smith likes welfare, then it is irrational for him to vote at all; and if he opposes it, then it is rational for him to vote against it. As a result, counterintuitively perhaps, the welfare state can be eliminated through electoral politics. Here is another way to think about this. Let us again start with Mises: Wage earners and small farmers want to make their revenues independent of the market. Both groups are eager to withdraw from the flux of historical events. No further occurrence should impair their own position... The farmer in a European mountain valley waxes indignant upon encountering the competition of Canadian farmers producing at lower cost. The house painter boils over with rage when the introduction of a new appliance affects conditions in his sector of the labor market. It is obvious that the wishes of these people could be fulfilled only in a perfectly stagnant world. (1996: 851-2) However, the farmer is unhappy over competition with him but benefits from the competition to the house painter. But the farmer cannot have both: either both he and the painter are protected, or neither of them are protected. The more professions are thereby multiplied – house painter, construction worker, taxi driver, accountant, … – the greater the harm to the farmer of “universal” protectionism. If the farmer weighed the costs and benefits wisely, he would assuredly prefer no protectionism for anybody. As would a member of any other profession. The interests of every branch or firm can be favored by all kinds of privileges granted to it by the government. But if privileges are granted to the same extent also to the other branches and firms, every businessman loses – not only in his capacity as consumer, but also in his capacity as buyer of raw materials, half-finished products, machines and other equipment – on the one hand as much as he profits on the other. (1996: 81)

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Again, let politicians A and B run against each other. A, if elected, will be an unscrupulous political prostitute; B, an incorruptible champion of laissez-faire. Businessman Smith decides to bribe A by financing A’s campaign; yet on the day of the election actually votes for B. Let the reader ponder whether Smith’s behavior is schizophrenic or smart. Given love of friendship, we come to the startling conclusion that the nature of man is not so much “rational animal” as “that thing which loves other human beings for their own sake and does good to them.” This is yet another argument against solipsism. For if other people had not lovingly brought us up and educated us, we would never have become human. Their love for us is responsible for our flourishing and moreover, for our own love for other people, meaning that the evolution of a person from an infant to an adult shapes his very essence. It would seem, therefore, that the most important way in which parents can influence a child is by teaching it the ways of charity. Mises concurs: “From the parents the child learns to love, and so comes to possess the forces which enable it to grow up into a healthy human being.” (1962 [1]: 105) My view is that learning to love others as friends is a metaphysical not moral improvement. A misanthrope or Mowgli is literally not human; greater or lesser love is a “theological” and essential quality. So far, in the process of commenting on Tables I.27.3, we have discussed, among other things, the human personality. Let us now turn to the second feature that separates men from machines, namely, the intellect. The intellect is semi-public for two reasons: first, it can both sense and reflect; and both, together with the will, command an action to be performed and contemplate. Second, it can unite with other intellects, not as sublimely as the wills unite through love, but still substantially through a conversation, discussion, and mutual learning. An essence is defined as a cluster of powers which can affect other things positively and therefore, be good or negatively and be to this extent evil. The terms goodness and essence or nature, as well as beauty, unity, and truth, are virtually interchangeable. For example, the Russian word for “ugly” is безобразный, literally, “image-less” or “formless.” But the beauty of a thing stems from its form, i.e., its essence. Similarly, a thing that is internally unified and harmonious can have an identity, once more, a form, an essence – it can be something; while an object that is discoordinated, being pulled inside by different forces every which way, is likely to tear itself apart and hardly possesses a persistent identity. Again, truth has the sense of conformity to a perfectly formed

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being; a thing’s form or essence is truer, the better that thing resembles an ideal. Wisdom then is quadriform; and we have seen that the other two intellectual virtues form a foursome, as well. Now all intellectual work entails deriving an output from some set of inputs. Inputs can be either empirical or innate. Outputs can reveal to us something either about the material world or about rational creatures. The mode of derivation can be either a posteriori, which means that one arrives to a conclusion by using his senses, “upon” of “after” experience; or a priori, which means that he does so by using reflection or introspection, “prior to” or without experience. To reiterate, a posteriori derivations are divided into inductive, meaning that in arriving to conclusions, one prefers to move from the particular to the general; and analytic, which means that the way one arrives at conclusions is through dividing, drilling down, as though dissecting a frog, going from one to many or from complex to simple. A priori derivations are divided into synthetic and deductive. The former means that the way one arrives at conclusions is through putting together, harmonizing, combining. The conclusion contains more information than the sum of the premises. One proceeds from many (e.g., virtues) to one (personality) or from simple to complex. The latter takes as its starting point the general (e.g., geometrical axioms) and ends up at the particular (the theorems derived from them). We can arrange the four permutations in the manner proposed by Table I.27.4: Derivation Deductive a priori Inductive a posteriori Analytic a posteriori Synthetic a priori

Meaning Exploration of the human mind Laws of matter and energy; knowledge how Knowledge of contingent facts Exploration of the human heart; understanding why

Examples Economics, mathematics, geometry Natural sciences Daily life Entrepreneurship, psychology

TABLE I.27.4. TYPES OF INTELLECTUAL WORK

The motion from analysis to synthesis to induction to deduction can be represented as progress from instinct to intuition to reason to

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creativity. Now the main intellectual tool for doing economics is precisely Artisan self-knowledge. Entrepreneurship, the practical cousin of speculative economics, is a priori, as well, but synthetic, based upon understanding one’s customers and what would impel them to open their wallets. [I] With respect to the contrast between deduction and induction + analysis, my hypothesis why many economists are so eager to imitate the methods of physics is that they, subconsciously or not, want to be able to predict events and boast about their power. They want to be in control of the future, as physicists often are. Unfortunately, prediction is very difficult in a complex free economy. Experiments cannot be conducted on an economy as if it were a lab, because one cannot isolate and vary a cause while holding everything else equal. The market process is a highly complex phenomenon, and simply put, no one is in a position to tinker with it. Recall my arguments in (I, 14) and consider a moment in Crusoe’s life. Is his operation efficient? This is a strange question. It may be more efficient than it was a year ago. But it is probably less efficient than it would be if Crusoe were able to take advantage of division of labor. How will his efficiency improve, as time goes on? We cannot tell that either. No experiment can simulate an actual society and actual work. [II] With respect to the contrast between deduction and synthesis, the latter is the proper job of entrepreneurs not economists. Unlike in natural sciences, there are in praxeology and history no constant relations between variables. Past performance is no guarantee of future results. History is but an unreliable (though still indispensable) guide to future human events. The only fixed axiom is that people seek happiness and the theorems following from this fact; how people seek happiness changes all the time in a hard to predict fashion. Economics is a qualitative science, both using and describing the structures of the human mind and will; nothing in it is open to statistical or mathematical proof or disproof. Thus, “if a statistician determines that a rise of 10% in the supply of potatoes in Atlantis at a definite time was followed by a fall of 8% in the price, he does not establish anything about what happened or may happen with a change in the supply of potatoes in another country or at another time. He has not ‘measured’ the ‘elasticity of demand’ of potatoes. He has established a unique and individual historical fact.” (Mises 1996: 55) This fact is of little value to an economist but can be useful to an entrepreneur or historian.

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[III] With respect to the contrast between deduction and wisdom, it might be objected, do we not seemingly judge other people by calling them “good” or “bad”? Yes, but these appellations must be rightly understood. Beside happiness and misery, there are also holiness and wickedness, sainthood and sinfulness, glory and shame. Kant proposed as practically self-evident that the aim of this life is to become holy or “worthy of happiness.” But actual happiness does not necessarily ensue upon holiness (another obvious point), yet there is no point of becoming worthy of happiness without at some point enjoying happiness. Hence, Kant’s argument for the existence of a just God and for immortality of the soul, such that holiness is crowned with happiness in the next life. A holy man hones his nature with works of mercy for other people and his virtue with a measure of disciplined self-denial. The puzzle introduced in (Introduction, 1) is now solved as follows: A murderer (say) seeks happiness without caring about either nature or virtue or both. Our murderer, then, would be lacking not just in virtue but in basic humanity, as well. See (Appendix, 8) for more. Psychopaths may be defined as people with a weakened nature trinity, unable to feel love of friendship. Normally, doing evil harms the soul of the evildoer; it is accompanied by guilt, remorse, feeling spiritually corrupted, despair, even self-condemnation. Psychopaths do not experience these things. When asked how he felt while he was strangling his victim, one serial killer replied, “Just focused on the task at hand.” Now this property of the soul to be unaffected and unharmed upon sinning would seem to be an asset. However, the flip side of it is that doing good deeds do not improve the soul either. Inhuman, a Monster in our system, a psychopath always remains a half-devil, half-child. An autistic person does not understand people, but if he did, then he would be just toward them or love them. (Such a person (1) may not realize that there is anything on earth to be understood: Barnbaum (2008) quotes a mother who questions whether her autistic son will ever be able to grasp that “she is a person with thoughts and feelings, not a wind-up toy.” (78) Again, an autistic person may be “unperturbed by the loss of her father, comparing his departure to a bowl of fruit that was on the table one day and gone the next.” (106) Alternatively, (2) an autistic may feel the presence of other human beings but be completely unable to “read” them.) He has the habit of justice, but a bodily sickness has prevented him from acting justly. A psychopath does understand people but is unjust to them or fails to love them. In fact, a psychopath may derive perverse pleasure from toying with people’s emotions. If the term “moral community” (where “moral” refers to otherregarding duties and virtues) is defined simply as the set of all people

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who as a rule treat each other justly or cannot do so but would if they could, then an autistic person would, and a psychopathic person would not, be a member of the moral community with all the rights and duties attendant upon such membership. It is true that one may feel other people’s pains and sorrows, not just their delights and joys. This is useful: shared joy is a double joy; shared sorrow is half a sorrow. Nevertheless, every sophisticated ethics counsels a certain amount of detachment from the world, lest one be overwhelmed, being in the world but not of it, such that one manipulates and changes the world in order to make himself and his loved ones happier but does not allow the world to manipulate him. As a consequence, the problem of pain and dissatisfaction which trigger human action can be approached in two ways. First, by seeking to change the world and bring it into conformity with how one thinks things ought to be to his liking. This corresponds to narrow happiness. Second, by changing the self, the soul, one’s consciousness in order to free it from dependence on the harsh realities of the world. This corresponds to holiness. Permit me to generalize these into the ways of the West and the East respectively. Thus, when faced with a disease, a Westerner would want to develop a drug to cure the disease. An Easterner would want to control his awareness, manage his internal experience, so that the disease does not bother him. A yogi or monk may be poor, malnourished, and sick, but his consciousness flows in such a way that he is unaffected by these external maladies. In both cases, evil disappears and is replaced with something good. The phrase “the cause of suffering is desire” means that if one is in pain, then he suffers for as long as he wishes relief from the pain. If one were to stop desiring to be rid of the pain and somehow learn to live with it, then one would be free from suffering, as well. The best way to set off the difference is to liken the West to teaching man how to change the things he cannot accept; and the East, to teaching him how to accept the things he cannot change. (Learning the difference is shared.) Thus, as Matthews and Deary (1998) point out, one may undertake “problem-focused” coping with stress which involves “efforts to change the objective external situation, often by engaging in some planned action” or either “emotion-focused” coping, i.e., “the strategies in which the person tries to change their thoughts and feelings about the distressing event, by trying to learn something from the situation, looking on the bright side, or expressing their negative emotions” or “avoidance” meaning “trying to evade the problem, through suppressing

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thoughts about it, through distracting oneself with other activities, and through active disengagement from the stressful situation.” The empirical evidence for which approach is more effective is “complex,” (181) as it should be when dealing with a problem of such generality. Needless to say, this book falls squarely within the Western tradition. Mises argues: There is hardly any greater divergence in value judgments than that between ascetics and those eager to enjoy life lightheartedly. An unbridgeable gulf separates devout monks and nuns from the rest of mankind. (1996: 87) Every world view and every ideology which is not entirely and unconditionally committed to the practice of asceticism and to a life in anchoritic reclusion must pay heed to the fact that society is the great means for the attainment of earthly ends. (1996: 179) At the same time, a metaphysically and morally good man need not avoid worldly pleasures; he need not be an ascetic and in fact, is advised not to be one. Narrow happiness without holiness is vain and unsatisfying, “a chasing after the wind”; holiness without narrow happiness, i.e., Misesian asceticism, is either a grave injustice or pointless fanaticism. Note that both ways can turn destructive: one might try to change the world by bombing it or change oneself by drinking heavily. Yet Mises did not realize that the statement “Man seeks happiness.” hardly exhausts our inquiry about either men or happiness. For besides “What does man seek?” we can also ask: “Who seeks happiness?” and “Man seeks happiness for whom?” For example, only a holy person is qualified to seek happiness; in that lies the essence of the entire discipline of ethics and moral philosophy and theology. John Stuart Mill opines: It is indisputable that the being whose capacities of enjoyment are low, has the greatest chance of having them fully satisfied; and a highly endowed being will always feel that any happiness which he can look for, as the world is constituted, is imperfect. But he can learn to bear its imperfections, if they are at all bearable; and they will not make him envy the being who is indeed unconscious of the imperfections, but only because he feels not at all the good which those imperfections qualify. (2001: 10)

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St. Thomas puts it this way: Hence the intellect which has more of the light of glory will see God the more perfectly; and he will have a fuller participation of the light of glory who has more charity; because where there is the greater charity, there is the more desire; and desire in a certain degree makes the one desiring apt and prepared to receive the object desired. Hence he who possesses the more charity, will see God the more perfectly, and will be the more beatified, [i.e., truly happy]. (ST, I, 12, 6) From the foregoing, it is clear that economics makes two assumptions. First, that no one loves any other person with the love of friendship. Economics does not admit love of friendship, because such love can make Smith happier, if his beloved Mary is happier, too. That vicarious enjoyment does not count. Let Mary exchange an apple for the orange to her profit. We see a transaction, the study of which belongs to economics. But it does not belong to economics to take note of Smith’s joy, as he sees Mary dig into the orange. Let me change the scenario slightly to drive the point home. Smith exchanges an apple for an orange, gives the orange to Mary as a gift, and feels pretty good. Odd. An economic good has been given up which, according to the hallowed law of marginal utility, should make Smith more miserable. Yet on the contrary, he rejoices, because Mary is now enjoying the orange. Economics can make neither head nor tail of the fact that love of friendship and joy increase in the process of being given away. We insist on mutually disinterested economic agents and on the Barely Human methodological individualism, lest our science becomes intractable. Second, that there is not even self-love, what people will themselves to be. People’s virtues and sanctity are irrelevant. With respect to the same law, as Marshall puts it, “we do not suppose time to be allowed for any alteration in the character or tastes of the man himself. It is therefore no exception to the law that the more good music a man hears, the stronger is his taste for it likely to become; that avarice and ambition are often insatiable; or that the virtue of cleanliness and the vice of drunkenness alike grow on what they feed on.” (1964: 79) As economists, we are concerned only with love of concupiscence. 28. THAT THE 3RD GRADE BELONGS TO GOD ALONE

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The science of God called natural theology or an attempt to discover God in nature (almost entirely) by reason alone is the subject of this chapter. The first lesson to be learned about this discipline is taught by St. Thomas in ST with such clarity as to admit no confusion: The existence of God and other like truths about God, which can be known by natural reason, are not articles of faith, but are preambles to the articles; for faith presupposes natural knowledge, even as grace presupposes nature, and perfection supposes something that can be perfected. Nevertheless, there is nothing to prevent a man, who cannot grasp a proof, accepting, as a matter of faith, something which in itself is capable of being scientifically known and demonstrated. (I, 2, 2, reply 1) The enumeration of God’s attributes together with the opinion that the concept of God thereby built up is neither meaningless nor self-contradictory and that a being with these attributes exists is called theism. Now the appropriateness of the following brief remarks on theology in a work on economics may be questioned. In my defense, Keynes himself believed that “the economist should be ‘mathematician, historian, statesman, and philosopher… in some degree,’ and that ‘no part of man’s nature or his institutions must be entirely outside his regard’.” (Skidelsky 2010: 189) I take further solace in Mises’ understanding: The study of economics has been again and again led astray by the vain idea that economics must proceed according to the pattern of other sciences. … What is needed to prevent a scholar from garbling economic studies by resorting to the methods of mathematics, physics, biology, history or jurisprudence is not slighting and neglecting these sciences, but, on the contrary, trying to comprehend and to master them. (1962 [2]: 4) Theology is one such branch that must be sharply distinguished from economics and other moral sciences. The discussion thus completes the metaphysical picture in part already sketched and helps to outline both the area of competence of economics and its limitations or those parts of our science that are properly beyond its reach. Mises notes with apparent relief that “the philosophers [have] abandoned the search for the absolute.” (1996: 70) Philosophers have done no such thing! An additional benefit then is to establish that nothing in praxeology implies

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atheism. We must take the cue from Mises himself who warns against attempting to apply the methodology of the study of human action to the study of God. Just as the methods of natural sciences do not work in praxeology, so the methods of praxeology do not work in natural theology. We must, therefore, keep the methodologies of rational “cosmology,” “psychology,” and “theology” (all traditional subdivisions of metaphysics representing the three “grades”) separate. Thus, attributing dissatisfaction or action to God is erroneous. Against Mises, however, I will contend that life need not entail change. Life entails action, and action can be both acting-toward-rest and acting-while-at-rest. In the wide sense, action can take the form of (a) pursuit of happiness or (b) contemplation of the good attained and its enjoyment or actual happiness. Only (a) involves an attempt to change something. In the narrow sense, one can act in order to (a’) acquire a good, or one can act by making an effort to (b’) keep the good in his possession. Moreover, the state of rest or its perception motivates actingtoward-rest. In physical effecting, the cause is prior in time to the effect; in teleological effecting (which is our main interest), it is the reverse: the effect, action, is prior to the cause, anticipated satisfaction of a desire in the future, when the action has borne fruit. Expected future utility triggers action in the present. God does not act-toward-rest, because He is perfectly happy. To complete the picture, Aristotelian effecting (consisting of his famous 4 causes) is co-present with the effect; and the divine grounding effecting has an eternal cause over the entire temporal effect. God is subject neither to any necessity nor to self-interested concerns. With respect to the former, God is “pure act” which means that He is not in any way in potentiality: He is not a body, potential to being divided into parts, not a conjunction of essence, accidents, and acts, not a union of a nature and a concrete individual, and so forth. This is the beginning of (α) 1st-level negative theology or remotio: if there is anything to be known about God, then it is, e.g., that He is not a carrot or anything of that sort. As we ultimately conclude, God is materially simple, i.e., not made up of parts, and efficiently free, i.e., is unconstrained by any laws. As a result, not even God’s nature imposes any demands on God. For example, God was free to make the world in which 2 and 2 produced 5 but lacked the power to do so; just as God had the power to make the world in which saints went to hell, but His goodness did not allow that.

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Notice how God on the 1st level is exactly like prime matter. An idealized particle of prime matter, too, is elementary or simple; formless or lacks any definition; is inert or obeys no natural laws or is free; and purposeless or lacks any aspect of mind-dependedness, i.e., is objective. If God is pictured as a blacksmith, and prime matter, as molten metal in His hell-forge, out of which all things are made, then God may have created prime matter in the likeness of His 1st-level “body,” such as it is. With respect to the 2nd level, the members of the human trinity within are not themselves persons. In God, they are. The Father, Son, and Holy Spirit signify God’s fully sated self-interest, the Father standing for intellect; the Son, for power; and the Holy Spirit, for God’s will. If the infinity of God to be understood as the extent of God’s reality, with His ideal thoughts – that cover all truth and no falsehood – becoming real qualities, then this aspect of God is like an infinite and complete (metaphysically, morally, and physically) rational being. This is the source of (β) 2nd-level positive or “perfect being” theology, often indulged in without much reflection.32 The eternal and immutable God cannot and does not act, for one cannot improve upon perfection: An acting being is discontented and therefore, not almighty. If he were contented, he would not act, and if he were almighty, he would have long since radically removed his discontent. For an all-powerful being there is no pressure to choose between various states of uneasiness; he is not under the necessity of acquiescing in the lesser evil. Omnipotence would mean the power to achieve everything and to enjoy full satisfaction without being restrained by any limitations. But this is incompatible with the very concept of action. For an almighty being the categories of ends and means 32

Thus, theologian Paul Copan asserts that “humans have been made in the image of a faithful, truthful, rational, morally excellent, worship-worthy Being.” (Stewart 2008: 142) But humans, too, can be faithful, truthful, rational, etc. How does this description differentiate between humans and God? Is God in a kind of bizarre reduction “really” “just” an unusually saintly person? Zeus? That we are so made needs to be proven not just asserted as self-evident. “The idea that God could be evil or command evil is utterly contrary to the very definition of God (who is intrinsically morally excellent, maximally great, and worthy of worship).” (160) But we are not supposed to define God but to unfold His attributes one adequate argument after another and in such a way as to draw undeniable conclusions about the difference between Creator and creatures.

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When the Father in eternity speaks the Word, He utters a self-description or self-conception, begetting the mirror in which He sees Himself. This procession of the Son is a kind of action, during which the Father comes to understand Himself. This action does not go outside but stays within God. As a result, the Son is the Father’s self-knowledge with which the Father is perfectly at peace, with the two loving each other through the Holy Spirit. This 2nd-level (that is, the level of social sciences that study rational beings) God comprehends Himself and knows all possibilities of finite existence. But He does not of and by Himself on this level know actual things outside Himself. He has no knowledge whatsoever which possible world is the actual one or what time it is now. There is no reason why He would. God in His aspect of the self-interested Trinity simpliciter can neither create nor interact with the world that He created. What would motivate a perfectly happy God to go to work? That God is His own existence and so the source of all existence and life, therefore, is incomplete without a further distinction between the natural satisfied 2nd-level self-interest or God which we recognize in the concept of the Trinity, in whose image we are made, and the 3rd-level supernatural goodness of God which is the maker of the 1st- and 2nd-grade images. Recall that prudence judges happiness; justice, virtue; and wisdom, nature on the 2nd and higher levels. God has prudence and justice in a somewhat metaphorical sense, i.e., suitably modified for the unlimited and content divine nature. Insofar as God realizes Himself to be metaphysically perfect, as compared with the possible worlds he beholds and the ideas of things in His mind, God is also blessed with wisdom. God contemplates Himself which pertains both to “apprehension of the truth,” namely, knowledge and understanding, and to “judgment according to truth,” namely, wisdom. Yet this wisdom bore fruit only at creation. St. Thomas explains: This [sacred] doctrine is wisdom above all human wisdom; not merely in any one order, but absolutely. For since it is the part of a wise man to arrange and to judge, and since lesser matters should be judged in the light of some higher principle, he is said to be wise in any one order who considers the highest principle in that order… He who considers

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absolutely the highest cause of the whole universe, namely God, is most of all called wise. Hence wisdom is said to be the knowledge of divine things. (ST, I, 1, 6) He who knows the cause that is simply the highest, which is God, is said to be wise simply, because he is able to judge and set in order all things according to Divine rules. (IIII, 45, 1) There can be no perfect and universal judgment that is not based on the first causes. (II-I, 57, 2) These passages refer to God as Creator and to His 3rd level. Again, it may have pleased God to judge Himself perfect “before” He created, but wisdom is even more useful now, because both God and humans on their 2nd level must understand external to them reality; in particular, the hierarchy of being. As a practical matter, we must understand where we are in this hierarchy, so as to determine which things are inferior to and serve us, and which things are above us and may have a claim on our allegiance. As we learn about the world, and our science and philosophy advance, we may find ourselves in a better position to judge both the created and the uncreated world. We might wonder why the universe is this and not that. We may wonder whether this is the best possible world. Did God truly create wisely? How can we improve the world; in other words, how can we do our part and participate in creation? In a real sense, there is nothing to be known about God on the 1st level, because He is (Amaterial) simple; (Aefficient) free; and (P) immense and so unmoved by any physical cause. Nor is there anything to be understood about God on the 2nd level, because (Afinal) the relations of the Trinity constitute God’s purpose, such that God’s pleasure is God Himself; and (T) God is perfectly satisfied with His nature, character, and well-being, is immutable, and does not act to make Himself better off. God is bothered by no unattained teleological end or interest or striving, whether external or internal to Him, and is unmoved in this sense also. God cannot be psychoanalyzed. The idea of God’s happiness requires a finishing touch. Happiness, as I have defined it, appears to involve 1st-order love of concupiscence or enjoyment of things other than oneself. But God wants nothing for Himself. St. Thomas denies that God can enter into composition with other things, including by desiring or enjoying them. God wants no toys to play with. It seems that happiness or satisfaction cannot be predicated of God, because He feels no love of concupiscence for anything. The

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solution takes cognizance of the fact that God possesses every possible perfection. But “that which is most perfect in any intellectual nature is the intellectual operation, by which in some sense it grasps everything.” (ST, I, 26, 2) God can be called happy, insofar as the Father sees and understands the whole of Himself in the Son – who is His true and faithful image – and rejoices thereupon. The objects that make humans happy are located outside of them; God finds happiness within Himself. We will examine the material and efficient causes of God’s 2nd level later. How then do we judge God’s 3rd level wisely? If, as we will see, goodness is beyond being, then the Aristotelian causes do not apply to goodness at all. God’s 1st level exists and is simple; goodness cannot be said either to exist or not to exist; therefore, “it” “is” in this most primal sense uncaused. (Language falters here, I am afraid.) In addition, goodness is the (G) grounding cause of everything; it is a grounding cause of (Aformal) all things. God’s 2nd level is perfect and complete; humans are in the process of everlasting becoming; both, however, are what goodness decides they be. For Father-Son-Holy Spirit, G is an eternal cause of an eternal effect; for the world, it is an eternal cause of a temporal effect. Note that God’s perfection of the 2nd level, as His nature, is subservient to His happiness with which we have already dealt. Goodness is like boundless fire, except that fire consumes and destroys, irrationally; whereas God creates and orders all things sweetly. God’s creativity is an unstoppable force, making a never-ending world of inexhaustible richness. It creates beauty as per its inner nature. It flows and coils through the void of non-being, leaving behind wondrous and remarkable things. It attends to the entire creation, making all things new when needed. The human life-force, that “impulsion of all impulses, the force that drives man into life and action, the original and ineradicable craving for a fuller and happier existence” (Mises 1996: 882), is but one form that the divine spark of goodness takes. Just as a man’s 2nd-level soul controls and commands the 1st-level body in acting, so God’s 3rd-level firestorm of creativity uses God’s own 2nd-level spirit as a prototype and drives it to act as a cause. As the human (1st-level) body moves, so the God’s (2nd-level) spirit loves; that is, as the body moves without any external forces moving it, so the spirit loves by creating things and infusing being without any dissatisfaction felt by the lover – without any external object, the non-possession of which causes God displeasure. Creation is associated with the Father, the first person of the Trinity, in His capacity as principle from which all things emanate. The Father dies in His creative explosion and is reborn along with the endless

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world. This is because God has to choose which possible (and later potential) world to actualize. But God is completely unprepared for choosing. He is pure act, but choice introduces a potency into God, thereby corrupting His nature and destroying Him. Thankfully, goodness remains to bring its 2nd level back to life. Not even the 2nd-level God is immune from the perennial theme of death and rebirth in a perfected state. In addition, it is plausible that redemption, associated with the Son, and sanctification, associated with the Holy Spirit, are also 3rd-level missions of God, unimagined by human beings. The reason is that God creates perfectly. Yet the world is manifestly imperfect, marked by actual sin. (The chief imperfection is not that we are bad but that we fail to improve at optimal speed.) This is sufficient grounds for God to reject and destroy it. Hence, the Son “redeems” the world (also by dying) in making it worthy of God’s graces. It is as if He sees Himself in us and feels compassion for us, saying: “There but for My divine nature go I.” At the same time, we can imagine a dialog between the persons of the Trinity something resembling the following. The Father says to the Son: “You don’t know how monstrous these people are. You say you love them? You say there is good in them? Go find out what they’ll do to you personally firsthand, and then if you come back and still say you love them, well then, the world is yours to judge as you see fit. I’ll accept them if you will; in that your redemptive mission will consist. But let’s see if being tortured, humiliated, and killed will not disabuse you of your misguided (in my opinion) affection for these creatures. I won’t bequeath you even this pitiful world without a trial.” The events triggered by the decision to redeem were, of course, foreknown by God. They were no less real for all that. The Son’s love for us was genuinely tested during the Incarnation; the fate of the world truly hanged in the balance. It is commonly understood that creation was a contingent event; God did not “have to” create. It is less commonly stressed that redemption was equally contingent. God the Son did not “have to” accept and bless the world in its past and present sorry state. Thus, on Christmas, we celebrate the fact that our Lord merited His inheritance the moment He was conceived; but we have to wait until Easter to find out whether or not He wanted it in the first place. He did, as it turned out; and joy, as it were, to the world. The Son is, indeed, reborn with all of humanity as His kingdom; unlike the Father, He is content to salvage everything that is good in the world. Essentially, the Son gives imperfect created rational beings the right to exist. He “forgives” (though does not sanction) suboptimal rate of improvement. It remains to make perfect what is imperfect, and that is the

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mission of the Holy Spirit who bridges the gap between man and God. In uplifting a man into deiformity, the Spirit, too, dies within him and is “born again,” as some religious folks phrase it. Indeed, saints are gods with small “g.” In short, the Father dies for the entire universe; the Son, for mankind; and the Spirit, for an individual human being. In the process, God’s nature is rebuilt and enhanced. As a result, I am now spiritually connected to the divine as a branch to a vine through which the Holy Spirit flows, nourishing me. As God breathes, so do I. But it was not always so, and, but for goodness, it might not have been. Creation adds something the 2nd-level God, or rather it shakes God out of the exclusive focus on Himself, i.e., on the relationships of the members of the Trinity with each other. From goodness, the Father obtains knowledge of (1) which possible world the actual world instantiates; (2) the extents to which each creature and the universe as a whole imitate or reflect Him or ought to; and (3) His providence, i.e., how the world is to be guided in its evolution or God’s interaction with it. The theological virtue of faith as an upgrade of the intellect is associated with the Father. Faith is simply knowing and being guided by the means to salvation or eternal happiness. A man has faith, if he has composed for himself a plan of entering heaven. In His turn, the Son obtains (1’) union and familial bond with humanity, as per the Incarnation; (2’) extra perfection from the additional duty done for the Father and from still more spectacular conformance to the divine principle; (3’) rulership over and authority to judge men. The virtue of hope or an upgrade of human powers is linked with the Son, insofar as man’s efforts, though they cannot forestall death, are shown to be not in vain. A good man does not become equal to an evil man and to zero in death. One does not disappear into nothingness. Life is not a cosmic abortion, and one will stand trial for his deeds. What we do in life echoes in eternity, etc. The Holy Spirit, finally, now (1’’) loves each individual and is no longer just the love between the Father and the Son; (2’’) gives gifts and sanctity to certain people in the form of grace, and (3’’) rejoices in understanding us and in watching us seek our goodness, virtue, and happiness and succeed. Charity, or an upgrade of the will, is engendered by the Spirit’s grace and enables men to love themselves so much as to seek glory and life everlasting, i.e., the eternal good and not just temporal ones. As an essential part of this transformation, one’s own will is interwoven with the wills of other human beings (through what has been called

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“gratuitous” grace) and God (through “sanctifying” grace). Friendship then changes the very natures of the friends, knitting their wills into one. The point of such a union is an enhanced experience of life: feeling, thinking, and acting more authentically, deeply, and powerfully. It is said, rightly, that friendship doubles our joy and divides our grief. For any human action, there exists a point of view – in fact, numerous points of view – from which that action appears insignificant and pointless and futile. But that is precisely the reason to tie one’s destiny to God. The meaning of life is to find happiness, and it involves transcending the limits of one’s non-ultimate ends into the last end. We first seek the particular limited goods for their own sake. Then, with religion and the theological virtues, we go up towards the universal good. For every man wants, even if he is not aware of it, everything. And only God has that and the fullness of His perfection to satisfy all human desires. But that good is unattainable in this life. So, having fixed our attention on that universal good, we go back into the world and continue seeking the limited goods but now for the sake of our last end. Our actions which seemed to be so trivial now attain overriding importance which is not shed in any perspective. No matter where one stands, he cannot help but respect such devotion and success. He cannot say: “That’s not for me” or “This guy is odd,” anymore. There is nothing odd about trying to reach God through any unique personal means. Hell is no longer other people, if those people are self-consciously seeking heaven. Asking “What sexual perversion are you into?” or “What’s your poison?” though seemingly unjudgmental, treats the other person as a freak, possibly contemptible, possibly disgusting, but definitely alien. But if the ultimate desire of both persons is the beatific vision, then the “poison” is merely a proximate means to that shared end. It can no longer be despised. Now personality or character may be called selective actualization of one’s powers and potentials. In becoming a good swimmer, one chooses to forgo becoming a good football player. In developing virtue A, one is neglecting partially virtue B. But all of God’s powers are fully developed. God does not specialize. For the God of monotheism, there is no division of labor, as in the Olympian pantheon. Moreover, all of those perfectly developed capacities are both at this very moment and in eternity being used to the max by God to achieve and maintain happiness. God can be described properly and fully then only as doing

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something, even as playing, and enjoying every “second” of it. (1) God is simple on the 1st level (and so is naturally impervious to any harm) but is composed of intellect, power, and will so separate as to form the three Persons, and is fully responsible for His actions and in maintaining His internal equilibrium on the 2nd. God has no definition on the 1st level but is perfectly defined on nd the 2 . God is free to be anything on the 1st level yet is 100% constricted by the relationships within the network of His infinite specified complexity on the 2nd. The self-control thereby manifested is a “negation” of freedom. God is objective on the 1st level, such that one cannot say that God is X from one point of view yet Y from another, but is pure subjectivity and unity of experience, feeling, and happiness on the 2nd. Lack of limitations on the 1st level allows God to go all the way in building Himself on the 2nd. (2) God is good, yet His creative acts begin with His death. He is omnipotent, creating the world out of nothing and in His likeness, yet a woman gives birth to God. God informs the world with natural laws and has full knowledge of every happening, yet the particular state of the world’s affairs at each moment conditions His providential actions. Lastly, that love is both unconditional and conditional means that a person is loved by God fully to the extent that he is lovable but also only to that extent. If God is able to save everyone, i.e., if salvation is universal, and hell is empty, we certainly do not know this for sure. These 3rd-level happenings are incredible and far too wonderful for us to comprehend. At the same time, though we cannot understand the 3rd grade of God, we can at least acknowledge it, judge it as the best thing in the world, and pay the proper respects. Why does God’s 3rd level or nature or goodness diffuse into creation? There are (1) physical causality (chance and necessity); (2) human teleology (voluntary actions which have reasons for them); and (3) God’s goodness which is the 3rd-grade mode of causation unique to God which will be discussed later, as indicated in Table I.28.1. Now the nature of physical necessity consists of three conditions. First, the effect does not occur before the cause. Second, A causes B by necessity in the case when if A failed to cause B, then it would instantly corrupt; its nature would be destroyed; it would be annihilated as an instance of its nature. It cannot afford not to cause B, if it cares to save its own skin. In short, B must follow A, lest there be fire-and-brimstone eternal damnation of the essence of the cause: the cause would

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commit a “sin,” and God does not forgive even a single sin to physical things: “You failed to follow the law, now you ‘die’.” At this point, we may see a problem, e.g., day always follows night, in fact, it must follow night, as per the natures of the sun, earth, space, etc., but surely, night does not cause day. So, we need to add a third condition which is that there is a transfer of energy between cause and effect, a kind of lowlevel love. The cause “gives of itself” to produce fruit, the effect. 1st grade physical causality necessity

2nd grade teleology self-interest

3rd grade grounding causation self-diffusion of goodness

TABLE I.28.1. CAUSALITY OF THE GRADES

God did not cause the world in this manner. He is eternal, meaning that He is all four of before, in-time during, after, and timelessly during the creation of the universe. If God had not created, then He would still be good, as per His essence. And some physicists even claim that the “total energy” of the universe – a somewhat obscure to me concept, I admit – is zero. In short, the first cause was under no necessity to create: nothing poked or prodded God to make the world. Similarly, there was nothing missing in God’s life that He needed the creation for His own petty desires. He was not lonely or bored or unfulfilled. Indeed, suppose that God was not completely happy and created because, for example, He wanted company. Then it would no longer be true that God “wills nothing except by reason of its goodness.” (ST, I, 19, 2, reply 3) He would have created because of the utility to Him of the creation which would be good as a means to the satisfaction of God’s “selfish” ends. In other words, there would be an evil in God which the creation would help remedy; and therefore, the creation would spring from something evil rather than from something good. God’s will is perfectly content for all three of metaphysical, moral, and physical goods. Yet here we are; and of us God is the first cause; so, there must be some other form of causation, for which “goodness” is the best moniker. The self-diffusion of this goodness is neither necessitated nor random nor voluntary. It was fitting for God to create, but we cannot assert more than that. Goodness can be of an effect or state of affairs or of a cause of this state of affairs. God on the 1st and 2nd levels is good, call this goodness G, but the combination of God plus the created world is very good, call it VG. The question is, how the superior or very good state arose

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from the inferior or merely good state, given especially that God did not have to create, meaning that His nature would remain intact, if He had failed to create; nor did He want to create, meaning that God would not in any way be distressed, if He had failed to create. It seems that G can be reduced to VG, if in addition to the G being and essence, God possessed the ability to improve this being into VG. But any capacity to improve something, especially the global state of affairs, is itself a wonderfully good thing, call this goodness 3G. Now rename 3G to shmoodness. Why reserve this term for selfdiffusion of 3rd-level goodness and not call the other two modes of causation good? There are two reasons. First, nature and men do not have to do good. Their actions need not have good consequences and often, in fact, do not, whereas God’s providence is presumably far superior in its ability to do good. Second, because physical causality and teleology, in making the world a better place, are motivated by the cause’s own needs: to persevere in one’s nature or to become happier. But God has no needs and acts solely so that good things may exist. The same effect can be brought about by any of the three kinds of causes. Thus, a brick may fall on Keynes’ head, surprisingly causing him to renounce his doctrine; or he may be dissuaded by reading the work of another economist; or God can subtly influence his thinking. Suppose, for example, that this book causes Keynesism to be annihilated as an economic school of thought and abandoned as an ideology. The state of affairs in which Keynesism is dead is superior to the state of affairs in which it is influential. But this better situation is brought about by teleological causation, because it makes me happier. Just as men are superior in nature to rocks, so God is superior to men; and as teleology is unique to rational beings, so shmoodness is unique to God. God on the 2nd level is perfect, and human beings as a whole, defined by their 2nd level, are pretty decent, resembling God to a certain degree. But God on the 3rd level or God as a whole is shmood, whereas human beings are not shmood at all, bearing no resemblance to God whatsoever. This is as solid a reason as any for holding that God is transcendent and totally other. For His essential mode of causation is rather unlike those with which we are most familiar in this world. Nevertheless, Mises is wrong in writing that “there are for man only two principles available for a mental grasp of reality, namely, those of teleology and causality. What cannot be brought under either of these categories is absolutely hidden to the human mind. An event not open to an interpretation by one of these two principles is for man inconceivable and mysterious. Change can be conceived as the outcome either of the

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operation of mechanistic causality or of purposeful behavior; for the human mind there is no third way available.” (1996: 25) He ignores the bigger picture. Just as if we do not admit self-interest, then we miss understanding people; so, by not admitting goodness, we miss judging God. God’s 2nd level is constituted by the power-reason-will Trinity. Here both God and man are of the same rank. A creature with at least 2 levels can be Godlike, angellike if you will, or humanlike. Everything else, including the amazing properties of God like omnipotence, eternity, immutability, separation of persons, infinite and perfect holiness, are accidents. They are not accidents in God, because God would not be God if any of His attributes were taken away, but they are accidents to the genus “rational being.” Men are not omnipotent or eternal, and God is, but both are rational. Now of course, St. Thomas denies that God is in any genus (ST, I, 3, 5), and he is right when it comes to the 1st level of God. His proofs are wonderful, but they confuse the levels. The intellectual virtues connect to the will as follows: (1) knowledge produces a kind of complacency upon learning everything there is to know about a thing and peace with possession of that knowledge; (2) understanding produces sympathy toward and affirmation of the subject understood; (3) wisdom produces love for or charity toward the thing judged and joy in the goodness of that thing. Understanding must not be confused with showing approval or disapproval which is evaluating-through-justice. Understanding is a profoundly human virtue. It alone makes brotherly love and communion possible. For him who understands, hell is no longer other people; those others are affirmed and strengthened in their individuality. When I understand, it is as if I am saying, “In your situation I might do the same.” When I understand, I and the person understood become ever so slightly more alike. And as St. Thomas writes, “Everything loves what is like it.” (ST, I, 20, 4) Understanding paired with love is an upgraded version of the Golden Rule. On the other hand, fraternal correction often begins by refusing to understand. An impartial “Why are you doing this?” is one of the most powerful questions one can ever ask of another human being.

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Summa Against the Keynesians 29. THAT GOD IS PERFECT ON EVERY LEVEL

Before we proceed, let me present an argument to the effect that God is intelligent, good, and simple and free, so that skeptics reading this book may have something to chew on. I begin by asking three questions. First, why does the world have the uniquely peculiar form that it does? E.g., why does it work the way it does? Second, why is there something rather than nothing? Third, what follows from the fact that the universe obeys laws as opposed to being chaotic? [1] This may be called the problem of particularity: why is the world this and not something else? The intuitive force of this query depends intimately on the idea that there cannot be such thing as an actual infinite of real objects. Real objects include both atoms and angels. Ideal objects expressed by thoughts cannot be said to exist; hence, abstracta can be infinite to the highest degree. We can contemplate countably infinite sets, the continuum, and still higher infinities with little trouble. The difference between (objective or mind-independent, let us assume) real and ideal things then is that a real thing is an ideal essence united with existence, i.e., an essence becoming actualized or created. But such creation would have to proceed sequentially, step by step. First, atom 1 is created; then angel 2; then human 3; etc. But an actual infinity cannot be accumulated in this manner which results merely in a potentially infinite set: it can grow indefinitely but always remains finite. That the actual world has the particular form or essence Fa is a contingent fact. We ask for an explanation why the proposition “the actual world is Fa,” which, being contingent, certainly need not be true, is in fact true. It will not do to argue that this world is just some sort of a brute fact. For in so doing one would be cutting himself off from possibilities. If I, a stinking bag of flesh with no fur, can contemplate possible worlds, then surely, there is a certain ghostly reality to them as abstract entities already. (Separated souls are imagined as ghosts for a good reason; just like abstracta, they are causally inefficacious at least in this world. Like, say, propositions, they cannot manipulate matter.) But there must be a reason why the possible are merely possible and remain in my mind (or wherever they are found in their most pristine form) and are non-actual, and the actual is not (horrors!) just a possibility I might one day entertain. But to explain something is to reduce it to a cause. For example, say, Smith throws a stone which breaks a window. This, too, is a contingent event. We explain why the window was broken by implicating Smith, his actions, the stone, etc. If there is determinism, then we can

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extend our explanation backward in time however far we want and can. We certainly do not explain why (T) “2 + 2 = 4” is true, because it is a necessary truth, if there ever was one, being part of every possible world. Insofar as possible worlds are imagined by human minds, the negation of (T) is impossible for both me and all other humans. Could there be a mind for which 2 and 2 equaled 5? For Mises, the ideas conceived by such a mind would be incomprehensible and irrelevant to us. “No knowledge from such spheres penetrates to the human mind.” (1996: 36) Even though there is a genuine distinction between what is conceivable and what is possible, for all practical purposes maybe that is enough. As we have shown, the explanation for Fa cannot be that all possible worlds exist, and we are simply in one of them. Therefore, the essence of the actual world had to be chosen. Now a choice can be made only either randomly or intelligently, as per the meaning of the word “choice.” A physical cause definitively results in a particular effect and is not capable of choosing the effect. Suppose random: Fa was randomly pulled out of an infinity of possible worlds. Let us associate each world with a number. We would imagine a mechanical random world generator (RWD) that is supposed to pick a random number from –∞ to +∞, (1) such that it is possible for it to pick every number and (2) given that the probability of choosing any given number is non-zero. There arise at this point three distinct problems with random choice. First, it is impossible fairly to consider for selection every member of an infinite set. I asked myself to pick a random number. My answer: 75 or 1/4 or π. Clearly, these numbers are those that are in use in daily life or at best, science. It certainly did not occur to me to choose x = googol^(googol^(...^googol)) 75 times. By how much greater than x is actual infinity! If I could not be fair here, then a fortiori, neither can a 1st-grade RNG machine (without actually infinite computational resources which we have disallowed). Therefore, (1) cannot be ensured. Second, an honest and fair RWG considers every possible world to be equiprobable. But for an infinitude of worlds, the probability of any to be picked is exactly – not close to; not almost; exactly – zero. Third, the RWG can solve the problem of choosing a world by picking an arbitrary world and using that as the solution. But each possible world is for an unintelligent chooser no better and no worse than any other one. The RWG is in the position of a Buridan’s ass. How does an impartial RWG pick even an arbitrary world? Now remember that all abstracta are convertible to each other. Thus, let us imagine a sequence of worlds, such that for all N, the Nth world has nothing but N elementary particles in it. This effectively

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“converts” possible worlds into numbers. Let world #1 be called 1E. The RWG can then say: “I will pick the world with the fewest non-zero number of particles in it.” This immediately narrows down the choice to 1E. But this is already an intelligent choice. The RWG would have to be programmed by an intelligent agent in order to be so clever, and to the extent that it is programmed, it is not random but deterministic. If not random, then intelligent. But would not even an intelligent being face similar problems? Yes, but it can avail itself of a trick. For an intelligent agent can choose according to a purpose. For example, it can choose the “best possible world” or a “world that permits life to exist” or “a world where there will be dinosaurs.” This purpose (or end) constrained the universe (or means) to a single thing or at least a finite set. We see that the world must have been purposively designed. But this entails choosing between possibilities and suggests an intelligence at work behind the scenes. We must conclude that God is smart. [2] Why is there something rather than nothing? At first glance, the question seems befuddling. Why should there be nothing rather than what we have around us? Why privilege either “nothing” or “something”? Why cannot this world be everything that has ever been and will be? On the one hand, we humans privilege nothing readily. We apparently come from nothing and go into nothing. In between we live for a little bit, always in danger, such that if we do not struggle with all our might, the nothing will arrive even quicker. All living things are born, thereby beginning to exist, and die, thereby ceasing to exist. But the inference from this human experience to the universe as a whole need not be taken. Moreover, “something” is also privileged. The moment we are born, we are surrounded with stuff to use, enjoy, and manipulate. Disembodied existence, while not inconceivable, is not part of our human experience. But “nothingness” is inconceivable; one can’t close his eyes and picture nothingness. However, that nothingness is inconceivable does not mean that it is impossible. Let possible world Empty be defined as follows: ∀(x I can think of) [x does not exist in Empty]. Then (1) Nothing = ∃[Empty]. We are dealing with “universes,” uni = “one”; so, any possible world is a maximally consistent state of affairs. As a result, Empty swallows up every other reality; so, it is not necessary to say “there exists only Empty.” Let our actual world be called Terra. “Terra” is the name of the

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universe we live in, not of planet Earth. As per the previous argument, let the form or essence of Terra be chosen. Then (2) Something = ∃[Terra]. Neither is privileged, but just as before, (2) is only contingently true and demands an explanation. We need to give the skeptic his best case. Is it possible that Terra has existed forever? According to classical theology at least, God is eternal, understood as “simultaneously-whole and perfect possession of interminable life.” What does that mean? Experience teaches that our lives are fragmented into four parts: the past, the present, the future, and timelessness, such as enjoyed by abstracta like “2 + 2 = 4.” Our past is gone, our future is not yet, timelessness is accessed only when we do math or philosophy (with propositions apparently outlasting our own lives), and our present is fleeting and evanescent. Far be it from God to suffer from so many imperfections. But He neither abolishes time nor keeps it unchanged but rather transcends and perfects it. For God those 4 time periods are folded up, unified as if in a package and present themselves as single eternal moment of boiling divine life. It cannot be doubted that such a life is superior in intensity, poignancy, and happiness it can generate to our human experience. In addition, it is another aspect of God’s simplicity (which we will prove in the next argument), His not being composed of real parts that are prior to God and interact according to natural laws that define God. The union of the “tenses” is “seamless” and cannot be analyzed or dissected like a frog. But if eternal existence is possible, then a fortiori, something much less amazing and spectacular that it, viz., everlasting existence, is possible, as well. God’s eternity subsumes merely everlasting existence, including time stretching back into the past infinitely. So then, if eternity as I have described it is how God lives, then everlasting time appears possible, too. God could be “co-eternal” or “co-everlasting” with the universe. It could immediately be objected that this undercuts our argument that there cannot be an infinite multitude of real things. For if we establish a one-to-one correspondence between hours passed up until now and existence-bestowing acts, such that an angel, say, is created every hour, then it would seem that there could be such an infinitude. Again, let a clock exist always along with the universe. How many revolutions of the hour hand have there been? The clear answer is, an actual infinite. An everlasting universe thusly conceived is an unintelligible notion. For example, if you start at –∞ (whatever that means exactly, since

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–∞ is not a date) and live for a million years, then you will still stay at – ∞ and certainly will never reach today. However, suppose that the universe was “frozen,” permitting no motion of anything up until 1/1/1970. Then the number of rotations of our clock’s hands is surely finite. Perhaps the prior infinitude of moments was somehow traversed in a single jump. In such a case, we can imagine an everlasting universe with a finite number of events or acts. Hence, this is something we are required to consider in this version of the cosmological argument. In addition, once Terra exists, I grant that it may be forever imperishable. First, there are no “predators” outside it that may kill it. Second, material objects, though they can in the course of their lives change from one form into another and even into energy, nevertheless seem imperishable. We might again say that they “follow the law” so faithfully that they are granted immortality. Not for them is the forbidden fruit; they fear disobedience so much as to persevere in being forever. In short, if the universe never began, has always been, then it has no physical cause prior to it. The second possibility, namely, that Terra had a beginning, also precludes a physical cause. For time, too, began along with Terra, and it is meaningless to ask what happened “before” Terra began. As a result, the cause of (2)’s being true, call it C2, is different from the cause of the broken window, CB, because both CB and its effect, the breaking of the window, are situated in time, with the cause preceding the effect. CB is a physical cause. Since we are interested in the origin of the universe, neither teleological nor Aristotelian causation is applicable, either. How then did C2 make (2) true? By joining Terra with existence, i.e., by creating Terra. As a result, (2)’s being true has a “cause,” and Terra’s existing has a “ground” of its existence. This ground is called God. We have already seen the causations of the first two grades: physical and teleological. An eternal grounding cause is the effecting of the 3rd grade, of goodness. Terra was united with its existence not at any moment in time but as a whole in eternity which “covers” merely everlasting existence.33 33

God then is not the Alpha because He was necessitated to create the universe; nor is He the Omega because creating the universe gave pleasure to God. On the contrary, it is humans who are moved by God. In being born, we or at least our souls are created as if by a physical cause, presumably God; and we are referred to our last end (such as “the sole contemplation of God seen in His essence”) to be realized after death as a teleological cause of our every

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This is only half the task. Now we ask: What is this God? It cannot be another real thing, for then it, too, would stand in need of its own ground. It must then be “beyond” being. We conclude that God is not a thing at all but a kind of force, a primal principle that permeates all, that creates this world, so that its inhabitants might enjoy life or try to. That is what we mean when we say “God.” God is not a thing but Creator of things. We may call it by the less ambitious and less potentially objectionable name, “creativity,” or by the more ambitious one, “goodness,” to the extent that one is inclined to consider Terra to be on the whole good and beautiful.34 But nothing is not a thing, either. So, in the beginning (of our story), we postulate nothing whatsoever (including the 2nd-level God). It is a kind of clean slate, in which whatever is created (by goodness) can be made into a top-notch project or performance from ground up, with no need for backward compatibility. Again, if goodness reigned, then in the beginning, there could not be anything, because only goodness creates good things, and nothing can exist whose existence goodness has not authorized. The choice goodness faced was: “absolutely” nothing, as in no intelligence and no abstracta including possible worlds, 2nd-level God + Empty, or God + Terra. To simplify: our options are: (a) goodness + nothing in the beginning and (b) a good thing, i.e., God or God + the world, in the beginning. Goodness implies “nothing,” and “nothing” implies goodness; and now we see that their combination, i.e., (a), is also implied. Further, in order to join essence, such as Terra, with existence, especially from nothing, an agent, such as our goodness, needs power, since to make anything exist requires power. The previous argument establishes that God has an intellect. And that God has a will was proven earlier, when we said that the Father so loved the universe that He died for its sake.35 action. 34

Remember that there are only two attempted freestanding proofs of the non-existence of God, as opposed to mere hit-or-miss objections to proofs of His existence. First, one we are dealing with here, namely that everything can be reduced to either physical causality or teleology; and therefore, God has no place in the structure of reality. Second, the existence of evil in the world and pessimism. 35 I am certainly familiar with the barbaric hypothesis by the physicist Victor J. Stenger to the effect that “nothing” is “unstable” and spontaneously decays into something. Unfortunately, “instability” is a mere property and as such, must be attached to a real object. An empty universe, by definition, contains nothing, including space, so there is nothing of which instability might be

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[3] Why law and not prime matter style chaos? This is an intuitive argument to the effect that at the beginning of every human project, there are raw materials and human labor that transforms them into something useful, virtuous, or pleasant. Similarly, it stands to reason that in the beginning of the universe, there was chaos which was later on ordered. The pure potency of prime matter is an ideal building block, because one is not constrained by any pre-existing form in shaping prime matter into whatever he desires. It grants absolute freedom to the maker to fashion out of such matter anything he likes. Why does matter obey laws? From [2], we know that the universe was created out of nothing. What informed the universe with laws? If object A gave the law to matter, then if A itself is law-bound, then the problem remains. What ordered A, we are liable to ask? We cannot go to infinity; hence, the ultimate first cause of the order of the universe itself obeys no laws at all. But there are only two sorts of things that obey no laws at all: one is pure chaos, and the other is absolutely simple; pure potency and pure act. But the chaos of the former does not generate order. We must acknowledge this simple thing that is free to such a perfect degree to be the cause of order of the universe and to be God. These are just a few ways of elucidating the meaning of the term “God” and showing that there exists something with these attributes. There are numerous other proofs of God’s existence. God deserves the appellation “supernatural,” because in Him the perfection of each level is realized. To recap, the perfection of the 1st level lies in God’s simplicity or lack of composition and in freedom. Freedom means absence of constraints imposed on one by anything other than one’s own nature. In particular, God is unified and integrated so tightly that He is a seamless simple being, whose existence is His essence. God is “being itself subsisting”; His essence is not activated by existence but is being itself. This means that God’s nature can in no wise be pried away or disentangled from His existence, and therefore, God is incapable of corrupting or dying. We might say that God’s absolute freedom is paired with His perfect responsibility. As a result, God is not a conjunction of some piece A and piece B united and interacting according to natural laws that are prior to God and which God obeys. St. Thomas puts it this way: “there is neither composition of quantitative parts in God, since He is not a body; nor composition of matter and form; nor does His nature differ from His ‘suppositum’; nor His essence from His existence; neither is there in Him composition of genus and difference, nor of subject and accident. predicated.

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Therefore, it is clear that God is nowise composite, but is altogether simple.” (ST, I, 3, 7) God is constrained by or owes his existence to no pre-existing conditions. Any non-divine object, such as a billiard ball or a human being, is unfree for two reasons. First, because it is constrained by things other than its nature; second, because in any case, it is still constrained, if only by its nature. Note here an ambiguity: I say that the a thing is not free, because it has an identity: it is something that cannot become everything else. But it seems that prime matter has precisely this sort of freedom, as the building blocks of all things. Am I following “David of Dinant, who most absurdly taught that God was prime matter”? (ST, I, 3, 8) In a manner of speaking; paradoxes usually vanish, when they are rightly understood. Recall that on the 1st level, we discuss what God is not, and it seems that God is like nothing created. But prime matter, too, is just barely above nothing: it is pure potentiality. Now prime matter consists (ideally, because it is an abstraction) of a vast number of completely inert point particles. Each particle has no internal structure and, therefore, is (a) pure act. It is, indeed, whatever it does; it is just that it does not do anything. Its act is of no interest; it is “purely” zero. But together the blob of particles is (b) pure potentiality, because one can build anything out of them. What is split in prime matter between one and many is united in God. Thus, God is (b’) pure potentiality, insofar as He could eternally self-actualize into anything at all; God could have “become” a rock, a horse, a man; though He thankfully chose to become God, a perfect being on the 2nd level. At the same time, God is (a’) pure act, insofar as He is most fully alive and happy; His act, the experience of being God, is infinitely wonderful. In short, God and prime matter differ from each other not by what they are not but by what they are, though even here we might say that God is absolutely free to act; and prime matter is absolutely free to be acted on. The perfection of the 2nd level lies (1) in Trinitarian completeness of God, (2) in His nobility and excellence, and (3) in happiness. Be careful not to confuse (1st-level) freedom with (2nd-level) power. Some political philosophers make a distinction between the positive and negative senses of liberty. Yet there is actually no such thing as “positive sense of liberty.” Freedom is defined aptly as “a : the absence of necessity, coercion, or constraint in choice or action; b : liberation from slavery or restraint or from the power of another.” “Positive

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sense of liberty” is not liberty at all; it is power: to act, to accomplish goals. Freedom is the ability to choose between A, B, or C, i.e., being presented with alternatives and having permission to pick one of them. Power is the ability to bring about good consequences as a result of making a particular choice. For example, a contestant on a game show is free to choose between doors number 1, 2, or 3. But he is powerless to ensure that his choice will be of that door behind which there is a prize. On the other hand, most of the time, an individual is not free to violate other people’s natural rights. Individual freedom is not never having to say you are sorry or being unconstrained by metaphysical duties to fellow men which preclude many course of action at the outset. Smith has the power to kill Jones, but duty demands that he abstain. The foregoing is precisely the difference between the ability and the right to do what one wishes. One can have the right to do something but not the ability, or the ability but not the right. A person who is free from interference by other human beings may be severely limited as to what he can do. Thus, a slave owner may by law and custom have a (supposed) right to use his slaves in any way he wishes (e.g., for backbreaking labor, for sex, as gladiators; he has no duties toward them whatsoever), but he lacks the power to use them contrary to their nature. For example, he is limited by the essence of the institution of slavery in how productive the slave labor will be. In fact, society will only become richer, if slavery is abolished. Conversely, a slave who accepts his condition as legitimate and is ever at his master’s beck and call can have considerable power and discretion to act as, say, the overseer of other slaves. Smith can trespass on Jones’ property, but it is illegal for him to do so; Brown is invited by Jones to come to his house, but he is out of town and cannot honor the request; or he is paralyzed and cannot walk; and so forth. Again, Crusoe alone on his island is free but relatively powerless; a man living in a modern society is constricted on every side by other people’s private properties, but his power to satisfy himself is immeasurably greater. The perfection of the 3rd level is in self-diffusion of goodness and in world without end. 30. THAT WHAT LINK PAST, PRESENT, AND FUTURE ARE HUMAN PLANS

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Keynes writes that “it is by reason of the existence of durable equipment that the economic future is linked to the present. … therefore… the expectation of the future should affect the present through the demand price for durable equipment.” (2008: 147) He means by this that a durable capital good yields or at least is expected to yield productive services over time. The cost of such a good takes into account its projected annual (or monthly or whatever) “efficiency” together with a discount factor that constitutes time preference. The past, present, and future are linked with each other in several ways. [I] A capitalist durable, indeed, persists from one round of production to another, but only together with the durable human capital and the durable plans for both. Capital is mind-dependent or subjectivereal; it comprises goods that some individuals consider in some way useful for the furtherance of their plans. A good, no matter how durable, can cease to be capital, if it is not participating in anyone’s plan of action. A rock 1,000 feet under the ground may be said contingently to persist through time and therefore, be durable. But it is surely not a piece of “equipment,” nor does it bind together time. The only reason to produce a durable capital good is in hopes of using it in numerous rounds of production or renting it out to other people who would do just that. Mereology is the formal theory and study of part-whole relationships. I submit that there exist three types of concrete objects: natural objects, human mind-dependent objects, and objects that are neither. A natural object is one that obeys a more-or-less tight and neat set of natural laws, one that can be profitably studied, one whose behavior can be understood and even predicted. Call these properties, if you will, an “objective” or real essence or identity, a natural kind. Thus, a water molecule, an eye, a human being are natural objects. They are natural despite their complexity and because of their unity: they act as one. The objective essence is synthesized from a thing’s material and efficient causes. Nature has “joints,” at which we can carve it up. Mind-dependent real objects are non-natural objects that we construct in our minds, because doing so is of some utility to us. Thus, a house is a mind-dependent object. Without humans, houses would lose their purpose and be pointless and quite arbitrary heaps of bricks and furniture (things that incidentally would also become purposeless) and whatever else. Let such objects be thought of as having “subjective” or nominal essences or artificial kinds. This is just a figure of speech: only real things exist, and only objective things have true essences. A subjective essence is assembled from a thing’s final cause. For artificial kinds, the formal and final causes are closer to each other than for natural kinds. Even if fishes as a species exist in some

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ultimate sense for the sake of humans; even if we define “fish” as “food for humans, when properly prepared and demanded”; a fish is still a fish, a distinct biological organism. But a particular house formally can only be defined as “a shelter for human beings, if any such exist and desire shelter,” and finally is for the sake of sheltering its owner, Smith. Both causes are inseparable from the effect’s value to men. Consider, finally, an “object” consisting of (my nose + the Eiffel tower) or (this proton from this oxygen atom + that electron from a nearby uranium atom). What possibly unifies these things into a single whole? It would seem that nothing does. Their natural parts surely obey the right laws; and their mind-dependent parts are useful for humans to recognize; but the combinations, the wholes are neither. Their behavior is erratic, so they are non-natural; and no human being would seem to have any need to treat the “wholes” as separate things-in-themselves. To the extent that economics, as part of its focus on human action, deals with objects used in action, it considers those objects’ subjective essences and final causes, to use these terms as synonyms. Unless there was a reason to make X, it would not have been produced in the first place. X exists in part because it is finally caused. But which subjective essence will be attached to a thing depends upon that thing’s role in someone’s plan. It is plain also that numerically one and the same thing – let alone qualitatively the same but numerically distinct things – may have numerous different subjective essences, and that this is precisely the meaning of market competition, wherein different entrepreneurs are of different minds on the best use of any object. Which final cause matters depends on who is willing to pay for X the most money. Thus, the durability of machines is complemented with the durability of human skills and human plans. A capitalist durable can be devalued or become worthless, if any of the following three events happen: (a) it breaks; (b) no worker who can operate the machine can be found (or more generally, its complementary factors of production are missing); or (c) at least one entrepreneur no longer finds it profitable to employ the machine in the upcoming rounds of production. [II] Then there is the plan of production within a single round. An entrepreneurial plan incorporates a commitment to a definite production project. It, too, unifies different time periods. Plans as such are timeless; a plan is an idea of a unified series of actions aimed at the attainment of a particular end. Plans abstract away time. In computer science, there exists the notion of “transactions.” A transaction is defined as an atomic, consistent, isolated, and durable – ACID – algorithm. In other words, a transaction either completes (durably or permanently) in its entirety or has no effect at all. For example, a two-

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step program that withdraws money from one bank account and deposits it into another must be transactional. For what happens, if the money is withdrawn successfully, but there is an error with depositing it? Unless the entire transaction is “rolled back” to the previous state and wholly annulled, the integrity of the data is compromised. Similarly, an ideal plan is a transaction in the sense that it either completes 100% as an atomic command, isolated from the effects of other transactions, or nothing whatever happens, and no resources are wasted. It is true that a plan may specify time periods, e.g., that the product is to dry for so long. But it does not matter whether this period is 20 minutes or 2 years. The ideal plan cannot be ruined, or if it is ruined, then the whole state of affairs is rolled back, and the situation is as if the plan was rejected at the beginning. Of course, in real life, there are no ideal plans; an entrepreneurial error is almost always costly. Payments to original factors cannot be recovered, and neither can depreciation of capital goods and time lost. A project is pursued according to its timeless plan. The goods used in the plan are inherited from past production endeavors or from nature. The purpose of a plan is monetary profit in the future. The momentary present actions consist in guiding production, such that labor in space over time with the help of (durable) machines transforms (non-durable) raw materials into consumer goods and consumer happiness. Note that the distinction between machines and raw materials within a production round is speculative, pertaining to the folk (in this case) difference between “agent” and “patient,” that which acts and that which is acted upon, and is of no praxeological significance. We will deal with the structure of production in (I, 48-52). [III] Finally, there is the human personal identity. An important link between the past, present, and future is human beings themselves. For we are in a real sense 4-dimensional. The past haunts us, and our past deeds either console us with the possibility of glory or make us cringe, if they dishonored us. We are enthusiastic about the future, anticipate its pleasures with gusto, and nurture our dreams. And we are excited about the fight to satisfy our desires taking place right now, in each moment. Note that I am willing to countenance 4D human beings but not 1st-grade merely physical objects, for the following reasons. (1) A 3D enduring object is wholly present to us. But a 4D object that is extended also in the temporal dimension is not wholly present; only its time-slice right now is present to us. Its other temporal parts are nowhere to be seen. Hence, it entails a controversial claim that presentism – the claim that only present objects exist – is false.

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Following Markosian (2004), we can identify two senses of presentism: trivial and non-trivial. On the one hand, “only present things exist” is trivially true, insofar as it is incorrect English to say that Socrates or tomorrow’s daylight “exists”; rather, Socrates “existed,” and tomorrow “will exist.” “Socrates exists” is not the case due to the rules of the language. On the other hand, the task is to figure out whether when one says ∀(x) [P(x)], x can be in the past (or future). Should we test P(Socrates)? Is our philosopher “out there” somewhere; can we still point him out? Now as a matter of fact, I do think that non-trivial presentism is false; but 4-dimensionists are committed also to the falsity of trivial presentism. They think that the past of any material object is part of this object’s inner essence right now. And this seems untenable. See (Appendix, 4) for more. (2) A related problem is a practical one. What can we do with a 4D thing? Its past is gone; its future is still to come; all we have is its present temporal slice. Of what use is postulating inaccessible to any human action parts? (3) A 3D object can stay the same; it may be able to endure. But a 4D object does not actually perdure and stay the same; it grows with the passage of time. Friends of temporal parts say things like “a statue exists from 10:00 until 11:00” (rather than at 10:00 and at 11:00). But a statue considered at 10:30 does not exist at 11:00. It keeps accumulating part after part every second. What causes this growth? How is the ticking of a clock able to alter an innocent object so drastically? In other words, a 4D object perdures only in its spatial aspect; as time goes on, it changes. How counterintuitive is that? A 3D theorist can, on the contrary, say, that the same object X has been persisting in being from 10 to 11 o’clock without having to make the strange claim that X has grown from an embryo into a fully actualized 4D worm just by sitting there and devouring time. A man’s personal identity encompasses his entire life. To leave the matter at that, however, would be incomplete. I ask further: what helps to make our identity? It is not our actions alone, for they persist only for a moment and seemingly disappear. Rather, it is our pursuit of virtue and happiness. In posing to himself a moral ideal, a man denies himself as he is now and lives in the future, hoping to enjoy himself someday only as a new person. In seeking to conform to an ideal, he looks into the past and repeats with steely determination what he has been doing despite temptations to give in to promises of pleasure, creating first, a routine, second, a lifestyle, and finally, habits and character. In seeking happiness, man integrates a timeless plan with

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actions in the here and now. He plans prudently and executes the plan with courage, panache, and elegance. Together this dual search unifies past, present, future, and timelessness into a coherent life story, perhaps even an interesting one. A society in which there were no capitalist durables would be exceedingly primitive; and a society in which there could not for some reason be capitalist durables would have its economic problem – obtaining the most consumer goods and ultimately pleasure by exerting the least amount of effort – much simplified. Even then, however, the past, present, and future would be linked via the nature of man. 31. THAT THE WILL AND THE FREE-WILL ARE SELFSAME POWERS BUT HAVE DIFFERENT CONNOTATIONS

The following disquisition on the will is important, because it will enable us to connect the notions of love and goods in a comprehensive manner. We will not be stupefied by philosophical subtleties concerning a wide variety of kinds of goods. For example, in an article entitled “Goodness and Choice” (2002: 132-147), Philippa Foot stuns us with countless examples of how the word “good” is used. Unbeknownst to her, all of these uses come under one of three categories which I will examine shortly. In addition, by the end of (I, 33) we will be in a better position to get a handle on uncertainty. Humans are distinguished from non-human animals by having a will. The will is the “intellectual appetite,” as contrasted with the sensitive appetite. It is appetite, because the will wants something. Its acts are desire and love; it seeks satisfaction or happiness or contentment or rest; its ultimate end is peace and joy. It is intellectual, because it is the intellect (rather than the senses) that presents a thing to the will, the thing is judged as more or less conducive to happiness, and it is thereby loved to the extent that it brings happiness. The distinction between delight or pleasure of the senses and joy of the will is entirely reasonable. The difference is two-fold. First, the former comes through the five senses of the body: touch, taste, smell, sight, and sound. The latter comes about through the exercise of the intellect or mind. Second, there is a phenomenological difference in the kind and quality of experience of these two kinds of pleasures. The experience of eating a candy bar and enjoying its sweetness is different from the experience of being honored or solving a difficult problem. For no one really rejoices from eating a candy; on the other hand, though one’s soul

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is elated at being honored by a community or one’s peers, the senses are silent. Another example: let Smith resolve to follow a diet. Yet on one occasion he overeats. Here Smith’s delight produced by the sense of taste co-exists with intellectual sorrow of realizing that he has sabotaged his own project. Smith is upset even though he genuinely enjoyed the food. Calculation of profits and losses can occur despite the fact that there are in man two appetites. For sensual pleasures are fed into the will which then tallies up the pleasures and pains, whatever their source. Mises agrees: Acting man also rationalizes the satisfaction of his sexual appetites. Their satisfaction is the outcome of a weighing of pros and cons. Man does not blindly submit to a sexual stimulation like a bull; he refrains from copulation if he deems the costs – the anticipated disadvantages – too high. (1996: 668) The will begins to desire upon being immersed into the external world. Upon encountering an object in one’s environment, one will naturally come to want the services rendered by that object and seek, through action, to use it or to transform it into an object more suitable for consumption. In the final analysis, the will loves, because it is like a lock, and the things loved are keys to that lock. From the earliest childhood, one is exposed to thousands of these keys; and one’s personality is such that some will fit, and others will not. In adulthood, the keys that fit become ever fewer yet ever more sophisticated. The following considerations suggest that this definition of will is adequate. Economics is essentially an extended study of man’s prudence and courage, as argued in (I, 12-13). But [I] Mises got it wrong in saying that what differentiates man from lower animals is man’s ability to act. Of course, all animals act, if by that we mean that they control their bodies. Therefore, “human action” should be distinguished from execution of the next step of one’s plan. An “action” that only humans can undertake is a trinity. [II] Robert Nozick asks what makes something a person. He says that it is “being an I,” a self. Unfortunately, “being an I” is hardly illuminating. Does it mean self-awareness? But animals, too, especially higher apes, can apparently recognize themselves, say, in a mirror. They must have a sense, however attenuated, of their identity. For Nozick, persons are, in particular, “value-seeking selves.” Let me be charitable to our author and interpret him as saying that personality involves

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seeking happiness (“values”). But that is true not just of humans but of all animals, indeed, of all life. All animals, too, seek their version of happiness. In following the sun, even the sunflower fulfills its needs. “However,” Nozick continues, “does not the different game of ‘pursue and kill the value-seeking I’ treat another as a value-seeking I? If he weren’t a value-seeking I, you would not pursue him; doesn’t your behavior therefore respond to his having this characteristic?” (1981: 464) Here Nozick is brushing against the idea of presence first introduced in (I, 25). One can, I suppose, react to the presence of another human being by wanting to pursue and kill him. This already differentiates him to an extent from everything else. Imagine that Smith is hunting another person, Jones, for sport, rather like in the movie Surviving the Game (New Line Productions, 1994), and that despite the fact that Jones is his prey, he is also dangerous to Smith. This is a contest of wills, cunning, ability to deceive and see through deception, strength, endurance, and the like. But surely, while humans can take this contest to a new level, many animals exhibit the foregoing qualities, as well. Animals, too, are cunning and swift and ruthless in both hunting and defending themselves and their young against being killed and eaten. [III] Now it is possible to have intellectual virtues without moral virtues but not vice versa. One needs some amount of knowledge to be prudent and some amount of understanding to be just. Therefore, the difference between plants and animals is that plants have no intellect and therefore, no virtues at all; their only appetite is “unconscious”; they have the nutritive or vegetative soul only. The difference between man and animals is three-fold. First, men have two appetites, the senses and the will; animals only have one, the sensitive appetite. Second, men have wisdom, and animals do not. These two are differences in kind. Third, animals, too, have knowledge and understanding in a manner of speaking: e.g., a cheetah knows how to hunt and understands the needs of her cubs. But those faculties are so primitive and undeveloped as to be essentially stubs filled to their tiny capacities entirely by “instinct.” Man has in addition to the moral or practical virtues (which in themselves and in their use make up the active life) also the conscious intellectual or speculative virtues (which make up the contemplative life). This difference is technically in degree, but the degree is so great that we might as well think of it as a difference in kind, as well. Thus, without the intellectual virtues, humans are merely very shrewd apes and therefore, do not qualify for any special treatment as demanded by the Nozickean version of ethics. Note that this puts our

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author (and me) in a somewhat peculiar situation of having to say that metaphysical consideration and behavior are due to creatures with intellectual virtues (i.e., knowledge, understanding, and wisdom) rather than moral virtues (such as, indeed, prudence and courage). Perhaps, (1) the four moral virtues are in us from the animal part of our nature; (2) the three intellectual virtues are in us from the angelic part of our nature; and (3) the three theological virtues are in us from our nature made deiform. (2) differs from (3) in that one improves intellectually gradually yet obtains faith, hope, and charity in one fell swoop. Moreover, desires of the will – unlike those of the senses – are unlimited, such that perhaps only the infinite God could fully sate them, and require for their satisfaction highly elaborate plans which, though made by prudence, make full use of all the capacities of the speculative intellect. The situation of economics is, therefore, curious. For in studying prudence and courage, it admits that prudent men use all the findings of natural sciences, biology and therapeutics, psychology, and economics itself in forming plans of action; in other words, a prudent community uses economics to enhance its prudence. Aristotle distinguished between lives of power, intellect, and senses (“the ‘political,’ the philosophic, and the voluptuary’s” (1216a25)). He means that the will can experience joy via active life, contemplative life, and sensual pleasures. For example, at times, the pleasures of the senses can overflow into the will, creating joy. A man who was sick and bed-ridden for a long time, upon hitting a critical stage in his recovery, ventures outside and rejoices from the feeling of power over his body. One may find joy in bending the world to his will. Another source of joy is intellectual contemplation, such as of truth or beauty (as well as discovery of truth and creation of beauty). The fourth way of feeling joy is vicariously by means of loving communion between friends. The exercise of speculative virtues is then both an input to prudence and direct cause of happiness; in other words, science is both an enabler of technology and a good in itself. A sophisticated computer game, a marvel of human ingenuity and storytelling, is available on the market at a low price and pleases the senses; mastery of computer science is far less easily obtainable but may please the will. In terms of possible (1) power over nature, (2) intellectual achievement, and (3) joy, for man the sky is the limit, something which is not true with regard to sensual pleasures. Quite a few economists, like Marshall, Mises, and Hazlitt, recognized that the sensual desires are under the control of the will: man decides rationally which sensual pleasures he will pursue and which he will abstain from. They also felt that

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there is in most people something akin to the Maslow’s hierarchy of needs, however arbitrary Maslow’s own hierarchy is. E.g.: “the conditions that surround extreme poverty… tend to deaden the higher faculties. Those who have been called the Residuum of our large towns have little opportunity for friendship; they know nothing of the decencies and the quiet, and very little even of the unity of family life; and religion often fails to reach them.” (Marshall 1964: 2) “Modern wealth expresses itself above all in the cult of the body: hygiene, cleanliness, sport.” (Mises 1985: 190) “The foremost social means of making man more human is to fight poverty. Wisdom and science and the arts thrive better in a world of affluence than among needy peoples.” (Mises 1996: 155) “A man can be neither a saint, nor a lover, nor a poet, unless he has comparatively recently had something to eat.” (Philip Wicksteed, quoted in Hazlitt 1998: 37) The virtue of temperance, in particular, is a kind of liaison, a middleman arbitrating between the delights of the senses and the joys of the will. It moderates animalistic sensual pleasures, so as to not cause any harm to conscious purposive plans of the will. Of the vices opposed to temperance, two are of note, both occurring when it is not the senses that are controlled by the will but the reverse: the will is a slave to the senses. The will can be such a slave involuntarily or voluntarily. In the first case, a man constantly gives in to passions which ultimately harm him either in happiness or holiness, yet always regrets this giving in. This vice is called “incontinence.” The man is always tempted with pleasures or avoidance of pain and “cannot help himself.” Though he understands that he is so impulsive and easily dominated by lust or rage and resolves to moderate his passions again and again, he often fails. He knows overeating is bad for health but cannot resist delicious food. Etc. In the second case, the man has consciously and deliberately chosen to pursue only sensual pleasures. He decided to order his life in such a way that he does not care for work or achievement or other people or wisdom but has lowered himself to the rank of animals, purposively seeking nothing but sensual gratifications: food, alcohol, drugs, sex, games, the pleasures of anger and vengeance, and so on. This vice is called “intemperance” and is much worse than incontinence, because the will has consented to being degraded like this. A third vice has the name of “insensitivity,” wherein the senses are so weak that it is not worth for the will to govern them. An insensitive man does not even attend to the necessities of life like food and sleep and so forth; he is like an inanimate object, passionless, not caring

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for pleasures. He is not interested in sex. He never gets angry, even when anger is perfectly justified, e.g., if he has been cheated. This is also inhuman and bad. Free-will, in contrast with the will, is the power of choice. If one desires x, then that which desires is the will; but that which chooses (the pursuit of) x, while setting aside y and z, is the free will. But both will and free will are the same faculty. Free-will adds two differentiae to the will: first, the fact that not all desires can be satisfied, and therefore, desires have to be ranked according to urgency or subjective importance; second, the fact that no single state of the trinity within – i.e., ends chosen, knowledge of how to attain those ends, and the powers to make one’s dreams come true – is essential to man. Any material entity, if it stopped obeying its own natural laws, would cease to be what it was. It would instantly corrupt, and some new substance would be generated. It is true that the will seeks happiness by necessity, but a man is able to pursue happiness in a wide variety of ways: no particular manner of this pursuit is essential to him. A man can switch from pursuing x to pursuing y and remain a man, what he is. It may be objected that a rock, too, can travel in this direction or that one; at this speed or that one; and remain a rock. Now the intellect regards choices. Suppose (contrary to fact) that a planet could say to itself: “The sun disrespects me; I keep rotating, with nothing fun happening. Should I move to a different solar system?” Even if the planet could consider these possibilities, it would have no permission from nature or God to escape its programming and choose to move. It would always (“voluntarily”) choose the same way, namely, to stay with the old sun. (Planets are decent people this way.) But a human being can say: “The boss disrespects me. I keep evenly rotating: get up in the morning, go to work, go home, sleep, get up… It’s just no fun. I’m getting into business for myself.” And actually choose it or do it. The first difference then regards the fact of the will’s weighing the options delivered to it by the intellect. The second difference emphasizes that no particular outcome of the weighing is required in order to preserve the essence of the chooser. Since animals do not have a will, they do not have a free will, either. But they feel sensual pleasure and have a rudimentary intellect. Hence, animals have “free sensuality.” A cat may need to decide between caviar and a Strasburg pie placed next to each other, and insofar as it chooses one and sets aside the other, the cat’s appetite is free. Just as in previous chapters I introduced the notion of negative theology, so there is such a thing as negative anthropology. I ask: Is man

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a body? Is the soul material? Note again the subtlety that I am inviting a materialist to agree with me that the words “body” and “soul” mean different things; but the materialist is welcome to disagree with me on whether they refer to different things, as well. To answer this question, we need to know what matter is. I already suggested the answer in (I, 25-26): matter is anything that is necessitated to behave in a precise way in any given interaction under threat of instant corruption upon disobedience. But a human being does as he pleases. For example, I trust it will be agreed that the Constitution of the United States allows everybody the free choice between cheesecake and strudel. As a result, one will go neither to hell nor to prison if he chooses either. Since body and soul have different properties, they cannot be identical with each other (as per indiscernibility of identicals, the less controversial part of Leibniz’s law), and therefore, whatever the soul is, it is not material, is not a body. Human desires are circumscribed by human nature, but my analogy of how desires originate is, to repeat, that some external objects (perceived by sensation) or thoughts and states of mind (perceived by reflection) fit the individual’s unique heart well, and others do not. The reason why desires are unpredictable is that we often do not know which keys fit which locks, even in the case of ourselves. But there is nothing random about emergence of desires. It is true that men are partly undetermined; they are mutable: for good, for evil, for different goods. But the actualization of such indetermination is not a random happening, as though Smith would be indifferent between choosing or just as likely to choose a or b, or b would be picked randomly, or his becoming a good person as vs. a bad person is a random and uncaused event. The soul is fitted the object, and if the object fits, then the soul desires it or rejoices in it. This act of fitting depends fully upon the configuration of the soul and the object whose goodness is being analyzed. The value of freedom is not, obviously, the variety of good and evil; it is the variety of good things. To each, as it were, his own. If the world, whether of the 1st or 2nd grade, is determinate (with true randomness, as you may recall, being in fact the mechanism through which the first cause nudges the world in the direction of its choosing), then to what extent is it predictable? Can God foresee the future and in what manner? First off, God by His essence is not a giant computer, laboriously crunching numbers in order to resolve present causes into future effects. It can be proven that God is eternal, which means that He enjoys His life all at once: the infinitudes of past, present, future, and timelessness coalesce into a single Now that pierces the heart. For example, it would be mistaken to describe God as “timeless”: “2 + 2 = 4” and other

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abstract trash including what Plantinga calls “the whole Platonic pantheon of universals, properties, kinds, propositions, numbers, sets, states of affairs, and possible worlds” are timeless; God’s eternity is taking up unto itself and uniting all four time periods. Therefore, our future is present to God. How this works exactly is a mystery, because we have no way of experiencing God’s way of being. But the conclusion is inevitable: God knows the future, because He already sees it in its full actuality. If deism were true, such that God exercised no providence over the created world and was unavailable, then the story would end there. However, the very existence of true randomness makes deism difficult to take seriously, because God would be seriously neglectful of His duty if He allowed random events to happen as they pleased. God continues to interact and tinker with the world – not because the world is flawed, but because the works of divine art non-coercively put the finishing touches on the works of nature, both material and spiritual – and can be called upon by any creature. As a result, if God is deciding whether to bestow grace on Smith, then He needs to compare the possible world in which He does bestow the grace with the possible world in which He does not bestow it. In order to find out which world is more desirable, God does need to have stupendous powers of foresight. We can illuminate God’s modus operandi by making a note of a distinction between simple and complex counterfactuals. Consider David Lewis’ example: “If kangaroos had no tails, they’d topple over.” Which seems true and I think, is. Kripke, if his politics is sensible, may be right, too: “If Nixon had only given a sufficient bribe to Senator X, he would have gotten Carswell through.” There is an objection. Which person is Nixon in the possible world in which someone gives the bribe? According to Lewis, there is no identical Nixon, only his “counterparts” more or less resembling him. Imagine a scientific experiment. A scientist has a well-understood cause and effect process. He wants to learn something new. He alters a single thing in the process, re-runs it, and observes the results. The key is the ability to change a single variable while keeping everything else constant. If one is writing a computer program which is misbehaving, then the proper thing to do, in addition to logically analyzing it, is to change it once, run it again, and see if the bug recurs. I once read somewhere the trick to writing science fiction: you change a single feature of the actual world and spin out the consequences in a fantastic tale. We should be seeing the point. The possible Nixon is the actual

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Nixon with a single change made to him, namely, he gives the bribe. Under these conditions, we can surmise what “would have” or “might have” happened. But let us continue the story. Nixon gives the bribe and then what? Does Watergate still happen? I have no idea. No man does. Changes accumulate too quickly. The new Nixon is now unlike the actual one and, as time goes on, is becoming increasingly more so. Moreover, the possible Nixons are completely untested; hence, they proliferate. Which Nixon is the right one a year down the line, the one who performs actions Q, D, S after giving the bribe or Q, L, Z? Just as full-featured identity does not apply to objective nonexistent abstracta like possible fat men or bald men in the doorway, there is no definite possible Nixon that is identical to the actual man, that is, aside from the actual Nixon just before giving the bribe. Fortunately, God does not deal with possible worlds but with potential worlds, where even drastic changes in both people and circumstances accumulate steadily one by one as God tests His providential tricks. Possible Nixons in our imaginations are completely disconnected from reality, whereas if God wanted Nixon to give the bribe, then He would have to cause this event, such as by moving Nixon’s will. Nixon would choose to give the bribe freely, i.e., because he felt like it, but his wanting to give it would be influenced by God. If God did that, then He would be able to predict exactly what sort of person Nixon would become, as well as all the other immediate consequences of this intervention. Having completed the analysis, God would continue running the simulation that would immediately branch out in a multitude of routes, tree-like, as further interventions are envisioned and tested. In short, God is able to resolve both the first and secondary causes into effects. Kripke then is right that what we may call “simple” counterfactuals are manageable and knowable by us humans; while Lewis is right that “complex” counterfactuals are neither. God, however, can calculate all counterfactuals, both simple and complex. When St. Thomas says that God knows the world “through Himself,” he is to be understood as saying that God performs the inconceivable number of calculations regarding His own providence from the beginning of the world to its end inside His own mind prior to creating. The resulting best possible world may be called the “Path.” Goodness supplies answers to two questions: 1) Which possible world is the actual one?; 2) What time is it in the actual world? It specifies the Path and the present point on the Path temporal location-wise. Once the Path has been mapped, God can retire into eternity and rest there. As before, a bestowal of grace is a “design event” provided for by God; a miracle is a “creation event.” For God, everything is

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proceeding as He had foreseen, with His own actions intertwined with secondary causes. God is available despite the fact that each and every one of God’s responses has already been determined and set in stone, and God is taking it easy in eternity. God is living both in eternity and – for our sake – in time. Knowledge of possible worlds can be called God’s natural knowledge; His knowledge of the actual Path is His supernatural free knowledge; finally, God’s knowledge of any potential counterfactual will be dubbed middle knowledge. Hence, color me a Molinist. Natural knowledge has always been in the 2nd-level God; middle knowledge is acquired via a great deal of work on the part of God; and free knowledge is a gracious gift of God’s 3rd level, i.e., goodness, downward, as it were. It may be asked: Is free will constituted by the fact that one “could have done otherwise” than what one actually did? Suppose that Smith ponders choosing between x, y, and z, and picks x. This process of contemplating alternatives and introspecting the utility of each alternative is the process of choice, during which freedom of the will is made manifest. But given Smith’s values scale, as well as his beliefs and powers, he would choose the same every time. In other words, if Smith were put into the same situation with the same “him” as he was at the moment of the choice a million times, then every time, he would, assuming that there is no random element influencing our choices, reliably pick x. By “the same him” I do not necessarily refer to his personal identity but simply to his totality of desires, know-how, and powers. In order for Smith to do otherwise, these things would have to be different within him. Call this experiment F. When a repenting criminal says that if he were presented with the same choices again, then he would choose the path of righteousness, it means that a different “him,” i.e., the criminal as he is after repenting, e.g., knowing what he now knows and feeling what he now feels, would, given the same circumstances, choose otherwise. But it does not mean that the same “him,” given the same circumstances, would choose otherwise. A rather similar sentiment is expressed in the saying “youth is wasted on the young”: the idea, of course, is that if one were magically enlightened with his older self’s knowledge and experience, then he would have chosen differently than he actually did, when he was young. But when he was young, he could not help choosing as he did. When free-will libertarians say that one could have done otherwise, they refer specifically to one’s power. And indeed, it is within one’s power to do many different things at any moment in time. Smith and Jones share the same 2nd-grade nature, just as rock1 and rock2 share

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a 1st-grade nature. When put in some situation, both rocks will always act in an identical fashion, yet Smith’s behavior is quite likely to be different from Jones’. However, what they fail to consider is that which power is exercised and therefore, which action is performed are commanded by the will and led to or provided for by the intellect; in other words, the action depends on (1) one’s desires of which ends one wants to attain and on (2) one’s apprehension of the means to those ends. Smith, indeed, could have done otherwise and remained a perfectly serviceable human being (unlike unfree matter); he just did not and would not, however many times we repeat experiment F. Free will’s definition is the capacity to choose among competing ends; work out costs and benefits, pleasures and pains, certainties and probabilities; and pick a course of action that seems best. In order for the choice of x to be free, alternatives y and z must be thought possible (i.e., within the agent’s power) and considered. But the choice of x remains free, even if y and z are rejected in all possible worlds with the same history prior to the making of the choice as the actual world. The discussion continues in the next two chapters. 32. THAT FREE-WILL COMPATIBILISM IS ESSENTIAL TO BOTH ETHICS, THEOLOGY, AND ECONOMICS Ethics. How can one reconcile the compatibilism espoused in (I, 31) with moral responsibility? Let me begin by describing a particular approach to morality. Wrongful actions involve a rebellion against the natural law. Punishment puts the offender in his place and reestablishes the proper hierarchy or order in the universe with the good triumphant and evil held in contempt and thwarted. A guilty person has illicitly appropriated to himself some goods or happiness. Justice demands that this happiness be taken away from him and then some. No one is allowed to defy the law or neglect his duties and get away with some (alleged) benefit. Individuals are allotted their just deserts for the sake of the integrity of the whole. Therefore, punishment for breaking the law can be given regardless of whether one’s choices are determined or not. The cosmic arrangement of individuals in the order of their righteousness or glory can be maintained by society’s gatekeepers, even if one’s place in the scheme of things is determined by one’s nature, personality, and external stimuli. The same reasoning is used for deterrence: whether or not their choices are determined, people respond to incentives somewhat

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predictably – they are “rational” (to use that word in its ugly neoclassical economic sense) – and so, deterring or encouraging behavior will “work,” i.e., affect behavior in some desired way, even if that behavior has a sufficient cause. (In other words, incentives are part of the sufficient cause.) Even considering virtue ethics, it is plain that even if one is not technically responsible for his character, still, good men can be recognized and honored, and evil men, forgotten. The superficial appeal of free-will libertarianism, as far as moral responsibility is concerned, lies in the legitimacy of blame and praise. However, the purpose of blame is to complement punishment, and punishment makes sense despite the fact that the criminal being blamed would do nothing else. People can change, and blame can point out who needs to change and how. There is something a person ought to do or be yet falls short of it. Blame makes his shortcomings public, and punishment makes them felt. (If it is determined that the person will not change, then he can be condemned, the most terrible form and purpose of punishment.) Praise can serve as reward, encouragement, or recognition. Now St. Thomas considers ignorance to be at the same time (1) a cause of sin, (2) a vice, and (3) an excuse for sinning (if not negligent). (ST, II-I, 76) Weakness can, too, be an excuse, even though there is nothing holy or pleasant about powerlessness. Malice is different, insofar as there is little hope for haters of neighbor or humanity. The way to remove this tension is simply to accept determinism and say that one (3a) would not do otherwise (and is, therefore, excused), yet (2a) is still, for example, an unworthy person (and is, therefore, shamed), and (1a) has sinned (and is, therefore, guilty). One can judge the goodness (or lack thereof) of a thing, an action, etc. regardless of how that goodness came about. What a thing is and how it was generated are two entirely different questions of radically different significance. Finally, determination of human actions occurs through 2ndlevel teleological causes. People have reasons for their actions, reasons they can explain to others. Indeterminism seems to deny people selfunderstanding, because it becomes impossible to for them to justify what they do. Theology. In Table I.27.3c, the temperaments correspond to the four Aristotelian causes and to times. Guardians represent material causation and the past; Idealists, final causation and the future; Rationals, efficient causation and timelessness; Artisans, formal causation and the present. The same table also lists act and potency for the nature, virtue, and happiness trinities within. These, too, relate to times. And this

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correspondence is distinct from that of the four causes. The four causes keep an object in existence right now. The physical, teleological, and grounding “effecting” (I abstain from using the word “cause” in order to avoid any confusion), are distinct, insofar as cause of the reduction of potency into act, of “entrepreneurial” action that makes the future different from the past, lies before the action begins in physical effecting, after the action is completed in teleological effecting, and in eternity for grounding effecting. For physical effecting, natural law dragged the world from state S1 at t1 to S2 at t2. The motion of the cue ball at t1 in the past is responsible for the present motion of the 8 ball toward the corner pocket. For teleological effecting, a contemplated satisfaction causes a person to get into action to attain his end. Imagining S2 at t2 in the future has driven him to act right now. The two types of effecting make the world evolve, change from one point to the next. They introduce induced motion to merely inertial motion (for 1st-grade things like rocks), and creative advance to a mere evenly rotating economy (for 2nd-grade things like humans). Effecting is about the maker; the four causes are about the thing made. For example, material causes lie in the past, because if object O is made of parts P, Q, and R, then these parts must have existed before I made O. They are prior to O. I had the things in storage, before I put them together. For efficient causation, in theology sometimes it is distinguished between a “creating” efficient cause and a “sustaining” efficient cause. The idea is that God both created the world in the past and somehow keeps it in being right now. This is a mistake. The creating cause is in fact grounding effecting by the eternal God; the sustaining efficient cause is the forces (physical forces, chemical bonds, whatever) that keep objects together according to abstract timeless laws of nature. Formal causes are in the present, because an object is defined by what it is, its essence. It exists right now, because of what it is right now. For final causation, the reason why object O exists is that it is useful to me somehow. I made O in anticipation of some future utility. So, the final cause explains why O exists. Is there anyone who wants to keep it around? If no one, then O will sit there rusting and eventually corrupt; or people will salvage it for parts. Unlike final causation, teleological effecting refers not to O but to me making O. It describes the state of affairs before O even existed and for that reason cannot be called a “cause” at all, for the Aristotelian causes are co-present with

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their effect (i.e., they answer the question, “What makes O exist now?”). The maker then is not a version of the efficient and final causes of the things he creates. If I made O, then I am not its cause but its creator (or effector). 1st-grade objects have the material and efficient causes objectively, in themselves. Now a composite object can be destroyed by being taken apart. But matter is precisely the parts. One cannot disassemble an elementary particle. Then there is the law of conservation of matter and energy. Material causes are ultimately indestructible. An efficient cause is essentially an object’s power of selfpreservation. That power is innate. It can be overwhelmed by a stronger force, but then precisely the strongest will rule. Now consider a man-made machine, a car. Its form, what it is, car-ness, causes the car to exist. But I sustain the car’s essence in being by building it and refraining from sending it to the junkyard. I am the effector of the car’s formal cause. Finally, the car’s final cause – its utility to me – is also subjective and depends on my state of mind. Should I (and everyone else) decide that the car is no longer of any use, the car will be instantly destroyed as a distinctive piece of human art and will not, at any rate, survive for long. 2nd-grade objects, such as humans, have in addition their final causes within. For they exist for no second party’s pleasure but for their own. Their final cause is their own happiness and its pursuit. It is impossible to extract that search for happiness from a human being. A person may fail at times in his undertakings but will eventually correct himself. Their formal cause, however, is at the disposal of God. It is for that reason that God can be trusted. For what we will become is ultimately His responsibility. If God is good and has the world, humanity, and each individual in His hands, then our hope in Him ought not to be disappointed. Finally, for God, even His formal cause is within Him, completing the quadriformity. It is objective and depends on no special perspective. It behooves me to describe the entrepreneurial advance in more detail. The physical world consists of four entities suspended in spacetime: 1. existing objects and their properties, 2. events generated by those objects, 3. events handled by other objects or objects’ reactions, and

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4. new objects created as a result. A ball (object) hits a window (event). An event is “thrown” by the ball as a kind of single instruction. The window knows what to do when hit: it handles the event by executing a complex series of instructions: for example, it cracks and shatters in non-obvious ways. Finally, glass shards fall every which way and are the new objects generated in the process of the window’s handling the event. A simple Web program will illustrate the point. function turnRed() { b.style.color = "Red"; b.value = "I've been clicked!" }

There are two objects here: the user and the button. The button just sits there, waiting for the user to do something with it. In particular, it knows how to react when clicked. When the user clicks it, the onclick event is thrown, and the browser invokes the turnRed() event handler which changes the color of the text and the text itself. (You can copy and paste the code into a .htm file to test it.) Handling events is done via a complex program injected into the essence of a thing. Event handling is written deep on the heart of the object. We cannot slurp up things’ essences, but scientists have figured out a great deal of how things work by reverse-engineering the Creator’s software. A new object, in order to come into being, has to be constructed. And the constructor which sets the properties of an object at the moment of its creation, too, is a complex program. Though it is not a trivial task to unravel its inner workings, it can be done. Both event handling and object construction are associated with timelessness. Objects are inherited from the past; without the present entrepreneurial action, they would continue in inertial motion or evenly rotating. That “those who do not remember the past are condemned to repeat it” is not the problem; it is precisely that those who do not remember the past cannot for the life of them know what to repeat that is the problem. Event generation is linked with the present; events, and human

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actions in particular, stand in between the past and the future like a filter, accepting the former as input and spitting out the latter as output. New objects are created in the future; introduction of novelty into the world is always an actualization of a potentiality. Potentiality is an inherent drive, impulsion, disposition, imperative of a thing to become actual. Take an acorn. It is possible that you plant it, and it is possible that you fail to plant it. Regardless of what you do, the acorn has within itself the potential to become a mighty fullfledged oak tree. There is a possible world in which a fetus is aborted, and a possible world in which it lives; in both worlds, however, the fetus, even in an early form, has the potential to become a human adult. A woman aborts child A and a year later conceives child B; if she had not aborted A, there would be no B. Is there a parity here, such that nothing theoretically objectionable was done? Not necessarily: when she aborts A, she destroys a potentiality; B at that point is a mere possibility. The former is more real than the latter. We tease out unactualized goodness hidden deep inside a thing. Given the right care, the goodness will shine forth and flourish. Potentialities are about an unrolling, at the same time orderly and creative, of the future from the past and the present. The future depends on and is constricted by both. Possibilities are entirely unconnected with the present; for them, imagination can run wild. Let me expand a piece of Tables I.27.3 as pictured in Table I.32.1.

HA HS

Intellect plan vision

Power execution comprehension

Will desire fruition

TABLE I.32.1. THE WORKS OF THE TRINITY WITHIN

Human action concerns a state begetting an act. Normally, a state would not beget anything but continue unperturbed. However, if the state includes suffering or dissatisfaction, then the act is a rejection of this state and an attempt to create a happier situation. A human being cannot “predict” the act by looking at himself, because it arises via a creative outpouring of the entire trinity within. Call the act HA. The act is either successful or not. In both cases, the act begets a new state. As an empirical point, man fails all the time; if he could predict his failure, then he would not act in the first place. But he does act even with this sword of Damocles hanging over him; therefore, he cannot predict which state will be begotten by his actions. Call the new state HS.

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Success entails having all three of be exactly as anticipated. One has failed when at least one is missing or different. The happiness that HS may involve will only be imperfect and partial, as new wants will rise up demanding satisfaction. State yields action that yields another state which yields a new action…, generating a sequence of events that continues indefinitely. HA is determined by the conjunction of the individual’s intellect, powers, will, and inputs to him sensed or reflected on. Call it the 4tuple of HS = or the combination of one’s “nature and nurture.” Let the determination of HA be known as the first locus of free will. Upon the termination of HA, whether fruition has been reached or not, the initial HS1 changes into some new HS2. Let the emergence of HS2 be called the second locus of free will. Remember my complaint in (I, 10) about Kirzner’s understanding of entrepreneurs as interchangeable. There is a sense in which Kirzner may be right. If Smith who became famous for founding company X had never been born, then some Jones, now facing less robust competition, might have founded company Y. One’s own actions are restrained by the actions of competitors. Jones’ attempts were weak, because Smith was better. Remove Smith, and Jones would triumph. The amount of disequilibration and equilibration would stay more or less the same, no matter how many creative people we subtract from society. Creative advance and the flow of yin and yang through the economy would continue even if we took out every actual successful entrepreneur who was destined for greatness before he founded his company. (I am sure that this would be difficult to test, even if we could, because altering even a single event in the past would throw us into a new possible world in which other entrepreneurs scheduled for deletion may not even exist. But the rough idea is clear.) Is Kirzner thereby vindicated? Let me suggest that the economic yin and yang is a general framework used in order to understand how a society grows richer. Creative advance consists of individual actions, and if we check them by preventing the best entrepreneurs from succeeding, then economic progress would be curbed or severely slowed down. Electrons are quite limited with respect to what they can do. But human action is extremely varied. Jones may not be able to duplicate Smith at all. Smith1 is the first cause of Smith2. If Smith2 is a “good person,” then Smith1, who as a creator is judged by its “effecting,” is also good. Similarly, Smith2 is judged by his fruits, namely, by the goodness of Smith3. If the final product of Smith’s creative self-making is good, and

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Smith attains glory, then his entire life is affirmed and glorified, as well, as having led to salvation. If Smith, on the contrary, drives himself to hell, then his entire life is condemned, as having led to perdition. Even if in the first case, Smith failed now and again, those failings are not counted against him, because they were part of an overall successful life. If he had not made those mistakes, then who knows how his life would have turned out: could he not have saved himself? Let us not mess, by playing with possible worlds, with what has worked. And even if in the second case, Smith did some redeeming things, they are completely devalued, because they were part of an overall tendency toward self-destruction. It is vain to say: “God exists in this possible world but does not exist in that one.” God-as-Goodness “spans” possible worlds and creates these abstracta. At the same time, the future is not a set of possible worlds but rather a potential world. The future is not an arbitrary creation of anyone’s imagination but an unfolding of the past through the present. There is a predictable by God series of states that succeed each other through acts. Quasi-random events on the 1st level are foreseen by God; and truly random events are determined exclusively by Him. Some equivalent of these must hold regarding human choices on the 2nd level, as well. God knows us all too well to make a mistake. God’s ability to compute the counterfactuals of freedom of any complexity is what allows Him to create the best possible world. Libertarian indeterminism claims that whenever Smith does x in the actual world, there is a multiplicity of possible worlds in which he does every other thing possible for him to do. On indeterminism, the future is unpredictable, because even when the relevant probabilities are assigned to the possible worlds as competently as could be done, the outcome, though not necessarily equiprobable with every other outcome, is still random. On compatibilism, the future is predictable at least for God. To deny compatibilism is either to rob God of His omniscience and rational providence or, on the contrary, to imbue Him with unseemly powers to determine human events by bending the indeterminist randomness to His will, thereby refusing to admit secondary teleological causation altogether. Economics. At the same time, free-will compatibilism entails that it is possible to an extent to predict one’s own or other people’s actions. Just as we seek to understand past history, by answering the public question “What did he do?,” the semi-public question “How did he do it?” (semi-public, because it is part of making any plan of action to consider and reject all poorer alternatives, and these opportunity costs

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are not seen by others), and the private question “Why did he do it?”; so we try to foresee the future by answering similar questions. And we are able to do both tasks, because the HS of together with its products of and are sufficient to explain any action. Entrepreneurs are in the business precisely of forecasting how people will respond to new products or services. But on libertarianism, predicting the future is like gambling, non-rational. So is even getting a grasp on any particular person’s character. So much for economic practice. But free-will libertarianism is dubious even for economic theory. Consider the law of marginal utility. Whenever one gives up one of his widgets, he will sacrifice the widget’s least valued use. Now that out of possible uses A through D, Smith gave up C is temporally and logically prior to his observers’ deducing that C was Smith’s least valued use of his widgets. For a third person, Smith’s sacrifice of C reveals some of his values, such as his bottom-most satisfied (by C) value. But for Smith himself, his values scale at the moment of choice is causally prior to his giving up C. According to the version of determinism defended in this book, Smith’s decision to forego C is determined by his reasons for doing so at the moment of the making of the decision. Of course, reasons are evaluated, and different people will evaluate them differently. For example, deliberation is in part a process of self-discovery. There is the discoverer and the things to be learned, both unique to the person. Moreover, “reasons,” such as pros and cons of different actions, do not float out there; they are thought up in the process of creative exercise of the mind. Courses of action are evaluated as possible or impossible according to how one grasps his powers and compared by the welling up of the energy of the will. The mind is distinct from the reasons it churns out; power is distinct from motions of the body; and the will is distinct from its yield of the most profitable end. As an agent, Smith makes his choice and acts on it. Therefore, even libertarians must admit that the 1st locus of free will is determined: a state of the soul, characterized by at t1, determines HA at t1. The claim that the 2nd locus of free will is undetermined is also problematic. Given the state HS1 = at t1, what will be HS2 = at t2? If HS1 does not yield HS2, then neither does HA determined by HS1. But if neither Smith at t1, nor his choices and actions, nor the environment are sufficient to yield a definite HS2 at t2, then what possibly connects the different states of a person’s character or scale of values? Smith is determined neither by himself nor by anything-outside-himself. The transformation of Smith1 to Smith2 is then

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entirely random. And that is a reductio of libertarianism. 33. THAT FREE-WILL COMPATIBILISM STANDS UP TO OBJECTIONS Suppose it were asserted: If Allison is coerced into doing a morally bad act, such as stealing a car, we shouldn’t hold her morally responsible for this action since it is not an action that she did of her own free will. (Timpe 2006, this and all the following quotations) Let Allison be coerced under threat of death. In that case, she prefers living and stealing the car to dying and not stealing the car, a perfect example of free will, i.e., the process of ranking goals which results in a values scale in Allison’s mind and heart, in uninhibited operation. She is not morally responsible, not because her will was unfree, but because she made a good choice by foregoing the greater crime of what would have essentially been committing suicide by refusing to obey her captors in favor of a lesser crime of stealing the car. Now perhaps it would be supererogatory of Allison to have a moral ideal so robust that it would prevent her from stealing the car no matter the personal cost to her. She would be willing to forgo happiness and even life itself for the sake of righteousness. But that decision, too, would be freely made. The soul commands the body as a crane operator commands his machine, infallibly; while a human master commands his human slave through mere incentives of fear and possibly reward. Even a slave, then, chooses by submitting to the lesser evil, i.e., working under duress, in order to avoid the greater, namely, a beating from the master. St. Thomas writes that “the throwing of the cargo into the sea becomes voluntary during the storm, through fear of the danger: wherefore it is clear that it is voluntary simply. And hence… what is done out of fear is essentially voluntary, because its principle is within.” (ST, II-I, 6, 6) Next: If Allison is brainwashed during her nap to want to walk her dog, then even if no external impediment prevents her from carrying through with this decision, we would say that her taking the dog for a walk is not a free action. … If Allison has been brainwashed to walk the dog at a certain time, then even if she were to turn on the news and sees that it is snowing, she would attempt to walk the dog despite having good reasons not to. Thus, manipulated agents are not

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reasons-responsive, and in virtue of this lack free will. The notion of brainwashing is a difficult one. If brainwashing is at all equivalent to creating a habit, then it is plain that habits do not nullify free will. A habit is a kind of settled disposition to prefer certain things as opposed to other things. It is an aspect of personality. But it does not diminish one’s power of rational deliberation, although it may at times prevent a person from even considering non-habitual choices. If brainwashing is developing a conditioned reflex, then it can always be overridden by cool-headed deliberation. Men are never absolute slaves to their automatisms. At any rate, suppose that Allison is somehow convinced that the news is not trustworthy and that she should believe the exact opposite of what is being reported. She holds a false belief, but presumably, she thinks she has good grounds for it. She is mistaken, but how does that undermine the essence of the process of choice? For choosing is ultimately weighing and ranking the possibilities. This weighing can proceed unimpeded even if some commands of the will under consideration cannot, unbeknownst to the chooser, be carried out. Allison may think that banging on the TV will make it work better; or that she can fly; and act accordingly. She will suffer the consequences; but her choice to do the wrong things will be free. Choosing on the basis of bad or invalid data and thereby making up a non-working plan is still choosing. She fails to attain the ends she seeks; she fails to increase her happiness; she may even become less happy, if she tries to execute an action based of incorrect information; but she chooses quite normally. Perhaps, a “manipulated” agent is someone in whom some great desire of the sensitive appetite is implanted. Such a desire does diminish both one’s merit and one’s demerit, if it precedes the act of the will which acquiesces in the desire. (The happiness felt after a desire is satisfied increases both the merit and demerit. E.g., the more one rejoices in an evil done, the guiltier one is.) This is because only voluntary actions have moral worth, and the impulse of a passion makes it harder to maintain control and renders one’s actions to an extent less voluntary. But no sensual desire, regardless of how strong, can completely obliterate the intellect and destroy the capacity to choose. Therefore, those who are manipulated do not, strictly speaking, lack free will. Coercion and manipulation undermine free will, on this view, in virtue of making agents not reasons-responsive. Coercion and manipulation do not undermine free will, as free will is

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part of the essence of human beings. Coercion makes one less free only in the political sense, because other human beings (presumably, unjustly) restrict his freedom of action beyond the limit that the laws of economics and the demands of social cooperation (such as other people’s private property rights) already impose on it. Manipulation and deception diminish happiness not free will, as shown above. Besides, who is Timpe to impose his ideas of reasonableness on Allison? Here is the final scenario to clarify my rendition of freedom of the will. Allison is contemplating whether to walk her dog or not. Unbeknown to Allison, her father, Lloyd, wants to insure that she does decide to walk the dog. He has therefore implanted a computer chip in her head such that if she is about to decide not to walk the dog, the chip will activate and coerce her into deciding to take the dog for a walk. Given the presence of the chip, Allison is unable not to decide to walk her dog, and she lacks the ability to do otherwise. However, Allison does decide to walk the dog on her own. … Frankfurt concludes that Allison is morally responsible despite lacking the ability to do otherwise. One can be morally responsible, because one willed an action or rejoiced in something, even if he did not bring it about. Suppose a person has envied someone’s success and wished for that person’s destruction. This internal crime has all the attributes necessary to make it a “sin”: it is against the natural law which bids man to love others; it corrupts human nature; it effects a debt of punishment, etc. It is not written in vain that “Anyone who hates his brother is a murderer.” (1 Jn 3:15) The inference that Allison is morally culpable, therefore, is hardly surprising. On the other hand, if the chip had forced her to walk the dog, then she would not have wanted to do so, in which case it would have been an involuntary action, something perhaps like akathisia or a muscle spasm, and she would not have acquired any merit or demerit for performing it. I will deal with two arguments against determinism: The Origination Argument: If determinism were true, it might be true that Allison chooses to walk her dog because of her beliefs and desires, but those beliefs and desires would themselves be the inevitable products of causal chains that began millions of years ago. Thus, a determined agent is at most a source, but not the

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ultimate source, of her volitions. According to proponents of this sort of argument for incompatibilism, the truth of determinism would mean that agents don’t cause their actions in the kind of way needed for free will and ultimately, moral responsibility. In order to counter this point, it is sufficient to reiterate that how a thing came to be what it is need not be relevant for our evaluations of what that thing is or what it is doing. Does it really matter to a judge that the criminal’s mother did not love him? In other words, let object A throw event E. Program B handles the event and in the process spawns a new object called Allison. It is clear that there is a chain of physical and teleological effecting culminating in Allison, stretching back however long. But the formal cause of Allison, what and who she is, is not dependent on this chain. Allison is now a full-fledged object herself, capable of event causation. The events that Allison now throws have a source in her nature, personality, and pursuit of happiness. That Allison is may well be an “inevitable product of causal chains that began millions of years ago”; who Allison is, is her inner being right now. And moral responsibility is imputed for the latter. Again, event handler B, among the other things it does, creates an instance of Allison. Before Allison is ready to act, however, her constructor, located deep within the definition of her essence, is run, setting her properties and defining her nature. This constructor is a complex series of instructions. B instantiates Allison. The constructor defines her formal cause at the beginning of her life. If a pebble falls on my head, then the reason why I do not blame the pebble is not that its beginnings can be traced back to the Big Bang, but because it is not the sort of thing that can be blamed. But if Allison hits me on the head, then I may blame her despite her murky origins, because she is a creature who can garner for herself praise or blame. The reason why her choice may be judged “bad,” taking goodness in the widest possible sense, is that a better person would have chosen differently. By blaming Allison we give her and others the knowledge and incentives to learn from their mistakes and improve. The pebble, however it may be altered, will never become in itself better. Chains of effectings, however far back they may stretch, are simply irrelevant. It is true that when Smith is making a decision, it is he who makes it, not some cause millions of years ago. What this means is that Smith cannot observe himself choosing; he cannot predict his choice by examining himself however carefully. There is no such thing as listless “que sera, sera.” Smith has to go through a process of making or discovering a decision which involves a degree of self-forgetfulness and focusing on the task at hand, namely, figuring out what he wants to do and

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how he wants to do it. Phenomenologically, the only way to engage in choosing is to forget that you are choosing. Therefore, Smith can be at any one time either an observer or an actor but not both. Smith cannot predict his own choices, because he is burdened with a period of blindness where he is fully a subject and in no wise an object. Otherwise, there is the problem of infinite regress: in order to decide, Smith has to decide to start deciding. And to decide to start deciding to start deciding… In order to get anything done, Smith has to quit watching himself. Once he decides, there is no longer a reason to predict. However, a third party, Jones, needs never stop observing. He is always studying the object-Smith. He assumes that Smith will go into the choosing mode and use this datum for predictions. For Jones (or more properly, God), intimate knowledge of the state of affairs one day before Smith’s choosing is sufficient to determine Smith’s choice. But, somewhat surprisingly, not for Smith. The Origination Argument can be put another way. Is the fact that Mother Theresa was virtuous, and some serial killer, call him Jones, vicious, a matter of luck? On determinism, our nun, the argument goes, had the lucky causal antecedents all the way to the Big Bang, while the killer did not. And this offends our sensibilities. The first claim in this version of the argument has just been dealt with: the determination could not be helped, but it does not matter. I answer the second claim simply by affirming the pervasiveness and importance of random – and lucky or unlucky – events. First, there is such a thing as the law of human nature. One just does not achieve glory by (unlawfully) killing people. Human beings are selfcorrecting. But perhaps, Jones’ self-correcting mechanism (e.g., his conscience) was damaged or corrupted somehow. Was that due to luck, too? Imagine a possible world in which Jones reads this book and reconsiders his choice of avocation. Surely, that is a great thing for him and for his victims. But alas, in the real world that does not happen. Who is responsible for this outrageous waste of goodness? It seems like nobody is. How come there was no good soul who would force our potential killer to read the book? Why else but bad luck? Finally, why did not God interfere? Perhaps for utilitarian reasons: Jones is sacrificed for the greater good, as God sees it. Two-Face in the movie Batman Forever (Warner Bros. Pictures, 1995) may have been on to something: “One man is born a hero, his brother a coward. Babies starve, politicians grow fat. Holy men are martyred, and junkies grow legion. Why? Why, why, why, why, why? Luck! Blind, stupid, simple, doo-dah, clueless luck!” As I explained in (I, 12-13), it is one’s courage and tactical prowess and opportunism that enable one to deal with random and

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unpredictable events. Fortune, indeed, favors the bold (though luck rewards the prepared). It is part of the meaning of “freedom of the will” that one has options to choose from, and the facts that those options often arise by chance and therefore, are to an extent “naturally unique” are precisely what imbue free will with significance. No human life is like any other life. It is, after all, a first observation of economics that division of labor comes about due to (a) differences in individual talents and skills and (b) the variety of natural environments and resources. Some of these differences and varieties are randomly generated. It is part of our trials in this life gracefully to handle the unexpected and the unlucky. Keynes, in particular, was deathly distrustful of future uncertainty. In a sense, he feared fear. He thought that uncertainty made entrepreneurship difficult and sufficiently subpar to be inferior to socialized investment. At the very least, for him, the state “was in a position to take precautions against the consequences of uncertainty.” (Skidelsky 2010: 160) Maintaining full employment was one essential uncertaintyreducing task of the government. Of course, it is false that the unhampered market does not always tend toward full employment. But it does so while respecting the fiery yang counterpart to its ice-cold yin, or economic creative advance, such as innovation and capital accumulation which disrupt any ERE and temporarily displace workers and dispossess capitalists. As we will see, lack of full employment has always been the consequence of government interference with business and of the boom-bust cycle, both of which are curable via social progress toward laissez-faire. Another objection is immediately forthcoming. The quality of our very attempts to deal with uncertainty is itself an outcome of luck. Our genetic patterns, the country and family we were born into, our strength of character, and all the rest determine our destiny. It is unjust of God to allow things to die simply because they lost in life’s lottery. Well, look, history is not just written by the winners; history is the winners. The winners are not just the strongest; in one of those paradoxes, for which religion is famous and which must be rightly understood, they are also the meek. Perhaps, the winners – physically and spiritually – were pre-programmed into the quark-gluon plasma seconds after the Big Bang; or intelligently designed into every technical improvement of biological systems; or written onto Adam and Eve’s hearts. What of it? Only the consequences matter; and what a man becomes is up to him in the most ordinary sense. God forms us and bears full responsibility for who we become, but He does this job via secondary causes, especially teleological

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causation (or effecting). We trust God but seek our happiness with full abandon. The Consequence Argument: The asymmetry between past and future is illustrated by the fact that we don’t deliberate about the past in the same way that we deliberate about the future. While Allison might deliberate about whether a past action was really the best action that she could have done, she deliberates about the future in a different way. Allison can question whether her past actions were in fact the best, but she can both question what future acts would be best as well as which future acts she should perform. Thus, it looks like the future is open to Allison, or up to her, in a way that the past is not. In other words, when an agent like Allison is using her free will, what she is doing is selecting from a range of different options for the future, each of which is possible given the past and the laws of nature. As I indicated in (I, 31), it is, indeed, within Allison’s power to do different things in the future but not in the past. For example, 1st-grade objects are called “blind,” because they are blind to possibilities. (They “see” the path to which they are determined very well.) Allison is not. Now deliberation and soul-searching are how plans to affect the future are formed. But if we understand Allison’s HS1 = , then, as per the first locus of free will, we should be able to infer from this understanding Allison’s decisions and actions.36 These HAs then will cause her character deterministically to evolve with time. A particular choice is free, if alternatives to it are contemplated 36

A person may be motivated by an ill-conceived desire to prove the determinist wrong and for that purpose try to multitask. “Look at all the weird things I can do!,” he may implore us. This, a libertarian might say, is the essence of indeterminism. In this case, the things done are randomly chosen in an attempt to illustrate the point. An action will have no purpose other than to serve as an example of an action. All actions are thereby made equal and indistinguishable. We have then that the end is to try to counter the compatibilist; the means is to pretend to have different ends and act on them, as if one actually had them; and the power is to perform those random actions. One cannot predict which action will be done, but it does not matter, because any action, if sufficiently “weird,” will work. We see that determinism, since instances of it here can co-exist with randomness elsewhere, is not affected.

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(by the intellect) and weighed (by the will); but it does not cease to be free, when those alternatives are rejected both in the actual and in every relevant possible world. 34. HOW JUDGMENT CONNECTS TO THE GRADES OF BEING (I, 25-29) discussed the “grades” of being; (I, 31-33) discussed the will. What remains is to say a few words about goods and goodness. Mises’ “understanding of understanding” was sublime. Unfortunately, while aware of the contributions of the epistemology of understanding, he neglected entirely the epistemology of wisdom. Surely, there is more to be said about good and evil than that they are “arbitrary and subjective value judgments.” I submit that there are three kinds of good and evil: physical, moral, and metaphysical, corresponding in a straightforward way to the three trinities within. Physical good is purely subjective, i.e., something is a good, because I value it, because it brings happiness to me, and that is that. I first value something, and then and because of this it becomes good. The judgment is of the subject for an object. Metaphysical good is purely objective; so, first something is good, and then I “had better” value it (or else). Loving metaphysical goods is essential, lest one’s nature be destroyed. Here the object judges and decides the destiny of the subject. Moral good is in between, intersubjective, deriving its character from agreement by rational agents. All law, be it natural or human, is intersubjective. Even in the case of a person on a deserted island, there is a law governing what he can do to himself. As I suggested earlier, there is a trace of the Trinity within all of us, and so even relations with oneself are intersubjective. To illustrate: Socrates is better than a pig metaphysically; Socrates is better than a fool morally; and Socrates satisfied is better than Socrates dissatisfied physically. Metaphysical goods concern essences and powers; moral goods, accidents and habits; and physical goods, acts and happiness. Metaphysical goods do not need a soul in order to be good; physical goods require a soul in order to be good; and moral goods are the result of a soul judging itself. Moral good, therefore, is self-perfection known as such and in itself and loved. There has been a good deal of controversy in metaethics about the proper status and definition of the word “good.” The debaters would be well-advised to realize that goodness is not an ultimate given but is

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produced by human powers of judgment seated in the virtues of prudence for physical good, justice for moral good, and wisdom for metaphysical good. But what is judgment, or what is required for judgment? Three things are individually necessary and jointly sufficient. First, a hierarchy, in which things are arranged according to some kind of shared property. Second, a measure, usually the highest item in the hierarchy, against which all other items in that hierarchy are evaluated, generating “better” and “worse” things. A thing is good to the extent that it approaches the maximum in its hierarchy; the closer it is, the better it is. Third, that the measure of things in the hierarchy be somehow perfect (lest we could form a hierarchy of persons from the shortest to the tallest and claim that a tall person is better than a short one). At this point, it might seem that I have merely defined “good” in terms of “highest good” which is unhelpful. But let me call this a “reduction” rather than definition, in which case it is useful, because there is only one supreme good per hierarchy, and if we are successful at identifying that singular thing, then the notion of goodness instantly becomes tractable. Given the three kinds of good just listed, there are three hierarchies. [I] The hierarchy of physical goods is the scale of values or scale of profits, fittingness, suitability for a purpose. Nobody can satisfy all of his desires; therefore, one must rank those desires in terms of intensity and urgency and choose between them. The measure is that one object that makes all human dreams come true. In theology, it would be of great value to demonstrate whether or not such an object exists. In ethics, however, we are unconcerned with this task. The measure, the ideal, might well be unreachable. An unsatisfied desire is an imperfection, because it is an impulse to action which remedies the imperfection, and all action is a costly exertion. It is clear from “prudence” that unrestricted pleasure and complete happiness, peace, and joy are, indeed, human perfections. To reiterate, happiness is not merely a feeling but rather engages the entire trinity within. Just as pursuit of happiness is divided into desire of the will characterized by love, plan or algorithm for the attainment of the end sought of the intellect characterized by knowledge, and bodily action characterized by hope of success; so enjoyment of happiness is divided into, in the reverse order, possession of the object that yields happiness called “comprehension,” mental grasp of the happiness-producing object called “vision,” and indeed, rest or repose of the will called “fruition.”

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As St. Thomas points out, “even among ourselves not everything seen is held or possessed, forasmuch as things either appear sometimes afar off, or they are not in our power of attainment. Neither, again, do we always enjoy what we possess; either because we find no pleasure in them, or because such things are not the ultimate end of our desire, so as to satisfy and quell it. But,” he continues with his theology, “the blessed possess these three things in God; because they see Him, and in seeing Him, possess Him as present, having the power to see Him always; and possessing Him, they enjoy Him as the ultimate fulfillment of desire.” (ST, I, 12, 7, reply 1) There is no happiness without vision or comprehension; as G.E. Moore (2004) pointed out, for example, in contemplation of beauty there are the “emotional element” and the “cognitive element.” (190) The cognitive element entails that included in one’s degree of happiness is the consciousness of desires still unsatisfied. [II] The hierarchy of moral goods is of virtue, nobility, greatness, excellence, spiritual beauty, clarity in the sense that one needs to hide nothing about himself in shame. The key property of a virtuous man is integrity, wholeness, organic unity. An ideal man is a harmonious union of numerous individual virtues. Equilibration and disequilibration occur not just in the economy but in the soul, as well. Greater complexity of personality, though it is an upgrade, may introduce spiritual conflict. When the conflict has been worked out and resolved, the complexity is complemented with unity, though on a higher level. That is why it is said that a good man comforts (i.e., equilibrates) the restless and discomforts (i.e., disequilibrates) the content. In the first hierarchy of narrow happiness, the end, i.e., a particular pleasure, is known, but the means to it, i.e., a good plan of action, are unknown and must be figured out by analysis. In our virtue hierarchy, on the contrary, the means, i.e., the virtues, are known, but the end, i.e., the perfect personality for any given human being, is unknown and must be figured out by synthesis. Curiously, growth in human power supplies greater knowledge of the means and proliferates the ends, such that world-making gets easier, and more fun can be had by all. On the other hand, self-making becomes more uncertain, because there are more possibilities of what one can become. The measure of this hierarchy is that being than which no greater can be thought. Again, if I wanted to engage in theology, then I might try to present the ontological argument for the existence of God, pioneered by St. Anselm, in a defensible way. It is clear that God, if He exists, with His attributes of eternity, immutability, unity, aseity, self-sufficiency, perfect rationality, dominion, and so on, is the measure and perfection of this hierarchy.

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Consider the distinction between virtues and arts. The usual way to distinguish between them is to say that it is better to fail to be virtuous involuntarily than voluntarily; and vice versa for arts. Though arts denote a state of the soul or some excellence possessed, they are not pure virtues but are beholden fully to search for happiness. The point of an art is to do well; the point of a virtue is to be good. Aristotle argues that “since the activity is better than the state, and the best activity than the best state, and excellence is the best state, that the activity of the excellence of the soul is the best thing.” (1219a30) This is true for an art: it is better to “cure a disease” than to “be a doctor”; it is better to “succeed” than merely to “have qualities required for success.” The art is subservient to and for the sake of its performance. But not a virtue: it is better to “be the kind of person to whom stealing is repugnant” than merely to “have lived a life without ever stealing”; again, it is better “not to be a glutton” than to “have on many occasions eaten in moderation.” A rock has never stolen, but we do not praise it for its justice. Thus, for both virtues and arts, there are states and activities; it is just that for arts, the activity is better than the state; and for virtues, the state is better than the activity. [III] The hierarchy of metaphysical goods consists of degrees of interpenetration belonging to natural kinds, identification with “the Other,” ability to improve the lives of others and be improved by others in return. The measure and perfection of this hierarchy is, once more, God as He is traditionally conceived, i.e., as sustaining all things in being, omnipotent, omniscient, all-loving, and again, eternal. These attributes make God infinitely happy, yet when His 2nd level is graced with goodness, are directed to work for the created world, as well. If the strange phrase thrown about sometimes, “ultimate reality,” has any meaning, then this is it, due allowance being made for the fact that goodness is beyond being. The proximate reality in this world consists of three things that have an equal claim on human attention: the reality of combat, the reality of defeat, and the reality of victory. It is a measure of a man’s wisdom that in defeat, he remembers that life is worth living; in victory, that only God is good; and in spiritual battle, that this world is the best possible one, as in as in bug-free, working out of the box, and worth fighting for. Metaphysical improvement for humans links the will to love of friendship, power to works of mercy, and the intellect to empathic understanding of one’s fellow men. For example, it is part of our mission in life to learn to love, because the union and mutual indwelling of lovers increases their interpenetration, and therefore, the richness of their beings and their lives.

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Even though the measure of each hierarchy is absolute (e.g., the thing than which no greater can be thought is an absolute good), nevertheless, each good within each hierarchy is relativized, simply because each man judges by himself and for himself what is good. Wisdom, justice, and prudence are part of each person’s natural capacities. Now society is constituted by the relations between its members. A habit can be for the sake of its act, in which case it is an art; or for the sake of a social relation. Are there “true” virtues that are entirely for their own sake? Is there anything the solitary Crusoe can do that will beautify (or on the contrary, mar) his soul? Some possibilities might be: not commit suicide, not have sex with his sheep, control to some extent whatever impulsivity he might have, meditate, worship God, and use his mind for speculative pursuits. But I will leave this question open. All three trinities within are informed with law. Breaking the law brings the corresponding type of evil upon the lawbreaker. Thus, violence and fraud cause the criminal to suffer metaphysical evil: he becomes an outlaw, hated, hunted, and pushed out of society and even life itself. Metaphysically, man feels servile fear of punishment; morally, filial fear of offending the moral ideal giver; physically, fear of failing to secure the narrow happiness sought. Of course, fear of all kinds can be counterproductive if excessive. Man must not fear evil so much that he refuses to do good. It is important to place economics within a bigger picture, so, a bit of theology will illustrate the point. God is better than man in two ways. First, as goodness, God is better than a human being as much as humans are better than tables and chairs. Second, even on the 2nd level, God’s essence is superior to humanity as a perfect archetype thereof. [A] On the level of nature, we can show that God is a rational being, possessing intellect, power, and will in unlimited measure. [B] On the level of virtue, we deduce that God is a trinity. God is both object and subject, and God’s knowledge of Himself is so complete and unified that it is a kind of a copy of Himself. This copy is the second Person of the Trinity, the Image that the Father beholds in His mind, God the Son, who is the fullness of the Father’s self-knowledge. Now God’s essence is prior to the His knowledge of that essence. We say that the Father “begot” the Son. And indeed, there is no reason why their relationship cannot be called somewhat metaphorically “paternity and filiation.” Paternity, because although there “was” no actual begetting – God is one in His eternal present – the logical priorness is still distinguishable. The begetting of the Son is not by will but by nature. God’s

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self-knowledge and self-love are part of an eternal act of His self-actualization. God is surprised and delighted to realize that He is God. In grasping who He is, God begets the Son; in seeing Himself to be a spectacular and matchless being, He spirates adoration for Himself or the Holy Spirit. Filiation, because God’s knowledge is both true and “true to His essence,” as in: conforms to it, never falters from reality, never errs, never sins. As a reward for such perfect fealty, the Father wills to the Son the perfect good and gives to Him everything He has, and that is Himself or the vision of His whole essence. This gift is called the Holy Spirit. This unqualified integrity coupled with infinity ensure that God has the holiest personality, i.e., that He is a perfectly moral being. Note that in God, the self-regarding and other-regarding virtues are one. God’s relations to His creatures are contained virtually in the Father’s relation to the Son. [C] On the level of happiness, we see that God is a unity. God’s essence as a thinking being is manifested in God’s having thoughts. What are the thoughts about? Himself. God comprehends Himself in a single self-image or self-conception. But comprehending oneself which in this case is holding of one’s image in one’s mind is owning oneself which pertains to power. (God’s power to create the world is due to His 3rd level of goodness.) Further, since God’s happiness lies not in anything outside God but rather within Himself, for God, love of concupiscence is the same as love of self. In keeping Himself in His mind, God ipso facto unites Himself and His understanding of Himself. But love is the only 2nd-level unitive force. Hence, God to His thought is as lover to the beloved. Insofar as God loves the thing He owns, He loves and enjoys Himself. We see that the act of God’s intellect, the act of His power, and act of His will are one and the same thing, namely, God’s conceiving and contemplating Himself. Consequently, the distinction between the three faculties is illusory. God is one and supremely so. When it comes to virtue, God is fully self-conscious; when it comes to happiness, He is fully self-forgetful. God gives it all He has got (which is both necessary and sufficient); He does not hold back any of His powers from “achieving” happiness, in whatever it lies, such as in His self-contemplation augmented after creation with perfectly executed care for His children. Two things can be predicated of God’s happiness: (1) that it is unmixed with any sorrow, except insofar as the sorrows of men are felt in the union of God and humanity through love by all so united; and (2) that it is infinite,

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e.g., God’s capacity for joy meets with no limitations. An important caveat here is that God is pure act. In Him, there is no real distinction between nature, virtue, and happiness. We can see that the human and divine natures are the same, consisting of the now familiar three faculties. Here the things attributed to God and creatures can be univocal. The human and divine personalities are completely different or different in kind, because God is a Trinity, and man is not. Predication in this case is equivocal. The human and divine happiness are different in degree, because God is perfectly happy, and man is and can only be happy imperfectly. Regarding this, names are said of God and creatures analogically. Consider the distinction between a good and loving a good in terms of the difference between judgment (an act of the intellect: good / evil) and sentiment (an act of the will: loving / hating). Suppose that a thing is good if and to the extent that it brings pleasure. Goodness, therefore, seems to be a completely derivative notion, defined exclusively in terms of the satisfaction it fosters in the lover. I will grant that, but this piece of reasoning holds true only in the case of physical goods. The reason to keep judgment and love separate is in order to account for the different directions of causation for physical, moral, and metaphysical goods. For physical goods, goodness is indeed reducible to pleasure: “I see that you like it; no wonder you say it is good (for you).” Economics studies exclusively these goods. But for metaphysical goods, causation runs in the opposite direction: “It is good, so it is obvious why you (and everyone else) cannot help but love it.” Consider Socrates again, only this time, he is infected with deadly bacteria. Now both Socrates and bacteria have more-or-less objective essences and therefore, a modicum of metaphysical goodness, having a claim on our love (or at least, regard) for them. As St. Thomas would say, everything that exists is good and good to the extent that it exists. Two points, however, make this situation interesting. First, Socrates and the bacteria are natural enemies. Second, Socrates’ nature is far more perfect than the nature of the bacteria. As Peter Kreeft explains, we recognize the inherent superiority of all those ways of being that expand possibilities, free us from the constricting confines of matter, and allow us to share in, enrich and be enriched by, the being of other things. In other words, we all recognize that intelligent being is better than unintelligent being; that a being able to give and receive love is better than one that cannot; that our way of being is better, richer, and fuller than

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In other words, that Socrates is metaphysically better than bacteria is true ad sapientes or self-evidently from “wisdom.” But wherein there is a conflict of interest such as postulated here, the more perfect wins over the less perfect, and so, we are permitted to will good to Socrates in desiring him to recover and to will evil to the bacteria in designing for it a speedy death. Finally, in moral good, judgment and love complement each other. It is asked, separately: (1) “Are you good? Do you measure up to a such-and-such ideal?” and (2) “Do you love your goodness and hate your privation of goodness, i.e., where you fall short?” One is a just person only if both questions are answered in the affirmative. St. Thomas insists that wisdom has a particular affinity with charity. We might say that innocence without wisdom is as bad as wisdom without innocence. I suggest that this is so for two reasons. First, the general reason is that judgment of all three kinds and not just wisdom is linked with love of all kinds and not just charity-love. Second, the particular reason is that wisdom is used to judge God’s goodness. To the question, “Is it possible to be mistaken in judgment?” I reply that in the case of physical goods, since love compels judgment, and one cannot be mistaken about what he at the moment of choice loves the most, it is only possible to be imprudent with respect to means but not to ultimate ends. In the case of metaphysical goods, since judgment compels love, it is easy enough to make a mistake, such that those who judge aright are called wise, and those who judge poorly are called foolish. E.g., a person might think foolishly that the welfare of the “planet,” whatever that might be, has priority over the welfare of human beings. With respect to moral goods, one can indeed be a “good judge of character” or a poor one, either one’s own or another man’s. But since in ethics, justice and love cooperate in forming goodness, one may be morally perverse in both judging incorrectly and loving viciously. In a Smullyanian twist, making both mistakes is similar to making none: a man who erroneously judges courage to be a vice and maliciously loves it for being vicious (e.g., wills it to other people in an attempt to harm them) is attracted to the same thing as a man who correctly judges courage to be a virtue and charitably loves it for that. 35. THAT PHYSICAL, MORAL, AND METAPHYSICAL GOODS ARE

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The metaethical theory of emotivism appears to suffer from the “implied error problem.” Some versions of emotivism argue that judgments are “projected” onto the world, creating fictional, though taken seriously, properties. Thus, torturing the cat is not really wrong; the wrongness of this is “just a projection of our discomfiture or horror” or, in Hume’s words, “gilding and staining all natural objects with the colors borrowed from internal sentiment.” (Miller 2008: 39-40) Are we really prepared to commit to the view that the wrongness of torture is just a subjective opinion? Is there no reality to moral good and evil? We have already seen the distinction between virtues and arts and between other-regarding virtues and self-regarding virtues. Before we proceed, let us summarize these distinctions in Table I.35.1. From Nature Habits other-regarding metaphysics virtues inborn self-regarding talents virtues

Nature For

Habits Happiness

interests

lifestyle

Happiness economics acquired arts, techniques deeds, enjoyment

TABLE I.35.1. TRINITIES CONNECTIONS

[I] Now with physical goods, projection is exactly what we do. X is a capital or useful good for Smith, because it participates in his production process. (I will examine the subjective aspect of the capital structure in (I, 48).) The plan in Smith’s mind to produce something incorporates X which makes X good. “There is nothing either good or bad, but thinking makes it so,” Shakespeare wrote. Trash may be an economic bad for Smith (he has to work to get rid of it), but the same trash can be an economic good for a recycling company, constituting its capital. I find classical music to be good, because I enjoy it; and rap music to be bad, because I cannot stand it. Someone else’s attitudes may be different, and there is nothing economically objectionable about that. An important argument in favor of individual liberty is precisely that it allows people with widely divergent preferences to co-exist and enjoy the amenities of civilization in peace. While there is in most nations something that may be called “popular culture,” in fact, everyone decides for himself which (if any) part of that culture he will enjoy or contribute to.

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It is popular only because many people’s tastes agree. So, physical goods are certainly projections: we are all value-givers. Subjectivism, and economics as a science, Mises writes, takes the ultimate ends chosen by acting man as data, it is entirely neutral with regard to them, and it refrains from passing any value judgments. The only standard which it applies is whether or not the means chosen are fit for the attainment of the ends aimed at. If Eudaemonism says happiness, if Utilitarianism and economics say utility, we must interpret these terms in a subjectivistic way as that which acting man aims at because it is desirable in his eyes. (1996: 21) Subjectivism, or connecting utility with price on the basis of the law of marginal utility and law of marginal cost (or their equivalent of demand and supply schedules), states that the price or price segments, at which an exchange will occur, are determined by the synthesis of the individual values scales of every buyer and seller. Straightforwardly, subjective values scales translate into objective exchange ratios and therefore, prices. Note that utility or more generally, value is both relativistic and defined recursively. In economics, the value of end E1 is measured by the fact that ends E2 - En that also had value were sacrificed or forgone in order to attain E1. The recursion has to end somewhere, which is why we must admit that some (though certainly not the best) things in life are free. In a manner of speaking, economists are reality checkers (or trickster imps?), asking in response to “I want that,” “What would you be willing to give up for this thing’s sake?” By considering end E2 that would have been picked without E1, end E3 that would have replaced E1 and E2, and so on, we obtain a values scale. Yet though we insist that the neglected ends are used to assess the urgency of the chosen end, we deny, as neoclassicals affirm, that the latter is in any way equal to the former. [II] Things are different with moral goods. A man is moral if (1) his ideals are sufficiently robust; (2) he conforms to those ideals; and (3) he loves the self he has thereby built. Thus, if he does not enjoy his moral goodness, then his virtue is unstable; he may be actively taking steps to convert his virtue into vice, and he may easily succeed. Let us examine a few cases. (1) Suppose that A thinks himself moral, because he imagines himself to be a great warrior fighting for a noble cause. But B dumps a

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bucket of cold water on A, saying that A is a mere bovarist who sold out or whose cause is absurd. One might accuse A of failing to satisfy (1). (2) A drug addict is fighting for self-control within himself. Even if his battle is valiant, he is not moral due to failing to satisfy (2). (3) A person considers helping his grandmother to be his duty, but he hates the sacrifices he has to make for her sake. He gets no karma points, because (3) does not hold for him. To use the terms introduced in (I, 30), he has a good routine or lifestyle without yet having the virtuous habit. (4) Smith is leading a “normal” life, when one day he gets an epiphany: he needs, he decides, to sell all his possessions, give the money to the poor, and become a hermit. As he now looks at his previous life, he is disgusted by how blind and materialistic he was. Smith has thereby designed a new ethic for himself whose demands exceed the old one’s. This is an instance of supererogation or an upgrade of one’s moral ideals. (5) In a certain society, sufficiently old bachelors are distrusted until they get married. So, being a bachelor is not in conformity with the social moorings. But a person may decide to renounce marriage for the sake of the kingdom of heaven. Is he moral? The answer is, to the extent that (1)-(3) hold for him. For moral goods, Smith’s enjoying being who he is is not sufficient grounds to conclude that Smith is a good man. He may be a comic book criminal mastermind who conforms very well to numerous vices (e.g., he is “good thief” or “clever liar”) and has great fun plotting to take over the world. He may be a dreamer who enjoys contemplating high moral ideals without taking steps actually to conform to them. In US politics, the Democrats are the stupid party, always bothering people with perverse moralizing and bad principles. The Republicans are the evil party, having no principles at all, whether good or bad. Yet the members of both, presumably, have high self-esteem. Since moral goodness is not projectable, emotivism fails. Moral good then is intersubjective. Intersubjectivity claims that it takes at least two for morality and for moral properties of actions and persons to come into being. Morality is always between two or more persons; it is irreducibly social. There are the (Mi) self-regarding virtues of a single individual that justify his trinity within and (Ms) other-regarding metaphysical morality governing interactions between individuals in society. With respect to the latter, two types of morality are identifiable: commutative and distributive. Commutative morality is some version of utilitarianism. It seeks to satisfy as many preferences as possible. It takes people as it finds them and takes preferences as given. Happiness, in

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utilitarian understanding, is satisfaction of desires, whatever they are. E.g., if Smith wants to kill Jones, then Smith’s desire to kill has to be weighed against Jones’ desire not to be killed. No one is privileged; the law arises out of agreement; and the law-making process ought to be such, according to commutativism, that the laws are “efficient” or guide behavior into its most productive, as subjectively decided by the lawmakers, outlets. For commutative morality, the prudence of Mi is converted to utilitarianism of Ms. Now morality by its nature requires sacrifices of “apparent” 1st-order pleasures. Since utilitarianism is concerned precisely with maximizing such pleasures, the only sense in which sacrifices are admitted in Mi is via opportunity costs of choosing. In a heavenly society whose members are bound by love into a single will, there are no genuine sacrifices either. Thus, Ms is not so much an ethic as it is instructions for this world on how and to whom to allocate happiness. Distributive morality comes into existence by being given from a ruler to a subject. Contrary to utilitarianism, it does not take desires as given. It asks: Is this desire a worthy one? Ought it to be satisfied? Is the subject conformed to the goodness or perfection of the ruler, such that the subject’s desires are somehow proper to him? Thus, “integritism,” as I have come to call distributive morality, complements utilitarianism in that it asks that only holy, cleansed desires, whatever that means exactly, be satisfied. All other desires must be extinguished or set aside as not befitting the dignity of man and his true and higher self. Only then, that is, after they have been purified, can people govern themselves and agree with one another on policy as commutative law. Distributive morality posits ideals for people to live up to. Preferences are not ultimate givens, according to this view; they can be judged as good or bad, true or false, worthy or unworthy. Only the desires of a saintly man or woman can claim the right to be fulfilled. The rest ought to learn be godly first. An obvious question with respect to any distributive morality is: Who has the authority to lay down duties for me? In the political philosophy of the Middle Ages it was thought that one of the functions of the state was to make the citizens good, i.e., to look after the distributive morality. “A law is nothing else than a dictate of reason in the ruler by whom his subjects are governed,” says St. Thomas. “The proper effect of law is to lead its subjects to their proper virtue: and since virtue is ‘that which makes its subject good,’ it follows that the proper effect of law is to make those to whom it is given, good, either simply or in some particular respect.” (ST, II-I, 92, 1) This is no longer the received view, though its echoes still exist in, e.g., the Drug Prohibition, in which dogooders of various stripes eagerly try to reform us poor sinners.

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The Prohibition is interesting as a case study of human fanaticism. I suppose that the reason for outlawry of drugs may have something to do with the idea that drugs “cloud the mind” and hinder contemplation. It is certainly a sobering thought that the anti-drug movement that started with a wish to uplift the wretched masses has ended up with savage violence on a truly epic scale. Many people consider drug buyers and sellers to be disgusting vermin to be exterminated or shoved into a government cage. They aim to cleanse the earth from the “impure.” But the impure dare to resist. A total war is inevitable. However, that is not the ultimate argument against the Drug Prohibition. The Prohibition is outrageous, not because “it’s filled our land with vice and crime,” as the song goes, although it did that, but because people are prevented from enjoying themselves in whatever manner they see fit. It is up to each individual to decide when, if at all, he will contemplate, and when and how he wants to enjoy “lower” pleasures. The government destroys happiness both in general and in this particular case. Let the reader recall the last time he bought a bottle of wine. He probably scarcely realized that “moralists” would have raped his behind, if he lived during the “Noble” Experiment. Does morality really change arbitrarily based on the declarations of legislatures? But if it is wonderful to be able to enjoy alcohol, then why not drugs? Of course, the difference between the Drug Prohibition quality drugs and the far milder and safer drugs that would undoubtedly be developed under lawful drug use is the same as the difference between the Alcohol Prohibition moonshine that could blind a man and sophisticated and delicious spirits that are perfectly respectable. Then there is the matter of justice. Consider that the drug war going on in Mexico – I doubt that I will take away from the “timelessness” of this book by referring to it, as it will continue uninterrupted for as long as drugs are illegal, and an end to that is surely not in sight – is a private war between the Prohibition-induced militarized drug producers and the naturally militarized government. The gang of G-men, as it were, battles against gangs of drug-men. The citizens are collateral damage. Yet it was the government that made this war a reality by imposing and enforcing the Drug Prohibition. The drug-men could be said to be fighting for their natural right peacefully to produce private goods for the consumers. The drug-men have the right to continue in their occupation of drug manufacture, and the government is being unjust in outlawing their trade and punishing them for it. The drug-men are in the right in jus ad bellum if obviously not in jus ad bello. But the latter injustice, too, was an easily foreseen consequence of the Drug Prohibition.

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The drug dealers fight not only the state but also each other. As Robert Murphy (2010) points out, the costs of doing business to a midlevel drug boss consist not inconsiderably in the risk of being imprisoned by the state or killed by rivals or underlings. This cost is largely the same whether the drug dealer controls a larger territory or smaller. (In addition, as we have seen, a business cannot evenly rotate for long: it ether grows or shrinks. Our drug dealer needs to go up, if he wants to stay ahead and stay alive.) Since the costs are fixed, the profits can be dramatically enhanced by a capture of a neighboring drug lord’s territory. He gives several more reasons for violence under prohibition, such as that the step from being a peaceful drug dealer to a violent one is much smaller than the step from being a legitimate and respectable businessman to a criminal, because the drug dealer is already an outlaw. Let me suggest another couple of reasons. [A] The state’s role here is not to protect transactions between drug dealers and their customers but on the contrary, to disrupt them. One drug dealer cannot sue another one and have the executive branch of the state enforce the verdict. Enforcement is “private,” which leads to greater violence overall. [B] In the illegal drug industry, creative advance is limited. Innovation is deterred. (1) There are high costs or even impossibility of advertising. (2) There is the difficulty of finding decent scientists who would agree to work illegally. (3) There is little quality control: I cannot look for customer reviews of drug retailers and their goods on the web. (4) The business favors highly concentrated and very potent drugs, because they are easier to smuggle, but those are hardly the most fun or safe drugs. (5) I cannot order online but must shop at the local market. Since prohibition makes it harder for drug producers to compete with each other for customers by continuously offering to the them better and cheaper products, it becomes so much more lucrative to go to war. A society in which drug use is legal will be both happier and more just. There is every reason to choose freedom. Even if people no longer assign to the state the position of society’s moral guardian as blithely as they used to, ask anybody, and he will tell you that being commutatively moral is certainly a key task of the state. The state, the modern opinion asserts, is to look after the common good. It is supposed to be a good utilitarian, manipulating the subjects with a wide variety of carrots and sticks. However, it is hardly the proper function of the government to entangle the populace and businesses in a web of bureaucratic mandates, injunctions, and incentives. Consider the difference that I have so far described with regard to abortion laws. Are these laws to be treated as commutative, having

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arisen out of complex political maneuvering of the various factions involved in the dispute, with the pro-abortion faction having been revealed as so far the stronger and hence, victorious? Or are our attitudes towards abortion to be thought of as the subject of distributive morality? Is it ordained from above that pro-choicers are evil and that their preferences are to be held in contempt and actually thwarted? Or is it similarly ordained from above that a woman is the sole master of her own body and that those who would hamper her are a disreputable bunch? If we want to find out whether this issue belongs to commutative or distributive morality, then we can ask: Would the pro-lifers be satisfied, if the pro-choicers were to chip in and pay them money to drop the subject altogether and allow abortions to happen unimpeded? Or would the pro-choicers be happy, if the pro-lifers collected enough cash and paid them, if they agreed not to interfere with efforts to outlaw abortions? If the answer to at least one of these questions is “yes,” then, to paraphrase Winston Churchill’s apocryphal exchange with a socialite, “We have already established what kind of people they are. Now we are just haggling about the price.” This is the essence of temptations, wherein one is asked to betray himself for a price, to fail to his own self to be true. Narrow happiness is preferred to holiness, but just as the first end of nature has priority over the second end of virtue, so, virtue is prior to the last end of happiness. A vile man has no right to be happy in the first place. Otherwise, this is a matter of distributive morality, wherein what is good is what is most approved; rather than commutative morality, wherein what is good is what is most enjoyed. Morality remains intersubjective whether it is commutative or distributive: in the first case, the conformance is to the agreement; in the second, to a moral ideal. For self-regarding virtues, a correspondence can be drawn between the trinity within and the divine Trinity. The results may be gleaned from St. Thomas’ disquisition on the effects of sin. There are three, according to him; the first is called “corruption of nature.” This is nothing else than the “father” in one becoming weaker, stupider, less demanding. It shakes his moral ideals. The second is “debt of punishment,” corresponding to the “son”; and the third is a “stain on the soul,” corresponding to one’s diminished love for oneself (because the stain makes the soul uglier and less lovable) or the “spirit.” Plainly, the effects of sin are: 1. Shame (opposed to glory), if one’s ideal is low or bad. For example, if Smith at one time felt that wallowing in his own filth like a pig or drinking himself into a stupor was a nice way of

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Summa Against the Keynesians enjoying himself, and then he realizes that it is not, then he will be ashamed of himself for demeaning himself in this way. This is what an intemperate man mentioned in (I, 31) will feel. 2. Guilt (opposed to righteousness), if one’s ideal is good, and he knows it but is too weak, with temptations being his bane, to conform to it. This is the punishment of an incontinent man. 3. Honorable sloth or insensitivity, insofar as one loses interest in his own narrow happiness, because he has forsaken virtue. One loves himself less and therefore, wills less physical good or wills physical good less intensely to himself.

That is also why the traditional penance includes prayer, fasting, and almsgiving. In prayer, one asks forgiveness and restoration of partially corrupted nature; in fasting, one denies to himself narrow pleasures in recognition of being “less worthy” of them; and in almsgiving, one pays the debt of punishment and once again conforms his soul to the good. [III] Metaphysical goods are objectively good; they have powers, and they are not afraid to use them. They act, and in general, acting is superior to being acted on. This is because, first, an agent has the locus of autonomous power within itself. Act follows upon nature and being and reveals both. The patient, on the contrary, is inert, without power to influence events. Clearly, power is a great-making property, and an agent is ontologically superior to a patient (again, from wisdom). It may be objected that while an agent has the power to affect other things, a patient has the power to be affected by other things. Can we not judge them then as equally great? This brings me to the second difference. An agent need not change as a result of acting, while a patient always changes. Therefore, an agent has an aspect of perfection which a patient does not have. In a similar vein, an agent is firm and unyielding and impassible, while a patient is soft and malleable and is controlled by its environment. And independence and autonomy are virtues and greatmaking qualities. Third, with respect to the agent, it is it that is acting. It has an identity; it is something. Acting affirms the goodness of the agent, for it molds other things in its image and likeness (for some effects resemble their causes), and it makes no apologies for its influence on them. A patient, on the other hand, affirms only its evil. For evil is a privation of good that can and ought to be there, and goodness is actuality, and a patient is a mere potentiality – it can be A or B or C or … Our patient is undefined, undetermined; it has no identity as yet, just as in physics

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potential energy can be converted into many different forms of actual energy. Now it is true that potentiality is not non-existence. But neither is it actuality. And it is true that a merely potential being can, upon its actualization, exceed in greatness some actual agent. But until that selfmaking takes place, its lack of selfhood makes it inferior to any agent. Yang and yin can be interpreted in two ways, namely, as either act / potency duality or good / evil duality, with good defined as that which creates act out of potency, and evil, as that which shreds act into potency. These notions are profoundly non-trivial, e.g., a local act can conduce to global potency and vice versa. •

Metaphysically, act and potency form the most general structure of the world and are both good.

•

Physically, potency is evil per se but good per accidens or in its possible consequences.

•

Morally, potency is evil in both ways, insofar as the wages of sin is death. When one does evil, yet God brings good out of it, it is glory to God and shame to the evildoer.

For example, for any finite actuality A, there exists potentiality P, such that P coupled with sufficient constructive work on it results in some actuality A’ which exceeds A in goodness. It is often the case that some inferior actualities are explicitly broken, crumbled into prime matter, so that something new and better may be constructed. The purpose of potency is to provide the raw materials out of which act will be built. Finally, act is better than potency all things being equal. For humans, suffering is precisely potency which, given enough effort, yields the actuality of happiness. Suffering is an impetus to action that alleviates suffering; moreover, there are numerous ways to develop oneself and one’s own lot in life. Are you dissatisfied in life? Take up… X, and each person finds his own X. In our world, yin is stronger than yang in the long run, because everything dies, or so it might seem to a mind unenlightened by religion. But in the short run, the allure of life triumphs. For example, I already mentioned the idea of moderate scarcity. Under such conditions, the forces of life, sustaining and nurturing man, and the forces of death, adversarial to him, challenging him to fight and improve his conditions, are in a rough balance that is most conducive to economic development. Insofar as the world contains plenty of moderately scarce environments, it is wisely designed.

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To sum it up, an agent is superior to a patient, because (1) it already has become what the patient is still in the process of becoming; (2) it is a force to be reckoned with, whereas a patient must yield to the power of its maker; (3) perfection and independence require actuality with as little admixture of potentiality in it as possible; and (4) agents affirm their own goodness – they stand tall and unashamed of their manipulation of the rest of the world, possessing, in Pascal’s words, the “dignity of causation,” while patients are undefined, without permanent identity, and subject to the whims of other entities regarding their destiny. As argued in the previous chapter, metaphysical goodness depends on one’s ability positively to affect others. The greater one’s power to do (all three kinds of) good to others, the more exalted one’s nature is. But such influence is exercised only by agents and not by patients. Metaphysical goods have a stubborn presence; they will not go away, and their sway demands to be noticed and judged wisely. Again, they are good to the extent that they exist and make their presence felt. 36. THAT EVIL IS COUNTERPOSED TO EVERY KIND OF GOOD God is perfect on every level, as per (I, 29), yet no creature that emanates from God is such. All created nature is a) metaphysically imperfect; moreover, it is imperfect essentially, necessarily. No being that does not have a divine nature, including the universe as whole, can ever in principle be without fault or flaw with respect to its essence. Metaphysical evil and defects are everywhere in us and in our surroundings. Now the universe can legitimately be called “perfect,” but by that two things are meant: one, b) suitability for a purpose, whatever it may be, such as soul-making (i.e., the making of holy men and women, folks who are part of the totality of communion of saints and worthy of personal happiness), for which the universe is presumably very well tailored37; and two, 37

NB: That the world is perfect for soul-making does not (and need not) mean that the souls made in it are perfect. Each person makes himself however he can and presents his work to God for evaluation.

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c) the fact that the universe contains all grades of being, from ants to angels, from “prime matter” to God.38 What I would never say is that the universe is perfect metaphysically. The fourth and perhaps, final meaning of “perfection” is d) the perfection of the human body and the paradisiacal external environment made exquisitely fit for human habitation, in which there is no pain nor sorrow nor illness nor sin; and the world is obviously not perfect in this sense. [I] Examples of metaphysical evils abound: scarcity; the inevitability of death; temporal as opposed to eternal existence combined with the weakness of both memory and foresight; practical unavoidability of errors in life, including those from which one cannot recover; natural poverty39; unlimited wants coupled with the paucity of power to satisfy them; proneness to moral corruption (being corrupt, e.g., having a vicious character, is, indeed, a moral evil, but proneness to corruption is part of human nature and therefore, is a metaphysical evil); to take complementary examples from physics and moral theology, entropy that wears on the body and temptations that wear on the soul; and suchlike. As suggested in the previous chapter, metaphysical evil takes 38

This reason was suggested to me by James Chastek. Given (b) and (c), if God were to create another world, then He would merely be repeating what He has already done in this one. He could not top Himself. In other words, goodness engages in two distinct acts of creation. First, it creates the absolutely best thing, which is the 2nd-level God; second, it creates a universe filled with numerous creatures of every rank, from the worst to the best, exclusive. 39 Strictly speaking, poverty is not an evil. Though poverty is, indeed, an absence or privation of a good, namely of wealth, nevertheless, it is not a privation of anything that in any sense ought to be there. Blindness is an evil in a man but not in a stone, because the stone is not supposed to see in the first place. Similarly, it is not written anywhere or, to reuse a phrase, ordained from above that man ought to be wealthy. Thus, poverty is not an evil, though wealth is good. This definition of evil gives us a distinctively Western reason for holding that evil (though not good) is an illusion. To the objection that suffering feels real, I reply that for any instance of evil, whether physical, moral, or metaphysical, it may be asked: “Why should the opposite to it good be?” “Who promised you a happy life?” “Who breaks his contract with you, if you suffer or die?” “Who except you is responsible, if you are a vicious person?” Good has no reason to exist, unless one wills it and brings it about.

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the form of apparent (1) evil per se or defects of created nature and (2) evil per accidens or the fate of human beings to suffer. At the same time, everything likes being what it is (if it did not, then it would not live for long). I enjoy being human, for example, and would want to turn into neither a frog below the level of perfection of my nature nor an angel above. The alleged metaphysical evil per se is nothing of the sort but is actually good! That a person is able to feel pain and anguish seems bad, too, until one realizes that this again is part of the design of the world and a good thing. Without the duality of suffering and pleasure, there would be no thinking, no action, and no soul-making. The evil per accidens, then, is also only apparent, and to a novice in philosophy. Of some interest is Barnbaum’s (2008) objection to the soulmaking position: it relegates persons with disabilities to a lesser status. On the soul-making view, a person with autism has a paltry supporting role in the life story of healthy protagonists who come to acquire a richer understanding of the world thanks to the participation of an autistic person in their lives. Unquestionably, this falls far short of treating a person with autism as a moral equal. Persons with autism should not be used merely as a means of character development for non-autistic persons. (103) Now soul-making entails two things: coming to love others and becoming lovable oneself. The former requires an improvement in one’s nature; the latter, improvements in one’s virtue and happiness trinities. Overcoming the evil of all 3 kinds in other people helps one to learn to love or acquire metaphysical good; overcoming the moral and physical evil in oneself helps one to become lovable. Soul-making occurs in the process of converting such evils into these goods. It is true that if a person is incapable of doing so, then his sojourn in this world is entirely wasted. However, evil, especially physical evil which is the most prominent and striking of all, is suffered by absolutely everyone. One does not have to look far to find unhappiness. If autistic people can themselves perform the conversion, then they are in no wise relegated to a lesser status. There is no clear distinction between the “star players” and the “supporting cast there to make the stars (look) good.” Good and evil are dispersed in the world in extremely subtle and complex ways, and no one can claim to be fully a “winner” or a “loser.” (104) Further, it is a calumny to claim that we “use” each other for self-improvement. Good deeds, works of mercy are not performed for

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the sake of halo polishing, i.e., so that we can feel good about ourselves, but so that we could feel other people’s pleasure – now the work partially of our hands – through friendly communion with them. If there are “useful” rational agents in the world to whom, however, no reciprocal consideration (if being in need of help can be called that) is due, then they would have to be demons who are already confirmed in evil40: “But man’s welfare is disposed by divine providence in two ways: first of all, directly, when a man is brought unto good and withheld from evil; and this is fittingly done through the good angels. In another way, indirectly, as when anyone assailed is exercised by fighting against opposition. It was fitting for this procuring of man’s welfare to be brought about through the wicked spirits, lest they should cease to be of service in the natural order.” (ST, I, 64, 4) “That the demons are useful to us is due not to their intention but to the ordering of divine providence; hence this leads us to be friends, not with them, but with God, who turns their perverse intention to our profit.” (II-II, 25, 11, reply 3) These conclusions are well in accord with the classical picture of the world: creation is metaphysically good, morally evil (meaning that without divine assistance, by using his natural powers only, man cannot become lovable enough to be dear to God and obtain thereby from Him eternal life) and physically ambivalent. Philosophers have wondered whether the idea of the best possible world even makes sense. Six billion people living presently seem like a lot, but cannot the world be improved by an addition of another human being? If God were to snap His fingers and create another person, would not the universe thereby become even better? But any 40 This is another way in which the universe is complete. One remarkable aspect of all earthly creatures is that they seem to ascend. Restricting now our attention to humans, they seek their own true happiness and are, as one, directed toward good. They start out as mere single-celled organisms. They grow. They strive. They improve. They end up in heaven in the end. If all life forms behaved this way, however, then there would definitely be a gap in the universe: things that on the contrary descended would be absent. Enter Lucifer, a being essentially corrupt, a murderer from the beginning. This understanding neatly solves the apparent scandal of why God’s best creature fell. The reason is obvious: if you want to descend, you may as well start from the very top. Thus, humans ascend, good angels stay put, and demons descend. It will not do to conclude from this that good is too weak to exist without evil. On the contrary, it is precisely the fact that good is not so weak as to be defeated by evil that permits a completed universe to exist with creatures not only of every manner of present perfection but also traveling in different moral directions.

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finite universe can be energized in this manner, and therefore, no universe can be best. The reply is that the metaphysical goodness of the world lies in not in the number of people in it per se (though it belongs to God to be prolific in creating) but in fostering the self-making of human beings. God cannot add another man to it except through the world’s “user interface” (apparently, of His own design), i.e., parents’ own unforced by God decision to add a child to their family. Another perennial problem is of compatibility of evil and God’s goodness. But formidable though it is for a theist, evil is not necessarily better evidence for naturalism than it is for theism, because theism, too, predicts a battlefield Earth, a bleak yet full of potential, vast but finite world suspended between heaven and hell, in which human souls are forged.41 The interesting question is: given the soul of man, did he and his environment evolve their complexity in a dance of some sort of random mutations and natural selection; or were the body and the environment designed around man to accommodate God’s interest in creating a challenge for man to overcome and an opportunity to grow in goodness? Or both, with the evolutionary process being a small part in God’s toolkit? [II] Examples of moral evils are: failure to live up to a half-decent ideal, crimes committed against other people, narrow self-interestedness, and the like. [III] Examples of physical evils are: pain of sense, pain of loss, sorrow, depression, moral fanaticism, and so forth. Again, 1. a particular instance of pain is a physical evil; 2. if that physical evil is unjustly inflicted on one person by another, then this crime itself is an instance of moral evil; 41

It follows in conjunction with the previous note that not only recognizing that evil is a “problem,” but even any conception of evil as such must be deeply religious. That it ought to be “on earth as it is in heaven” but is not presupposes a good God who mysteriously permits us to live in a non-heavenly environment. Suffering for an atheist is merely bad not evil. Uncanny wisdom and with it, knowledge and understanding are required for the construction of any decent theodicy, because one is under the necessity to show how numerous laws according to which the world works that allow evil, nevertheless, each alone and all together, contribute to the good of the universe as a whole, such that this universe would be worse without them. At the same time, some burden of proof should be placed on the atheist. If one claims that this world is not the best possible one, then he owes us a reasonably coherent and complete vision of a better world.

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3. finally, the “existential” fact that pain is unavoidable in the life of a human being is a metaphysical evil, a fundamental and inescapable limitation of the world. 37. THAT MARGINAL ANALYSIS COMPLETES SUBJECTIVISM We are about to emerge from the thicket of philosophy and get back into pure economic theory. Subjectivism regarding physical goods is naturally paired with marginalism. As an example of thinking “on the margin,” consider the following. Suppose that a newspaper editor is deciding whether to include a new and funny comic strip in the newspaper. If he does, then there will arise three classes of people. First, there will be people who will not read the newspaper, even if it has the new comic; third, there will be people who will read the newspaper, even if it does not have the comic. But there will also be, perhaps small, a second group of people, for whom this comic makes a difference between reading and not reading the newspaper. They would not read without the comic but would read with the comic. These are the people the editor is concerned about. We can go further. Of the people who merely read the newspaper (e.g., abandoned papers in the coffee shop) – who will now include the second group above – some will actually buy it. Of those, some will buy it even without the comic; others will not buy it even with the comic, yet there will also likely be individuals on the margin who will change their stance from being freeloaders to paying for their papers. Again, that is the group the editor has in mind when making the choice whether or not to include the comic into the newspaper. The same analysis can continue. Of the people who buy, some will actually subscribe. The comic will make a difference for the marginal group of people who will decide to become new subscribers solely because of the comic. They “really like” the newspaper already, and the comic makes the paper so good in their subjective estimation that it acts as the “final straw that breaks the camel’s back”; it pushes them “over the edge”; that is, it impels these marginal buyers to subscribe. In each case, the cost of the comic is compared with the revenue from new buyers, subscribers, ads, and suchlike. This is where the virtue of prudence shines; but entrepreneurial courage is in the background. Someone had to create an entertaining comic and pitch it to the editor; the editor is estimating the new demand and knows that other newspapers and other types of competitors are at this very time scheming to lure his readers away. All sorts of risk and uncertainty are being borne.

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Again, let the government of Ruritania decide to go to war with Waldavia. As part of preparations for the war, in order to drum up public support, the Ruritanian state engages in heavy propaganda. Its aim is to change the opinion of marginal individuals. For, as before, most citizens will either support the war even without the propaganda or oppose the war even after being exposed to the propaganda. But some folks who sit on the margin will be converted, which is precisely the aim of the propagandists. An “economic” example is an increase in the quantity supplied of a good due to a decrease in marginal costs. The aim here is to capture the revenue from those marginal buyers who would not pay the old price but who would pay the new price. The demand and supply curves arise due to diminishing marginal utility of adding an extra item to one’s collection, its mirror image of increasing marginal disutility of losing an extra item, and increasing marginal cost of employing an extra factor of production. Bade (2009) explains informally the law of marginal utility as follows: “If you’ve been studying hard and haven’t seen a movie this week, your marginal benefit from seeing your next movie is large. But if you’ve been on a movie binge this week, you now want a break and your marginal benefit from seeing your next movie is small.” (12) This is quite beside the point; the law of marginal utility has nothing to do with the psychological phenomenon of “satiation.” It is an a priori theorem. If Smith has 6 horses, then another horse added to his stock will be put to the least valued use out of the 7 possible employment possibilities that Smith can identify for his beasts. At the very least, one of the 7 horses, assuming they are all identical, will be reallocated to the use ranked 7th most urgent on the Smith’s values scale. That use will give to Smith less happiness than the use toward which the 6th horse is assigned. The textbook example is slightly more complex. Let me assume that 3 movies are available to be seen this week. The movie watched on Monday will be the best one, as subjectively determined by the student. The movie watched on Tuesday will be second best, etc. Thus, the utility of each movie declines. This is because it is less painful to wait a day for the pleasure of watching a worse movie than for the pleasure of watching a better movie. Minimizing the disutility of waiting (a crucial concept to be developed in (I, 41)) and maximizing psychic profit ensure that the best movie out of the total supply will always be seen first. (I do not mean that “rational” people will use this strategy; I mean that the movie seen first will by definition be expected to be the best one.) The same book explains the shape of the production possibility frontier by saying that when the amount of good A produced is small

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(and the amount of good B produced is large), the opportunity cost of increasing A is small, because the people working on A are best at this activity and worst at producing B. Reallocating resources toward producing A will transform the worst workers employed at making B into the best workers employed at making A. This is a grotesque confusion of physical productivity with value productivity. I will describe the matter in two ways. Since a lot of B is being produced, its price is low; therefore, each unit of B supplies the firm making it with only a bit of revenue; which, in turn, means that a marginal factor employed in making B is not very productive; as possibly opposed to a marginal factor employed in making A. (What is not definite, contra the textbook, is that such a factor produces more physical units of A than units of B; or that an incompetent employee working on B can miraculously become a great expert on A.) Shifting some factors from producing B to producing A may make sense. An alternate explanation is that with lots of B being manufactured, again, B’s price is low, such that even those people who do not value B very much will buy it. If we give up an extra B, little consumer happiness will be lost. On the other hand, substituting an extra A for an extra B, given a low number of As produced, may yield greater happiness than that given up. It is always important to identify the marginal unit. Rothbard points out: For example, it is erroneous to argue as follows: Eggs are the good in question. It is possible that a man needs four eggs to bake a cake. In that case, the second egg may be used for a less urgent use than the first egg, and the third egg for a less urgent use than the second. However, since the fourth egg allows a cake to be produced that would not otherwise be available, the marginal utility of the fourth egg is greater than that of the third egg. This argument neglects the fact that a “good” is not the physical material, but any material whatever of which the units will constitute an equally serviceable supply. Since the fourth egg is not equally serviceable and interchangeable with the first egg, the two eggs are not units of the same supply, and therefore, the law of marginal utility does not apply to this case at all. To treat eggs in this case as homogeneous units of one good, it

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Summa Against the Keynesians would be necessary to consider each set of four eggs as a unit.42 (2004: 73-74)

Suppose that it costs $1 to buy a candy bar. Smith starts giving Jones pennies, one after another. First Jones has 1 penny, then 2, then 99. No matter how many he has so far, he cannot get what he wants. Whether Jones has 1 penny or 99 does not make a difference. But now Smith gives him the 100th penny, and suddenly Jones has the wherewithal to obtain the candy bar. It is no longer merely more of the same 42

The sorites puzzles show that the marginal unit can be elusive. A lot of grains of sand put together constitute a “heap.” What is the minimum number of grains that we must take away in order for the collection to stop being a heap? If N grains are a heap, then surely, so are (N – 1) grains. We may start with N = 1,000,000, a surefire heap, and go down by “induction,” until we reach the bizarre conclusion that even a single grain of sand is still a heap. It is hard to decide what the marginal grain that separates a heap from a no-heap is. A solution would probably admit that the purely speculative approach to sorites will not work: the definition of “heap” is simply vague. We do not know what the essence of a heap is in this case. Of course, since there is no common definition, I could “homestead” it and claim that the sand grains collection loses its heapness at N = 200,000. But that would surely be arbitrary. There are, however, good arbitrary, namely (to some extent), human desires. Hence using praxeology or man’s active life seems fruitful. After the summer solstice, the day grows shorter by a few minutes per day. When does the day cease qualitatively to be “long” and become “short”? Suppose that on June 21, I go jogging at 8:30 PM, when the heat has subsided a little. I keep doing that until one day I notice that while I am jogging, it gets dark. I realize that 8:30 is now too late and adjust my schedule. Here, the diminution of daylight has been submarginal until the realization. St. Augustine wondered famously how he could catch the present moment which seemed so evanescent. The actual present as an infinitesimal point in time on its own can only be caught through experiences, specifically pleasure felt during it (though not pain which involves precisely rejection of the present). Perhaps more usefully, what we may call the praxeological present is that time period, comprising the temporal past, present, and future, during which a state of affairs has persisted and is expected to persist and as a special case of this, when a human action remains possible or an opportunity, extant. “If a man says: Nowadays Zeus is no longer worshipped, he has a present in mind other than that the motorcar driver who thinks: Now it is still too early to turn.” (Mises 1996: 101) Similarly, sorites can be solved by considering not the vague formal cause of the heap but possibly the more precise final cause of it. Thus, for example, when the pile of sand ceases to be serviceable to me for building a sand castle, as far as I am concerned, it is no longer a heap.

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– the situation is qualitatively different. Does it mean that the 100th penny has more utility than any other penny or even the first 99 pennies? No. The entire set of 100 pennies constitutes one marginal unit, and “submarginal” thinking is simply not helpful. The diamond-water paradox is now easily solvable, as well, if we keep in mind that what is traded are marginal units of diamonds (such as 1 diamond karat) and marginal units of water (such as 1 gallon of water). Under realistic supply and demand schedules, it is no wonder that a diamond would cost more than a few gallons of water. In fact, water may be so plentiful as to be, as Rothbard called it, a general condition of human welfare (2004: 12), in which case what counts for the values scale is the disutility of labor in obtaining N gallons of water from nature. A trade of diamonds for water may be desirable if that disutility is high enough. But even here, what is being bought is delivery of water not water itself. An example from management theory can go something like this. In managing large projects, it is customary to set up milestones, i.e., intermediate targets to be achieved. This is useful not only for dealing with the project’s complexity but also in order to create quasi-marginal units. Here is what I mean: until the project is done, its manager Smith has nothing. The marginal unit, that is, the unit that is significant for human action and for human happiness, is the whole project. No matter how much time and effort and money Smith has poured into the project, representing the costs, the profit will not be realized until he sells the completed thing. That can be bad for the morale of his employees and even Smith himself who can get discouraged with such risk-taking. So, the milestones are like small marginal sub-units. Smith is neatly tricked into believing that he has succeeded at something, whenever he has reached a milestone. This also demonstrates the difference between psychic consumer surplus and entrepreneurial profit. When Crusoe exchanges his fish for Friday’s berries, both immediately benefit. But none of the exchanges that an entrepreneur makes while creating his product, such as purchasing original factors, capital, directing production, are profitable for him, because they are submarginal. The marginal unit that makes the entrepreneur happier is the completed and sold good. Economist Steven Landsburg (8/28/2002) has posed a puzzle why people walk on stairs and sometimes stand on escalators: Taking a step has a certain cost, in terms of energy expended. That cost is the same whether you’re on the stairs or on the escalator. And taking a step has a certain benefit – it gets

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Summa Against the Keynesians you one foot closer to where you’re going. That benefit is the same whether you’re on the stairs or on the escalator. If the costs are the same in each place and the benefits are the same in each place, then the decision to step or not to step should be the same in each place. In other words, a step either is or is not worth the effort, and whatever calculation tells you to walk (or not) on the escalator should tell you to do exactly the same thing on the stairs.

Landsburg’s (erroneous) solution is that before you can weigh costs against benefits, you’ve got to measure the benefits correctly. And in this case, “getting one foot closer to where you’re going” is the wrong way to measure benefit. Who cares how close you are to where you’re going? What matters is how long it takes to get there. Benefits should be measured in time, not distance. And a step on the stairs saves you more time than a step on the escalator because – well, because if you stand still on the stairs, you’ll never get anywhere. So walking on the stairs makes sense even when walking on the escalator doesn’t. Our author’s confusion is due to his foolhardy decision to treat a single step as the marginal unit. In fact, the marginal unit is not a step and not even the whole staircase or escalator; it is (a) getting to one’s destination (b) the quicker the better (c) comfortably. The cost of walking is the same in both cases: physical exertion. The cost of not walking, however, is very different: in the case of the escalator, it is losing a few seconds of time (which may be irrelevant, anyway, if, for example, one is on his way to the airport and is early); in the case of the stairs, it is never getting to one’s destination. The utility of the time saved by walking on the escalator may well be outweighed by the disutility of making an effort to walk. Hence, standing will be profitable. (a) is achieved, and (b) and (c) are traded off against each other. But physical exertion will surely be considered a worthy expenditure, if the opportunity cost of not making the exertion is as huge as never getting to wherever one is going. If one does not secure (a), then who cares about (b) and (c)?43 43

(a) may be phrased as “getting to one’s destination on time,” e.g., so as to catch a plane, in which case there is a minimum speed, at which one must walk. (b) would read “the quicker the better, but at any rate, before the plane leaves.” The puzzle would then ask why people do not either stand or walk

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Keynes is not entirely happy with marginal thinking. For example, according to him, the situation of “each worker’s DMVP = his wage” need not result in full employment. Harry Block writes: “The problem noted by Keynes is that when wages and prices move together, a reduction in the money wage cannot be relied on to remove excess supply of labor. What is required is an increase in effective demand…” (King 2003: 250) Block may have in mind one of two things. Consider a situation in which the owners of the original factors of production hoard 10% of their income, regardless of its amount. Then a slight diminution in aggregate demand will set off a deflationary spiral that will never stop. Prices will fall which will cause some workers to be overemployed; this means that their wages will need to fall, causing aggregate demand to drop still more; and on it will go, with prices and wages chasing each other down to zero. Now of course, this scenario is completely implausible. Diminishing returns to hoarding and consumer competition (such that consumer A’s hoarding lowers prices and gives a greater incentive to consumer B to dishoard and spend or invest) ensure that this practice must at some point stop. Second, let Smith’s DMVP be lower than his wage. Sooner or later, his employer will notice this and reduce his wage to a more appropriate level. If the economy consisted of the production and consumption of a single good, then the wage-price level would be irrelevant. Everything an entrepreneur paid his factors of production would come back to him, when the factor owners spend their income on the entrepreneur’s product. But when numerous goods and services are being produced by numerous firms, that Jones pays Smith a lot of money does not guarantee that Smith will spend his money on Jones’ product. He can use it to buy the products of other businessmen. Therefore, it is essential to Jones’ success that Smith contributes to production at least as much as he costs to Jones. Chick (1991) argues that it is a “contradiction” that “producers want cheap labor but rich consumers.” (109) Well, yes, on the level of the (closed) economy as a whole, entrepreneurs cannot have both. But on the level of individual companies, some smarter and more efficient businessmen will pay their workers less and garner attention from wealthy customers, while their competitors lose money. Similarly, workers want cushy jobs at high pay. With respect to macroeconomy, they cannot get both, either: any worker benefits from being paid a lot for doing little, but he loses from other workers’ being paid a lot for doing little themselves, since this impairs production and wealth slower than this minimum speed necessary for success at (a).

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creation. But individual workers compete with each other every day. Chick further examines the idea that “if only producers knew that consumption would rise if they offered more jobs, the full-employment position could be reached. This view… regards the presence of unemployment to be due to lack of information, based on uncertainty about consumers’ intentions. This was not Keynes’ contention.” (111) It had better not be, because this “contention” treats entrepreneurs as some sort of public servants who extend jobs and pay wages so that their employees could consume other firms’ products! One does not hire workers in order to stimulate aggregate demand but to obtain his own profits. Of course, this idea fails on its own terms, as well. From the Keynesian point of view, an equilibrium with unemployment cannot be cured even by public-spirited entrepreneurs. This is not a case of positive externalities that we wish could be realized, if only human selfishness did not interfere. Yet one effect of this selfishness is precisely the equilibrating process that impels the economy toward a full-employment ERE. Marginal analysis is not the be-all and end-all of economics. It need not always hold. For example, if company NF charges me a few dollars per month for unlimited access to movies streamed to my TV, then the cost of production of a marginal movie and the price of watching a marginal movie are both zero. The NF’s business model is not describable by the conventional supply and demand curves. Nevertheless, it is remarkable how useful marginalism generally is at understanding economic affairs. For example, even for NF, the subscription price is calculated to yield the most revenue; every additional feature of the service that might make it more valuable to the consumers is weighed against the cost of the factors needed to develop it, etc. Another interesting point made by Chick regards hiring decisions. “If a producer employs an additional worker at less than the wage received by others, he violates the principle of uniform rate for the job and creates unrest among his existing workers. The fear of retaliation must make him hesitate. The potential worker will feel a similar hesitation to accept, knowing that he will not be treated well by his fellowworkers, who rightly see him as a threat to their own wages.” (145) I think that the alleged realism of this scenario is bought at too high a price, namely, repudiation of marginal analysis. Now if Smith is trading cows for horses, then we might surmise that (1) each horse obtained is valued more than the cow sacrificed, and (2) each cow sold produces more disutility. Out pops Chick and asks what would happen if (1’) the traded cow’s father and mother missed it and as a result produced less milk; or (2’) the remaining cows appreciated the company of the new

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horses and on the contrary became more productive. The stark definiteness of marginalist thinking seems tarnished by these difficulties. My reply is that look, I fully agree that in the very short run, there may be all sorts of complications, frictions, or “imperfections” regarding market transactions, not just on the labor market but everywhere. But the market works as advertised by marginalism in the somewhat longer run. At this point, Keynes might interject that Smith’s new lower wage will result in a drop of aggregate demand. And he would be wrong. Smith’s employer will either (a) use the savings he has gained to hire some Jones or (b) consume the savings, thus ensuring that Jones is employed to a greater extent somewhere else in the economy. Whether the employer invests or consumes, the same aggregate demand is maintained. In sum, marginal analysis is a staple of both micro- and macroeconomic economic reasoning. No one can be an economist without the ability and habit of thinking on the margin. 38. HOW PHYSICAL GOODS ARE DIVIDED Philosopher Brand Blanshard takes the following swipe at Mises: An eminent economist writes: ‘The spheres of rational action and economic action are… coincident. All rational action is economic. All economic activity is rational action.’ And what is the end of economic activity? One’s own pleasure. ‘Action based on reason,’ goes on Professor von Mises, ‘action therefore which is only to be understood by reason, knows only one end, the greatest pleasure of the acting individual.’ Blanshard adds in a footnote: Von Mises adds, to be sure, that ‘pleasure’ covers all human ends, ‘noble and ignoble, altruistic and egotistical’. But he presumably means that it is the pleasure involved in beauty, knowledge, and the rest, that is actually sought; to identify pleasure with knowledge, e.g., would hardly be possible. And how the end of ‘the greatest pleasure of the acting individual’ could be described as ‘altruistic’ I do not understand. (1991: 53) Blanshard scores a point in that there is speculative knowledge

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in addition to practical knowledge, and consequently, the intellectual virtues in addition to the moral virtues. Where he is wrong is in holding that prudence is identical with vulpine craftiness, selfish cunning, and “scheming sagacity,” the archetype of which is (to him) Odysseus. Prudence is a great virtue, but it has vices opposed to it, like guile, fraud, “prudence of the flesh,” and so on. Still, even contemplation of truth or beauty does not take place without the will’s commanding it and rejoicing in it. There is no need to identify pleasure with beauty and knowledge. I will borrow the answer to this problem from St. Thomas who divides physical goods into useful, virtuous, and pleasant and not merely into “means” and “ends.” (ST, I, 5, 6) A means to an end is a useful good or in economics, a capital good; the end itself or the consumer good or the services derived from that consumer good (such as light or the ability to see from a lamp) is called “virtuous,” “the virtuous is that which is desired for its own sake”; and the will’s or senses’ rest or enjoyment of the virtuous good is called the “pleasant good.” Neither Mises nor Blanshard recognize this distinction. Let me put it this way: a knife is good, if it cuts well or efficiently. Therefore, goods’ usefulness is linked with vision or mental grasp of how exactly a useful good serves one’s interests, e.g., “if one ever needed to cut something, then one would be well advised to use that knife.” Virtuous or consumer goods, in addition, require comprehension or possession, because they are wanted for their own sake. (Useful goods are owned, too, of course, but only derivatively. For example, an entrepreneur derives no immediate benefit from ownership of capital. He must use his means of production for the benefit of others; moreover, he is vexed with the necessity to use them better than his competitors one period of production after another or lose the money.) And goods become pleasant with fruition, i.e., when virtuous goods bring satisfaction to their owner. How can one’s pleasure be described as altruistic? When the good sought for another person is also one’s own good; when the beloved whose happiness one seeks is another self or “half of one’s soul,” as St. Augustine put it. After all, utilitarianism (one ought to maximize overall good) can be derived by combining ethical egoism (one ought to maximize his own good) with loving one’s neighbor as oneself. It is a good piece of advice that if you love a friend, then give without further thought: the profit to the beloved is your profit. And if you are loved, then take without fearing that you will need to repay the favor: your profit is the profit of the lover, as well. The will and its joy play their

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indispensable roles in all three of the nature, virtue, and happiness trinities. Since capital goods are not immediately useful, it is their destiny either to be transformed into consumer goods (if they are unfinished goods) or to help to transform other useful goods into consumer goods (if they are tools or machines). If a certain good is used in a plan of action, though it is not scarce but is rather superabundant, then it is not a means per se but a general condition of human welfare. Some goods, such as technological recipes, knowledge or all kinds, ideas, patterns are non-rivalrous “intellectual” goods. Once one such good exists, it can be reproduced costlessly, such as by being copied from one mind to another or from one parcel of matter to another. However, original new intellectual goods are definitely scarce. All goods, however, are for the sake of happiness arising out of their direct use. All production is ultimately for the sake of human enjoyment. 39. THAT ECONOMICS STUDIES ACTING MEN AND NOT “CONTEMPLATING” MEN There is a tradition of distinguishing between the active life and the contemplative life. The former exercises moral virtues; the latter, intellectual ones. Now being intellectually aware of distinctions in things need not necessarily affect one’s “appetitive” preferences for these things. This is because it is not worth to an actor to pay attention to all the distinctions in order to satisfy his desires, but only to those that are relevant. In other words, not all “truth” is “useful,” and economics deals with acting men, not with “contemplating” men. Two opposite mistakes are possible in regard to the subject matter of economics. First, one might claim that economics is the study of wealth. Second, that economics is a sort of psychology. In fact, however, economics deals neither with the purely 1stlevel motions of dumb things or with physical events nor with purely 2nd-level disembodied thoughts and spirits; rather, it describes the processes by which man’s intellect through action relates to and makes an imprint on the external material world. Its subject matter lies within the nexus of planning which involves inventing uses of scarce resources and putting the plan into action, of conceiving practical ideas to “remove felt uneasiness” and their actual implementation. Related to this understanding is a long-standing puzzle within

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the Austrian school of economics which puts the law of marginal utility to the test. Suppose that Smith wants some butter. He has obtained 5 pieces and is now hankering for the last piece he needs, the 6th one. But consarn it!, he is presented with 2 identical pieces of butter. Or perhaps, he needs to choose one of the two halves of a stick of butter. Given that for the law of diminishing marginal utility to hold, one needs identical and perfectly interchangeable units, how does Smith choose between them? How does Buridan’s ass choose between two haystacks exactly alike? Economics busies itself with formally describing what happens when people make choices. In situations in which there are no peoplemaking-choices, economics is silent. If Smith is in some sense truly “indifferent,” then there is no economic problem associated with his predicament. A few remarks, therefore, may be sufficient. We must distinguish between physical differences (relevant to contemplation) and economic differences (relevant to action). Physical differences encapsulate any material, efficient, or formal distinction between the two units of butter. If one is a cube, and the other has an irregular shape, then that is a physical difference. Economic difference belongs to the purpose of the units, their usefulness to a person, their final cause. For example, Smith may be indifferent between the shapes of the butter he wants, as long as they weigh the same. In this case, a physical difference fails to give rise to an economic difference. On the other hand, one piece might be on the left, and the other, on the right, and Smith happens to be right-handed and therefore, instinctively prefer the piece on the left (forgive me, if my psychology here is wrong). Here, there is an economic difference without any essential physical difference (insofar as different spatial locations are accidents) in the items. Now whatever unit of butter Smith chooses to add or give up will satisfy his least valued end. The spatial difference will not matter for the serviceability of the unit for the satisfaction of this end. But it will matter for the efficiency of the choosing process itself. Choosing entails paying the transaction costs of making the choice. If these costs are too high, e.g., one has to walk a mile to get the butter, then the choice will not be made at all. My contention is twofold. First, in the world we live in, there will always be something physically different about any two non-numerically identical to each other objects. Second, one or more such physical difference will result in an economic difference. It is an empirical truth that people do not die from indecisiveness, like the Buridan’s ass. Smith’s choice could be due to as little as “the first thing he laid eyes on.” It may be immediately objected: What if our two units of butter are behind a wall, such that one does not know their spatial

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locations? Can one still choose? Sure, how about this: “I want the unit that is to the left of me or closer to me or on the top of the other.” Now let me imagine a service, such as a massage, that Smith can choose to be performed by an either male or female masseur. If he does not care, then once again, spatial differences come to the rescue: in the form he fills out, he checks the first name he finds. If the choice is proposed verbally, then he can choose the first name mentioned, this time using a temporal difference. We assume that Smith is concerned with spending the least amount of effort choosing. Smith may be asked to choose between hot sake and cold sake, and again, he seemingly could not care less. People choose freely, but each choice is determined by Smith’s reasons for it. There must always be a physical difference that gives rise to an economic difference. Even if one chooses “at random,” the random choice is also determined, if somewhat unfathomably; hence, a reason can be found for it if one digs deep enough, according to which A is preferred to B. In short, the Austrian concept of choice is not jeopardized by the problem of homogeneous units. Another objection would proceed as follows. Let Jones be willing to sell a widget for $70 but not for $60. He would also sell it for $65. But not for $62.50. And not even for $63.75. But he would sell for $64.38. Narrowing the gap in this manner, we eventually arrive to a situation, in which Jones would sell for $Y and would not sell for $X, and Y – X < $0.000,001. It is obvious that he is genuinely indifferent between getting $X and $Y for the widget. What gives? Well, in order for Jones not to be indifferent, there must exist a basket of goods that he can purchase with $Y that is unaffordable with mere $X and moreover, is superior to any basket that he can purchase with $X. The physical difference between X and Y is the margin, and it may or may not matter or make an economic difference to Jones. In fact, the margin may be far higher that one millionth of a dollar and still be empty. In such a case, more money fails to acquire a superior collection of goods, and assuming that money has only exchange-value, $X and $Y have the same effective purchasing power. Though Y > X, there is nothing that Jones can and wants to buy with $Y that he cannot also buy with $X. But the fact that he is indifferent to money does not mean that he is indifferent to the goods that he can buy with that money. The neoclassical notion of indifference applies to goods, as well, and in this, it is perverse. As a result, the Austrian idea of the ordinal values scale and goods being ranked in a hierarchy by human choosing is not at all disturbed. My second point is that human desires are different from

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wishes. Desires, unlike (mere) wishes, come with plans for their satisfaction, and plans are acted upon. Wishes lack any such plans. Suppose Robinson says: “I wish that men could fly by flapping their arms about.” It is an empty daydream, useful to children, perhaps, for exercising their imaginations but not for much more. Again, I must stress the primacy for economics of human action not human daydreaming. The wish does not result in any action, because the wisher does not know how to substitute the present unfortunate (for him) state of affairs with a more desirable one. Normally, however, while strong desires that cannot be realized cause despair, wishes are much less pressing. Or consider this: “I wish that the number of atoms in the universe be even.” This is scarcely even rational, because the number of atoms either is even or is not even. One may wish to know whether the number of atoms in the universe is even, but why wish for it, when the situation is already one way or another? (See (Appendix, 6) for more on this.) My points are that on the one hand, wishing retains its essence as a desire (Robinson really would be happy, if the number of atoms in the universe turned out to be even); but on the other hand, it is a vain activity, unless one is prepared to plan and act on the wish. Third, it is an axiom of economics that humans seek future expected utility. They foresee that either an existing desire will persist until or a new desire will arise at a certain time in the future and work to satisfy that desire. The reason is that any action intent upon substituting a more pleasant state of affairs for a less pleasant one takes time. Speaking strictly, there is no such thing as instant gratification. Here, then, is another puzzle: what motivates Brown to go to work now, when the desire that will be satisfied by his actions will only torment him in the future? If what drives Brown into action must needs be some kind of desire, then what is it that he has now that rouses him to toil for the sake of the future? The answer is that while the desire that will be satisfied in the future is that of concupiscence, the desire that drives one to take care of the future at the present moment is that of friendship, namely, the friendship between the present Brown and the future Brown. Brown now sympathizes with, loves, and consequently wills good to the future him. And that willing good to his future self is what motivates Brown to act now. In particular, sensual desires, like hunger, are filtered through the will, creating sorrow that does not disappear even when the hunger is sated. Even though sensual pain is in the here and now, spiritual sorrow remembers and anticipates. There is in Brown both recollected and foreseen unhappiness from past and future wants. Of course, if human beings are 4-dimensional, as suggested in

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(I, 30), then the problem disappears entirely: Brown wills good simply to himself, though he foresees that his personality will likely be slightly different in the future. Fourth, the foregoing allows one to get a better grasp on the concept of profit. This will prove useful in (I, 40-45), where we will take up the distinction between interest and profit, one which, as will be made clear, cannot reasonably be made in Keynesian economics. Suppose that Armstrong has $100. The interest rate is 10% for some time period Δt. Armstrong invests his money into company A and makes $25 after Δt. But he later learns that he could have invested the money into company B and made $30. Assuming low time preference, answer: 1. Does Armstrong profit, because he has $25 more after Δt than he had originally? 2. Does he profit, because he has $15 more than he would have, had he put the money in the bank? 3. Does he lose, because he has $5 less than he would have, had he invested better? Given that there is no such thing as perfect foresight, nor perfect human happiness, one need not always be too hard on himself for not doing better. Failure to predict the greater relative success of company B may be excusable (e.g., if not negligent). If it is, then the remaining question is whether the entrepreneur made a $15 or $25 profit. Rothbard considers a similar case, where interest income is $50 rather than $10, and concludes that by investing into A, Armstrong suffered a $25 loss (2004: 512-3). The combined cost of the factors of production, including time, was greater than the revenues. This is very reasonable, because profits arise from superior ability to deal with risk and surprises, and technically, there is nothing surprising about interest income. Therefore, in Armstrong’s case, his profit is P = P1 of $15 ± P2 of the difference between his originary interest rate and 10%. (A discussion of interest will begin shortly.) It is important to realize that P2 is not the opportunity cost of P. For suppose Armstrong’s values scale is as follows: (i) consume coffee and cake (ii) drink coffee (iii) eat cake

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When he drinks coffee and eats cake, is consuming coffee alone an opportunity cost? Certainly not, because he satisfies his desire for coffee, when he drinks coffee with a cake, just as well. Opportunity cost is an unsatisfied desire that is ignored because one chose to occupy himself with pursuing something more urgent at a particular time. Two physically different goods that have no economic difference are considered to be substitutes for each other; the state of affairs of same physical good’s being used for more than one purpose may be called composite demand. Suppose further that Armstrong drinks coffee, but he could have drunk tea, yet he slightly prefers coffee. Tea would have soothed his craving for a hot drink almost as well as coffee did. Again, not drinking tea is not an opportunity cost, because exactly the same desire that tea would have satisfied is satisfied with coffee and then some. Drinking tea is “virtually included” into drinking coffee; in other words, tea and coffee are substitutes for each other: Armstrong might want either, but if he has one, then he does not want the other. Now all goods are substitutes for each other broadly considered. I may want both a printer and a pair of headphones; but if I buy one, then I might not be able to “afford” the other. In the more narrow sense, it is conceivable that I may buy both the printer and headphones, but I am unlikely ever to buy two similar printers (for consumption) at any price. “Printer” or, say, “laser printer than costs less than $200” is the “essence” of my desire; within it, there are choices of printers with different “accidental” features. All of them may be satisfactory substitutes, though only one will be best (hence, one interpretation of the difference between “satisficing” and “maximizing”), and it is my choice how much time and effort to pour into my market research. Here are a few more scenarios. First, suppose that Armstrong was coerced under threat of having his legs broken to invest into company A. The profit he made was not merely $15 but also the preservation of the integrity of his body. His profit is $15 + avoidance of pain. Second, Armstrong is hungry and decides to cook dinner. When the dinner is almost done, either (a) for some reason he loses his appetite or (b) his friend comes in with a pizza, which he prefers to his own cooking. Did he profit, because he no longer has the desire to eat, or did he suffer a loss, because he spent time and resources cooking in vain? The question is whether losing a desire in (a) is equivalent to satisfying it. A desire extinguished may bring peace, but only a desire satisfied brings joy. Peace could be called the absence of pain; while joy, the presence of pleasure. But peace is inseparable from joy, for otherwise, a stone could be called at peace. The tricky situation in both (a) and (b) is that Armstrong

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obtained satisfaction without effort. The effort was entirely superfluous. Therefore, there are two distinct events here: one of windfall profit (due to the lucky visit from the friend) and one of loss, because cooking was a complete waste. In other words, what he lost was the alternative use of the resources used up during cooking and of his time and labor, the alternative use he contemplated before starting production. Third, Armstrong is now 33 years old. If he exercises, then when he is 70, he will be healthy, though slightly less so than he is now. If he does not exercise, then he will be very sick. If he does exercise, then by the time he is 70, will he have (a) made a large profit (healthy vs. sick) or (b) suffered a small loss (less healthy than now)? Again, Armstrong works in order to satisfy a future (namely, 37 years from now) desire to be healthy. We must compare (healthy – the disutility of exercise) with (the benefit of not bothering to exercise – sick). If the cost of exercise is low, then he will have made a large profit. Hence, (a). Profit then is the difference between the revenues which come in after the action is completed according to plan and the highest opportunity cost of the action as perceived during deliberation and planning prior to any action. Opportunity costs and profits are, therefore, highly subjective and mutable, though even if it is later found out than a better course of action was available, it does not alter the amount of profit earned. This parallels ordinary entrepreneurship, in which the income to factors may be advanced long before any sales revenues are forthcoming. It follows that the line of reasoning: “I was miserable; now I’m happy; therefore, I made a profit.” is illegitimate. Instead, one should say, “If I had not acted, then I would now be as miserable as I was before or even worse; but I did act, and despite the costs of the action, I am now happy or at least, better off. Therefore, I made a profit.” The course of action that a person will choose depends on the ends called forth by the will, the means devised by the intellect, and one’s power and skills to see the action through. The decision-making procedure is as follows. One imagines several desires he can try to satisfy. For each such desire, one finds out the least costly means of succeeding. Then he estimates whether he has the ability to subtract the means from the ends by satisfying the latter and enduring the disutility of the former. The possible action that yields the higher distance between the benefits and costs, i.e., the highest profit, is then selected. 40. THAT INTEREST RATE CANNOT BE DEFINED VIA THE MARGINAL PRODUCTIVITY OF CAPITAL

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For Keynes, the marginal efficiency of capital is the discount value that equalizes the cost of a marginal capital good with the total discounted product that the good can yield over its serviceable period. Thus, the higher the marginal revenue produced by a capital good, and the lower its cost, the higher the maximum discount rate must be in order to match the two values; the higher the discount / interest rate can be below the maximum to make investing into that good still profitable; and the higher, therefore, the marginal efficiency of that good. Marginal efficiency of capital, then, defines a capital good’s marginal product, entirely similar to the marginal product of a worker or nature, minus its marginal cost. Since numerous factors are involved in making any product, it is not necessarily possible perfectly to isolate any factor’s contribution. Still, a worker earns wages, and capital earns rents (while the entrepreneur obtains the income from the worker’s output and quasi-rents from use of capital goods). The interest that has to be paid along with these costs depends upon the time it takes to complete production. In the evenly rotating economy, the discount rate is precisely the interest rate. But if we were to define interest rate in this manner, then we would be helpless in a real economy, in which profits and losses are allowed, to distinguish between interest and profit. Since there is in any economy a tendency toward equilibrium or eradication of profits, the interest rate is that ineliminable difference between the yield of a capital good over its lifetime and the cost of that good. However, as Keynes himself points out correctly, “what the schedule of the marginal efficiency of capital tells us, is, not what the rate of interest is, but the point to which the output of new investment will be pushed, given the rate of interest.” (2008: 184) In other words, Keynes’ marginal efficiency discounts the cost plus both the interest and profit on it. I concur, therefore, with Keynes about the two kinds of risk: the risk taken on by an entrepreneur and the risk taken on by a lender. The former risk is that the entrepreneur will fail to make a profit. If Smith has invested $1,000 in Widgets, Inc., then it is possible that he will lose some of his money. An entrepreneur who is such a loser I will call colloquially imprudent. But the latter risk, in principle, is not supposed to exist at all, because lending money is a transfer of property rights, an exchange of present goods for future goods. It is to be repaid with interest according to justice. The borrower owes money to the lender. It is his legal responsibility to pay off the debt, and failure to do so constitutes theft. After all, the lender does not share in the borrower’s profits; why should he be

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exposed to his losses? (This economic difference gives rise to legal differences, such as that creditors have first dibs over shareholders on the assets of a company that has declared bankruptcy.) A borrower who cannot or will not pay back the loan I will call unjust. It is plain that the risk of investing into a imprudent person is quite similar to the risk of loaning money to an unjust person. An investor is taking both risks: he risks the possibility that he will fail to make a profit, in particular, that the company he is putting money into is run by imprudent managers; but also that he will fail even to obtain the interest return on his investment, and that moreover, he will lose the principal itself, such that he would have been better off keeping his money in the bank. But so does a creditor: though he can or should be able to compel his debtor to pay up by the force of law, even if the latter is being unjust and resists, there is nevertheless an entrepreneurial aspect to lending. Since lending is still at least nominally distinguished from investing, the lender’s risk must not be quite as high as the investor’s risk, yet it still exists. Keynes aptly calls this situation “moral risk.” (2008: 208n) Keynes thinks that lenders seek to hedge moral risk by increasing interest rates. Since Keynes deplores relatively high interest rates (as well as the phenomenon of interest as such), this for him is a problem. Could we have satisfied him by reforming the bankruptcy laws, for example, to allow creditors to enslave the debtors until their debts are paid in full? If creditors are assured of their return, the “unjust borrower” risk premium will decline, benefiting society at large. The productivity theory of interest is illustrated in Figure I.40.1. The quarterellipse is the production possibilities frontier (PPF) between goods produced this year and goods to be produced a year from now by means of a sacrifice in present consumption which is channeled into saving and investment. Point A is where the marginal rate of substitution is 1, beyond which (in the upper and leftward reaches of the curve, such as in point C) it no longer pays to convert present consumption into future consumption (because we would absurdly sacrifice more present goods for fewer future goods, or so it looks on this theory). If we start at point B, then if we save and invest the amount of goods equal to segment 2, then we will obtain more goods equal to segment 1 a year from now due to the shape of the PPF curve. Therefore, the length of 1 divided by the length of 2, call it r, is greater than 1, and therefore, (r – 1), signifying the interest rate on the productivity theory of interest, is positive. The reason for the shape of the curve is supposed to be that at low levels of investment there are extremely profitable opportunities, but as investment increases, new enterprises become less and less productive, while the sacrifice of present goods becomes more and more disagreeable. Call

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this argument PTI.

FIGURE I.40.1. THE PRODUCTIVITY THEORY OF INTEREST

Let the goods in question be grain only, and let Smith’s company invest into non-durable combines which make him more productive at harvesting crops. Smith saves 1,000 bushels of wheat this year, which he sells for 1 gold ounce per bushel, with each combine costing 90 gold ounces. Suppose he spends it all on 10 combines (plus 100 ounces on the complementary to them goods and services) which cooperate to produce as many as 2,000 bushels next year. Upon selling them on the market, Smith consumes half and reinvests half. On the productivity theory, the “interest rate” is 100%, because 1,000 bushels this year have been converted into 2,000 bushels next year. It is plain, however, that the 1,000 extra bushels that Smith obtains next year is by no means interest but rather profit. It is precisely the failure of productivity theorists to notice this that has played havoc with their system. Indeed, this 100% return is a profit opportunity for other people in the economy. As competitors notice Smith’s extremely high entrepreneurial gains, they will imitate him, causing (1) growing wheat to be more expensive by bidding up the prices of the factors that go into producing it, such as labor and combines which become dearer due to increased demand, and (2) wheat produced to be cheaper due to increased supply. At some point, Smith will realize that he can only buy as many factors services with his 2,000 bushels of wheat as to make 2,000 bushels next year, perhaps a bit more. Instead of doing that, he is better off just keeping the wheat in the granary until next year. In other words,

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after all the profits are arbitraged away, Smith will only be able to buy with the entire amount of revenue from selling the harvest all the combines which will collectively produce, abstracting from real interest whose source will be explained in the (I, 41),… 2,000 bushels! On the productivity theory, it becomes impossible to draw a dividing line between interest and profit, that is, to identify either component in the set of incomes. In the evenly rotating economy, when we disallow profit and at the same time refuse to consider interest as being determined, as I will demonstrate, by a combination of time and risk preferences but accept the productivity theory, we have an absurd but apparently possible scenario, in which a person would take $10,000 that he already has and spread it out over a period of time, for example, by buying a capital good that yielded an income of $1,000 per year over its life span of 10 years. This is because the marginal efficiency of the good can on this theory be arbitraged all the way down to zero. But production must go on. Since nobody in his right mind would ever do such a thing, our economy ceases to be a meaningful construction. What must happen instead is that less money is used to buy a capital good than is yielded by that good over the period of its lifetime. This behavior of acting men is fully consistent with the fact that the good is productive or, rather, that the user of the good is more productive with it than he would be without it. In some sense and for some reason, therefore, time must cost money. No less erroneous is it to call interest the “price of capital.” As we will see, the price of capital is called rent, not interest. But interest does enter into the determination of the prices of capital goods. If Smith buys a capital good from Jones, then he must take into account the time it will take to transform that good, with the help of other inputs, into a consumer good. The essence of a capital good is that it is incomplete, not ready for consumption; and the essence of its incompleteness is that it takes at least time and possibly other factors to advance it down the structure of production toward a good of the first order. This waiting time that must elapse is a fundamental defect inherent in any intermediate good. It reduces the good’s price, when it is sold on the market. The good will be discounted by the rate of interest (e.g., percent per year) times the amount of time (e.g., years). Argument PTI assumes that each resource on the values scale can be either consumed or invested. If we start at the bottom of the values scale and go up, then each resource will yield progressively more utility if it is consumed, and less utility if it is invested. This is, indeed, how an entrepreneur allocates his money in the real world. The argument is of no use, however, for finding out the interest income within the

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overall return obtained by the entrepreneur. In other words, (1) if the PPF curve has the equation y = 3 – 3x, then how big a part of the 200% return does interest constitute? No matter how few present goods are left, it is always open to a person to sacrifice them for the sake of greater future bounty, unless such a sacrifice leads to his physical death. (And on the contrary, any future pleasure can be postponed still further, if the payoff in terms of immediate consumption seems high enough.) The marginal rate of substitution of future goods for present goods need never fall below 1. That is, (2) for many entrepreneurs, there will be no point A on their curves at all; and if there is such a point, then (3) an entrepreneur will always stop investing “long” before it is reached rather than “just a bit” before. By how much is precisely the problem. The reason is that providing for the future, regardless of the amount of present austerity, entails waiting for future goods, and waiting, as we will see, has disutility. If the conversion is to take place anyway, this disutility has to be compensated for. In short, the PPF is inapplicable to the problem of interest. 41. THAT THE REASON FOR TIME PREFERENCE AND THE PARTIAL CAUSE OF INTEREST ARE DISUTILITY OF WAITING; AND THAT (I) PRODUCTION TAKES TIME The law of time preference (TP) is usually stated this way: present goods are preferred to future goods. Mises’ proof of this is extremely interesting. He derives the law of time preference solely from the meaning of the act of consumption. Suppose, he says, that two goods are valued the same today and tomorrow. This is a crucial assumption, call it (V), because without it, we get into all sort of trouble deciding whether the future good is actually a different good than the present good. For example, ice-in-winter is a different commodity from icein-summer; a chocolate cake now is a different (and less valuable) good from a chocolate cake two days from now when I will have a birthday party. Or rather: it is the same virtuous good but different pleasant good. Thus, ex hypothesi, the good will yield the same amount of pleasure both today and tomorrow. Now if an acting man chooses to postpone his consumption today at t1 till tomorrow at t2, then tomorrow he will face the same choice as today: whether to consume at t2 or, again, the next day at t3. But the same logic that impelled the man to put off consumption till t2 will with

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an equal force necessitate that he postpone it again until t3, given that the situations are alike. We continue in this manner ad infinitum, resulting in an absurd situation in which the man never consumes. But the only way to prevent the regress is to deny on a priori grounds that it is possible for the man to fail to consume at t1. Therefore, it would seem that present goods are apodictically preferred to identical future goods. An objection may be lodged against this analysis to the effect that no two goods can ever be valued equally. Valuation is ranking. However, we postulate that Smith values virtuous good X the same at t1 when t1 is now and at t2 when t2 is now. There is nothing that prevents a good from yielding the same amount of utility at different presents. There is no such thing as a “choice” for one good made at two different moments; only a choice between at least two goods made at one – present – moment. Mises is arguing precisely that X at t1 when t1 is now must be valued differently and in fact, more than X at t2 when t1 is now. Smith is temporally located at t1 and chooses between (a) X-at-t1 and (b) X-at-t2. He must, Mises asserts, choose the former. Since X is the same pleasant good, the only difference between (a) and (b) is that for Smith the first X is in the present, and the second X is in the future. This is the meaning of time preference or preference for present vs. future goods for Mises. Another objection is that it is true that an act of consumption reveals that consumption now is preferred to consumption at any moment in the future, but it also reveals that it was preferred to consumption at any moment in the past. Mises himself points out that “there is in the course of a man’s life a right moment for everything as well as a too early and too late.” (1996: 486) But this presupposes different valuations of consuming at the “right” moment as opposed to at every “wrong” moment (i.e., either too early or too late), contrary to (V). That this interpretation is reasonable may be gleaned from some telling quotes: He who consumes a nonperishable good instead of postponing consumption for an indefinite later moment thereby reveals a higher valuation of present satisfaction as compared with later satisfaction. If he were not to prefer satisfaction in a nearer period of the future to that in a remoter period, he would never consume and so satisfy wants. He would always accumulate, he would never consume and enjoy. He would not consume today, but he would not consume tomorrow either, as the morrow would confront him with the same alternative. … Every penny spent today is, precisely under the

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Summa Against the Keynesians conditions of a capitalist economy in which institutions make it possible to invest even the smallest sums, a proof of the higher valuation of present satisfaction as compared with later satisfaction. … We must conceive that a man who does not prefer satisfaction within a nearer period of the future to that in a remoter period would never achieve consumption and enjoyment at all. … We must conceive that consumption and enjoyment of any kind presuppose a preference for present satisfaction to later satisfaction. (1996: 484ff)

In other words, Mises is constructing a peculiar algorithm. Let X = Later. Sooner < X. It is asked: Would you like to consume Sooner or X? If the answer is “sooner,” then let X = Sooner, and let Sooner = Sooner – 1 (say, hour). Again, we ask: Would you like to consumer Sooner or X? And so on, until Sooner becomes Now. Since I cannot consume in the past, I must prefer to consume now to consuming at any later time. If the choice is X, then let Sooner = Later, and let X = X + 1. The same question is asked, but in this case Sooner will never become Now, and therefore, I will never consume. Apparently, QED. Unfortunately, Mises failed to realize that the question “Would you like to consume Sooner or X?,” though it looks the same every iteration of the loop, is nevertheless always different, given that its two variables take different values. Nothing stops a man from answering the question “Would you like to consume 23 hours from now or 24 hours from now?” “24 hours,” even though for all Sooner > 23 he picked Sooner as the answer. Mises’ error lies in the fact that the (true) negation of (false) “I always prefer to consume later to sooner” is not “I always prefer to consume sooner to later” but “Sometimes I prefer to consume sooner to later.” Mises’ proof amounts to saying that if a man has a motive, means, and opportunity to consume, then he will consume. He will not fail to consume for any reason, including by postponing consumption. This, however, is hardly interesting. Again, while we act for the future, we enjoy and live only in the present, and so the statement that present goods are preferred to future goods turns out to be, according to the Mises’ interpretation of it, as perfectly analytic as that enjoyment is preferred to lack of enjoyment. If we couple this point with the law of diminishing marginal utility, then we can see how a person might rationalize allocating a sum

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of cash over time. The more he spends at t1, the less important the ends he satisfies at t1 become, and the ends at t2 that will be not be taken care of accumulate and grow more important. The cash should be so spread out over time as to provide the most happiness at all the future moments on the whole. However, this neither is time preference, nor has anything to do with the problem of interest and interest rates. Let us therefore approach this problem differently. Let Smith’s income be $100k per year. He is considering buying a house worth $240k. “Necessities” of life, as far as Smith is concerned, take up $20k per year; in other words, Smith adamantly refuses to spend less than this amount. He is particularly attracted to the following three choices: (1) he saves $80k per year; or (2) he saves $60k per year; or (3) he decides against buying the house at all and spends the entire $100k each year. Either way, the house will be unavailable to him for at least 3 years. This fact is studied not by economics but by arithmetic. The difference between (1) and (2) is that in (2) his standard of living in the first 3 years is higher, but he has to wait an extra year to buy the house. The former is a benefit of choosing (2); the latter is a cost. Even if Smith chooses (2), the cost needs to be felt and given proper respect. This cost I term “disutility of waiting.” If he chooses (3), then the disutility will be perpetual. Again, this is a cost, and on his deathbed, Smith would have to reflect on his life and say: “Despite the fact that I never got to own a house, I have no regrets.” It is a corollary of Misesian time preference that waiting, understood as the cost of a choice to save less and consume more, has disutility; and the longer the wait, the greater the disutility. Mises seems to anticipate this argument but counters that “impatience and the pains caused by waiting are certainly psychological phenomena. … However, the praxeological problem is in no way related to psychological issues.” (1996: 486) I beg to differ. Consider the following deduction starting with indisputable axioms: 1. Human beings are not perfectly happy. 2. Human beings have ends they want to attain. 3. The unattained ends cause them unease, suffering. The unsatisfied desires are eating at them, gnawing at them, demanding loudly to be quenched. 4. Even in moments when one is not conscious of a desire, one is still living in its “shadow”: his thoughts and efforts are determined or conditioned by the desire nonetheless. 5. All things being equal, the less suffering and the more pleasure,

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Summa Against the Keynesians the better. 6. But suffering increases, the longer it is felt. 7. In other words, the period of time from Sooner to Later can be either peaceful or discontented, and everyone will prefer it to be peaceful (by virtue of the meaning of the terms “end,” “action,” “preference,” etc.). 8. Therefore, waiting has disutility, and people always prefer to consume sooner, thereby relieving suffering quicker as opposed to slower.

Of course, if for any time period there are no desires, then there can be no satisfactions of those desires and therefore, no positive time preference: if I do not want X, then I surely do not want X either sooner or later. A seeming objection is that the alleged “disutility” is simply the unhappy feeling or longing resulting from not having the good desired. It is just that the good is out of reach for a period of time. There is no special disutility of waiting apart from “dissatisfaction that lasts a while.” It is not the waiting that is unpleasant but lacking ownership and enjoyment of the good. I agree completely and define disutility of waiting as snowballing misery from continual dissatisfaction, as time goes on. The disutility I have in mind is always of not having good G over T, say, days. The point is that the disutility of waiting for G over fewer days is smaller than the comparable disutility over more days, because greater overall suffering will be endured in the second case. The word “waiting” is used in order to underscore that G will usually materialize at some point. Disutility of waiting then is always relative to an opportunity forgone, a course of action not chosen. It is a cost inherent in preferring present consumption at the expense of some particular future enjoyment that gets inevitably postponed (perhaps indefinitely) as a result. Time preference refers to an individual’s strategy of managing this disutility. Time preference is a value; even Crusoe alone on his island will experience this phenomenon; interest rate is a price agreed upon by at least two people as part of a mutually beneficial exchange. That these are intimately connected will be shown further on. Once the saving is complete, time preference has played its part, and a new decision is at the forefront. Thus, let Smith save $24k per year for 10 years, for simplicity’s sake putting the cash under the mattress. He then loans out the money for another 10 years at 5% interest,

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augmenting his future income by $30,547 / year. He chooses the equivalent of a Lexus in years 11-20, forsaking a “Ford” in year 1 until year 20. LeAnn works at a regular job. Deep down, however, she wants to be a cowboy’s sweetheart; she wants to learn to rope and ride; etc. She imitates Smith’s saving strategy; except at the end of 10 years she quits and goes west, hoping that the income from the loan will be sufficient to keep her financially sound while she realizes her dreams. Jones does likewise but saves the entirety of the loan income. 20 years later he has accumulated $240,000 * 1.0510 = $390,934 which he uses to buy an especially nice house. The waiting time is considerably increased, but Jones keeps his own counsel and is happy. So much for consumer saving. But it is a universal feature of production that it, too, takes time. The costs of hiring factor services are paid long before the revenues come in. An entrepreneur has an incentive to minimize production time in order receive the revenues sooner, thereby realizing profit sooner; and the profit can then be consumed sooner. As a result, the entrepreneur might be willing to pay money to shorten his period of production. If “time” could be bought and sold in this manner, then perhaps some efficiency gains could be obtained.44 Chick (1991) renders the “classical” theory of interest as regarding it “as a reward for ‘waiting,’ for putting-off consumption.” (207) Mises counters: “There is in the world of reality no mythical agency that rewards or punishes.” (1996: 846n) A man deprives himself of immediate pleasures not in order to strengthen his will or do penance in the hope of earning forgiveness from God but in order to obtain the wherewithal to build or stimulate building capital goods to be used in those novel techniques that promise to bear relatively greater fruits. The abstinence is due entirely to a “selfish” calculation. Time preference regarding production then has two aspects. First, different methods of production take different amounts of time to bear fruit. The longer any such method takes, the costlier it is. Second, each such method will take more or less time to complete depending on how much present consumption is given up in order to finance it. It is agreed by many Austrian economists that the fact that labor has disutility is an empirical observation, because a world in which labor is pleasant is conceivable and possible, even if it is not actual. I beg to differ again. For think of what this would mean. Labor is a means to an 44

The period of production can follow a period of saving, but only when the entrepreneur intends to buy capital goods; payments to original factors and for rents on equipment can be financed from present income.

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end. If labor were a source of utility, then there would be no reason ever to achieve the end; laboring would continue forever as an end in itself. If the means are not costly, then there is no need to economize on them but on the contrary, a need to multiply them. If, far from being painful, labor is actually pleasant, then it becomes its own end, and that, for the sake of which labor is supposedly expended, need never come to pass. Indeed, if it is truly better to travel hopefully than to arrive, then arrival would be a bad event, signaling as it does an end to something good, namely, traveling or, in my case, working. It is true that working may be “fun,” but that is beside the point which can be proven as follows. At any time, one would prefer to finish production to continuing working; otherwise, the foregoing difficulties are upon us. In other words, one would for all N prefer to expend N – 1 units of labor to expending N units. Therefore, expending 0 units is best. Therefore, attaining the end by not working at all is better than attaining it by means of working. Hence, all labor is a cost. An objection could be that labor can both have its own utility and some external to it goal which provides, let us postulate, some massive amount of happiness, enough to justify ending one game for its sake and then possibly starting another. A hobby might qualify as such a thing. A man grows flowers which is a recreational activity he enjoys, but in addition he is aiming at a luscious garden. However, the two utilities interfere with one another. The more one gives himself to playing, the more he risks forgetting the purpose attached to it. Conversely, the moment one focuses on the future end to be attained, keeping his eyes on the prize, as it were, one is no longer immersed into his ecstatic selfforgetful present but considers the means to this end to be irritating exertion rather than simply a good time in themselves. The praxeological distinction between labor and play remains in force, even though a particular human action can at times manifest traces of both. Similarly, a world in which waiting has utility is utterly inconceivable, for it is a world in which people never consume but always wait to consume. Incidentally, this proof shows the absurdity of Keynes’ reasoning that “for a man who has long been unemployed some measure of labor, instead of involving disutility, may have a positive utility. … Pyramid-building, earthquakes, even wars may serve to increase wealth…” (2008: 128-129) Labor cannot but have disutility. Keynes may have been fortunate never to have experienced an earthquake or fought in a war; otherwise, he might have had second thoughts on the alleged delight that people feel from employing themselves at rebuilding their destroyed homes. Perhaps, Keynes thinks that people can be energized by

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an emergency. Very well, let me change the scenario a little, such that every time they rebuild, their cities are again and again destroyed by bombs. Surely, it will not be long before they finally get demoralized. Goleman (2006) argues that “emotional skills” include “delaying gratification.” However, time preference is a value-free notion. Neither the ant nor the grasshopper is praised or condemned. Economists consider TP to be as personal and subjective as a preference for vanilla vs. chocolate ice cream; moreover, good when satisfied and bad when unsatisfied. In the modern society, Smith may have the luxury of not needing to wait for his house at all, even if he has no savings of his own, if some Jones agrees to loan his own savings to him. The essence of a loan transaction is this: Jones gives Smith $240k to spend on the house, but Smith agrees to pay Jones back $400k in monthly installments over the next 15 years. We might characterize this as Smith getting net worth and Jones getting income. This appears to be a non-trivial transaction; like many other business practices, it had to be invented by humans. The source of demand for time lies in the utility of alleviating the pain of waiting. The demand is in terms of money; the money that is paid for time is called interest. Demand for time is not demand for capital, because capital is a produced factor combining original natural resources, land, labor, and time and therefore, more than time alone. In other words, capital is not time because of Rothbard’s technological / economic law of production which states that “at each stage of production, the product must be produced by more than one scarce high-order factor of production. If only one factor were necessary for the process, then the process itself would not be necessary, and consumers’ goods would be available in unlimited abundance.” (2004: 34) The reason to save and supply present money is the expectation that interest income will outweigh the more immediate sacrifices of consumption. Another reason for consuming now is in the case of perishable goods, the perishable consumer, or the perishable desire. One eats his strawberries now, or they will spoil tomorrow. One enjoys life today, for tomorrow he dies. One grabs a candy bar now, lest (he foresees) he will cease craving sweets five minutes from now. These examples are fine, but they do not demonstrate time preference, because one is not choosing between goods in different time periods. Further, consuming now may become the preferred behavior if any of reasons for saving outlined in (I, 20) wane for a person. Again, there is nothing here that contradicts my explanation of what time preference affects; TP is only one factor among many others which

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determine the allocation of goods or pleasures over time. It may be odd to think of time as a positive factor of production. It is true that the mere passage of time can improve something, as a harvest; in other words, creation by nature and human labor takes place over time. But it is more often the case that time breaks things down. Depreciation of things can also happen due to time alone, labor along, or both. Even a machine that is just standing there idle is vulnerable to the entropic forces of time. Goods suffer from being exposed to the ravages of age. Depreciation of an item can have the technical sense of losing its essence, corrupting or economic sense of becoming less useful by either producing less per time period or getting closer to being destroyed. Hence, we obtain the four Ds of reasons for economizing time: disutility of waiting, depreciation, death, and dithering. In this book, I will focus on the first and leave the other three mostly by the side. Let my rate of discounting the future be 5%, such that the present value of $105.26 a year from now for me is $100. If offered $100 now vs. $105 a year from now, then I might pick the latter. But if offered $100 million now vs. $105 million a year from now, then I would definitely pick the former. Why the inconsistency? Does my rate of discounting the future depend on my income or wealth? No. In order to see how TP works one must find a desire or set of desires that are being considered for satisfaction now or satisfaction later. Then one is to determine by how much the deal to postpone satisfying the desires must be sweetened in order to be picked. There must be a definite end that will be unattained with the help of the mere $100 million that would be attained by means of the $105 million. There must exist a basket of goods that I can afford only with the help of the marginal $5 million that is superior on my values scale to every basket of goods available without it. For example, if this offer is due to my winning the lottery, then the lottery owner might say: “Wait a year to get your money, and I’ll throw in an extra mansion worth… 5 million dollars [applause] in Beijing!” But the way in which I have phrased the puzzle leaves it unclear exactly on what the $5 million will be spent. It seems to be a trivial appendage to my otherwise huge win. What can I buy with $105 million that I will not be able to afford with $100 million? I am thinking. And I am making sense, until I take this question seriously and calculate in full detail how I am going to spend the loot. If I do, then I might decide that I really do need the extra $5 million in order actualize my plans. Conversely, why might I prefer $100 today to $110 tomorrow yet prefer $110 thirty-one days from now to $100 thirty days from now? The reason is that I have not looked so far into the future: I am not aware

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at this early stage of any end that is so urgent that I would be willing to satisfy it a day earlier and forgo a higher return just a single day later. I literally cannot imagine thirty days before getting paid what I could be losing by waiting another day. Of course, this could be a premature judgment: as the day of the payoff approaches, my plans may solidify, and I might regret failing to account for the possibility that I would, indeed, find a use for the money – good enough use so that the utility of quicker gratification outweighs the utility of the extra $10 – a day earlier later in the game. With respect to disutility of waiting, more objections can be advanced. Consider again the desire to travel to the Andromeda galaxy. It is never going to be satisfied. Should it be bothering me? Now to forget about a desire is inhuman: why not turn into a rock? But one may want to let go of an impossible dream, accept something one cannot change. Not traveling to Andromeda is not a reluctantly resigned to cost of any feasible choice and therefore has no disutility. Immediately, however, we can ask: “Why not ‘let go’ of my desire for a given future good, as well? Why should I dwell on it, when I know that I can only gratify myself a month from now?” Is it not enough for human action if a desire arises at the very moment when the action is completed? First of all, this is pretty hard to do: postponed desires persist and annoy, even grow stronger. One cannot really turn desires on or off at will. Moreover, if one has no interest in achieving a goal, can he stay motivated and keep the eyes on the prize? If one programs himself somehow to start desiring at the completion of the work, then what happens if in the middle of the project he finds a way to finish it quicker? Will he be able to switch the desire on “manually”? These seem implausible. Second, even if one can let go of a desire, the opportunity cost of doing so is the persistence of joy for the duration of waiting, if this desire had been satisfied. For privation of “joy” can take the forms of both “boredom” and “sorrow,” just as privation of sight can be (1) blindness and (2) seeing illusions and being deceived by the sense of sight. One may be afflicted with the first, even if he avoids the second. Disutility of waiting can take the form of boredom, as well. Suppose that I wish to observe a certain comet through a telescope. I know that it will arrive in the Earth’s vicinity in three months. Here I am not laboring at all, just waiting for something good to happen. But if told that the original prediction was wrong and the comet would make its appearance two weeks sooner than expected, then I would still be overjoyed. The disutility of waiting in this case consists in absence of happiness (say, with the state of affairs of the comet’s having been studied and knowledge of it, contemplated) not presence of pain.

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The three major human feelings with economic relevance can be arranged as follows: pleasure (or pain) is the difference between present good and past evils suffered to bring about the good; fear (to be considered later) concerns anticipation of a future evil; and hope is anticipation of a future good. Interest is a creature of hope. A hopeful person is conscious of a defect: he hopes to enjoy the good in the future but does not yet have it in his possession. Now hope is often linked with fortitude which makes it about what St. Thomas calls “arduous” goods, goods hard to obtain, goods that one labors to bring about. It follows that disutilities of waiting and labor are often suffered together in combination, because the painfulness of waiting is often felt especially pointedly due to the fact that during the time spent waiting, one labors. Yet just as hope is distinct from fortitude, so waiting is distinct from labor. In particular, patience is a virtue, because hope kindles or at least helps preserve desire; unsatisfied desires bring unhappiness; and a patient person’s unhappiness is minimized while he waits. Can one wait for a compound event of feeling a new desire in order to satisfy it instantly and enjoy it? It seems that there are enough of present wants to occupy the mind; no one really waits impatiently to be hungry just in order to enjoy food. Still, when going to sleep, am I not anticipating the pleasures of waking up in the morning? I anticipate feeling rested, seeing daylight, starting work, and having coffee under these circumstances. But I do not anticipate feeling the desire for coffee, i.e., how bad I would feel if I were deprived of the drink; only feeling the enjoyment of it. In this case, I am waiting for the right moment to consume. One praxeological difference between past and future, though both are long intervals of time is that the past is a collection of events (happening to things), whose only temporal relationship with each other is the qualitative “before” and “after.” The future, on the other hand, has another important aspect, namely, the actual amount or quantity of time that will pass between now and some future moment. This is because as one works on a project, nearing it to completion, he waits for the future satisfaction and in so doing experiences disutility of waiting. Either pain of sense or pain of loss (i.e., absence of pleasure) is felt at every passing moment. The amount of time before a desire is satisfied matters. It is true, finally, that anticipation of a pleasant event can itself be pleasant. But that does not negate the disutility of waiting, because a pleasant event now is always preferred to thinking about that pleasant event. For example, G.E. Moore (2004) distinguishes between a

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“pleasant thought” which, he says, causes “desire” which might in turn result in “thoughts of pleasure.” In fact, these three things are merely different ways of approaching the same phenomenon. To say that one [I] desires is to say that one wants to substitute one state of the world’s affairs for another one, which he likes more. A [II] pleasant thought is contemplation in one’s imagination of that happy situation before it is realized. It is an essential component of the process of choice. One must consider which of the possible worlds that he can create by acting promises to be the most pleasant one, and one does that by imagining each of these worlds already repaired to his satisfaction, i.e., by having [III] thoughts of pleasures. Imagination is a powerful enough faculty to supply an ephemeral approximation of the actual happiness that is still to be obtained. It is also checkered with sorrow, because imagination hints not only of the future pleasure but also of the pain associated with the costs of attaining it. That future pleasure is picked for attainment the thought of which now is overall – costs taken into account – most pleasant. But a pleasant thought is pleasant, only because one thinks of an actual happiness that the changed world will, it is hoped, surrender to him. In addition, that pleasuresooner is preferred both to pleasurelater and to daydreaming about the pleasure is not disturbed by the possibility that, occasionally, (thinking about pleasure + pleasurelater) together may be preferred to pleasuresooner. This is a case when one prefers to “savor” his enjoyment. 42. THAT CONSUMER GOODS ARE HARDLY A SUBSISTENCE FUND FOR PRODUCERS OF FUTURE WEALTH

Richard von Strigl (2000) makes an odd claim. He realizes quite well that under unhampered capitalism, the workers are the main consumers of the goods they help produce. Capitalism is mass production by the people (insofar as the consumers “elect” the successful entrepreneurs), for the people (insofar as production is for the masses), and even “of” the people (insofar as anybody can test his skill and fortune at entrepreneurship). But then he says that the stock of the consumer goods available today is a “subsistence fund” which permits production to continue the next day. This fund supports the laborers, the producers of raw materials that are transformed into consumer goods, the producers of machines, and the producers of the raw materials to be transformed into those machines. (2000: 18-9) There is an air of paradox here. For Strigl almost reverses the direction of final causation in the economy. Normally, we say that

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production is for the sake of consumption. Our author says, on the contrary, that consumption today is for the sake of production today which is for the sake of consumption tomorrow which is for the sake of… Consumer goods today sustain the very people who are producing consumer goods for tomorrow. The problem with this reasoning is that the amount of goods in the subsistence fund needs to be only so large as to physically preserve the lives and perhaps the health of the workers, as well as, of course, to maintain capital. There is no need to provide enjoyments to the masses beyond mere minimum (as of food and shelter) necessary to support life. In that case, production could be made ever more roundabout without ever actually bearing fruit in the form of an abundance of consumer goods. It would be forever lengthened without ever resulting in anything. If Strigl had had the right understanding of time preference, then he would have realized that the extent of the subsistence fund depends on subjective consumer preferences for pleasure today as versus at various future dates. If time preferences rise, then there is increased depreciation and using up of capital and shortening of production structures, a kind of regression into primitivism, “decivilization.” (Forgive me if I sound judgmental here; it is not intended.) If time preferences fall, then there is less present consumption, because resources are redirected into investments: most likely, into setting up longer production processes. To illustrate the issue, consider the following “amazing” statistic cited by the philosopher Peter Singer: People in the poor countries consume, on average, 180 kilos of grain a year, while North Americans average around 900 kilos. The difference is caused by the fact that in the rich countries we feed most of our grain to animals, converting it into meat, milk, and eggs. Because this is a highly inefficient process, people in rich countries are responsible for the consumption of far more food than those in the poor countries who eat few animal products. If we stopped feeding animals on grain and soybeans, the amount of food saved would – if distributed to those who need it – be more than enough to end hunger throughout the world. (1999: 220) This paragraph is instructive in the sheer number of despicable absurdities contained therein. Permit me the pleasure of pointing out some of

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the most atrocious ones. First, notice the “we” who feed grain to the animals. Who are these “we”? I personally, e.g., do not own any grain or animals who eat grain, so why the collectivism? Singer assumes the position of an omnipotent manager dictating to people what to consume and how to produce. But “we” do not live in a totalitarian society, and unless Singer wants to defend this additional assumption, that is, that we ought to be ruled like sheep or government serfs, his notions, though many, are not worth a penny. Second, converting grain to meat, milk, eggs, etc. is only inefficient from the point of view of a swine herder. The swine are presumably content with grain. But “we” want to eat not like swine but like human beings, and that means enjoying all the delicacies that civilization has to offer. The conversion is inefficient only if the goal is to survive another day. It is not at all inefficient, if the goal is actually to take pleasure in eating, because so far feeding grain to animals is the only and therefore, perfectly efficient means of obtaining these wonderful higher-order foods. What I mean is that if, for example, it were both possible and economic (as determined by the market) to grow same- or better-quality food synthetically or feed animals industrial waste, then we could talk of more or less efficient paths toward our chosen goals. As things stand, such discussion is moot. Third, is not “our” goal (why are the citizens of poor countries in Singer’s imagination our wards, like pets or little children, of whom we must take tender care?) to make poor countries so rich than they, too, will be able to use the same “inefficient” processes of getting their food? We should not respond to Singer’s emotional blackmail with guilt for enjoying life. Fourth, whenever there is talk of how rich countries consume a lot of resources (such as, indeed, food) in the world, there is never mentioned the crucial fact that these same countries produce most of the world’s resources, as well, and are therefore, perhaps, entitled to the fruits of their labor. Goods in the market economy are not “distributed.” They are produced and ipso facto come to be owned by their makers. “It is certainly very easy for the governmental apparatus of compulsion and coercion to embark upon confiscation and expropriation,” Mises reflects. “But this does not prove that a durable system of economic affairs can be built upon such confiscation and expropriation.” (1996: 804) Fifth, the reason why farmers “feed animals on grains and soybeans” is that there is demand for animal products: meat, eggs, etc. If

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that original demand were to disappear, then the derived demand for grains and soybeans would plummet, as well. Farmers would produce enough to feed those who will buy products made directly from grains and soy, but no more than that. (E.g., a drop in the demand for paper can actually cause deforestation, as entrepreneurs do not re-plant those privately owned forests that were grown specifically for paper production.) The point is that those in poor countries should themselves take part in the global economy and participate in social cooperation on equal terms with everyone else. They should produce, like “we” do, for other people’s consumption. They, too, should contribute to society. Then they will have the money to fill their stomachs with grain and other junk food or even, as their economies grow, with better food, as well. If they produce nothing, then, of course, they will be able to consume nothing either. It would surely be counterproductive to put them on government foreign aid “welfare.” Sixth, perhaps, Singer simply wants us freely to donate money to charity. But if that were his purpose, then his advice would concern American consumption patterns only. He would be able to tell people: “Chew grass yourselves and send whatever cash you have left every month to the poor.” But Singer is not content to be calling us to make straight the way for the Lord. He is also devising schemes of government interference with production. And that is just wrong. Utilitarians like Peter Unger who harp on our alleged duties to the poor in faraway lands fail to grasp the details of their own moral theory. For the demands of utilitarianism are hierarchical. At the base lies the prescription to make a society (or the world as a whole) as efficient as possible. There are very few truly needy in rich and successful societies. The second tier is private charity, voluntarily discharged duties to help the poor, the widows and orphans, the church, and suchlike. The reason why there is a lexicographical priority is that it is worse than useless to throw charitable donations into a society that cannot but remain poor because of its abhorrence of capitalism. First, the citizens must learn economics and cooperate according to its teachings. Only then, with respect to abandoned infants, the incapacitated, and so on, will charity play its indispensable role. One must first teach the vast majority to fish and give fish only to those who cannot produce.45 A reply to Unger’s Living High and Letting Die then is that 45

To this proverb, “Give a man a fish, and he’ll eat for a day; teach a man to fish, and he’ll eat for a lifetime,” it may be added: “Give a man freedom and his property rights, and he’ll feed the entire world.”

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unless the poor countries put themselves together and on their own eliminate poverty for the general population, flooding them with foreign aid or charitable donations is futile. If we want to help, then we should send them economics teachers who will explain to them what’s what. Only once laissez-faire capitalism is accepted and implemented, and the standard of living is rising rapidly, will it make sense to care for the sick, the dying, and so on. When the masses are dying from hunger or live on the brink of starvation or barely subsisting, there can be no talk about helping the few deserving poor, because everyone is poor. Again, what “they” need is not charity but a solid grounding in economics and libertarianism. It is contrary to utilitarianism for the failed nations to leech off the successful ones: must not “they” cooperate with “us” honestly? Paying people for not producing diminishes overall wealth and happiness. Unger postulates second-tier duties to “us,” while forgetting about first-tier duties to “them.” If it is objected that they cannot in principle help themselves, then I reply that in that case, they for all intents and purposes are not human, and we have no duty to feed them, just as we have no duty to feed wild animals. I agree that it is a scandal that many people in Third World countries are malnourished. But “we” are not responsible for that. Left-liberals, for all their coercive “compassion,” think that the Africans, etc. are an embarrassment to humanity. In a way, they are right: it is their flaws that cause their poverty. That does not mean that we should be treating them as subhumans who (we have decided) cannot take care of themselves. Not only does acting on our alleged second-tier duties tempt them to violate their first-tier duties, but if the latter were fulfilled, then the former might disappear entirely, because the givers, “we,” in Unger’s cases, are too far away which violates the subsidiary principle which may have some authority even for a utilitarian. Why should an American help the beggars in Africa and not someone closer to them by location, kinship, language, etc.? It should not be a “burden” to be a “white man.” In addition, second-tier duties are limited, I believe, to a large degree to rescuing people from life-threatening situations. Once rescued, however, people ought to provide for themselves. It is also clear that failure to be charitable is not a crime like theft but merely a vice, and vices are not crimes. Just because Scrooge is a bad and stingy person does not mean that it is OK to steal from him or tax him. That would be a (first-tier) crime, whereas Scrooge’s behavior is merely a (second-tier) vice and “does not rise to the level” of a crime. A breach of a moral duty is not necessarily a breach of a legal duty.

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The third tier is paternalism. If everything fails, and a person’s powers incline to evil, then those powers must be temporarily taken away, until such time when he will learn to use them responsibly. Thus, taking what seems to me everything in account, utilitarianism is promoted by (1) a social system of efficient laws which create such incentives as to make individual profit and the good of society (or common good) to harmonize with each other, i.e., making society prudent; (2) teaching people how to succeed in their personal undertakings, i.e., making individuals prudent within that prudent society; and (3) prescribing certain limited, imperfect in the Kantian sense46, and voluntarily discharged duties, such as helping the poor or donating to the church, that redistribute resources within the social values scale (insofar as love of friendship entails merging of the values scales of the lovers) to satisfy the most urgent needs, i.e., remedying situations in which the prudence of an individual fails through no fault of his own (essentially bad luck). It is plain that the amount of the consumer goods available is much greater than is needed merely to maintain present production activities. One could do the latter with many fewer present resources. But because people want to live like civilized human beings, they seek refined pleasures which is a goal that constrains how fast an economy can grow. Only when present desires are (reluctantly) sacrificed for what people perceive to be a greater good, namely, future bounty, do there arise more roundabout production processes, but they, too, are for the sake of consumption, though in the future and moreover, at some precisely specified future date rather than in the present. 43. THAT THE INTEREST RATE IS SUBDIVIDED INTO ITS ASPECTS OF ORIGINARY, PERSONAL, AND EQUILIBRIUM The first aspect of the interest rate concerns the price of waiting. If I am to have any incentive to choose to give up today’s consumption for the sake of a particular satisfaction tomorrow, then it must be the case that bringing closer to fruition the future good ranks higher on my values scale than the present good sacrificed. However, if I want to put a number on the interest rate, then I cannot deal with valuations alone, because those are ordinal: they form a hierarchy, a scale and cannot be 46

“Develop your talents” is an imperfect duty: one ought to do it generally, but one need not be developing the talents every waking moment of his life. One can relax, forget about this duty, and watch some TV. “Do not steal” is a perfect duty, in the sense that one may never take a break from not stealing.

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divided by each other. Still less is it possible to obtain a numeric interest rate by comparing “present goods” with “future goods,” because no mathematical operations can be attempted on heterogeneous goods. Therefore, originary interest is a monetary phenomenon, insofar as it requires a yardstick to deal with valuations. This is a crude but unavoidable makeshift: the first aspect of the interest rate arises only when money prices are assigned to satisfactions of subjective desires. Suppose that I am considering buying a new computer which costs $1,500. I ask two questions: “What is the maximum price that I am willing to pay for the computer?” And: “How much is waiting for this pleasure that I can enjoy now worth to me?” Suppose that the computer is pretty valuable to me and worth as much as $21,500. At the same time, I would be content if someone gave me at least $1,000 under the condition that I wait for a year to buy the computer. (Assume that all other things, such as the computer’s quality, are held equal.) In other words, I choose to forgo $20K of immediate consumer surplus for the sake of an extra $1K. From these, I conclude that my ratio of discounting the future is 5% per year. Having obtained the ratio, I can now find the price of waiting for any good whatever. If a bottle of rum is worth $20 to me, then I would require at least $1 to agree to put off buying it for a year. The discount ratio will be called the originary interest rate or OIR. We must not be confused by the distinction between value and price. A 10-day supply of meals is worth a great deal to me, perhaps, in fact an infinity of dollars, because if I do not eat, I will die, and money is of no use to a corpse. But this supply probably has a fairly low price. The implication is that, since 5% of infinity is still infinity, I would need an infinity of dollars to consent to wait for my meals; in other words, that no amount of money will stop me from eating. This is a good result, since it is consistent with the obvious point that food is a necessity. That time preference is the correct explanation of interest rate can be gleaned also from the fact that one can choose between borrowing money on the loan market and starting his business immediately or waiting a period of time to save enough himself. Sometimes one option will be chosen; other times, the other. It is clear that the choice involves paying money to save time vs. waiting to save money. Hence, waiting must have disutility, if people are willing to pay to relieve it and also to sell their time and endure waiting for money, both given the right price. The second aspect of the interest rate is, given my income, how much of it will I consume, and how much will I save, given a particular array of returns on various investments I have identified? The more I save and invest, the greater the number and urgency of my present desires that I must leave unsatisfied, as per the law of marginal utility,

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which means that forsaking them will be increasingly more painful. At high level of saving, there had better be for me some extremely lucrative ventures. At the very least when it comes to necessities of life, regardless of the interest rate, I must at some point stop saving and consume. For example, regarding my buying the computer, I would save the $1,500 for $1,001 right now and consume the $1,500 if offered only $999 right now. This yields a 67% interest rate. I would need a return of at least 67% (and perhaps, more if I have still more urgent desires) to redirect my consumption of the marginal $1,500 into investing it into some company. The variable that has this value, 67%, will be called the personal interest rate or PIR. This number will determine which investment opportunities are profitable and which are not. The interest rate reduces the profit. If I want to invest $1,500, and my PIR is 67% / year, then no company that fails to return to me more than $1,000 one year from now will have a chance of claiming my savings. I survey my perceived profit opportunities and eliminate all of those whose rate of return is below 67% / year. This is because it does not pay me to wait so long for such a meager, in my estimation, gain. If I am not a stellar entrepreneur and cannot find an investment whose risk and reward are such as to result in a projected return greater than 67%, then I will certainly consume the $1,500. Note that the OIR is essential to calculating the PIR: to obtain the latter we need (1) the price of a good whose purchase is being contemplated ($1,500 in the example), (2) the consumer surplus that one will enjoy by buying the good ($20,000), and (3) the OIR (5%). The third aspect of the interest rate revolves around the loan market. In it, people benefit from the differences in their time preference rates. If my PIR is 67%, and Smith’s PIR is 80%, then it will pay me to lend him some amount of money (how much money is part of the second aspect) at, say, 75%. My profit is $(0.75 – 0.67) * (the amount of money lent), and Smith’s profit is $0.05 * (the amount of money lent); so, everybody is happy. If Smith fails to return my money to me a year hence, then his fate is more than merely the stigma of being a poor entrepreneur; it is debtor’s prison for him or would be in less permissive times. 75% is here the market equilibrium interest rate (from now on the EIR), and it is plotted on a graph with the quantity lent / borrowed. There are then two kinds of profit that must be distinguished from interest: (1) psychic profit from loan market exchanges, which I will call interest-profit, and (2) entrepreneurial monetary profit above and beyond that. Suppose that Smith is considering buying a boat that costs $10K. The EIR is 5% per year. The maximum rate at which Smith would want to borrow is 20%. He also has an investment opportunity that promises to yield 30% return from the $10K invested.

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Thus, Smith can get the boat 1 year from now and pay $10K for it 1 year from now; or he can get the boat now and pay $10.5K 1 year from now. Smith values not waiting a year at $2K. He does not want to wait, if he is obliged to pay for this privilege $2K or less. But he would wait and save by himself for a year, if he were charged $2.1K. At first, Smith does not have the $10K. The interest rate is low, so he borrows. If he spends it on the boat, then his consumer surplus is $1.5K. But he can also invest. He needs to decide whether to get the boat now and forgo $2.5K in overall “profit” or wait a year and receive this extra amount. But we just saw that Smith would wait, if he had to sacrifice over 2K in order to be relieved of waiting. Since 2.5 > 2, Smith invests the $10K. His consumer surplus (the opportunity cost of investing in terms of pleasure) or (1) is $1.5K, and entrepreneurial profit or (2) is $1K. Schumpeter (2010) considers interest to be simply lender’s profit. In so doing, he fails to tell apart interest and (1). Moreover, interest arises, Schumpeter claims, because the supply of money or “purchasing power” to be sold is limited; money is scarce. He is led into giving an argument in favor of inflation and credit expansion is as follows: 1. 2. 3. 4.

There is no development without credit. (See (I, 15) for more.) There is no credit without money. Interest is lender’s profit. There is interest, because purchasing power, that is, money is scarce; there is a definite limited supply of it. 5. Interest is a “break on development,” a “tax on entrepreneurial profit,” ripe to be objected to by any “critic of social conditions.” (210-1) 6. Hence, society will benefit from less scarce money and credit. 7. Hence, credit expansion is justified. Schumpeter should have realized that it is not money that is sold (how can it be sold, when the borrower has to give it back?) but rather the opportunity to enjoy or act for the sake of future enjoyment now as opposed to in some more or less distant future, when the consumer or entrepreneur has personally completed saving the funds needed for the purchase. Interest is no more a hindrance to growth than the fact that most wage-earners work 40 hours per week and enjoy leisure the rest of the time instead of working 80 hours per week, producing more as a result. In other words, what is sold on the loan market is neither money nor capital but instant gratification whose price is increased future hardship. The term “usury,” though it has no economic meaning, may have

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a moral meaning, insofar as some people may be “tempted” to borrow above their means in order to “eat, drink, and be merry, for tomorrow they die”, only to come later to “regret” their incontinence. Usury was proscribed in olden times in order to save people from themselves. Note that the OIR and PIR are “neoclassical” interest rates, since I use the concept of indifference in their derivation; the EIR is the only version of the interest rate shared by both traditions, because for the Austrians all prices arise only out of interpersonal exchange. The originary and personal interest rates are, therefore, to an extent illusory; however, I find them useful and will continue referring to them. 44. HOW THE VARIOUS INTEREST RATES ARE DETERMINED What brings about the phenomenon of universal positive time preference, of preferring present goods to future goods, is disutility of waiting. Satisfying a desire sooner is always preferable to living with it, to being “uneasy,” unhappy, discontented, for a longer period of time. This is entailed by the meaning of economic terms such as pleasure and pain, end, and action. The reason for the common failure to take into account interest may lie simply in the distinction between what is seen and what is unseen in human action, between benefits and opportunity costs. What is seen is that Smith invested $10 and received a $15 return on his investment a year later. We are liable to credit him with a $5 or 50% profit. What is unseen is how Smith suffered for this money, namely, that he had to wait a whole year to get it. He gave up the pleasures that the $10 could buy. The amount of this suffering depends on Smith’s personal interest rate or the consumption opportunities he had to surrender for a period of time. This disutility has to be counted as a psychic cost, diminishing Smith’s profit. Again, it is permissible to think of interest as a monetary phenomenon, requiring economic calculation and therefore, a unit of account. I lend money and am paid in money, and I must know the ratio of what I am paid to what I lend. In other words, by using money I am able to assign a numeric value to the interest rate, something which would be much harder to do, if I were considering a choice of a “large” candy tomorrow vs. one “small” candy today and one tomorrow. But money is merely a stand-in for present happiness given up and future happiness enhanced. My individual values scale determine whether I prefer to spend my $1,000 now and forsake the 75% interest on it or prefer the extra $750 a year hence to the pleasure I could derive by consuming

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now. The first aspect of the interest rate, OIR, varies for every individual and uniquely specifies the points of “indifference” between now and any future time. The rate of the second aspect also varies between people, justifying its moniker PIR, and is about who will invest how much in what. The first two aspects together determine the third, namely, the loan market rate of interest or EIR which is the same for all people, proper allowance being made for risk and duration of the loans. If a saver wants to take advantage of his relatively low time preference, then it is open to him either to loan the money to another person with a higher time preference to consume or to invest into a business firm. He will thereby receive either psychic consumer surplus alone or both such surplus and entrepreneurial monetary gain. On the loan market, people with different time preferences benefit from each other’s existence. (Again, a pure Austrian can argue that it is superfluous to assign money values to consumer surpluses and suchlike. If Smith agrees to lend $1,000 to Jones at 10% interest, then that is the EIR. It makes little economic sense to say that in so doing, Smith obtains $50 “worth of pleasure,” and Jones obtains $75. But in this case, it is harmless.) As I will show shortly, the key cause of the business cycle is artificially wide divergence of the PIR and EIR under a fiat / credit money regime. That interest rate is the “price of waiting” is a crude formulation; rather, it is the price the borrower pays in order to obtain the wherewithal to enjoy an otherwise unattainable good here and now. The cost to him is diminished future income and therefore diminished command over all future goods. Conversely, the interest earned by the lender allows him to buy a definite future good – i.e., the good the lender was explicitly aiming to buy, unless he is planning to hoard the money – earlier than would be possible without giving up present consumption to this particular extent. If the lender chose to consume instead, then he would have to endure unsatisfied desires which would trouble or vex him for a longer period of time. On the loan market, some people supply present money and others, demand it. Of course, nobody can be both a supplier of present money and a demander of present money at the same time, but one can be a supplier at one, higher, interest rate and a demander at another, lower, interest rate. This is because a higher interest rate increases the opportunity cost of immediate consumption. Each curve connects the amount of money out of one’s income saved and loaned or borrowed and consumed with the interest rate. At high EIRs, a person will be a supplier of present goods (curve A in Figure I.44.1); and at low interest

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rates, he will borrow money.

FIGURE I.44.1. INDIVIDUAL SUPPLY AND DEMAND FOR PRESENT MONEY

For example, at a high interest rate, Smith may think it would be unprofitable to go into business for himself. But as the rate drops low enough, he might change his mind and instead of loaning out his money, decide to borrow a sufficient amount to start the business (curve B), hoping that with decreased costs (namely, the time factor), his business will come out ahead. A is the supply curve of and B is the demand curve for present goods. Note that the supply of and demand for present goods are not independent of each other, being part of the same curve, with the demand curve mirrored from the 2nd quadrant into the 1st quadrant, resulting in its familiar shape. If a person ceases to be a net demander of present goods, then he will become a supplier of present goods. If demand decreases, then supply increases, and vice versa. One consequence is that an increase in aggregate voluntary savings, i.e., in the supply of present money, does not mean that the equilibrium quantity supplied must also increase. It is instructive that Murray Rothbard has denied the importance of the loan market for economic theory. In fact, he said it concealed reality: “Instead of being fundamentally suppliers of present goods, capitalists are portrayed as demanders of present goods.” (2004: 421) The producer loan market (PLM) arises only in a real economy and not in the ERE for people who like to invest on the margin, that is, try to profit with borrowed money. This spares them the psychic cost of having

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themselves to save over a length of time. Moreover, investment opportunities come and go quickly, and the loan market enables entrepreneurs to take advantage of an opportunity as soon as it is noticed, to “seize the day.” Of course, if the loan market did not exist, then entrepreneurs would on average still be in the same position relative to each other. Thus, the PLM has social utility but does not necessarily benefit any particular capitalist. Finally, the PLM is useful as a means to flexible profit sharing: some people will want just interest-profit (or the difference between the EIR and their PIRs) but with the benefit of not putting their money at risk; and others will want full profit but at the expense of exposing themselves to the full extent of business uncertainty and with it, the possibility of loss. Even then, entrepreneurs are properly net demanders of future goods, inasmuch as their return exceeds the market rate of interest, constituting pure profit, and this profit lies in the future. In other words, an entrepreneur can borrow money, use that money to advance present income to the factors of production, including the payments of interest, say, every week or so. When he sells the completed product after a while and receives a profit, he can “validate,” to use a Hyman Minsky’s term, the loan; in fact, he can renew it and continue evenly rotating (if he can and wants to) for another round of production. Thus, a common error is to think that the reason why deflation harms entrepreneurs is that they have to repay their loans with more valuable money. But if we keep in mind that the PLM is only of secondary importance, then we should see that accurately foreseen deflation on the contrary is a boon, because whatever profits will be collected will be amplified by the revenue’s higher purchasing power. I am not saying, of course, that deflation encourages production for society as a whole. First, an entrepreneur who profited despite deflation might (though not necessarily) have gained in nominal terms even more, were it not for the deflation. Second, such an entrepreneur is able to buy capital goods and services from other entrepreneurs at lower prices in future production rounds, only because those others ended up with losses. In the long run, it does not matter, because lower prices will spread up the structure of production, reducing income to most original factors and equilibrating costs and revenues. But in the short run, if wages are sticky, then output may decline somewhat. Note that when I say that deflation, such as due to voluntary hoarding, may temporarily slow down the economy, I do not imply that the government ought to step in and counteract that. People seek their self-interest without any prodding from the government. There is rarely any need officially to

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“encourage” anything. All the government has to do is get out of the way. Continuing this line of thought, the significant loan market is the consumer loan market (CLM). The CLM is “subjective,” insofar as decisions to consume now and pay the interest are weighed against decisions to save on one’s own; the PLM is “objective”: either the interest payments make the investment, when all costs and revenues are accounted for, unprofitable, or they do not. The result of the CLM transactions is a scale with a few values on it: one prefers to borrow and enjoy in the present to waiting less for future goods; or one prefers to save and retain full future income to postponing future pleasures for the sake of instant satisfaction; the result of the PLM transactions is a number representing either profit or loss. On the PLM, a person is presented with an interest rate and can use it to calculate the cost of the time factor and weigh it against the expected revenue. If profit can still be had, it is reasonable to borrow; if not, not. Now it is true that even on the PLM, values are compared: if an entrepreneur’s time preferences are high enough, then he will consume rather than invest. But assuming investing, the point stands. If Smith is a lender, then it would be incorrect to call him a supplier of capital or of money. All that he supplies are present goods in whatever form they are demanded.47 Smith does not care how these goods will be used, nor whether they are money or candy. The money lent out may, indeed, be used to purchase capital goods for a business. In such a case, a demander of present goods “buys time,” or rather, if he uses the money borrowed as capital, then capital goods constitute for him “packages” consisting of “stored-up” natural resources, labor, and time. But he can also buy a consumer good, such as a house. A person may derive such high utility from house ownership now that he would be willing to pay a high interest rate and thereby forsake some future goods. He wants immediate gratification now at the expense of future consumption. Alternatively, the borrowed money can be used as protection against inflation: for instance, Smith correctly forecasts hyperinflation, borrows at 5%, and invests into gold. One year later, gold prices are up 100%. He sells the gold, pays off the debt, and pockets the profit. Though the PLM is irrelevant for understanding production, as 47

A supplier of present goods is at the same time a demander of future goods; and conversely, a demander of present goods is a supplier of future goods, as per the contract between both. Therefore, the “nowadays obvious” to Joan Robinson plank of Keynesism that “the level of interest rates is governed by the supply and demand of money” is completely wrong.

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Rothbard has argued, it is not without economic significance, which is that it is an aspect of competition. Entrepreneurs compete with each other for investors directly and for lenders indirectly. In both cases, they reduce each other’s profits. In the first case, because they cannot expand production as much as they might have liked, because investors smell diminishing returns; in the second case, by bidding up the interest rate and increasing the cost of time to their businesses. Thus, the demand of entrepreneur-borrowers enters into the determination of the rate of interest as much as the demand of the consumer-borrowers. The consumer-borrower sacrifices future pleasures, because a portion of his future income will have to be devoted to paying interest on the loan. The entrepreneur-borrower also sacrifices future money, because the existence of a given interest rate eliminates certain profit opportunities that might have been invested into, had these rates been lower. His risk to reward ratio rises with the rise of the interest rate. There are, then, two reasons to abstain from immediate consumption. First is to receive a gain from trade with people with higher time preferences, i.e., the producer-of-present-goods surplus. This corresponds to the CLM. Second is to invest, usually into more time-consuming techniques. The PLM is peripherally linked with this. We will deal with the consumption / investment trade-off at the end of our discussion of interest. The lender is influenced by both his time and risk / liquidity preferences. The consumer-borrower deliberates regarding his TP only. The entrepreneur-borrower does not care about either TP or LP. And if there were such things as hoarder-borrowers, then those would care about LP only. Time preferences are a long-term phenomenon, associated with advancement of civilization itself. A society in which people are just trying to survive another day has very high TPs; a society in which people start business projects that are expected to culminate 10 years in the future has very low TPs. The two societies may be separated by several thousand years of development. But this long-term secular trend of people’s looking after ever more remote future, a kind of growth in social prudence, is effected by short-run drops in TPs manifested in entrepreneurs’ choosing new and somewhat more roundabout than before production methods. Each such drop in TP lowers the interest rate temporarily, because the PLM and CLM are part of the same “complex” loan market, the CLM being its “real” part, and PLM, its “imaginary” part. As soon as the new factories, etc. are online, and novel capital goods have been formed and incorporated into industry, the interest rate rises to the level determined by the CLM alone. We may call these

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fluctuations of interest rates due to the adventures of the PLM (under sound money and banking), the essence of economic progress. Though rental and interest incomes are distinct phenomena, there are enough similarities between them to make figuring out how they are different one the most difficult problems in economics. Rent can be of space, to allow other people to put things in it for a price, or of goods for their services. Rent is, indeed, the price of capital, and it is forever distinct from the additional fact about capital that it is incomplete or imperfect goods which yield their services over time rather than all at once; the use of one’s machine, itself subject to forces of supply and demand, carries with it the separate extra cost for its user of waiting for it to complete its work, and that is the source of interest. Rent arises out of two-fold utility. First, if one owns a capital good, such as a machine, then one is not under a strict necessity to find a single person who wants the entire good for himself, e.g., to work for him 24 hours per day, and sell the good to him. One can just as well find 24 people, A, …, X, each wanting to use the machine 1 hour each day and rent the machine to them. Second, there is the problem that the time period during which a machine can remain serviceable can be very long, but no business can calculate accurately too far ahead. It would be inconvenient to buy a piece of equipment whose lifetime is 10 years and end up staying in business for only 6 months. The machine would have to be re-sold with all the transaction costs that that implies. Surprises liable to spring upon one at any moment make it difficult to plan for very long. The point is to allow buyers easily to opt in using the machine or out of it, depending on their changing business needs; that is to say, to use the machine only if they are able at least to evenly rotate another round of production. Rent in its pure form is not discounted by the rate of interest for three reasons. First, there is no waiting for goods whose production has not yet began and will commence only in the future. Suppose that Crusoe on his island wants to build a computer. To do so, he has to construct whole factories to output computer components, even if he has all the relevant technological knowledge. This would take a massive amount of time. As a result, this desire is pretty low on his values scales, since there are numerous more important things for him to do first. While Crusoe is taking care of those other needs, he is not advancing the computerbuilding project at all. Today it would take him two years to build the computer; the same, tomorrow; and the next day; and so forth, until he actually starts saving and working. A desire which is not being acted upon is an empty daydream. The computer will not fall for Crusoe from the sky, and in the absence of action to bring the end closer, to keep

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shortening the time left until the computer materializes, there is no waiting for the end. To put it slightly differently, Crusoe in his capacity as a consumer experiences waiting during the period of saving for the computer; and in his capacity as an entrepreneur, he experiences waiting (for profits) during the period of production via certain present pleasures sacrificed. Similarly for rent: a production period of an item is 1 month; production rotates one month after another; hence, during the first month, the consumers are waiting only for the items being manufactured right now rather than for the items scheduled to be produced in the future rounds of production. This is because those future rounds have not yet been started! Without the disutility of waiting, there is no reason to discount. This is similar to the idea that some desires are quenched today and flare up again tomorrow; so, production has to go on day in and day out. While a desire is temporarily soothed, one is not waiting for production to complete to satisfy it. If even one of the trinity within is missing, then there is no waiting. Second, the fact that income from rents is not guaranteed to the good owner causes the future to be only partially discounted, within a range of possibility of prediction. For if Smith counts for sure on being able to keep the machine working for his clients for a year, then the sum of the rents he receives every month has to be discounted when calculating his yearly income: if Smith could arrange to receive the entire sum at the beginning of the year, then he could lend it out and earn interest. But given that Smith’s clients are here today and gone tomorrow, Smith may not have the luxury of this alternative. The only way for him to receive income may be with the help of rent; he cannot get the full capitalized value of his machine. Failing to earn interest then is not an opportunity cost of employing the machine in production. In other words, profits are not discounted, because they are unique to each period of production, not duplicated tomorrow and the day after. In short, interest comes into being within a period of production; rent does so in between periods of production. The third reason why rents ought not to be discounted is that a simple Crusoe-Friday economy differs from an advanced economy in which numerous production processes all take different times. If the interest rate is 5% / month, then the opportunity cost of renting a capital good for twelve distinct consecutive 1-month long projects for $500 / month payable at the beginning of each month could be renting it for some 1-year long project for $4,653 / year payable at the beginning of the year. One can then consume or loan out the money. For Crusoe and

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Friday, rent would most likely not be discounted for that reason. In a manner of speaking, interest has penetrated and polluted the concept of rent. For example, if machine X creates 1 consumer widget per month sold for $100 and lasts for 12 months, and the interest rate is 1% / month, then the $1,200 in revenue by all rights has to be discounted only by 1%. This is because it is impossible to obtain this income right away but only after a year has passed. The machine has the deficiency of postponing the creation of each widget for 1 month; but production starts anew every month. However, the owner of X, Smith, in the modern economy may easily have a choice of selling the machine for $1,200 / 1.01 = $1,188 and lending the money at 12.68% per year. Therefore, X’s quasi-rents will in practice also be discounted by the rate of interest, such that, e.g., the 4th month’s revenue will be worth only $100 / 1.014 = $96.10. The machine’s capitalized value is now only $1,126 or $62 less than it would be normally.48 If X is perfectly specific to Smith’s business, and Smith already owns it, then he does not have the option of selling it; regardless, he would have considered the opportunity cost of lost interest income before investing into it. The “interest rate” at which things are discounted then is lowered by the phenomena of uncertainty of the future and of imperfect convertibility of capital. The confusion between interest and rent can be illustrated in the following scenario. Jones owns a certain object C. Smith wants this C for himself to use in his own business. The period of production is 1 month. At the end of the month Smith returns C to Jones. Question: What information do we need to discover whether C was loaned or rented to Smith? Renting C confers ownership of C’s services to Smith for a month, while keeping ownership of C itself in the hands of Jones. The first clue lies in the timing of the payment. It Smith paid for C at the beginning of the month, then this suggests renting; if at the end of the month, then lending. The second difference is whether C is allowed to depreciate. If not, i.e., if Smith must return C to Jones in the original condition, then it could have been loaned; but if C is allowed to depreciate from use, then it was probably rented. Money does not depreciate; goods usually do; hence, money is a decent candidate for being loaned; and goods, for being rented. 48

$1,126 loaned at 1% interest per month for a year will, of course, yield the same return over $1,200 as the sum of returns of $100 loaned out at 1% / month for 11 months, 10 months, …, 1 month or approximately $68.

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The third difference depends on whether Jones, prior to letting go of C, had use for it himself. If not, then he rented C. Money always has reservation demand for its owner who must decide whether to consume it or save and lend / invest it. A good need not have any use-value for its owner who might have produced it solely for other people’s consumption. Fourth, interest compounds; whereas renting out C is a brandnew sale every period. Fifth, rent is paid for productivity, but money (formally as opposed to the material out of which money may be made) has no usevalue and is not productive other than in its capacity as a store of value (SoV). Money serves as a SoV, yielding services over time, when it is hoarded. Thus, Chick (1991) calls hoarded money “idle balances.” What an error. For the only way in which money has a use-value and “works” and is not idle at all in itself is via cash balances held out of the “precautionary” motive. However, if the money borrowed and hoarded is ever spent, then it will cease to be a SoV; at the same time, if the contract stipulates that it cannot be spent, then it is not a SoV in the first place. Moreover, borrowed money is immediately spent either on consumer wants or business needs of the borrower; whereas a rented good remains with the renter. Sixth, it is difficult to calculate the interest rate unless what is loaned and repaid is money. Consequently, it seems that only goods can be rented, and only money can be loaned. For example, it is easy to imagine the situation in which Robinson loans Smith money which Smith then uses to rent C from Jones. This gives the lie to the idea that interest is a “payment for money and as such rewards no genuine sacrifice.” (Dillard 1948: 195) The only way to make sense of that quote is to interpret it as a collage of two mistakes: first, that interest is rent; second, that money can be rented. The second error can be avoided by saying that interest is a payment for the things money will buy, such as capital. Of course, that, too, is incorrect. Capital is a produced factor which combines time, natural resources, labor, and nature into an attractive bundle. How can interest on its own possibly be a payment for all these factors? Another misunderstanding has to be guarded against. Rent is, indeed, often spoken of as income from land. But what is land? Its first meaning is “space,” whether two- or three-dimensional. But for Marshall land means “all free gifts of nature, such as mines, fisheries, etc., which yield income.” (1964: 66) That is just incoherent. For an acting man does not care whether a capital good he is using is original

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or produced. That is a datum of the past, and the past holds no interest for someone who calculates for the future and lives in the present. What the acting man does take into account is whether, once this good depreciates during production, it is replaced by nature, as it were, “automatically” and “on its own” or by human labor. Fish multiply; new coal keeps coming up underneath the coal that is taken away. The question “Must additional resources be bought in order to maintain capital, if one wants to continue evenly rotating for a spell?” is important. Therefore, land means not goods of the highest order that are just found and appropriated but rather the power of nature to replenish those goods without human assistance. For one can usefully own that power in owing land, as well as owing the present free gifts of that power. The factors of production, then, are simply space, nature, insofar as nature, whether in its original state or in any way modified by man, possesses a modicum of creative power, capital goods, human labor, and time. Free gifts or nature are then produced factors, with nature being their producer. It is sometimes asserted that the quantity of land is fixed and cannot be produced. This is only partially true. For plenty of land is still submarginal and is not used at all. Secondly, while humans, indeed, cannot produce space, they can most definitely produce access to space and to the resources encased in it. Thus, tall buildings allow humans to live and work in points in space far above ground; ships allow travel upon the waves; and miners dig earth in order to get to the valuables beneath. What I understand Mises to be saying in the chapter on interest in Human Action is that the reason why my PIR = 1.67 is that at 67% interest I will be neither a lender nor a borrower. Indeed, suppose that I have $1,500 and am thinking of spending it on the computer. Surely, I will not lend this amount at any interest rate below or equal to 67% but will lend it at any rate above 67%. This is a simple calculation given my “indifference” between a computer now or $1,000 a year from now.49 Moreover, I will not borrow still more cash at a rate above 67%, because buying the computer is assumed to be my most highly valued option, and the desire for no other good after I have the computer is expected to justify getting into debt this large. 49

We can disavow indifference, as per the Austrian method (arguing that indifference is not an economic category, only choice is; only choice has economic consequences; indifference cannot be demonstrated in action; etc.), in principle but accept it as practice as a useful abstraction.

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Analogously, if I don’t have $1,500, then I will not borrow this amount at any interest rate above or equal to 67% but will borrow at any rate below 67%. Similarly, again, I will not lend whatever amount of money I do have at anything below 67%, because I would be better off taking this money and spending it on the computer, an action that would yield $1,000 return a year from now. The curve in Figure I.44.1 depicts quantity lent or borrowed as a function of the interest rate: Q = f(IR). The connection between this function and the PIR is that f(PIR) = 0; it is a breakpoint, such that at lower rates I will borrow, and at higher rates I will lend. If someone’s PIR is 80%, then he can borrow from me at the EIR = 75%, generating a mutually beneficial exchange, i.e., profit for both of us. (Note how now we are able to tease out interest from profit.) When the equilibrium quantity supplied is added into the picture, we obtain (1) a person’s income and (2) his willingness to save and invest or lend $X out of that income when offered a rate of return of I%. The next step is to sum up or aggregate all the supply and demand curves of each individual into a single pair of curves relating the quantity supplied / demanded with the interest rate for the entire community. Their intersection will yield the equilibrium interest rate, at which the quantity supplied of present goods equals the quantity demanded of present goods. (Below the equilibrium, there will be too many borrowers; above, too many lenders.) To sum it up: disutility of waiting causes the phenomenon of positive time preference as such and the OIR; the OIR is used in the derivation of the PIR; an individual time preference scale created in part by means of the PIR causes individual schedules or curves of the supply of present goods and/or demand for present goods; these curves, put together, determine the market supply and demand curves and the EIR. 45. THAT HUMAN ACTION GENERATES PROFIT OR LOSS NOT INTEREST INCOME

Jörg Guido Hülsmann (2002) rejects the classical Austrian account of time preference and interest and substitutes his own notions. In what follows, I will critique his position and try to vindicate the theory of interest as arising out of positive time preference and the market for time. Hülsmann starts out by criticizing a theory of interest based on the idea that “human beings could not survive if they did not consume. Hence, there must be some time preference in human action, lest the human race would perish. … in order to survive human beings must, at

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some point, prefer shorter production processes to longer ones, even though the longer ones are more physically productive.” Hülsmann’s first mistake is attributing this theory to Mises, when on pages 487-8 of Human Action, Mises explicitly rejects this explanation as being fundamental to time preference, levying criticism on it similar to my own of Strigl in (I, 42). Again, it is true that the cost of not continuously consuming necessities like food and water is infinite; no amount of future pleasure is sufficient to cause me to agree to die from starvation by failing to eat for too long. One must be alive to taste any pleasures. But the phenomenon of time preference is not exhausted by this trivial observation. Having constructed this straw man, Hülsmann proceeds to refute it by referring to “warriors and martyrs” who “have the tendency to be oblivious of the physiological requirements of sustained life.” I agree that though corpses have no desires, while a person is alive, he is under no praxeological necessity to care for his life and health. But a martyr, too, presumably, is concerned with the good of others or the whole society, loves these people as friends with their hearts becoming one, and in so doing, busies himself with goals that are expected to be consummated only after his death. Mises argues, correctly, that in providing for others in the time beyond the duration of one’s own life, one alleviates “his own present dissatisfaction with the expected state of other people’s affairs in various periods of the future.” (1996: 499) Even a martyr does not waste his life by sacrificing himself for no good reason. I would be hesitant to interpret Mises even as saying that consumption demonstrates time preference, because all consumption by definition takes place in the present. This is true but toothless: yes, any enjoyment takes place in the now; so does any experience whatsoever; but it is not really because one prefers to enjoy now, but because there is no way to enjoy anything at any time other than now. One cannot either choose or renounce the impossible. The basic point to grasp is that waiting, like labor, is not only a full-featured factor of production but also, again like labor, has disutility. Not consuming $1,500 a month from now is an opportunity cost of consuming $1,000 presently. The opportunity cost is the persistence of unsatisfied desires which result in a discomfort, “uneasiness,” sorrow from seeing a goal so close yet being unable to reach it for more than a month for the sake of some immediate pleasure.50 50

St. Thomas describes the disutility of waiting of, of all things, souls in purgatory as follows: “And since after this life the holy souls desire the Sovereign Good with the most intense longing – both because their longing is not

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Let me start out with the Mises’ challenge to explain why some people invest $100 to receive $104 a year later, and other people do not. What accounts for the difference in the behavior? Mises answers: time preference or preferring to be paid sooner rather than later. Hülsmann objects: Economic comparisons are not cast in terms of physical units, but in terms of choice alternatives, and choice alternatives are always heterogeneous. In the present case, therefore, the economic comparison does not involve different multiples of the same good, but two different goods. “104 dollars in one year” are for purposes of decisionmaking a good that is completely different from “100 dollars now” even though from a physical point of view these might be homogeneous quantities. Therefore there is no reason to assume that 104 future dollars are inherently preferable to 100 present dollars. I find this argument strange. Does our author mean that the situations now and a year from now will be different, including the mental state of the actor and his economic environment? But Mises specifically points out that his explanation assumes other things’ being equal. When are things ever equal?, Hülsmann might counter. But we are interested in theory where we have to untangle causes and effects; we do not necessarily need to jump straight into the complexities of a modern economy. Thus, the only differences in the two cases are (1) $104 vs. $100 and (2) future vs. present. That $104 is always preferred to $100 (assuming the extra $4 is useful for something) follows directly from its status as money and the law of marginal utility (both uncontroversial). Therefore, if $104 is not, in fact, preferred, then it must needs be because some evil or defect attaches to it that makes it less valuable than a smaller amount which lacks this evil. The only possibility is that the second difference plays a role: the gain lies in the future, and future money must be ranked lower on one’s values scale than present money, so much lower (for some people) that even the extra $4 is spurned in favor of the present good. Why, I will show in a moment. But the conclusion is almost self-evident. Similarly, if a person has a desire, then it is contrary held back by the weight of the body, and because, had there been no obstacle, they would already have gained the goal of enjoying the Sovereign Good – it follows that they grieve exceedingly for their delay.” (ST, Supplement, Appendix I, 2, 1) The disutility of waiting is less pain of sense than pain of loss.

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to his nature to want to postpone its satisfaction for no good reason. If this satisfaction can be had for $100, then $100 sooner will always be preferred to $100 later. It may be true that (a) $104 a year later is different from (b) $100 now, but that only means that “for purposes of decision-making,” (a) needs to be reduced to the amount of money now. One can reason: “(a) for me is almost like $52 now. By choosing (b), it is as if I am getting $48 extra over (a).” Hülsmann writes as if a reckoning like this makes figuring out the interest rate illegitimate. For Crusoe who does not use money, the phenomenon of interest still exists, insofar as he may judge a later satisfaction to be superior to immediate ones but choose the latter anyway due to high time preferences. But there would not be such a thing as interest rate, and there would be no way to distinguish between interest and profit. (This is somewhat analogous to the fact that Crusoe enjoys psychic but not monetary profit, or that there are in Crusoe’s world valuations but not prices. Crusoe cannot distinguish between wages and profit, either, because he has no opportunity to work for anyone else.) We could not say: this is where interest ends and profit begins, unlike in a monetary indirect exchange economy. We could only say: Crusoe prefers x to y if both were available now but chooses y instead to satisfy a desire earlier; hence, the interest rate is “greater” than x / y – 1 (whatever that means); and he prefers z to y and chooses z despite the present privation that he by that very choice brings upon himself; hence, interest is “smaller” than (z – y) / y, with the ultimate border lying somewhere between the two values. Hülsmann complains that time preference does not explain “why the selling proceeds exceed the expenditures for factors of production.” Of course, time is a factor of production. Rothbard makes it abundantly clear: “all actions must take place through time. Therefore time is a means that man must use to arrive at his ends. It is a means that is omnipresent in all human action. …time is always scarce, and a means to be economized.” (2004: 5; 15) Early in Man, Economy, and State Rothbard fails to count time as an original factor of production alongside labor and land. (10) But he corrects himself later, as is evident from: “Capital goods are vital and of crucial importance in production, but their production is, in the long run, imputable to land, labor, and time factors.” (373) “Ultimately, only land, labor, and time factors earn net incomes.” (481) And finally, “Capital goods have no independent productive power of their own; in the last analysis they are completely reducible to labor and land, which produced them, and time. Capital goods are ‘stored-up’ labor, land, and time; they are intermediate way stations on the road to the eventual attainment of the consumers’ goods into

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which they are transformed.” (58) There are land, labor, and time markets. (375) Thus, time is a scarce factor of production; it costs something. Capital is a combination, a package of labor, land, and time; so, it is a produced factor. Even natural resources have to be found which takes employment of labor over time. Land and natural resources are essential factors, because humans cannot create ex nihilo; they can only transform existing goods. Sometimes a natural resource is a consumer good, e.g., a cave used as shelter. Otherwise, either labor or time is essential to transforming nature’s bounty into a consumer good. Sometimes a good will mature on its own, as wine does; other times labor takes an infinitesimal amount of time, such as driving in a nail with a nail gun. Most often, however, both labor and time are necessary. Hülsmann concedes that time preference may, indeed, explain why a businessman would in any circumstances sell his product sooner rather than later or receive back money lent sooner rather than later. But, he continues, a lender would prefer to get his money back sooner, even if the interest rate at which he had lent this money was 0% or –10%. “When I lend 100 ounces of gold now to receive 90 ounces in one year,” he writes, “I thereby demonstrate my preference for having these 90 ounces from my debtor sooner rather than later.” In other words, it fails to explain the phenomenon of interest; positive time preference seems compatible with negative interest rates. This is odd. Is it not obvious that besides the fact that 90 ounces are valued more 1 year from now (Hülsmann’s “sooner”) than 2 years from now (Hülsmann’s “later”), there is also the fact, according to the very theory of time preference that our author claims misdescribes interest, that 90 ounces now (my “sooner”) are valued more than 90 ounces 1 year from now (my “later”), and moreover and a fortiori, 100 ounces now are valued still more than 90 ounces 1 year from now? (Since now is sooner than a year from now.) The exchange Hülsmann uses as an example, all things being equal, is impossible and does not demonstrate negative interest rates. Hülsmann goes on: The fact that we use a good right now always involves a time preference for this present use as compared to possible – but unrealized! – future uses of the same good. Hence, while time preference is an intertemporal aspect of each observed human action, in each single case it explains only the action under consideration. That is, it explains only one action. Money interest, though, as it is observed on the market results from at least two actions: purchase of means of

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Summa Against the Keynesians production and sale of products; granting of credit and payment of principal and interest. The problem of interest theory is therefore to explain a particular relationship between at least two actions.

Again, I sense a misunderstanding of the essence of interest. Smith saves $100, waits a year, and observes his balance increase by $4. Robinson chooses a large candy tomorrow over two small ones today and tomorrow. These are our author’s “one action.” Jones spends $1,000,000 on factors of production; spends, in addition, a year building the product; and sells it for $1,040,000. These are the “two actions.” However, interest explains the same phenomenon in both cases, namely, the compensation for the sacrifice of present consumption, for having the money tied up in some project for a spell that prevents it from being spent on the satisfaction of some or another immediate pleasure. Of course, if one had no desires while waiting for the principal plus interest, then though time would still be a factor of production, it would be one like breathing which accompanies every act of labor, causing no concern and costing no money. Interest and profit are both responsible for the difference between the sum of the prices of the “observable” factors of production and the revenues from the sale of the finished goods. It is easy to miss time in the list of the factors; for example, Mises condemns the “naïve reasoning” which “does not see any problem in the current revenue derived from hunting, fishing, cattle breeding, forestry, and agriculture.” (1996: 524) The key trick is precisely disentangling interest from profit. A 10-percent interest rate obtained by making steel product X, for example, does not mean that 110 ounces of gold obtained through the future sale of X are inherently more valuable than the 100 ounces paid now for the corresponding factors of production. And neither does it mean that all current investments yield in fact a 10-percent return. What it means is that there are here and now no men ready to invest 100 ounces into the production of X unless the yield is at least 110 ounces. The combined originary interests of the market participant do not allow for any arbitrage that would eradicate the minimum return of 10 percent on the production of X. Very well, I will bite. Why are there no such men? What stops them from emerging? What is wrong with a 10% return? Hülsmann throws his

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hands up in the air at this abject mystery and says that interest is eliminated when people pursue projects for their own sake, such that the means and the ends are one. But the time preference theory also explains why interest does not arise in such cases: because there is no sacrifice of any present happiness! That is exactly how Mises describes the behavior of the creative genius: “The activities of these prodigious men cannot be fully subsumed under the praxeological concept of labor. They are not labor because they are for the genius not means, but ends in themselves. He lives in creating and inventing. For him there is not leisure, only intermissions of temporary sterility and frustration. His incentive is not the desire to bring about a result, but the act of producing it.” For him, work is play. At the same time, such people “tower far above the millions that come and pass away.” (1996: 139) They represent a highly special case and, though hugely significant for economic progress in any actual society, are not of enormous importance for economic theory. Hülsmann makes a distinction between interest or the difference between the prices of the means and the end; and gain or the difference between the happiness produced by satisfying the most important end and happiness that would have resulted from satisfying the (neglected) second most important end, had the means not been occupied satisfying the former. One might take account of this fact by calling the price paid in form of forgone ends “praxeological price” or just “price” while calling the price paid in form of abandoned means “market price.” Similarly, we may call the value of the forgone ends “opportunity costs” and the value of the foregone means “costs.” These definitions are confusing. Let r stand for revenue and c, for cost. Profit has to be r – c in some shape or form. So, let me call r1 – c1 or the difference between means and ends (Hülsmann’s “interest”) “simple profit.” Further, let (r1 – c1) – (r2 – c2) be “real profit” (Hülsmann’s “gain”), where ri and ci are “pros” and “cons” of the two most valuable alternatives under consideration. It is plain that simple profit is a special case of real profit, where the second r and c are negations of the first r and c. In other words, simple profit can be instantly converted into real profit, if we compare it with the utility of selling the means c1 and forgoing the satisfaction of the end r1. Or: Crusoe expends labor which has disutility for the sake of getting food, and relieving one’s hunger is worth the effort; hence, (r1 of satisfying hunger – c1 of labor) is preferred to (r2 of leisure – c2 of staying hungry), and Crusoe enjoys psychic profit.

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Therefore, Hülsmann’s entrepreneurial profit, which he further distinguishes from interest, is also simple (and therefore, real) profit, wherein c1 is the sum total price of the factors, and r1 is the sales revenues (r2 and c2 are refusing to invest in this manner in the first place). It is not “a special income component that results from errors in human decisionmaking.” It is special only because it is expressed in terms of money. At any rate, the reason why a state of equilibrium is not achieved is due to never-ending entrepreneurial creative destruction; certainly not because there is a mystical non-interest income that causes an inevitable price spread between the producer goods and the consumer good. Hülsmann argues that his theory makes sense of why exchanges are made. For example, Smith values his apple less than Jones’ tomato, and Jones values his tomato less than Smith’s apple. And the spread, according to Hülsmann, is interest. Of course, it is nothing of the sort; it is profit. Now every voluntary exchange yields profit for both parties, because its opportunity cost is not making the exchange, and the difference between the revenue and this cost is positive. But the point is that exchanging $100 now for $100 a year from now, all things being equal, is never profitable. And even exchanging $100 for $104 a year from now may not be profitable for some people, if the $100 now is valued more than $104 later. If it is profitable, then the revenue, namely, $4, has to be compared with the cost, namely, the renouncing of present enjoyments, because the ownership and control of present goods are transferred for a period of time. To use neoclassical terminology, if one is indifferent between $100 and $102.50 a year from now, then the profit or producer surplus of the supplier of present goods is $1.50. The $2.50 is an interest payment. Furthermore, for proper understanding of exchange, we must distinguish between use value and exchange value of the objects being exchanged. Smith’s apple’s use value (before the exchange) is lower that Smith’s tomato’s use value (after the exchange). But the apple’s exchange value is equal to the tomato’s use value, assuming no transaction costs. In case equal values are found objectionable, let me rephrase: the apple and the tomato are no longer distinguishable as separate physical goods but become as if units of a homogeneous good, perfectly interchangeable, such as two ounces of the same lump of butter. The crux of Hülsmann’s theory is that unless there was an ineliminable difference between the ends and the means, there would be no action. But the fact that men act entails that some “interest” is being had. To counter that, it is sufficient to point out that the alleged interest can be arbitraged away until the difference between the ends and the means reaches the smallest marginally valuable amount. Yet market

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interest rates persist at far higher values. Hülsmann’s interest is simply profit. Moreover, the spread between revenues and costs in different enterprises varies dramatically: one person expects (or receives) 200% profit, and another, 2% profit. Since there is no equilibrium profit rate but only interest rate (in fact, profit is a disequilibrium phenomenon), profit and interest cannot be identical concepts. In other words, what for our author determines the market interest rate? To appreciate the difference, it may be useful again to distinguish between psychic and monetary profit. The former cannot be arbitraged away; the very idea of such a thing is absurd. One acts if A is preferred to B, sacrificing B for the sake of A; or the other way around. There is action if and only if there is an expectation of psychic profit. But we can easily imagine monetary profit to be zero in an ERE, such as where unowned factories are working robotically with no entrepreneurial direction. However, that neither interest nor psychic profit can be eliminated by the market process does not mean that they are the same thing! Hülsmann claims that his theory explains “‘negative money interest’ resulting from philanthropic undertakings.” But we need not resort to his peculiar theory to do so; the standard time preference theory of interest does so very well: the philanthropist suffers not only the loss of his donation but also the interest he could have earned on the time market, for example, by loaning the money to someone. Yet he finds the expression of his charity a greater value than even this combined loss. Even the case of the miser (1996: 490), whose consistency with time preference Mises admittedly failed to prove, is easy to explain: the miser’s satisfaction and consumption consist of contemplating his hoard rather than in spending it even on bare necessities. He prefers the loveliness of the glint of his gold coins to the food he could have bought with them. Must he be condemned for his eccentricity? Or perhaps, the “pathological withering away of vital energy” can be interpreted as selfhatred, whereas economics reasonably presupposes that people love and will good to themselves. Alternatively, as I will show in the next chapter, the miser can be seen as preferring hoarding to both consuming and investing. In sum, time preference explains why the interest rate (all three of the originary, personal, and normally, equilibrium rates) is positive, i.e., why future happiness must be drawn nearer if resources are to be channeled into producing the goods that will do just that, over than present happiness that could be had by consuming those resources immediately. The spread between the cost of the means and revenue of the end,

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whether monetary or psychic, is not interest but profit. 46. THAT RISK PREFERENCE CORRESPONDS TO HOARDING AS TIME PREFERENCE, TO INVESTING; OF THE COMPLETE CAUSE OF INTEREST; AND THAT (II) THE SUCCESS OF PRODUCTION IS UNCERTAIN One’s time preference answers the questions: (T1) How much is waiting less for a future good worth to me in terms of present suffering? (T2) How much more must I gain in the future in comparison with the present’s even rotation in order to agree to abstain from some immediate pleasure? One’s risk preference answers the questions: (R1) How much is being prepared worth to me? (R2) How much security must I gain by hoarding my income in order to choose not to consume or invest my rainy day savings? Let risk preferences be “high,” if one is very fearful; and low, otherwise. A person with high risk preference prefers to “be prepared.” He is the boy scout of the economy. He keeps a chest full of gold in his attic “just in case” or would, if we had sound money. He avoids debt and pays all his bills on time and in full. He loathes inflation which diminishes his hoard. Etc. On the contrary, a person with low risk preference lives paycheck to paycheck. He likes to test his skill and luck. He is confident and optimistic. Since there is a trade-off between liquidity / security and profitability, he may keep his money in illiquid assets, hoping to profit, even if the assets are harder to convert to cash, should he, say, fall ill and require an expensive surgery. The future is not only by its meaning remote, such that waiting for something pleasant is painful; but also uncertain, such that to live without a “cushion” of ready cash is for many people unbearable. Such people want the flexibility to handle unexpected changes that might come their way in the future, to keep their choices open. They are prepared to sacrifice present consumption and even opportunities for future profit just in order not to expose themselves to ever-possible surprises. The cause of greater security seeking might be depression or broken economy and the increased chance of losing one’s business or job. Hoarding is best understood as a quasi-permanent reduction in

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the money supply. One’s time preference dictates how one will balance less pleasure now vs. more pleasure a definite amount of time from now, everything else being equal. Risk preference balances some amount of pleasure when things are well vs. formally the same amount of pleasure when things are bad; or (e.g., $100 in) a good situation now vs. (the same $100 in) a possibly bad situation later, everything else being equal. The latter is more valuable than the former. Thus, the originary interest rate is, roughly speaking, the “ratio” of future goods to present goods (see above for a dissection of this notion), and “originary confidence rate” is the “ratio” of future situation to present situation. With risk preference, there is no trading off consumption; there is a permanent reduction in consumption, until the event insured against comes to pass, if at all. The fear of losing money on the stock market is the same thing as the fear of not being prepared to meet unforeseen contingencies. If one’s stocks are guaranteed to go up, then he can always convert them into cash on a moment’s notice, while at the same time making a profit. The problem is that one might need the money at an unpropitious moment, namely, when his stocks are (perhaps, temporarily) down. In saying these things, I am not expressing any value judgments. There is nothing improper about the heart’s desire for security in the face of the unknown and unpredictable. Some, namely, the entrepreneurial types, choose to embrace this uncertainty and boldly go where no one has gone before, hoping that their plans will win out against other entrepreneurs’ similar endeavors. But numerous others pile up cash in order not to be taken aback by any contingencies. Is it better to be secure or to risk it? I think that it is a matter of temperament. The market serves all kinds of people and does not privilege one temperament over any other. Just as the personal time preference schedules give rise to the equilibrium interest rate, which reflects people’s taking advantage of the differences in their PIRs, and the loan market; so in the similar pattern the different risk preferences give rise to the futures market, in which people who feel more confident in taking risks offer, for a price, to shield the more fearful from future uncertainty. There are other devices designed to minimize risks, the most obvious of which is insurance. The overall fate of any amount of money can be decided as follows: one compares consuming $X now with investing it at a projected I% return (or lending it at a guaranteed I% return) and compares the winner with hoarding the $X. Given the holy trinity of economics, namely, consumption, investment, and hoarding, interest can be conceived as that incentive that entices a person both to postpone consumption and to “part with liquidity.” Suppose that Smith prefers investing at 10% / year to consuming now and also hoarding to investing at 10% /

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year. In that case, he may need a higher return on investment, say, 15% / year, in order to impel him to invest. Here the 15% return is necessary to get Smith neither to consume nor to hoard. The PIR then is the maximum of the prices of (1) waiting and (2) taking the risk or possibly suffering the inconvenience of not having the money available on demand in case of emergency. Risk preference (RP) and time preference (TP) are separate variables. The relationship between the supply of and demand for loanable funds and changes in RP is not entirely trivial and is pictured in Figure I.46.1. The individual PIRs curve, following a drop on RP, is flattened. Supply in the “loaning” quadrant increases; demand in the “borrowing” quadrant decreases in segment B and increases in segment C.

FIGURE I.46.1. INDIVIDUAL INVESTING / HOARDING / CONSUMING CURVE

The reason is that greater confidence can manifest itself in two ways: less hoarding and more borrowing. In A, at high IRs, a person whose RPs have decreased is likely to reallocate some of his hoarded money toward investing. In B, at moderate IRs, most of the work of boosting consumption is again done by redirecting hoards to it, which means that the person does not have to borrow so much. He may actually choose to retire some of his debt, no longer desiring to hold as much cash for security. But as the IR continues to decline, a person who is now more confident and less fearful feels that he wants to borrow and consume more and more, and the amount borrowed in C increases relative to the previous RP rate. In other words, if Smith lends, then lower RPs entail that he will

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lend more; if he borrows, then they entail that he will borrow more. Note that we must not consider it illogical that a person may want to borrow and hoard. I list a few points on the two curves in Table I.46.1. Negative numbers in the I columns indicate amount borrowed.

IR 15% 10% 2% 0.5%

I 10 0 –5 –10

Before C 6 12 14 18

H

I 4 8 11 12

12 3 –2 –15

After C 7 15 16 27

H 1 2 6 8

TABLE I.46.1. ALLOCATION OF CASH TO INVESTMENT (I), CONSUMPTION (C), AND HOARDING (H) BEFORE AND AFTER A DECREASE IN RP, IN THOUSANDS OF DOLLARS

When the RP and TP change, the effects of the changes on the supply, demand, and EIR are summarized in Table I.46.2. “↑” stands for increase, and “↓,” for decrease. For simplicity’s sake, segment B is ignored. D↑ D↓

S↑ Lower RP Lower TP

S↓ Higher TP Higher RP

TABLE I.46.2. THE EFFECTS OF CHANGING TIME AND RISK PREFERENCES

A lower rate of TP will assuredly lower the EIR, but its effect on quantity lent / invested cannot be predicted; lower RPs will definitely increase quantity but can affect the EIR either way. I have a sneaking suspicion that Keynes knew quite a bit about time and risk preferences, and rates of interest and confidence. On p. 93 of General Theory, he “approximates” the “rate of time-discounting, i.e., the ratio of exchange between present and future goods” to the rate of interest, saying only that real-world interest rates take into account expected monetary inflation or deflation. On p. 107, he connects interest with preferring “a larger real consumption at a later date to a smaller immediate consumption.” Again, on p. 107, he lists “building up a reserve against

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unforeseen contingencies,” i.e., hoarding to alleviate risk in life, as a reason for saving. On p. 161, Keynes prefers that if one is “assailed by doubts concerning the future” and curtails his investments, then one should rather turn to consumption and avoid “the disastrous, cumulative, and farreaching repercussions of its being open to him, when thus assailed by doubts, to spend his income neither on the one nor on the other,” i.e., to hoard it. On page 166, he discusses the two “decisions” that one must make in allocating one’s money: the “propensity to consume” governs “for each individual how much of his income he will consume and how much he will reserve in some form of command over future consumption”; and “liquidity-preference” answers the questions “Does he want to hold [the income left over after consumption] in the form of immediate, liquid command (i.e. in money or its equivalent)? Or is he prepared to part with immediate command for a specified or indefinite period, leaving it to future market conditions to determine on what terms he can, if necessary, convert deferred command over specific goods into immediate command over goods in general?” And on p. 174, he argues that “the concept of Hoarding may be regarded as a first approximation of the concept of Liquidity-preference.” Yet all of these and other hints scattered throughout General Theory of Keynes’ being a good economist add up to nothing. Keynes, in building up his own now discredited theory, simply does not appreciate what he has. 47. THAT, SIMILARLY TO THE INTEREST RATE, THE CONFIDENCE RATE IS SUBDIVIDED INTO ITS ASPECTS OF PERSONAL AND EQUILIBRIUM

As the rate of interest corresponds to time preference, so the rate of confidence corresponds to risk preference. It was sufficient to analyze time preference within the confines of an evenly rotating economy. In order to understand risk preference and its related concepts, it is necessary to enter a real economy, one in which not only does production take time but also planning and estimation of profits are uncertain, i.e., liable to constant adjustments due to surprising or startling events. A person might learn a great deal about the industry and company into which he has finally decided to invest. Suppose that Smith’s best understanding is that he can make 30% profit a month from now on a $1,000 investment. Recall from (I, 12-13) that

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entrepreneurship requires both prudence and courage. While prudence does the planning for the future, courage by the essence of this virtue is used to counter surprises. The key concept I am now introducing is the rate of confidence. Its direct opposite is fear, worry, and doubt. It is sometimes alleged that one marketing technique that companies use is attempts to sow “fear, uncertainty, and doubt” about their competitors’ products. This is abbreviated as FUD. The fundamental point is that feeling FUD has disutility. Now it would be mistaken to try to prove this by saying simply that fear, worry, doubt, etc. are “negative emotions.” For that need not at all be the case. Fear of dying is usually healthy; fear of doing evil is praiseworthy; a roller coaster ride can be scary but also fun; doubt is perfectly fine, if it keeps one from believing a falsehood, or if it impels one to investigate the matter for oneself. This list can be extended. However, what FUD does is it may cause one to be paralyzed in the face of the unpredictable. It makes one weaker, less efficient, slower at dealing with unexpected troubles. Again, there are two kinds of fear. First is the fear1 of transgressing the moral law. One has duties to himself and others and must go through with them. Sin, moral evil dissolve the evildoer’s soul, and fearing this is highly constructive. The servile fear of not conforming to natural law and filial fear of not conforming to one’s moral ideals (perhaps, self-generated ones), i.e., of being unjust, are key cardinal virtues. But another kind of fear2 refers not to one’s determination to persevere in moral goodness but instead to incapacitating terror or anxiety about one’s ability to attain an end. It is no longer something that drives one to improve morally but is a real obstacle to improving physically. We might say that a frightened person “freezes” in place, unable to act. Now a duty or good lifestyle or character is precisely something that ought not to change. It should be frozen. On the other hand, boldness heats up life which flows readily from less to more happy. Fear of the law and fortitude are the yin and yang of the “power” aspect of the active life (just as prudence and justice are yin and yang of its aspect of the “intellect”). In other words, sometimes one does not distinguish between a virtue that he must fear to lose and unhappiness that he must intrepidly triumph over. One ought to fear falling to temptations not to perform a Guardian duty, but one ought to be bold as a lion while executing an Artisan action according to plan. Sometimes, however, fear can seep from the area in which it is an asset into the area where it can cause damage. A man can fight for several reasons: for survival; through

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natural joy in roughhousing; imprudently, without knowing the dangers or judging them correctly; when cornered, when there is no hope to escape; in anger, especially at an injustice or slight; in shame upon being called a coward; dispassionately, when he knows that he will win easily; and others. Aristotle does not call fighting for these reasons brave. Let me suggest that a brave man is he who prevents any fear2 that he may feel from negatively affecting his performance for a noble cause. Offensive actions bring with them an abundance of fear2, insofar as a brave man puts himself into dangerous situations. Fear2 gives rise to building up one’s defenses; in particular, by mastering the arduous and difficult tasks at hand, becoming competent. This reduces fear and permits the person to act still more courageously. Fear2, though usually unpleasant, is useful, because in conquering it, one improves in both defense and offense. Bravery then has two aspects. First, it is not letting one’s fears choke and repress him; second, it is mastering oneself and one’s environment in order to diminish similar fears in the future. Even if one’s calculations are impeccable, should some danger arise that requires quick action, boldness, and even intimidation to overcome, one may easily end up cowering under the bed, in which case no amount of favorable probabilities will save the investment. St. Thomas with his characteristic luminance argues in this way: The act of fortitude is twofold, aggression and endurance. Now two things are required for the act of aggression. The first regards preparation of the mind, and consists in one’s having a mind ready for aggression. On this respect Tully mentions “confidence,” of which he says… that “with this the mind is much assured and firmly hopeful in great and honorable undertakings.” The second regards the accomplishment of the deed, and consists in not failing to accomplish what one has confidently begun. On this respect Tully mentions “magnificence,” which he describes as being “the discussion and administration,” i.e., accomplishment “of great and lofty undertakings, with a certain broad and noble purpose of mind,” so as to combine execution with greatness of purpose. (ST, II-II, 128, 1) A superb piece of advice to all aspiring entrepreneurs. “Hope whereby one confides in God is accounted a theological virtue… But by confidence which here is accounted a part of fortitude, man hopes in himself.” (Ibid., reply 2) God gives man a chance, sometimes more than one, St.

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Thomas seems to be saying, but it is man who has to make best use of it. God helps those who help themselves, etc. In short, the reason for the disutility of FUD lies in FUD’s essential ability to hinder victorious action. He who fears will not give 100% to the task at hand; will fail to take advantage of momentary opportunities in his environment; will be self-conscious and unable to use his training to act with a killer instinct and with self-forgetful virtuosity; will experience moral doubts about himself and again, fail to be appropriately ruthless and win-at-all-costs single-minded; will perversely favor defense over offense, fearing attack from everywhere; will not be able to make his enemy afraid of him; and will make himself more prone to losing. Worrying that the future will bring undetermined gloom and doom makes one powerless and scatterbrained, lacking presence of mind, and since action is an expression of directed power, incapable of responding properly to danger or emergency. And yet people do fear. Let us go back to Smith and his $300 profit. The question is, how confident is he about this estimate? The more (less) subjectively confident he is, the less (more) subjective fear and worry he will feel. Smith knows that his fear is a liability. He would like to be rid of it, but he cannot help it. He is genuinely afraid of the future. He worries about his investment. Could something terrible happen all of a sudden? Now the question becomes: How much is being relieved of fear and worry worth to Smith? Suppose that he would be just content, if someone, call him Robinson, gave him a sure $200 a month from now on the condition that Smith surrenders to Robinson all the profits on his investment above $200, if any. Smith has to weigh on his values scale: fear and worry yet $300 vs. complete certainty and peace of mind yet only $200. If these are close, then Smith’s personal confidence rate or PCR is 200 / 300 = 67%. The PCR is about Smith, not about the investment; therefore, it is the same for all investments. This is because, while the estimations of companies’ profitability can vary wildly, the “unknown” and the “unforeseen” are always the same grayish monsters under the bed. Cassidy (2009) recounts an experiment by Colin Camerer, in which the subjects were asked to choose between a risky action and an uncertain one. The former had a definite probability assigned to it; on the other hand, nothing was known about the latter: the probability of winning could, for all the subjects knew, have ranged from 0 to 1. Camerer’s conclusion was that “the brain doesn’t like ambiguous situations. When it can’t figure out what is happening, the amygdala

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transmits fear to the orbitofrontal cortex [in the brain].”51 (quoted on 203) Note that this version of the futures market is different from the producer loan market, though it may at first glance seem that transactions on both provide guaranteed income. First, in the real world, lending money is still speculative. Second, interest rates offer a far lower yield than many profit opportunities. Third, interest-profit due to differences in the time preference rates of the buyer and seller is distinct from entrepreneurial profit due to differences in their risk preferences. Consider an example. Let three men invest their money in Widgets, Inc. as outlined in Table I.47.1. Robinson’s higher PCR does not mean that he is more reckless and less responsible than Smith; insofar as confidence as I am describing it is a virtue, it obeys the mean. Robinson can tell Smith that he is willing to beat his confidence by 8%. Instead of luring Smith with only $200 of “sure money,” Robinson can give him $225! Smith’s extra profit is $25; Robinson’s profit is $300 * 0.8 – $225 = $15. The equilibrium confidence rate or ECR is 75%. This is how confident the “market” is of the projection of a 30% profit for Widgets, Inc. a month hence, when the market consists of just Smith and Robinson. Including Jones into this market and then a million other people will, of course, alter the ECR, but only to another definite value.

67% 20%

$1,000 $5,000

Est. Profit % 30% 30%

80%

$8,000

30%

PCR Smith Jones Robinson

Investment

$300 $1,500

Real Profit % 20% 6%

$2,400

24%

Profit

Real Profit $200 $300 $1,920

TABLE I.47.1. AN EXAMPLE OF A FUTURES MARKET

A slightly more complex example is pictured in Table I.47.2, in which profit estimations are different for each person. What can these people trade for mutual benefit? Robinson can give Smith $310 and pocket all the profits above that number, if such there be. Smith’s profit is $110; Robinson’s profit is $1,000 * 0.32 – 51

This is crudely put, to be sure. Philosopher Victor Reppert once quipped: “Sometimes, when people talk about what the brain does, I want to say: ‘Interesting fellow, Mr. Brain. Remarkable what he can do.’” In other words, for Cassidy, does the brain have a mind of its own?

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$310 = $10.

67% 20%

$1,000 $5,000

Est. Profit % 30% 50%

80%

$8,000

40%

PCR Smith Jones Robinson

Investment

$300 $2,500

Real Profit % 20% 10%

$3,200

32%

Profit

Real Profit $200 $500 $2,560

TABLE I.47.2. ANOTHER EXAMPLE OF A FUTURES MARKET

Alternatively, we can deal with real profit rate. Robinson can offer $225 to Smith, requiring him only to send all profit above that value to him. Robinson believes that he can make $320 off the Smith’s $1,000 investment; so, his estimated return, his suffering from FUD taken into consideration, is $95. To put it in the terms of the previous example, here, Robinson can offer to buy Smith out at “75% confidence” or (75 – 67)% * $300 = $25 profit accruing to Smith. Smith no longer fears; he has his beloved certainty; and he is happy to have received more than the minimum he would have agreed to receive. Robinson obtains 80% * 40% * 1,000 – 75% * 30% * 1,000 = $95 extra profit. The ECR here is also 75%. There is a clear sense here in which Smith relinquishes his entrepreneurial functions to Robinson, becoming essentially his employee. A more realistic futures contract between them would provide for Smith to deliver a commodity of agreed upon quality and quantity to Robinson. Higher confidence rates lower one’s inclination to hoard. By discounting expected profits by less, one’s opportunity cost of hoarding (in terms of money not made via uncertain investments) is higher. If one’s confidence is zero, then one is cowering under the bed. Investing then makes no sense (because something unexpected will arise), and one will hoard instead. One may not even consume beyond the minimum necessary to preserve life, because overpowering fear ruins all pleasures. 48. THAT PRODUCTION HAS A STRUCTURE Building on (I, 9) and everything said so far, it is possible to identify three kinds of production structure: physical, temporal, and valuational. The physical structure is observed both within a firm and in-

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between firms. In the first case, this structure is the series of stages of the good from the condition it is in when it is purchased by the firm to the condition it is in when it is finally sold by the firm to the lower-order capitalists or directly to the consumers. In the second case, the physical structure comprises the stages of all the goods used in production from the way they are found in nature to the way they connect with the pleasure of the consumer. In the beginning of production, there may not even be an identifiable “good”: all a firm might have are a certain amount of raw materials and equipment that bear no formal resemblance to the final output produced with their help. The entire physical production process for a particular high-order good or the good’s “set of destinies” may be pictured as an upsidedown tree: say, metal ore is used in N1 production processes, the output of each getting transformed with the help of other factors of production into N1*N2 particular objects, as they move down the structure of production; those objects, in turn, are altered further into yet more specific N1*N2*…*Nm items and so on, until we obtain a wide variety of consumer goods, all of which, however, stood in need of metal ore at some point in their creation. Physical stages are important, because an application of labor or machine input (during which the machines (a) depreciate and (b) are unavailable for other tasks) is required in order to transform a good from one stage to another. A firm would need to calculate its expenses in advancing a good from the raw to salable condition. The physical structure of production is objective, in that it lists each good as a material entity and all the inputs that cooperated in transforming it. Let two methods of production use inputs to manufacture outputs as pictured in Table I.48.1.

P1 P2

Inputs 2a + 3b + 4c 7a + 8b

Outputs 5m + 6n 9m + 10n + 11o

TABLE I.48.1. JOINT AND COMPOSITE SUPPLY AND DEMAND

Following Marshall, let me call the fact that a, b, and c are used in P1, “joint demand” for those factors. That several goods are produced by P1 will be called “joint supply” of m and n, e.g., beef and leather, chicken meat and eggs, wheat and straw. The fact that a is used in both P1 and P2 will be called “composite demand” for a. Finally, m’s being

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produced by two different techniques justifies its moniker “composite supply.” The valuational structure of production concerns the pricing of each capital good. This price is imputed from the price of the final consumer goods that are made by means of the capital good. Each consumer good into whose construction the capital good has gone influences the price of that capital good. The marginal unit of any capital good for a firm, say, Widgets, Inc., is the unit when it is ready to be sold. The firm is not concerned with how that good will mature after it is sold. It cares only for its own profits. At the same time, these profits in future rounds of production critically depend on the future adventures of the goods of which Widgets, Inc. has seemingly successfully disposed. For the marginal unit with respect to the whole destiny of a capital good is the consumer good, when it is at long last exchanged for money. Should that consumer good prove inconsumable (entirely useless or salable only at a loss), the consequences will be felt throughout the entire production structure. The heavens (the values and prices of the higher-up capital goods) will tremble, if the earth (the consumers) refuses to accept their handiwork. The valuational structure of production is subjective, in that it depends on how important each useful good is in the production of virtuous goods and ultimately pleasure (these terms are defined in (I, 38)). The subjective valuational structure is found within each margin; in between margins, it is also intersubjective, because it arises out of competing entrepreneurial profit-seeking plans for capital. There are thus (a) both cooperation of the factors of production on any project and competition for factors of production (b) both within a firm and between firms. This competition ensures that successful entrepreneurship remains forever a high art. But what saves the day is that everybody faces the same challenges with respect to our “surprises.” One does not have to be a super-entrepreneur in the absolute sense; one just has to be better than others in foreseeing the future in order to profit. This is because, even if entrepreneur A is making a modest profit, and entrepreneur B is correctly forecasting a great profit, B can bid the resources that A is using in his own production process away from him and still profit despite their now higher price. At that point, A, lacking some complementary factors of production, may no longer be able to continue his business activities to the same extent (and neither, by the way, in all likelihood, will A’s suppliers – i.e., certain entrepreneurs in the earlier stages of production – the derived demand for whose products will decline). But it is no skin off B’s nose. In other words, in entrepreneurship, “success” is achieved and

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“failure” is suffered by means of “victory” over others and “loss.” The word “loss” can now mean several things: (1) a situation in which costs exceed revenues; (2) diminution of profits relative to the previous round of production; or (3) loss of market share to other entrepreneurs in the competitive race. Taleb (2010) discusses what he calls Black Swan events – rare yet momentous occurrences that are hard to predict. (The idea is that the proposition “All swans are white.” can be invalidated by a single, if rare, sighting of a swan of a different color.) His main examples deal with earth-shattering episodes for individuals like writing a successful book and society like the 9/11 attack. (Taleb does not seem to draw a distinction between events that one prepares for and then passively awaits and events one actively brings about. He may be forgiven, insofar as these are two sides of the same gold coin, and an entrepreneur must be good at doing both, namely, at both spotting opportunities and seizing them.) I suggest that the capture of any business opportunity quicker than the crowd and milking it for all it has got constitutes a mini-Black Swan event. Every human action that does something interesting is a Black Swan. Every disequilibrating maneuver is by definition a deviation from routine and as such is largely unpredictable and Black Swan-ish. These incidents are far more frequent than Taleb gives them credit for. The idea of a capital good is inseparable from the role which a given object plays in the successful completion of someone’s plan to produce a consumer good. To put it differently, all capital is mind-dependent, which means that an object is designated as a “capital good,” only if there exists a human being who considers it to be a means to an ultimate end. It follows that what is a capital good used to create consumer good A to one person may be a consumer good to another person, a different capital good used to create consumer good B to yet another one, and something quite useless to someone else still. For instance, the same manual on car repair may be a capital good to a mechanic who uses to diagnose car problems, a consumer good to someone who uses it as a doorstop at his home, a completely different capital good to a recycling business that manufactures something out of old paper, and an entirely uninteresting item to a person who can neither read nor imagine any other use for the manual. Furthermore, what is a capital good today may not be one tomorrow, and alternatively, a thing which today is looked over with indifference may tomorrow turn out to be the hottest thing since sliced bread. Humans are both creative and inventive, and objects are repeatedly graced with new subjective essences. Technology determines which things can be capital goods;

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entrepreneurs decide which things shall be such. That entrepreneur will come to own a given capital good who is willing to pay for it the highest price. The example of the trade-off of the “resources” used in the production of guns and butter in some introductory textbooks is revealed as rather formulaic. The example succeeds in drawing attention to scarcity of capital goods but ignores these goods’ plasticity. As time goes on, a resource A that used to participate in the production of both guns and butter may end up being used only for guns; again, resource B that was not shared between the two purposes may come to be in demand for both. Scarcity and plasticity ought to be emphasized with equal vigor; it is precisely this duality that imbues the business cycle with the property of taking its sweet time to work itself out: boom, followed by bust, then recovery. For a view of the big picture, take a look at Table I.48.2. A thing is objective, if it is mind-independent; subjective, if it is mind-dependent, i.e., if its properties vary with human inner experiences. A thing is real, if it exists “out there”; ideal, if it exists as a thought or concept in the mind or emotion in the heart. God’s goodness is metaphysical and objective, and ice cream’s goodness is physical and subjective, though both are evaluated by human minds. (a) Wisdom that judges God is (b) an intellectual virtue, and (c) the mind is bound to (d) the true. Thus, not considering God to be good is a genuine error. (a’) Prudence that judges ice cream is (b’) a moral virtue, and (c’) the will is not bound to any particular (d’) good: it creates goodness via desiring; thus, not judging ice cream to be good is not an error of any kind. Note that the extra complexity added by moral good and evil is not captured by this understanding. The proposition “2 + 2 = 4” and feelings are both unreal, but the former is true whether or not one thinks it; the latter comes into being only when felt or entertained.

Real Ideal

Objective the author of this book “2 + 2 = 4”

Subjective capital goods feelings: delight, fear, anger

TABLE I.48.2. DIFFERENT KINDS OF EXISTENCE

As goods are advanced, they become more and more specific and therefore, less and less convertible. Metal ore is much less specific than a metal bolt, and a metal bolt is less specific than a tool in which the bolt is used. If it so happened that a better or cheaper tool could be

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manufactured without the use of the bolt, then the bolt will cease to be useful for this particular purpose; but given its partial non-specificity, it can be salvaged by the entrepreneurs producing other things, though its price will likely fall, along with its quantity demanded. For example, in the 2009-10 recession, we witnessed a substantial fall in gasoline prices. During a recession, specific factors of production suffer the most. If a factor of production can at present be used only in certain particular projects, and these projects turn out to be unprofitable and are slated for bankruptcy and liquidation, then there will be, temporarily, no use for these specific factors of production – various kinds of labor skills, capital, and land. Their prices will plummet, and only after a while will they somehow be reallocated. Now consider that the price of gasoline had, by 2009, gone down by 50%. But gas is a fairly non-specific good. If certain production processes close down, then lots of other more profitable ventures will still be around and use gasoline which, as far as I know, has few substitutes when it comes to powering machinery. It seems that this factor can be repurposed without much difficulty. Yet here we have a dramatic fall in its price, anyway. This underscores the severity of the downturn, for if even highly non-specific goods like gasoline begin costing must less, then how many businesses have had to close to drive the price of gas so low? Probably quite a few. If gas is a complementary factor in numerous methods of production, then the fate of the more specific goods is even more bitter. This is evidence for my hypothesis that the 2009-10 recession is a nasty one. The valuational capital structure is something we have inherited from the past. It is a conservative element, winnowing many innovations that could take place, if we had the opportunity to recreate the whole production structure anew at a moment’s notice. But entrepreneurs have to calculate on a case-by-case basis whether abandoning existing capital goods is justified by the extra productivity of brand-new factories and technologies. Therefore, what is economically efficient is often different from what is technologically efficient with a bias toward the former: at every moment, there exist numerous brilliant scientific discoveries and technologies that cannot yet be mass-produced without a social loss. It is precisely the valuational structure that a central planner under socialism cannot reproduce. Consider that knowledge is about (1st-level) causes and effects; while prudence is concerned with profitable actions. A socialist central planner may know that there are N different production processes that he can authorize to bring drinking water to the inhabitants of a certain area. When he consults with his advisors, they give him all the information on the various ways of setting

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up the production of drinking water. The planner knows all the scientific causes of clean fresh water and all the technologies of producing it, such as from salt water, from the neighboring lakes, from ground water, by importing it from other regions, and many other possibilities. But without the market for capital goods and money prices, the planner cannot know which of these methods is the most economic; i.e., which method will yield the most benefits at the least cost, or equivalently, which is the most profitable course of action. He is faced with the impossible task of deciding between alternative ways of producing the water without any idea precisely which combination of means to attain this end is superior to all other possible combinations, i.e., which combination will not cause the more urgent wants of the consumers to be unsatisfied. Under socialism, (1) for any project to be undertaken, the planner cannot know what combination of inputs is best for producing the output; and (2) for any non-specific resource, the planner cannot know in which projects under consideration this resource ought to be used, and for each specific resource, he cannot know to what extent it ought to be used. (Thus, even largely specific goods can burden the planner. Hayek points out that for a perfectly specific good, “if it is at all durable and may be used up either more or less rapidly, its wear and tear must be counted as true cost if the appropriate volume of production at any one moment is to be rationally determined. This is true not only because its possible services in the future have to be compared with the results of a more intensive use at present but also because, while it exists, it saves the services of some other factor which would be needed to replace it and which can meanwhile be used for other purposes.” (1948: 168-9)) The planner may be said to have knowledge but no prudence. Note that I am extending here to the socialist every benefit of the doubt. Thus, I am assuming the existence of both the consumer goods market and the labor market. The former assumption is consistent with the definition of socialism which is: government ownership of all capital goods, such as factory real estate, tools, machines, and raw materials. Now even the final goods in the inventories of the state’s factories or on stores’ shelves can be considered the state’s capital goods of the 1st order until they are passed into the consumers’ hands. Nevertheless, that output is distributed rather than sold normally is so strong a version of socialism as almost to be a caricature and straw man. (To be sure, on many occasions the Soviet subjects were issued “coupons” which limited the total amount of some good, say, sugar, per month that they could buy. But there were ways around the restrictions.) In other words, only private property is outlawed; personal property is

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not; e.g., so long as the state allocated toothbrushes to people, in the USSR, no private individual could lawfully steal them. Further, it is certainly inconsistent that each person owns his own body, i.e., his human capital, and decides which talents to develop and where to work, and the government owns all extensions of the human body. The division is arbitrary and sure to interfere with the government omnipotence required for a proper attempt at central planning. However, an old Soviet patriotic song informs us that the singer “does not know another such country Where a man breathes so freely,” that “Man walks as a master Over his vast Motherland,” and that “The young have everywhere an open road; The old are everywhere honored.” It would scarcely have been possible to sing such verses, if the Soviet economy had not had a labor market, i.e., with a fully enslaved populace. Let me illustrate the problem this way. Let Smith the central planner produce only two commodities: guns and butter. Suppose that the number of guns to be produced is determined at, say, 2,000 units. There are ten distinct methods of producing a gun, each method using some of the same resources that can also be used to produce butter. In such a case, guns can essentially be priced in terms of butter and that method of production be chosen that would cause the least amount of butter to be sacrificed for the sake of our 2,000 guns. With the ends chosen, the allocation of resources is rational. Consider now the real economy with millions of kinds of consumer goods, most of which can be produced by means of, as matters actually stand, a variety of different techniques. It can easily happen that making the 2,000 guns by method A now takes resources away from (and therefore, has the opportunity cost of) 750 other items of 200 different types of consumer goods. Making them by method B prevents very different 1030 items grouped into 75 kinds of consumer goods from being created elsewhere in the economy. Etc. Which method, A or B or …, is the most economic? And how should the entire social structure of production be reshaped, when new technologies are researched and developed? The problem is now much more difficult, though still tractable. Let the consumer demand, i.e., the demand curve for each final product, be given. Mises, too, grants this concession to the socialists in order to penetrate into the essence of the problem by avoiding weaker targets: “We may for the sake of argument at first disregard the dilemmas involved in the choice of consumers’ goods to be produced. We may assume that this problem is settled. … We do not deal with the problem of whether or not the director will be able to anticipate future conditions.” (1996: 698ff) In other words, we assume that Smith does not make entrepreneurial errors. Smith always gets the amount of

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revenue from selling consumer goods that he has anticipated. Let also the quantity of each good be set to whatever the planner desires, as in the previous example. For instance, it is known that 2,000 guns will sell for $100 each, generating $200,000 in revenue. Let good A similarly generate $50,000 in revenue; good B, $35,000; etc. Finally, let the schema be: p is the price of capital good P. At this point, we can bring forth a system of simultaneous equations like this: $200,000 = 2,000( 5p + 3q + 18r + 7s + …) $50,000 = 80(12p + 11q + 3t + …) $35,000 = 1,250( 2q + 3s + 8t + …) … If these are solved, then we obtain the prices of the factors of production. However, Hayek points out that this is “a task which… could not be carried out in a lifetime. Yet these decisions would not only have to be made continuously but they would also have to be promptly conveyed to those who had to execute them.” (1948: 156) Mises agrees: “the fabulous number of equations which one would have to solve each day anew for a practical utilization of the method would make the whole idea absurd even if it were really a reasonable substitute for the market’s economic calculation.” (1996: 715) Let us start with an evenly rotating economy. The ERE is not impossible, only unrealistic or non-actual. Monetary profits can be zero for every firm, as long as psychic profits from exchanges within the ERE are positive. An ERE is unrealistic because of entrepreneurial actions that keep disturbing it. But under socialism, there is only one entrepreneur, Smith. Hence, an ERE is the natural state of a socialist economy. Suppose that Smith is making 200 units of product P. He decides to lower that number to 190P. This act releases some factors from their employment. What is the most efficient way of re-incorporating these factors into the rest of the economic system? The issue rests with deciding whether 2Q + 5R that these factors can also on their own cooperate in producing will be valued by the consumers more than 3S + 2R + 6T, and one can figure it out. Let Smith then try to introduce a marginal improvement to the ERE, say, a new product C. As before, Smith knows the state of consumer demand. He knows the revenues he will obtain by selling n Cs to the consumers for all n. In order to produce C, Smith has to withdraw the factors involved in making it from other lines of production. This means that some of the goods previously made will not be made. Having calculated the costs of production in the ERE by solving the system of

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simultaneous equations, for every method of producing C, Smith can find those products, canceling which will harm the consumers the least. He can do that by tallying up the lost revenues for the different possibilities and sacrifice those combinations of other consumer goods for the sake of C that already provide him with the least amount of revenue. Comparing these amounts yields the cheapest way of producing C. If Smith finds that he receives a profit by producing k Cs, then he can keep withdrawing factors from elsewhere in the economy, until the marginal costs of the factors go up so much, and the revenues brought by an extra C go down so much, that the two are equal. For example, if Smith produces 1 C, then he can sell it for $1,000. But the factors of production that go into making it cost (in unmade other consumer goods) $100. Since this is socialism, we cannot have profits. Smith needs to equilibrate “in place.” If Smith produces 2 C, then he could sell them for $950 each, and the factors’ cost would be $150 per C. As we can see, marginal revenue declines, and marginal cost rises. On we go, until the revenue from a marginal C comes to be equal to the cost of the factors needed to make it. At this point, we have a new and improved ERE, because each C produced is superior on the consumers’ values scale than its opportunity cost. It seems that we have an instant motion from one inferior ERE to another superior one without any need for entrepreneurial competition or market for capital goods. There are neither disequilibration and profits nor imitation and disappearance of profits but what seems like a perfectly efficient smooth move from one ERE to another. There are neither monopoly prices nor entrepreneurial losses. So far: socialism, 1; free market, 0. But things are about to get more complicated. For the key assumption of our argument has been that Smith introduces creative advance into the economy sequentially. He makes a single marginal improvement at a time. He then waits until the new ERE is reached (since setting up any new production process and obtaining its fruits take time) and continues from there. In such a case, his actions are rational and economic. It is possible, of course, that Smith may be able to get away with making several reforms at the same time, if they do not interfere with each other. But that only means that the markets are not well connected and therefore, are more primitive than they could be. The very process of growth that Smith hopes to initiate for the society he controls must lead to a more unified and complex global economy that will eventually deny even that consolation to Smith. The more sophisticated the economy is, such that every part comes to be influenced by every other part, the more restricted the central planner’s powers will

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be. The market economy works differently. In it, millions and billions of creative and inventive changes occur at the same time, in parallel. Millions of entrepreneurs are working every day to make their businesses perform better, all at the same time. Disequilibration and equilibration, the light and dark side of the “Force,” enable the market to be coordinated in the presence of numerous entrepreneurs competing with each other. But Smith cannot process and optimize so many changes, no matter how much power his computers have. There are too many possibilities and variables to consider. As a result, the massively parallel market system will outperform a sequential socialist economy even under the best possible conditions. And these conditions are hardly best. For example, Mises points out: “Each case offers special conditions and requires an individual solution appropriate to these data. The number of elements with which the director’s decision has to deal is much greater than would be indicated by a merely technological description of the available producers’ goods in terms of physics and chemistry.” (1996: 699) The socialist economy may be likened to a vast monopolistic firm that stretches over an entire nation and has hundreds of millions of people as employees. It is obvious that a company like that is simply ungovernable. The dictator-asCEO has to be aware of a far greater number of realities and possibilities than a single man can process in his own mind. Further, if the entire world is socialized under a single government, then Smith the planner, residing, say, in some capital city in Mongolia, can scarcely discover what I, living in Akron, Ohio, USA, would be most willing to pay for. Numerous businesses are local, started in order to serve local customers, though companies that ship worldwide have become more common thanks to the Internet. Preferences, therefore, are often discovered by area businesses. It would be a formidable problem for Smith to find out my most urgent desires. Further, in competing with other entrepreneurs, every businessman is offered a rigorous incentive to excel. He puts his own time and money on the line. He must do his utmost to win. Smith, on the contrary, would need to be “public-spirited” in order to push himself to get anything done. We all, however, know that the search for private profit is far more motivating than some vague desire to improve the world. In other words, Smith is interested in his own profit, and so is an individual entrepreneur under capitalism. Smith, also like an entrepreneur, is disinterested in the common good of the whole society. Mises provides a cogent reality check: “The real Führer, however, turns out to

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be a mortal man who first of all aims at the perpetuation of his own supremacy and that of his kin, his friends, and his party. As far as he may resort to unpopular measures, he does so for the sake of these objectives. He does not invest and accumulate capital. He constructs fortresses and equips armies.” (1996: 850) However, the capitalist entrepreneur is embedded into the free market as a whole which is quite intent on (or “interested” in) fulfilling its utilitarian duty. Finally, even if only Smith is allowed to act, the economy will change every day through causes other than Smith’s actions. Smith cannot just “control” the world. It will experience what economists call “shocks” which will range from a tornado to exhaustion of a coal mine to a demographic shift. The equations that are valid this hour may well be useless the next hour. The market, on the other hand, succeeds in real time. I agree with Mises that socialism is theoretically impossible, if it tries to imitate the market’s mode of operation. If it stays within its own limits, a socialist economy is possible, though it will grow exceedingly slow. We have seen the difficulties with socialism; why is what may be called über-capitalism (UC) a bad idea, as well? How come there are employers and permanent employees as opposed to the market being made up entirely of independent contractors? The distinction between entrepreneurs and workers would be maintained even under UC. Each item to be produced requires numerous complementary factors of production including labor and time; so, there must be people who are such factors (workers) and people who gather them and direct them (entrepreneurs). Other differences between workers and entrepreneurs are mentioned in (I, 16). The question is why the factors thereby collected are arranged into a firm. The solution is best expressed in the distinction between wage and salaried employees. A person receiving a wage probably does one particular task, say, attaching part A of a device being produced to part B or screening the items on the conveyor belt for any defects. At the same time, his job situation is very precarious: should markets turn to make that particular highly divided job obsolete or less valuable (ultimately in the eyes of the consumers), the worker will be fired. At the very least, new terms will have to be renegotiated, possibly every week or even every day, introducing exasperating “transaction costs.” A salaried employee (SE), on the contrary, essentially sells himself into quasi-slavery for a period of time. He agrees to update his salary demands only once a year. A slave has perfect job security: if no use could be found for him, then he would become a free man and lose his

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essence as a slave. At the same time, the entrepreneur obtains a great deal of flexibility: an SE can be reassigned from task to task, from project to project, from department to department within a company with ease and at the owner’s discretion. It enables him to seek internal efficiencies far more adroitly. Of course, the analogy to slavery is very slight: any salaried employee in the free market can quit and be fired at will. It is just that neither of these is usually to the benefit of either the worker or the entrepreneur. This long-term continuous association, wherein job security is traded for a measure of loyalty, vaguer job description, and multiple competences, helps everyone. On one extreme is our wage worker who contributes to the production of a widget. He is paid per widget. On the other extreme is a person whose services are “retained”: he is “on call,” always there to do whatever is requested on demand. Emergency services are of that nature, as is insurance. Lawyers and certain other professionals can be paid on this principle: a lawyer would usually just sit there waiting to be consulted on whatever his client chooses. He is paid per hour of convenient availability. In between is the SE who is paid a lump-sum (obviously split into weekly, say, payouts to permit firing and quitting) for a year’s worth of moderately well-defined work. Additionally, a useful prerequisite to shifting an employee around is training him, something that also is worthwhile only when the employee is expected to stay with the company for a decent length of time. The sum of the relations between an entrepreneur and his SEs constitutes a firm. To recap, the free market is a planetary, real-time, parallel improvement and optimization engine that is able to accommodate changes to the economy that are happening to it every second, and whose every member struggles with a “will to power,” causing the economy as a whole to bear fruit in the form of greatest happiness for the greatest number. On other hand, socialism is a local, delayed, sequential, inflexible, and disinterested system. It is clear that this looks almost like a description of internal workings of a capitalist business firm! V.I. Lenin who, when asked about the economics of socialism, answered that it would be organized along the lines of the postal service, was hopelessly confused. The commies thought that the world market and one’s neighborhood oil change shop worked the same way; and for this folly, I hope that they will not get out until they have paid the last penny. Therefore, saying, as some people used to do, that socialism

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“sounds good in theory” but “won’t work in practice” because of “human nature,” whatever that means, is premature. Socialism sounds awful in theory, too. Perhaps, the attraction of socialism to persons of the Rational temperament can be explained as follows. Suppose Smith wants to build a cathedral. He draws up plans, saves money, starts a business, hires factors of production, manages all work, monitors progress, and in the end, say, 3 years later, something beautiful is created. A complex longterm project was started and successfully shepherded to fruition. Smith can feel justly proud of himself. He has achieved something momentous. Now why cannot Smith be put in charge of a nation or the whole world, so as to build and realize his vision of a great society? Perhaps, in 100 years, Smith will have created something glorious. Yes, it is an ambitious project, but Smith is an ambitious guy. Allowing other people to compete with Smith for resources and consumer interest will detract him and society as a whole from Smith’s wonderful and far-reaching vision of how things ought to be. The reason is that Smith is not omniscient. He is a human being, and his “vision” will be flawed. Other people have their own visions, as well. We need the competition, so that Smith can test himself every day as to whether his grand plans are still acceptable to the people. Finally, the temporal structure of production is crucial for understanding business cycles, as I hope to demonstrate in (I, 61-64). Now it seems that there is a separate and unique structure of production for every consumer good or service. By what right do we agglomerate all of these into something called “the” structure of production? The answer is that we are concerned not so much with the physical structure itself, but with the fact (1) that advancing capital goods of higher order into capital goods of lower orders and finally into consumer goods takes time; and (2) that time costs money, an income called interest paid by the demanders of present money to the suppliers of present money. Thus, if interest is paid once a year, and a certain production process takes 5 years, then we can consider that process’ temporal structure to have 5 layers, each layer representing payments to the higherorder capitalists and being shorter than the previous one as we move up towards earlier stages, because of payments to factors and interest. If interest is paid once a month, then the structure will have 60 stages. That the real particular structure of any process involves numerous transformations of intermediate goods each taking various amounts of time is true but irrelevant when considering the temporal structure. There thus comes into consideration a general temporal

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production structure reflecting the timing of interest payments and summarizing the payments to other factors in between. Keynes is oblivious to the production structure altogether. In an amazing passage, he writes: For if producers of investment-goods are making a profit, there will be a tendency for them to endeavor to increase their output, i.e., to increase investment which will, therefore tend… to raise the prices of consumable goods; and vice versa. If, on the other hand, producers of consumable goods are making a profit, but those of investment-goods are making a loss, then there will be a tendency for output to be changed over from the latter to the former, which will… lower the pricelevel of consumable goods and obliterate the profits of the producers of such goods. (1935: 181) Here, in the first place, Keynes treats “investment-goods” as an undifferentiated blob, which means that he fails to take account of the interest rate effect on the prices of capital goods within the production structure. This effect tends to increase these prices and is stronger for such goods in longer production processes, for which interest payments or disutility of waiting are of greater importance than for shorter processes. Lower interest rates which arise, say, as a result of a greater supply of savings encourage lengthening of the production structure. The interest rate effect, therefore, is most pronounced in the early stages of production. In the second place, Keynes fails to notice the connection between consumer goods and capital goods which consists in the obvious fact that the latter are demanded and used for the sake of the former. He might as well have said that if making widgets is unprofitable, and making trinkets is profitable, then entrepreneurs will switch from producing widgets to producing trinkets, a true but trivial observation. He thereby ignores the derived demand effect on the production structure. This effect, unlike the interest rate effect, is stronger in the late stages of the production structure. This is because as we travel up this structure, goods become ever less specific and capable of entering into the production of ever more consumer goods, including the goods for whose production more time is now allotted. The demand for such nonspecific capital goods in the earlier stages of production suffers less from the decrease in the demand for particular present consumer goods than the demand for the relatively more specific capital goods in the later stages of production.

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In other words, to alter Keynes’ example a little, if widgets represent consumer goods, and trinkets, capital goods, then it may well be that replacing existing widgets of kind W1 is unprofitable, if production of novel widgets W2 that do not yet exist is, on the contrary, expected to be profitable. Therefore, the production of the trinkets that enter into the making of W2s is also more profitable than before, because demand for them has shifted through the actions of capitalist savers from factors employed in the old production processes aiming at churning out W1 to new ones outputting the consumer goods that are yet to be consummated and delivered. A change in consumer demand occasioned by an increase in savings and decrease in present consumption, will decrease the demand for the capital goods used more or less immediately in the production of these consumer goods. An increase in saving, then, will cause the entrepreneurs producing final goods and lower-order intermediate goods to suffer losses due to decrease in (a) the original demand for the final goods and (b) the demand “derived” from this original demand for the intermediate goods used in making those consumer goods in the later production stages. On the other hand, it will cause interest rates to decline, which means that new stages of production will be added to the economy, increasing society’s overall productive capacity. In blissful ignorance, Keynes continues: “The lower rate of interest will stimulate the production of capital goods by raising their prices.” (1935: 263) To be sure, the price of a capital good in an ERE is its discounted value product over the good’s lifetime. If interest rates fall, then the discount factor is lowered, and this, indeed, puts an upward pressure on the good’s price. But Keynes forgets to ask what causes this decline in the rate of interest. The cause is a decrease in the demand for present money and increase in the supply of present money, e.g., on the loan market. If the supply of savings rises, then consumption must needs decrease, and the derived demand for capital goods declines, lowering their value products, thus putting a downward pressure on the goods’ prices. The (a) interest rate effect and the (b) derived demand effect act in opposite directions relative to each other, but in the early stages of the production structure, the former dominates; while in the late stages, the latter dominates. 49. THAT THERE IS NO SUCH THING AS GENERALIZED “INVESTMENT” Capital is a heterogeneous, non-permanent (as per its nature of

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intermediate goods that depreciate in the process of transformation, needing at various intervals to be replenished), flexible, complex, interlocking structure of goods of various scarcity and specificity within the market process. The interlocking is both horizontal, emphasizing the complementarity of the factors, the physical structure of production, and technological recipes, such as “7A, 2B, and 12C, when combined, will yield 3 units of output P and 5 units of Q”; and vertical, emphasizing the orders of the goods and their progression from unfinished to finished goods (the “order” of a capital good reflects its remoteness in comparison to the final consumer good of the first order.) The Keynesian understanding of capital as a “blob” is similar to Ernst Haeckel’s view of the living cell as a “homogeneous globule of plasm” in the early 20th century. Just as cell biology has progressed tremendously, so economics has regressed, under Keynesian guidance, into a primitive form. Investment is a purchase of particular capital goods within that structure. One investment can come at the expense of another investment and not merely of consumption. In the free market, there is no such thing as “total capital”; indeed, people compete as to who can first identify, take ownership of, and exploit new means to assist other people in realizing their various ends – for a price, of course. Capital goods are (1) well-suited for (2) particular production processes deployed to create (3) specific consumer goods which will satisfy (4) some definite desires in the consumers. There is no such thing as “world resources”: a physical object can be a resource only relative to a particular entrepreneur and his valuations and plans. Given an unnecessary but sufficient method of production, each capital good used in it is an insufficient but necessary cause of the consumer good; hence, capital is an INUS material cause of final output. Each good will be to some extent specific. Of course, there is no such thing as “degree of specificity”; specificity is not a number but a set of the good’s potential uses in the economy. Finally, each capital good’s both actual extent and manner of employment and potential extents and manners of employment will be changing all the time according to entrepreneurial discoveries and calculations. Then there is the valuational structure of production. It has two aspects. The first aspect is exceedingly simple and consists in the fact that as goods are transformed and passed down to the lower-order entrepreneurs and to the consumers, value is added to those goods. Now if by “value” it is meant “subjective utility,” then seemingly no value is added, because the marginal unit is the finished consumer good; i.e., capital goods are submarginal. However, by using the distinction between useful, virtuous, and pleasant goods introduced in (I, 38), it is

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possible to say that as the good is being transformed, it becomes ever more useful, though it becomes virtuous only when production is finished and the good is placed in the inventory of a first-order capitalist, and moreover, it becomes pleasant when actually sold to the consumer. If by “value” it is meant “price,” then there are two distinct effects on the price of a good being transformed. On the one hand, a lower-order good is more specific. But more specific goods have fewer opportunities to be employed elsewhere. If the entrepreneur realizes that he has erred, and the use of his newly produced widget in his own project is a losing proposition, then the more specific the widget, the harder it will be to re-sell it. This puts a downward pressure on the prices of useful goods. For example, if the production of almost-finished consumer goods were for some reason shut down (e.g., by the government for non-payment of taxes, or because a competitor has come up with something vastly superior), then the businessman may have better luck disassembling the goods and selling them for parts. On the other hand, the more specific good requires fewer complementary factors in order to bear fruit in the form of a consumer good. It is less deficient, less evil than the goods that were used to make it. This state of affairs puts an upward pressure on the widget’s price, if it were to be sold. Of course, if it is put up for sale, then its order may well change: it may be moved up or down the production structure by its new owner. In the previous chapter, we dubbed these the derived demand effect and the interest rate effect respectively. The second aspect of the valuational structure concerns pricing of the factors. On the one hand, each higher-order good can enter into the production of many lower-order goods. Thus, lumber might be used to produce good X and good Y; and one unit of good Z uses 4X, 10Y, other factors, and some more lumber. Here, lumber is part of the material cause of Z both directly and indirectly through X and Y. On the other hand, the production of each lower-order good uses many higher-order goods. E.g., 20 different factors might cooperate in producing Z. There is multiplication of output as we go down the production structure and multiplication of factors as we go up that same structure. The dependencies can be quite complex, contain loops, and so forth: for example, an axe can be used to chop down trees that will yield lumber, and lumber can, in its own turn, be used to produce replacement axes. The prices of capital goods are determined by the interplay of these two

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“graphs,” namely, the graph of what lower-order goods a particular capital good is used to produce and the graph of what higher-order goods are used to produce that capital good, together with consumer demand. The structure of production, as well as the changes it undergoes every day, illustrate the fact that capital goods are convertible, and their subjective essences are very fluid. Every economist from Marshall to Rothbard linked price formation of factors of production with opportunity costs, and these costs are most preeminent for non-specific goods which can be used in multiple projects with multiple aims. Schumpeter considered it the essence of economic progress that entrepreneurs find novel uses for old things. Hayek argued that the fact that production has a structure is instrumental in explaining business cycles. Moreover, the slump part of the business cycle lasts for a while, because new uses must be found for capital made unemployed by the bust which is a time-consuming process. If goods were perfectly inconvertible, then there could be no booms. A good would either be used for some unique purpose or be completely idle. Since misallocation of a resource is relative to some correct allocation of it, any attempt to bring something into use would be considered economic growth and cause no economic sickness. On the other hand, if all goods were perfectly convertible, then vicious booms could occur, but recessions would be much shortened if not eliminated completely. When Taleb (2010) finds himself “obsessed” with the notion that “progress… cannot take place without… redundancy,” (318) with the example he gives that aspirin over several decades has been used for several unrelated purposes, he is picking up on this primordial (yet apparently non-trivial) idea. Especially useful for understanding business cycles is the temporal production structure described in (I, 48). Given the reasons for saving outlined in (I, 20), a part of saving is inseparable from investing and means simply a redirection of resources from the existing production processes which make the presently available consumer goods to new and as yet nonexistent projects. With an increase in saving relative to immediate consumption, the number of consumer goods produced and sold temporarily declines, and there occurs a disinvestment away from current producers of the consumer goods and the capital goods used to make them into new (and longer) production processes. Factors are reallocated from making old consumer goods to making new producer goods as an immediate consequence of capitalist saving. Greater savings indicate lower time preferences and lower interest rates, with the result that the costs of doing business for every firm engaged in comparatively longer production processes decline, making

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many of such ventures profitable. Investing into more durable capital goods is one way to benefit from lower interest rates, because the investor loses less money from buying such goods – the money which could instead have been loaned out and earned interest. In other words, suppose that Smith is trying to decide whether to purchase a new building which costs $1,000,000 and will last for 40 years or to put the money in a CD. The interest on this amount over this time can be quite large, but if interest rates are low, then the profits obtained from using the building even given the yearly maintenance expenditure of $25,000 have a better chance of outweighing the counterfactual interest return. Let us take stock. When savings increase, in simple terms, the consumers buy fewer goods being produced. As a result, there is excess capacity in the later stages of the production structure. The competition there (that is, between companies which operate closest to final consumption) will intensify, and the marginal firms will go out of business, releasing their factors of production. If these factors are specific, then they may be rendered altogether (if temporarily) useless, because the demand for them there has disappeared, and they have nowhere to go. If they are relatively nonspecific, then they will be reallocated and re-employed in the earlier stages of novel and more circuitous endeavors. Any such reallocation will take time and require (perhaps, extensive) testing the market, paying the transaction costs of buying and selling the goods, moving physical capital and labor to new locations, and learning new human capital by laid-off workers. But unless we are dealing with a business cycle, any instance of which is marked by mass entrepreneurial errors and therefore, the need during the bust for mass liquidation and reabsorption of numerous capital goods into less unprofitable projects, this is simply the market process in action, where the “action” is within the intertemporal capital structure. In other words, following upon the heels of a drop in interest rates, specific factors in the late stages of production undergo a drop in price; non-specific factors undergo a drop in quantity (after they are reallocated). The former seems to be pure waste. However, the influence of lower interest rates permeates the entire economy and affects factors of all specificities. Occasional excess capacity and rusting machinery, being more generally consequences of discoordinative entrepreneurship, can be signs of economic progress. Losses here and therefore, temporary un- and underemployment of factors affected by such losses, are engendered by profits elsewhere. Creative destruction is no joke, and there is

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little creative advance without its concomitant destructive part. For example, a worker will be faced with a choice of whether to acquiesce to lower wages for his non-transferable skills in the later stages or to be enticed by higher wages for different skills (which he may need time to learn) in the earlier stages. The structure of production in general will lengthen – the money that used to accrue to the factors in the later stages of production and no longer does (because the consumer decisions to curtail buying present goods are transmitted up through the structure until a certain point in the form of decreased income to factors) has to go somewhere, and it will go into the new earlier stages of new production processes. If the width of a stage represents the amount of money paid to the previous capitalists and to factors, then the production structure will narrow in the later temporal stages, widen in the early stages, and deepen in terms of the number of the stages. The Rothbardian triangle, also called the Hayekian inverted input function, shown in Figure I.49.1, assumes for the sake of simplicity that (1) all capital is working or circulating, i.e., that there is no durable capital, and (2) an evenly rotating economy. Income to Labor, Space, and Time Factors $150 $150 $225 $375 $145 $520 $180 $700 $830 $1,000

time money

$130 $170

$1000 Worth of Consumer Goods FIGURE I.49.1. THE SHADED AREAS ARE INCOME TO CAPITALISTS FOR PRODUCED FACTORS OR FINAL GOODS; THE WHITE AREAS ARE INCOME TO ORIGINAL FACTORS, INCLUDING WAGES, RENTS, AND INTEREST

In the triangle shown in Figure I.49.2 an increase in savings is manifested by the morphing of the structure of production from shape A to shape B. Its foundation – which stands for consumption – shrinks, say, from $1,000 to $800; but gross investment increases. Without taking cognizance of the structure of production and

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the different influences of derived demand and interest rates on the different stages of that structure, it becomes possible to argue confusedly that the process of saving has two aspects. Seen from one side, it constitutes an addition to the supply of capital goods. Seen from the other side, it is a reduction in the immediate volume of effective demand. In its former aspect, through a lower rate of interest, it makes investment more attractive. In its latter, by reducing the sales expectations of entrepreneurs, it makes investment less attractive. In the one aspect, it reduces cost; in the other, it reduces demand. (Estey 1946: 294, channeling Keynes) Little sense can be made of this quote, unless it is added that lower demand hurts the producers operating in the late stages more than lower cost benefits them; the opposite is true for projects that take a long time to complete.

FIGURE I.49.2. A RESULT OF POSITIVE NET SAVINGS: MOVING FROM THE WHITE WITH BOLD OUTLINE STRUCTURE A TO THE SHADED ONE B52

An increase in savings does not entail that there are too many consumer goods – there can never be too many consumer goods – but that there are too few future goods as compared to present goods from the point of view of the time preferences and interest rates of the moment. The sacrifice of present consumption occurs when the money in the hands of the public is channeled into capital goods used in more roundabout, longer production processes. But precisely because they are longer and new, they take time to set up. Production of novel capital is 52

Cf. Rothbard 2004: 369; 519.

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time-consuming. While that is going on, the same effort results in fewer consumer goods. To be sure, the sacrifice is worth it, because in the end, perhaps months, perhaps years later, there will more and better goods out there than there would be otherwise, again in obedience to the new consumer time preferences. Demand will be restored; meanwhile, however, the savers are by their own choice shortchanged. 50. THAT ANTICIPATING CONSUMER DEMAND AND ANTICIPATING DEMAND FOR CAPITAL GOODS CALL FOR DIFFERENT ENTREPRENEURIAL TALENTS

On p. 123 of General Theory, Keynes proposes something strange. He examines “the extreme case where the expansion of employment in the capital-goods industries is so entirely unforeseen that in the first instance there is no increase whatever in the output of consumptiongoods.” This “case” is so contrary to reason as to be impossible. For consumer goods are the end result of any process of production. When a new plan to begin producing new consumer goods is being contemplated by an entrepreneur, these consumer goods are the most remote from the time of such planning. Any capital good participating in the production of some consumer good is closer to completion than that final consumer good. It is a means to, a way station on the path toward the consumer good. But the value of the means is subordinate to and imputed from the value of the end they serve. If a capital good is being created, then someone, somewhere has a plan (or thinks he has a viable plan) to use that good in the creation of some final consumer good. Otherwise, the capital good would not now be manufactured. It may be, of course, that a particular firm has labored to produce a superior technological process, and lower-order firms are surprised and delighted when this process is marketed to them. But there is no reason at all to expand production and employment within any capital goods industry, unless it is hoped that some consumer goods can be profitably produced with the help of those capital goods. Therefore, the expansion of output in the capital goods industries can in no wise be “unforeseen,” at least by the companies that do expand. At the same time, expansion of employment is merely an investment into labor, and it will take time to produce the requisite capital and consumer goods. Again, and I hope the reader will not fault me for repeating it, in the short term, this expansion must needs be at the expense of present consumption. No wonder, “there is no increase whatever in the output of consumptiongoods”! There is, in fact, a temporary decrease.

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Producing for higher- and lower-order capitalists requires different combinations of sympathy / understanding and technical knowledge / IQ. The producers of final consumer goods need to have deep insight into what makes their customers happy. They must understand the consumers and their desires, even empathize with and root for them, in order to market their products successfully. The entrepreneur’s will is exercised to the greatest possible extent here. The entrepreneur provides safety and comfort and pleasure and fun and must genuinely feel his customers’ feelings, being sorrowful for their problems and rejoicing with them when he solves those problems. At the same time, the final goods are exactly that: final. They do not require any further transformation to be used by the consumer. Of course, many such goods are somewhat tricky to use and come with manuals describing their functioning. But these user guides are usually simple to figure out, as compared with the mental power needed to come up with most technological recipes employed in transforming and adding value to higher-order goods. If we go one level up the production structure, then we observe something new. A consumer good is more perfectly formed than any capital good. It is more specific, and its purpose, more precise than those of capital goods. Since capital goods usually can enter into the production of many different consumer goods, the former are less defined and have less pronounced “identities.” It is a rare case that a consumer good designed for purpose P can be used successfully for purpose Q. Capital goods, on the other hand, trade their actuality (consumer satisfaction) for potentialities (capability of being used in numerous production processes). A maker of a second-order capital good no longer needs to be as customer-oriented as the maker of final goods. This is because his good is used in more than one production process. Even if one such process shuts down, others will remain, cushioning the blow from the diminution of the derived demand. Yet the demands on the higher-order capitalist’s intelligence increase, because the good he is supplying is part of several technological processes used to produce lower-order goods. In a real sense, the maker of machines and raw materials delivers to his customers not just isolated goods but entire integrated “solutions.” He has to offer them the best technological process utilizing the stuff he is producing relative to his competitors. But a technology is a means to an end, and it is the intellect that invents and provides the means. The higher up the production structure we go, the greater the potential of each capital good, and the longer and more complex the entire manufacturing process – that begins with transforming those goods and ends in final consumer goods – becomes, regardless of

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whether production is vertically integrated within a single firm or split between many firms. The entrepreneur’s mind needs to work harder and harder; and his heart, less and less hard, insofar as the technologies that use the capital goods multiply and lengthen and become more elaborate, and the number of consumer goods into whose production this capital good enters rises. In the abstract limiting case of “prime matter,” this pure potentiality is used to produce absolutely everything which is good news for the supplier of prime matter, yet this supplier is also under the necessity of knowing how to produce everything, as well, which is bad news, requiring as it does enormous knowledge and competence. My argument is a reflection on the categories of means and ends. The ends are “subjective and arbitrary”; who knows what the human senses and heart desire! There is no accounting for taste, etc. The means are far more constricted. There are millions of consumer goods out there, but for any consumer good, there are normally only a few viable ways of producing it. At the same time, ends are simple and “atomic” ultimate givens; means are usually composite and complex and amenable to analysis. Herein again the difference in the tasks of the will and the intellect in predicting consumer and business demands. The will is loving, insofar as one penetrates into his customers’ hearts; the intellect is rational, insofar as one chooses the best means to satisfy their desires, as far as the present economic calculations determine. It may be pointed out that in the case of capital goods two mistakes can be made: first, that the consumer goods built with the help of these capital goods will not sell, in which case the derived demand will plummet; and second, that a competitor will offer a cheaper or more efficient way to produce those consumer goods. On the other hand, for consumer goods, it is only possible to be mistaken once, namely, regarding whether or not these goods will be in demand. However, the mistake of the maker of consumer goods is fatal, whereas the first kind of mistake of the producer of capital goods is not, again, because of the capital goods’ greater versatility. To be sure, this advantage is offset by the existence of competition (making the second kind of mistake possible), such that overall it is not obvious whether producing for consumers or businesses is more challenging. Perhaps, some people will excel at one, and others, at the other, generating useful specialization and division of labor. Now while useful goods produce virtuous goods, virtuous goods produce pleasure. A useful good may either fail to produce pleasure or fail to produce a virtuous good most efficiently which are different

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occurrences. But if the virtuous good does not sell, then this is because consumers prefer to buy something else. This event can be described as either that the good fails to produce pleasure or that it fails to produce pleasure most efficiently which are the same thing. Hence, the two errors are still distinguishable. Another objection that may be levied on this argument is that producers of final goods only have to predict consumer demand; while producers of higher-order goods must, in addition, predict the demand of the lower-order entrepreneurs; they have to predict the plans of those who themselves are fallible predictors. For example, the companies that mine zinc cannot sell their product directly to the consumers; they must somehow hope that there will arise entrepreneurs who will require zinc in their production processes. This seems to imply that zinc producers are more “helpless” than producers of things that use zinc. Once again, this drawback, i.e., greater uncertainty, is compensated by the fact that zinc is popular with numerous lower-order companies. A single wrong prediction will not destroy our producer. Meanwhile, consider a situation in which entrepreneur A is contemplating a business plan to produce consumer goods with the situation in which this plan has been finalized, and entrepreneurs B, C, and D who are thinking of which capital goods to make are apprised of it. It is true that if A fails, then B, etc. will suffer with him, but for the moment most of the responsibility falls on A; B is just a handmaiden helping A out. All business profits are fleeting, not just those that arise for the makers of capital goods for projects whose destiny is to fail. B, C, and D should rejoice, however briefly, that A is ordering their products, even if it is written that A will eventually declare bankruptcy. Finally, even zinc producers start with some existing economy, say, for simplicity’s sake, an ERE. They already have certain customers. Then they try to figure out how they can improve things, i.e., capture greater profits by serving their customers more faithfully. They may try to lower their cost of producing zinc and hence become more competitive by offering lower prices. They may try to improve the quality of zinc. And they may try to invent technologies that use zinc that will cause their product to be demanded by more lower-order firms. They are no different in this sense from any other entrepreneur. 51. WHY LONGER PROCESSES ARE MORE PRODUCTIVE The term “roundabout” does not mean “requiring more capital

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and intermediate steps before final production” but simply “requiring more time.” That is, it refers to the temporal not physical structure of production. Eugen von Böhm-Bawerk noticed that productivity can be increased by the adoption of more time-consuming or roundabout production techniques. Adds Mises: “As acting man prefers those processes which, other things being equal, produce the products in the shortest time, only such processes are left for further action which consume more time. People embark upon these more time-consuming processes because they value the increment in satisfaction expected more highly than the disadvantage of waiting longer for their fruits.” (1996: 481) It is time that costs money, along with labor and land; the actual number of intermediate steps is next to irrelevant for our purposes. If it takes 10 months to carry good G through 10 transformations down to the final consumer good, and it takes 1 month similarly to carry good H through 100 transformation, then the process involving G is more roundabout than the process involving H. “Roundabout” may be synonymous with “circuitous,” but I take it to mean “more time-consuming.” As we have seen, disutility of waiting produces time preferences; disutility of fear and powerlessness, liquidity preferences. Both the TP and LP combine to form the interest rate on the loan market, in both its consumer and producer incarnations. The interest rate then influences the choice of more or less roundabout methods of production. Let me make the following points. First, it is true that a less time-consuming method of increasing production might now and again be found than those that already exist. But the normal state of affairs is that human beings have a strong incentive to find all the shorter processes first, for disutility of waiting is always troubling them. Suppose that Crusoe uses fishing rods to catch fish and replaces his rod once it wears out, a process which takes him 1 day. At one point, luckily, Crusoe finds a cache of fishing rods on a steep hill, such that to go there, grab one, and come back takes 1 hour. Unfortunately, climbing the hill is too much for Crusoe who feels he might get a heart attack in an attempt. We see that not all shorter processes are in use. Second, is it not often possible to initiate a more productive and at the same time shorter process with the help of new technology? What if it is the same process yet with lower costs of, say, labor (e.g., Crusoe gets healthier due to all the manual work he had to do or more experienced and capable of churning out more goods each workday)? Will it not be more productive yet take the same amount of time? As this example indicates, reducing the time it takes to build a useful thing is not the only way of cutting costs. One can also rely on less labor or less land. Finding an equally good shorter process will

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mean disinvestment with the same revenues and therefore, greater profit. The problem arises if no way of profitably disinvesting can be found. Then only longer processes remain to be considered. Third, an economy can become more productive by means of more sophisticated division of labor. This can intensify with increased population, incorporation of faraway lands into the global social cooperation, increased freedom of trade and of movement of capital and labor through political boundaries, better protection of private property rights of foreign investors from confiscation, and peace. Keynes calls this way of improving productivity, reasonably, changes in “institutions.” Fourth, time is just one of the traditional three original factors of production. Why not say that if a particular process has expensive labor, then it will be undertaken, only if it is sufficiently productive to offset the extra costs? What is so special about time? Why do we not say: “more labor-costly processes tend to be more productive”? Or: “methods which enhance the regenerative power of land tend to be more productive”? Or even: “Better tools make work more efficient”? Fifth, suppose that process A takes 1 week to produce its consumer goods. Process B is just like A but is preceded by a 3-week diversion of digging ditches and filling them back up. Surely, B is less productive than A, and yet it is longer. What is going on? Consider the following propositions about this problem. 1. Longer projects have to be more productive than some shorter processes in use, or else they will not even be considered. 2. Still more, longer projects have to be quite a bit more productive, if they are to be selected and implemented. 3. Both kinds of processes actually exist. The fact is that both [I] longer processes that have elicited the interest of an entrepreneur are expected to be more productive, and [II] more productive processes tend to take longer. [I] Longer processes tend to be more productive, insofar as mixing labor with natural resources or higher-order capital goods in order to advance them down to the final consumer goods or having the goods mature on their own (e.g., harvest) takes time. The more time one invests, the greater the amount of labor and machine input that can be mixed in a step-by-step fashion which makes it possible to produce the intermediate goods that will be more labor-saving or final goods that will yield more pleasure to the consumers.

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This means that longer processes should normally be [i] more physically productive, that is, increasing the quantity supplied more than proportionately to the increase of the time input. In other words, if a company profitably manufactured 100 TVs per day with method A, and competition intensified, then it may have no choice if it is to remain afloat but to use new method B that produces 250 TVs every two days. B is longer in the sense that more time is now needed fully to satisfy the demand, while again maximizing the company’s profits. The output will probably be more complex and sophisticated purely from the engineering perspective, which means that using up more time can result in [ii] completely new kinds of goods that were at all impossible to produce in shorter amounts of time. But in addition, no entrepreneur will bother investing time, unless profits due to higher productivity of labor outweigh the extra interest payments or extra disutility of waiting. (These payments will be either in terms of money; or, in Crusoe’s case, the psychic benefit of more fishes one day from now and for as long as the fishing rod lasts has to outweigh the psychic cost of lessening present consumption, while the rod is being assembled.) This means that new and longer processes ought to be expected to yield [iii] more value than old and less timeintensive techniques. It is true that digging and refilling ditches will make a process longer, but that is why I say that longer processes merely tend to be more productive: I assume the human desire not to waste production time; in other words, to maximize profits. Keynes objects that “lengthy processes are not physically efficient because they are long.” (2008: 214) True, but longer processes are more resource-intensive and more expensive to set up; their opportunity cost is shorter processes that allow one to save time and bring success – if not an equally impressive one – closer. Hence, they had better be more productive. And the same thing can be said about the other original factors: a process requiring more labor or land is more expensive; hence, analogously, if an entrepreneur chooses it anyway, then it is expected to be more physically productive, as well. It is important to understand why time is a factor of production. There are a technological reason and economic reason for it. First, there is a general relation that the more productive one wants his machine to be, the more time he has to spend constructing it. One can accomplish more with more time, just as one can accomplish more with more labor or land. There is, of course, no precise equation connecting the physical productivity of a machine and the time invested into building it, but a general proportion holds. In other words, one can hire several laborers

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to work on things simultaneously; or one can hire a single laborer and give him more time, depending on the production needs. In both cases, one invests more and hopes to gain more. (Or the investor can do both, if all stages of production exist alongside one another at any moment in time.) Thus, imagine that Crusoe is contemplating building a computer from scratch. Suppose that he is omniscient, and moreover, all the natural resources needed for the construction of the computer can be found on the island or under its ground. Even if Crusoe were distracted by nothing, could devote himself wholly to the task, and worked with full self-giving, he probably would not finish the computer in his lifetime. Technologically, he cannot build a computer. But what if he could? Then most likely, economically, he would not want to build it, because there are far more urgent needs on his values scale, for which he is not willing to wait. In other words, Crusoe has better things to do than waste his time on such an extravagance. The more “far-out” desire one wants to satisfy in a consumer, the longer one has to labor on it, because more urgent desires have priority. It is also true that one must compare the costs of building a new piece of equipment with merely maintaining old equipment. Nevertheless, sometimes the former will be preferred. [II] More productive processes (again producing either (a) much more of the same thing or (b) things that cannot be made available in shorter time intervals) tend to take longer, because there is an incentive to utilize all the feasible shorter processes first, other things being equal: this way, the waiting time will be as low as possible. I add “feasible,” because there can always be a short process that, for example, is hugely expensive in terms of the original factors other than time, such as labor (e.g., Crusoe’s climbing a hill or employing a genius at menial jobs), and for that reason is eliminated from consideration despite its shortness. Now in the case of (b), the process will not be longer but on the contrary, the shortest possible means to a particular satisfaction. Even in the case of (a), the allegedly longer process is nothing of the sort; it is rather the most efficient way of satisfying a desire for more goods or services. From the point of view of technology, the new process is longer, though physically more productive; from the point of view of economics, it is the shortest one, given that its initiator aims at a certain end and disregarding entrepreneurial error and ignorance. Human beings want to get results as soon as possible; so, it is likely that most of the shorter processes have been perfected, and any increase in business efficiency must, therefore, require more time-consuming (and therefore, more productive for reasons outlined in [I]) projects. At some point, the entrepreneur will throw his hands and say that

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he has done all he could with the time he was given and that he just needs more time. Again, that is only one of the ways of boosting efficiency. To conclude: the more resources, including time, firms within an economy profitably utilize, the more ideal or efficient the economy becomes. In a primitive economy, man looks upon bounty of nature with stupefaction: he must leave most of nature in pristine condition. But as population grows, and capital accumulation continues unabated, a greater and greater share of the previously useless or inaccessible external environment comes under human control and within the purview of the entrepreneurs. Even though it is always best to complete any project with the help of as few resources as possible, including as soon as possible, at some point, all such projects will be exhausted, and all novel undertakings will involve more factors and take longer to complete. In other words, there is never such thing as full employment of time. Paul Davidson (2009), in charming naiveté, paints a simple Keynesian picture. A penny saved is a penny not earned, he argues. A decline in spending, for example, lowers the amount of money received by business firms. As a result, they take losses, curtail production, and fire (or refrain from hiring) employees. And so we enter a recession. This account looks superficially plausible, until a few considerations are introduced. First, firms will suffer losses, only if they forecast consumer demand incorrectly. If they produced too much or the wrong stuff, thereby losing to their competitors, then there is, indeed, trouble for them. But, second, why must they make these entrepreneurial errors? Well, Davidson might say, perhaps, there is a recession; people’s risk preferences fall in a surprising fashion, and they hoard money. Does hoarding cause recessions or vice versa? Significant changes in people’s spending preferences are an effect not a cause of recessions. Furthermore, as I will show in (II, 10), these changes are economically benign and actually make recessions shorter. Third, direct your attention to the following scenario. If a company has received profit in a given period, then this profit is a validation of its way of doing business. But let it be that entrepreneur Smith perceives a danger from a competitor, Jones. Anticipating Jones’ next move, Smith wants to create a better product and keep the relevant slice of the market for himself. In principle, he could find a production process that is both cheaper and produces a superior article. This happens often enough with technological progress. In such a case, Smith’s costs in comparison with his old project will be lower, and his revenues, higher. That surely is a spectacular success. But most of the time, such

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feats will not be possible for reasons proposed above. Therefore, even though Smith expects his new product to be loved by the consumers more than his previous product, his expenditures on the factors of production will also be greater. He still hopes to beat Jones, but now the situation is less fortuitous. Suppose then that Smith decides to go ahead and start producing. Where will he get the money to pay his costs of doing business? For, remember, factors of production – labor, space, time, produced capital goods – must be paid long before finished output makes its first appearance. By stipulation, Smith’s revenues from the sale of the old product are not enough to cover these new expenses, even if he profits. The only answer is that the money must come from his own or somebody else’s savings which represent abstention from both consumption and hoarding. The amount of savings in the economy must increase in order to permit Smith to expand operations. Such (successful) expansions are the meaning of the term “economic progress.” Therefore, economic progress is primarily driven by increases in savings that are invested into winning lines of production. Now to be sure, for every winner, there are losers. If Jones, unlike Smith and others, malinvests repeatedly, then he will lose his capital. His savings, with which he pays wages and rents and so on, will be depleted. With nothing to pay the factors, Jones will exit the market and become a mere worker. But money did not disappear from the economy. What used to belong to Jones now belongs to others. They will use these savings to step up their production. This is creative destruction in action. Davidson objects that no one ought to believe that “if people are saving more and buying less from business firms, business firms, in the face of this decline in market demand, immediately invest more in additional capacity to enable them to produce more product,” especially “when they already have capacity that has been idled by this decline in sales and orders.” (2009: 56) Well, they will certainly not invest any more money in producing more of the same things! But they will liquidate their present capacity and cut the budgets for existing production processes for which they experience weaker demand, and use the greater available savings to invest into something else, something new, some project that, perhaps, could not up till then be undertaken because of relatively high consumer time preferences but which is now no longer uneconomic. The very act of saving for the sake of investing re-routes the efforts of entrepreneurs into producing brand-new capital goods. The time it takes to build those goods adds to the length of new projects that utilize them, making the overall temporal structure longer. If our author had ever identified the main cause of an investment boom to be credit expansion, then he would have realized that, given

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tons of artificially cheap credit, companies do invest into crazy projects. They act similarly, though without mass errors, if credit is naturally enlarged by means of private voluntary savings, as well. Mises is quite explicit in saying that in the market economy “a tendency to overrate rather than to underestimate the potentialities of an innovation prevails. The history of modern capitalism shows innumerable instances of abortive attempts to push innovations which proved futile. Many promoters have paid heavily for unfounded optimism. It would be more realistic to blame capitalism for its propensity to overvalue useless innovations than for its alleged suppression of useful innovations.” (1996: 512) This result is unsurprising, given that courage is the defining virtue of the Artisan temperament, the very sort of people who make the best entrepreneurs. Artisans do sometimes overestimate their powers. But a new, longer, and hopefully more fruitful production method is indeed an innovation. Davidson’s “Keynesian” observation about spending is hereby revealed to explain much less that it claims. In addition, Davidson proposes a complex scheme in order to “reform” the international monetary system. (2009: 134ff) What his idea boils down to is that nations with trade surplus or “creditor” nations must be forced to spend the money in their possession rather than sit on it. Davidson even goes so far as to suggest that nations whose surplus is judged by his International Monetary Clearing Union to be “excessive” will have their cash holdings confiscated. One way to avoid this would be to “provide foreign aid to deficit IMCU members.” So then, various individuals and companies within country A have sold more stuff to individuals and companies within country B than they bought from them, receiving, let us imagine, monetary profits. The government of A then taxes those profits away and gives the money back to the people of B. The global economy is thereby stimulated. I do not know whether to laugh or cry at this. Keynesians just do not understand saving. 52. THAT THE ECONOMY GROWS BY MEANS OF NET SAVING Capitalist saving allows an entrepreneur during a period from t1 to t2 to buy factors of production. Consumer spending allows an entrepreneur at t3 to sell the finished product at a profit. There is no 1st round of production without saving, and there are unlikely going to be further rounds of production, unless what is produced in the 1st is successfully sold to the consumers. Thus, saving and spending are two sides of the same coin. As we will see, Keynesians base their entire political program

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on these seemingly innocuous facts. They argue that capitalist saving can be boosted by the Central Bank’s credit expansion; and consumer spending, by the government’s borrowing and spending. In other words, the monetary policy can be used to lower costs of doing business, and the fiscal policy can be used to increase business revenues and boost entrepreneurial expectations or confidence or animal spirits. Once started, the quasi-boom can continue forever. In my retort, however, we will also see that the saving of money must be complemented by the contemporaneous creation of new capital goods; and that consumption must be the exclusive privilege of the people rather than the state, neither of which happens under Keynesian policy mix. Some of the savings in any economy must be devoted to capital maintenance, lest there sets in a degeneration of productive power and general impoverishment. An economy can grow by means of increase of capital in two ways. Extra savings for Smith can come at the expense of overall consumption in the economy, or they can come at the expense of the savings of Jones. [I] In the first case, people elect to increase their savings beyond the minimum amount required for the preservation of the current structure of production. Then present gross saving and investment will exceed the old quantity. Of course, one does not have to maintain existing equipment; he can allow it to run down and create something all-new in its place. For example, suppose that everything in Smith’s factory is rented. Upon selling the final output, Smith can stop production, at which point the owners of his machines will pick the factory apart, and Smith can use the money in invest into something else. In the actual world, new technologies are invented all the time. This is an important path of the procession of creative advance. Shorter techniques are snapped up first, because they are cheap in terms of time. In this case, the need for extra money savings to fuel growth may be obviated: entrepreneurs will naturally let their tools and machines depreciate and eventually replace them with technologically more efficient goods. At some point, only longer processes remain. If they are to be implemented, then they need to be especially productive to justify waiting an additional amount of time for their fruits. Since these technologies take longer to finish, they are more expensive in terms of time. (The most significant “metaphysical” obstacle to economic growth is precisely the scarcity of time.) This greater expense means that an entrepreneur cannot just quit maintaining the old project and switch to a new one. He needs to save extra money. This results in accumulation of novel

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capital to be used in a new project. Finally, time preferences fall slowly, as people learn to control nature better: human beings become more prudent and able and willing to provide for increasingly more remote future, which accelerates growth by making an additional number of lengthy technologies economically viable (i.e., profitable). Building a new capital good from scratch requires an increase in savings. Maintaining a good can mean two things. First, repairing it. Second, building and having in one’s inventory a new machine to replace the old one, when it breaks or becomes obsolete. For some equipment, it is cheaper to fix it than to replace it, in which case maintenance will take less money savings; for others, it is the other way around. (To be sure, the information about the machine’s durability is reflected in its price; an item that lasts longer would be more in demand; so would an item that yields a given amount of services in less time; and so would an item that is easy to repair.) A machine may lessen the amount of time needed to maintain other capital goods, e.g., if it is a powerful tool. For example, building a fishing net by hand may require Crusoe to devote two weeks to the task. If he had the right equipment, however, then he could finish production in one hour. It is true that the net-building tools would also have to be maintained, but it is not clear in general that the more capital goods there are in the economy, the more time and effort need to be set aside for their maintenance. The amount of capital that is possible to support depends, in addition, in part on the amount of human labor available and therefore, on the level of population. Since division of labor vastly increases productivity of labor, the total capital on hands in a global economy is much higher than merely the maximum possible amount of Crusoe’s capital multiplied by the number of people in the economy. According to Paul Davidson, economic growth “is more closely associated with the accumulation of fixed capital than working capital.” (1978: 94) This is plausible, insofar as maintaining durable goods is cheaper than re-creating non-durable ones. Let me distinguish between three time periods: (a) the time it takes to produce a good, be it intermediate or final; (b) the time the good can stay serviceable in storage; and (c) the time it takes for the good to depreciate in the process of operation, so that it needs to be replaced. Davidson thinks that high (c) makes a good worthy of being counted as civilization-sustaining. I will add to that, however, that what defines material prosperity is not just the amount of capital and consumer goods in use at any given moment but also the existence of “evenly rotating” routines that replace these goods as soon as they wear out. For durable goods, the former factor dominates; for raw materials and the like, the latter factor

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dominates. But the factors complement each other and are equal in importance; hence, growth depends equally on both fixed and working capital. The first thing to notice is that as a result of economic progress through higher investments in the time factor, the income to other factors declines, i.e., the nominal wages fall; but so do the incomes to individual entrepreneurs, both operating in the consumer or low-order capital goods industries. This means that prices will fall, as well. These two factors cancel each other out; it would seem that we have in essence a purely monetary phenomenon of general price deflation. However, (1) I proved in (I, 51) that longer processes are normally more physically productive. Even if nominal wages fall, given constant or slowly increasing money supply (obtained, say, by mining gold and silver), there will be eventually a greater abundance of goods at lower prices than would prevail, had there been less saving. Money will experience increased demand and enjoy greater purchasing power, because each money unit will purchase more goods and services: entrepreneurs will have to lower prices in competing with everyone else for one’s pennies. These will more than compensate for lower wage rates. (2) Since labor, say, is applied in production through time, a fall in time or risk preferences and the corresponding diminution of the interest rate in every temporal stage will lower the discount rate for the factors, raising their DMVP and therefore (in the evenly rotating economy), their income. For example, if a consultant spends 3 months on a project for which he is paid after the project is delivered, then his disutility of waiting for his wages is lower. If an entrepreneur embarks on a 3-months long project, then his costs of doing business are lower due to lower interest rates, which frees up his capital for purchasing more labor. The two factors assure that prices fall faster than nominal wages; therefore, real wages rise.53 Secondly, the prices of factors in the earlier stages will, in the short run, temporarily, rise (due to their greater DMVPs) and then, in the long run, fall; the prices of factors in the later stages, on the contrary, will, in the short run, fall (due to the lower derived demand for them) and then rise, when the new goods, after a period of time, reach the later stages. This deflation is a virtuous process, though it does enjoin upon any entrepreneur who is contemplating his business plan to take into account not only an increase in the productivity of his own enterprise but also the possible improved efficiency of everyone else in the economy. 53

Cf. Rothbard 2004: 525-527, “The Effect of Net Investment.”

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However, that he must do so is analytic, as in contained in the meaning of the phrase “entrepreneurial competition” and the fact that production takes time. Any entrepreneur Smith must believe that other entrepreneurs will not have outdone him by the time his own product is set to be sold. This is because if the overall supply of consumer goods increases with time, then more of other goods will have to be sacrificed by any consumer to purchase Smith’s goods; buying from Smith will have a higher opportunity cost, lowering Smith’s prices and therefore, his profits. All this is simply a corollary of the axiom of human action. To put the matter another way, wage and price deflation is a human right.

FIGURE I.52.1. PRICE DEFLATION DUE TO (A) MONEY SUPPLY CONTRACTION, (B) INCREASE IN THE DEMAND FOR MONEY

Just as Say’s law is sometimes stated as a succinct “supply is demand,” so this analysis can be phrased as “saving is spending.” This is because the first beneficiaries of a higher savings rate are factor owners, including workers. They will be the ones spending money on the new product once it is finished and be the richer for it. Deflationc1 (for cause) or deflation proper is diminution of money supply. It happens, for example, when the Fed sells its securities on the open market, or when the reserve requirements for banks are tightened. Deflatione (for effect) is a general drop in prices due in one case to deflationc1, pictured in Figure I.52.1(a). We move from S1 to S2 which causes the price of money to go up. But the price of money is the set of all things that a unit of money can buy or, in other words, the money’s purchasing power. For example, in the SEQ with S1, $1 costs 1/2 of a loaf of bread, 1/1000 of a TV set, etc. In the SEQ with S2, $1 costs more, such as 1 loaf of bread, 1/700 of a TV set, etc. The purchasing power of money cannot in the long run help but go up. But there can also be deflationc2 which is an increase in the

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demand for money, causing deflatione, seen in Figure I.52.1(b). The move now is from D1 to D2, and again it causes the purchasing power of money to rise. For example, people might hold on to money, if previously useful capital goods become less valuable in the bust part of the business cycle. In thinking about this matter, we must avoid equivocating between these three kinds of deflation; and in calling deflation a human right, I refer to the drop in prices due to deflationc2. Sometimes the desirability of stable prices is asserted. But stable prices are a chimera. Mises explains: Exchange ratios are subject to perpetual change because the conditions which produce them are perpetually changing. The value that an individual attaches both to money and to various goods and services is the outcome of a moment’s choice. Every later instant may generate something new and bring about other considerations and valuations. (1996: 217) Stability, the establishment of which the program of stabilization aims at, is an empty and contradictory notion. The urge toward action, i.e., improvement of the conditions of life, is inborn in man. Man himself changes from moment to moment and his valuations, volitions, and acts change with him. … It is vain to sever valuation and action from man’s unsteadiness and the changeability of his conduct and to argue as if there were in the universe eternal values independent of human value judgments and suitable to serve as a yardstick for the appraisal of real action. (1996: 219) …rigidity in the monetary unit’s purchasing power is unthinkable and unrealizable… (1996: 223) In order to grasp the absurdity of “stable prices,” it is enough to imagine any disruption of any evenly rotating economy whatsoever. Such a disruption, be it due to an invention being put into production, a new consumer good being introduced, positive or negative net savings, a new investment, demographic changes, or an increase in the supply of gold, if gold is monetized, will reconfigure the entire price structure of the economy. Economic progress, in fact, economic change of any kind is totally inconsistent and incompatible with monetary stability. The prices 50 years ago are of little use in today’s economy. How can the perpetually changing set of goods and services on the market, in terms of their nature, quality, and quantity, maintain the same price? How can

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the perpetually changing ways of producing those goods and services cost the same? And if stability is nonsense for those reasons, then adding to those reasons two more, namely, (1) secular deflatione caused by deflationc2, and (2) inflatione caused by inflationc1, such as an increase in the supply of precious metals, if they serve as money, by mining them out of the ground, need not impair the ability of money to fulfill its functions. Digging for gold has often been derided as a socially useless endeavor. But one cannot maintain the evil of both any deflation, however modest and steady, and the laissez-faire way of adding to the money supply, namely by mining gold and silver, which gently neutralizes this deflation. I understand very well that lowering wages can be bad for employee morale. To which the precious metals mining industry is a natural and safe remedy! It is especially ironic to hear the US Federal Reserve talk about price stability, when it over the course of its existence has been responsible for a dramatic erosion in the purchasing power of the dollar. Far from somehow “countering” the secular deflation just described, the rate of Fed-initiated inflation has far outstripped whatever rate would have been necessary (if it could in a meaningful sense) merely to “keep up” with the increasing standard of living. Price stability under laissez-faire, such as it is, is naturally (that is, without government intervention) maintained, insofar as prosperityinduced deflation makes gold mining more profitable; on the other hand, overinvestment in gold production will create inflation and cause this industry to become less attractive. Thus, deflationc2 is counteracted by inflationc1, and appropriate price stability efficiently serving the purposes of economic calculation is thereby secured within the free enterprise system. Paul Davidson objects as follows: “Once economists recognize that rapid movements in money-wages can, in a modern monetary economy, destroy the usefulness of money as a store of value and consequently induce a reversion to barter, the general equilibrium delusion of the unmitigated desirability of freely flexible wages and prices will be apparent.” (1978: 239) This statement contains so many fallacies that it is hard to know where to begin. First, under what circumstances do prices change rapidly? My only guesses are (1) in disaster areas, during massive floods, fires, or earthquakes. But in such cases, price increases are both very brief and necessary efficiently to (a) ration and (b) encourage delivery from other geographical regions of goods that suddenly become extremely scarce. Prices also change rapidly (2) during hyperinflation, but

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hyperinflation is not a market phenomenon but rather one of government interference with the market under a state-controlled fiat money regime. Lastly, Davidson may be referring to (3) the bust coming in after a boom swiftly like a thief in the night and resulting in a spate of bankruptcies and job losses in a short amount of time. I cannot imagine how even the need for a severe economic readjustment can destroy the medium of exchange. Second, if real wages increase, and prices decrease as a result of the process described in this chapter, whether rapidly or not, then money’s utility as a store of value will only be enhanced. Third, inflexible wages and prices create shortages and surpluses and unemployment (that is, permanent SD disequilibrium; see (I, 2) for more). Fourth, unless prices are flexible, equilibrating entrepreneurial action is impossible. This creates immense economic inefficiencies (that is, permanent RC disequilibrium). Fifth, prices may be potentially flexible but actually sticky, as suggested in (I, 3). Nothing prevents inflexible or rarely changing prices, if that is the best business model. Finally, wages represent income, and income is different from monetary wealth or a cash balance. Therefore, wages can change relatively to each other without affecting the overall purchasing power of people’s savings. It does take certain chutzpah, arrogance of a fanatic, to support price controls on the grounds that free market prices can fluctuate “too much” and damage people’s hoards. Did I say “free market”? Perish the thought! For Davidson, a burger’s costing $4 today and $4,000,000 tomorrow is a live possibility, but only because of his own schemes. Davidson gets a thrill out of the idea of flooding the economy with fiat and credit money, effecting money supply inflation. But price inflation puts a damper on his omnipotence. What to do? Why, control prices, of course.54 Even on his own terms, Davidson makes no sense. For, as we will see, Keynes hated the fact that money is an excellent store of value. Destroying that is precisely what Davidson’s own master would unequivocally demand. Davidson is being disingenuous. [II] The second possibility is that Smith will receive his savings, because investors will withdraw money from some Jones’ enterprise. As 54

Jones (2008) claims that Keynes “had a horror of the perils of inflation.” (175) That certainly is not apparent in Keynes’ works. But if he did abhor inflation, then it is only inflation of prices and not of the money supply.

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a result, Smith’s business will become more complex, while Jones’ business will regress into a more primitive form. This transfer is justified by the expectation that Smith is about to please the consumers more than he used to. If Jones does not become discouraged but on the contrary intensifies his efforts, the money may eventually flow from Smith back to him. This competitive back and forth will, every time a temporary winner is established and as per creative destruction, result in an improvement of economic conditions. 53. THAT SOLOW’S THEORY’S PUZZLES ARE EASILY SOLVABLE The first “puzzle” about growth, as outlined by Gordon (2009), has to do with the neoclassical theory’s claim that the most significant determinant of material prosperity is the saving rate. But its calculations suggest that “even very large differences in the saving rate or rate of population growth cause only small variations in per capita income, not the large variations observed in the world.” (334) On the one hand, the theory seems falsified; and on the other hand, large disparities in the wealth of nations are not explained. A hint to the solution was given in (I, 21). Savings can be subdivided into Sm or savings used to maintain existing capital in an evenly rotating economy; Sp, for savings needed to keep up with population increases; and Snet or net savings used to create additional capital and with its help additional consumer goods. (In a real economy, goods continuously acquire and relinquish the status of useful or virtuous upon human willing, planning, and acting. No man is under orders to maintain any capital. Sm is an abstraction and has no meaning in a real economy.) Now the more prosperous a society is, the greater the ratio of Snet to income or of Snet to consumption must be, if the same growth rate is to be maintained. This is a direct result of the law of diminishing marginal utility: a 10% increase in the saving rate in a rich country will produce future goods that will satisfy desires ranked relatively low on the consumers’ values scales, unlike a similar increase in the saving rate of a poor country. Therefore, among advanced countries, even large differences in Snet do not signify greatly different standards of living. Even a much higher saving rate in wealthy Ruritania will yield a fairly low return as compared with almost-as-wealthy Waldavia where people choose not to sacrifice present consumption to the same extent. (While Ruritania is saving and building the intermediate goods, its standard of living will be

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lower than it would be with less saving. Only once production finishes, does Ruritania outcompete Waldavia. The grasshopper does enjoy himself, while the ant is laboring heavily to prepare for winter.) On the other hand, between an advanced country and a poor country, the same saving rate will have vastly different consequences, i.e., the economy of the poor country will grow must faster. In other words, a low saving rate in a poor country will grow its economy as fast as a much higher saving rate would in a rich country. A poor country then will grow quickly, but the richer it becomes, the slower it will grow, if its saving rate remains the same. Conversely, a rich country that has embarked on consuming its capital and is growing poorer will eventually accelerate its self-destruction until famines start killing off the population. Both parts of the phenomenon are thereby explained: when comparing two rich countries, even large differences in their saving rates will fail to produce large differences in economic welfare; but when comparing a rich country with a poor one, indeed, we observe great differences in the rate of growth even with similar saving rates. It follows that our poor country with a decent saving rate will over time improve by orders of magnitude, generating the observed differences between per capita incomes of rich and poor nations. This explanation needs to be qualified. In (I, 6), I suggested that a poor society grows by satisfying a few very important needs, while a rich society grows by satisfying numerous less important needs. Thus, the wealthy Ruritania is slightly better than Waldavia at everything; whereas the poor Congo is a lot better than even poorer Niger at just a few necessities. A tablet computer that is a little lighter and faster than the previous version may not seem like much of an improvement, but take millions of such improvements, and the meaning of economic growth becomes clearer. It is true that “first world problems” are different from “third world problems.” Perhaps small improvements in a vast number of consumer and capital goods do not feel as progressive as huge improvement in the goods satisfying a few basic needs. But in fairness, the two may be comparable. If that is the case, then this puzzle is even easier to figure out. The assumption of small variations in per capita income is unfounded. High saving rates, all other things (such as the efficiency of law in different nations) being equal, are mainly responsible for growth in every type of country in a straightforward way. In addition, leaders in growth spend a lot of money on research and development, and new technologies can be adapted by followers for free. This narrows the gap somewhat between the best (our Ruritania) and the mediocre (our Waldavia).

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This brings me to Gordon’s puzzle #2. Poor countries, he says, do not have a higher rate of return on capital. What does that mean? Smith might want to invest into a poor country in order to exploit the advantage of cheap labor. The labor is cheap, precisely because only a small amount of capital is invested per capita in that country. Smith’s own money might make some difference, but it will not be great. Still, it is possible that his investment will raise the standard of living of the population of some African village to such an extent that the villagers are no longer starving, sick, or without shelter or clean water. Investment in an advanced country might lead to Smith’s driving a marginally better car, when his lease expires in four years. Investment in a poor country can mean the difference between life and death or between life with a desire to die and life with hope for the future. Thus, the monetary profits of a multinational corporation which builds a factory in a poor country will not be enormous. The corporation will save some money on labor. On the other hand, the psychic profits to the local populace who now have jobs and are able to feed and clothe themselves, when before they were dying of hunger, are off the scale. If one insists on putting numbers on things, then we can argue that living both on $15 / month and on $15 / day is living in poverty, but the 3,000% improvement of the latter over the former is surely tremendous progress. The case is the same if foreign investment is substituted with saving by the citizens of the poor country themselves: it will have an extremely high psychic return, since the investments undertaken first are the most profitable. Of course, without investment from abroad, a poor country will accumulate capital slowly, going through all the stages of wealth building that rich countries have already traversed. The main beneficiaries of investment are the very people whose productivity increases by means of tools and machines that they are now able to use. A third puzzle draws attention to the lack of universal “convergence”: why have not all poor nations by now become rich? I believe the answer is due in part to 1. the need to acquire human capital which is just as precious as physical capital which slows down wealth creation; 2. possible race differences in intelligence, motivation, virtues, and suchlike; 3. better and worse ideologies and political systems which include such things as security of property rights, freedom, independent or private judicial system, stable money supply, no obstacles to

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A high saving rate may worsen the standard of living in wartime, because capitalism excels at making efficient weapons which expertly destroy person and property. A free and frugal nation would tend to be rich but also powerful, and power can be used for destructive ends. A supposed counterexample to the “saving drives growth” theory may be overturned if we take into account these factors, as well. These concerns aside, however, and as long as all things are held equal, it is plain that the saving rate is key to prosperity. 54. THAT SPECULATORS PERFORM A SOCIAL FUNCTION Chapter 12 of General Theory is particularly painful to read, so many fallacies it contains. Keynes distinguishes between three kinds of people participating in the stock market: the masses, the speculators, and the investors. Speculators seek to profit in the short-term; and investors seek to profit in the long-term. These seem to cover all possibilities. What then are the masses supposed to be doing? Keynes alleges that speculators “gamble” with the market, that they “are concerned, not with what an investment is really worth to a man who buys it ‘for keeps,’ but with what the market will value it at, under the influence of mass psychology, three months or a year hence.” (2008: 154ff) In playing against the masses, speculators try to foresee how they will value a stock; in playing against other speculators, they try to foresee how those others will foresee the masses valuing the stock. Now if the masses’ investment strategy is not based in some way on profit expectations, then those people are irrational, and their behavior cannot be predicted. But we have just seen Keynes condemning speculators for outwitting the average dull market player. Perhaps, our author means that the masses are both poor speculators and poor investors; the masses have the same aims as the professional speculators and investors; it is just that they are bad at this work; they make mistakes. But then why is Keynes praising “the high brokerage charges and the heavy transfer tax payable to the Exchequer, which attend dealings on the London Stock Exchange” which deter the masses from trading on

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the stock market? (2008: 159-60) This policy is bad for two reasons. First, the whole point of the stock market is to allow (possibly or even usually poor) business newcomers to challenge established firms. Insofar as the charges and taxes permit only the rich to trade, they are the exact opposite of what is needed. How rich a person is and how good an investor and entrepreneur he is are entirely separate questions. Second, Keynes himself admits that there is a process of natural selection going on that causes the masses to lose their money and leave the market, leaving only highly skilled speculators and investors. These artificial barriers to entry are superfluous. To begin with, changes happen on the margin, and for any given company, only a few stockholders buy and sell every day. The volume of trade is far smaller than the total number of shares in people’s accounts. Those who hold shares determine share prices as much as those who buy or sell. This means that the prices of most stocks do not fluctuate wildly. Keynes overrates the power of speculators. Of course, if there is an economic bust with what I will later call “mass losses,” and stocks do collapse, then it is due not to normal market activity but to government interventionism that brought about the preceding boom, of which the bust was an inevitable consequence. Secondly, Keynes faults the speculators for playing against the mob, but it is precisely in this that their social function consists. If the mob is irrational, such that if “everyone” is buying, then they rush to buy, too, and if “everyone” is selling, then they are moved, like lemmings, to sell, as well, then speculators check this irrationality and smooth out high fluctuations by selling high and buying low. They thereby do not permit the deviation of stock prices to become too great. As such, they inject rationality into the stock market by keeping prices within reasonable limits. True, they outmaneuver the lemmings, and Keynes criticizes them for this tactical guile. He understands quite well that speculators play not only against the masses but also against other speculators: “this battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years,… can be played by professionals amongst themselves,” (2008: 155) yet makes nothing of it. In fact, overall, “speculating” is no more profitable than “investing.” There are good and successful speculators and investors, and there are bad speculators and investors, whom the market quickly dispatches.55 55

Skidelsky (2010) writes on p. 73 that Keynes argued in a letter: “Is not the rule [for an investor] to be in the minority? It is the only sphere of life and activity where victory, security, and success are always to the minority and

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Third, long-term changes in the price of equities come about as a result of numerous daily short-term trades. The “short-term” speculating and “long-term” investing morph imperceptibly into one another. Fourth, there is no such thing as a safe investment. Even the debt of the government itself, even when it is secured by the possibility of inflation, even when it is continuously monetized, is not fully safe. It is true that with the government’s access to the printing press, the default premium of its bonds is removed, but the premiums of the general collapse of the fiat money unit and of hyperinflation are added; however, the first effect dominates, for as long as the government is thought to be “too big to fail.”56 Mises, for example, did not believe that “the states will eternally drag the burden of these interest payments. It is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract.” (1996: 227) In a crisis, things can turn on a dime. Even investing in something like the S&P 500 mutual fund is hardly safe, for owning this fund serves essentially two things: first, as a bulwark against inflation; and second, as a show of trust to the US government to the effect that its policies are wiser than those of the governments of other nations, such that foreigners invest in the US and not elsewhere, swelling the price in dollars of the US economy. One is investing into a “more profitable government.” So far this trust has not never to the majority. When you find anyone agreeing with you, change your mind.” On p. 92, he says that Keynes “thought it reasonable to ‘follow the crowd’ in the face of uncertainty. He would have seen it as an example of ruleutilitarianism – which is simply the belief that the best results on the whole are to be achieved by following generally accepted practice.” Obviously, the two quotations contradict each other. The first quote is true, and the second one is not even false: rule utilitarianism is an ethical theory demanding that each person act according to those rules that will tend to maximize society’s general happiness. But (1) such rules are not “whatever everyone is actually doing right now”; the investors (2) are not doing ethics and (3) are maximizing their own happiness and not trying to achieve “the best results on the whole.” Was Keynes, therefore, a better entrepreneur than he was economist? 56 Instead of this preposterous anti-laissez-faire slogan, would it not be better to return to the tried and true “the bigger they are, the harder they fall”? The Soviet Union, too, was thought too big to fail, an idea at least as offensive as that “socialism is inevitable,” and it was vastly better armed than our pathetic financial companies. Yet now it is gone, and the world is a better place for it.

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been completely misguided. But sooner or later things will be shaken up, all to the good, of course. For any investment, just as for any speculation, there are right and wrong moments to buy and sell. Consider Taleb (2010), whom I find strange. He presents himself as a “practitioner” of applied science. Hence, he is no academic. But he is scarcely an entrepreneur either, mired as he is in make-believe numbers rather than real insight into some particular business niche. When he was a trader, he did not wake up in the morning and think: “What can I do for the consumers today that is better than what everybody else is doing?” He was a “macro”-businessman who did not build his business in his garage, animated by a desire to serve the public in some highly specific area in which he possessed technical expertise, but thought he could find companies into which he should invest based on some number-crunching model. Black Swan is an admission of guilt that he cannot do this. Macro-business is fraud, even more so that macroeconomics (insofar as the latter is merely an apology for interventionism), permitted by government / Central Bank manipulation of interest rates. If macro-business, a.k.a. institutional investing, is construed as sustainable, then it is little more than investment into political systems. If it is taken as a way to exploit business cycles – and the mathematically über-complex “finance” as we understand it today revolves solely around spotting and taking advantage of booms – then it appears to work at first; but since Taleb does not know the (economic) causes of the business cycle nor has a particular (entrepreneurial) insight into how to figure out when the boom will turn into a bust, so that shrewd investors can pull out in time to make profits, his book is of limited interest. Fifth, in both speculating and investing, a person is counting on his superior foresight as compared with the foresight of everyone else. An investor thinks that a company’s stock is underpriced. People have failed to seize the opportunity to buy the stock that the investor thinks will be very profitable. Now is his chance. But a speculator, too, thinks that the mob has undervalued a stock. So, he buys it. Again, he is foreseeing that the “animal spirits” will drive the stock back up. In both cases the trader’s entrepreneurial alertness is tested. The only difference might be that “it takes more intelligence to defeat the forces of time and ignorance of the future than to beat the gun.” (2008: 157). Sixth, Keynes claims that the objective of speculating is to “pass the bad, or depreciating, half-crown to the other fellow.” (2008: 155) But this sort of thing happens predictably only during an unsustainable Central Bank-induced boom. Neither investing nor speculating involves any kind of deception but rather different honest estimations of the

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companies’ being traded profitability. It is true that some will be right and some, wrong, but what of it? Competition within the market process by its very meaning entails the emergence of both winners and losers. Still more can be said, however. There is no such thing as a longterm investment; all investments that involve risk and surprises (and which do not?) are short-term. Those who think they can buy a company’s stock and keep it for years, enjoying the dividends, are usually disappointed. Profits as such are a short-term phenomenon; to stay in business, entrepreneurs have to win each day anew, and each day the state of the market and the winning companies will be different. Interestingly, in this chapter, Keynes for the first time attacks “liquidity” or liquid assets as economically perverse. He will continue the attack later, because of his belief that liquidity, far from being a virtue of assets, is vicious, because “liquidity preference” drives up interest rates and reduces consumer spending. These for Keynes are an abomination. Here, however, the condemnation of liquidity as anti-social has a different reason. Liquidity is bad, because it masks reality: the entire stock of capital goods is not liquid for the whole society. Liquidity is an illusion. It should be clear that this argument is bizarre. Is Keynes even against consumption as such, because whenever a consumer good is purchased, it does not change; the only thing that happens is that the property right to the good is transferred from the 1st-order capitalist to the good’s consumer? It is true that capital goods cannot be physically turned into money like Lot’s wife into a pillar of salt (thank goodness for that!). The point of liquidity is to move resources from people who do not know how to use them properly into the possession of better entrepreneurs. The former, being blind to opportunities, will agree to a low price which for the latter will allow the reception of profits. Keynes acknowledges this opinion: “the proper social purpose [of the stock market] is to direct new investment into the most profitable channels in terms of future yield” but denies it any validity, insofar as “enterprise” is “the bubble on a whirlpool of speculation.” (2008: 159) As I have pointed out, however, a company’s share price is a sum of the company’s present capital and its expected dividends or “future yield.” One cannot, therefore, be a pure speculator, interested in the former; or pure investor, interested in the latter. One is necessarily part both. Keynes writes that Americans rarely invest for income but only in the hope of capital appreciation. But whether it is one or the other depends to a large degree on how profits to the company are allocated by the CEO. They could be distributed to the shareholders for consumption or ploughed back into the business. (The latter case seems actually to be

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concerned with the long run more.) Keynes has posed a distinction without a difference. Moreover, (actual) profits enhance either capital gains, present dividends, or both. Hence, anyone playing the stock market, investors and speculators alike, will chase after profits, thereby fulfilling their social function. Moreover, the total stock of capital is not the same from one moment to the next; as I argue in (I, 30), each objective essence can have numerous subjective essences that are in a constant flux, as entrepreneurs make previously useless goods capital, make previous capital goods useless, and change the purposes and extent of use of still other capital goods. That is what “creative destruction” is all about. But this churning of subjective essences requires a fluid stock market, wherein resources can easily acquire purpose or be re-purposed. The market is always changing, and today’s prospect will be a losing proposition tomorrow or vice versa. Liquidity is essential for people to take advantage of momentary opportunities. I am in full agreement with Keynes that the market “rewards” a company’s both strategic planning and tactical prowess, as I point out in (I, 12-13). For plans are always readjusted according to changing market data. However, Keynes’ idea that it would be beneficial to “make the purchase of an investment permanent and indissoluble…, except by reason of death or other grave cause” (2008: 160), so as to force investors to think long-term, is absurd. The “reason” to sell an investment is because one needs the cash, or because the investment is losing money (and is foreseen to keep doing that), or because one has found an even better investment. Here is how to make sense of his ideas: 1. Speculators do not (or cannot because of present surprises) care about the future. 2. Which is bad. 3. But the state can and does, which is why it would be best, if the state took over the direction of investment. 4. Which is a radical proposal that may take a long time to implement. 5. As an interim measure, private investors should be forced to think for the long term according to the proposition above. Unfortunately, in this scheme, entrepreneurial errors cannot be fixed quickly or even at all; one has to wait to die to get rid of worthless paper. For a man who thinks that “our basis of knowledge for estimating the yield ten years hence” of various firms “amounts to little and sometimes to nothing” (2008: 149-50), Keynes is far too eager to enforce

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predictions. In addition, premises (1) and (3) are highly dubious. Dynasties of many wealthy capitalists and financiers last for generations; renewable natural resources, when privately owned, are usually lovingly attended to. On the other hand, the US Congress spends with freewheeling abundance – what is for it another trillion dollars?; and this year’s Congress cannot bind next year’s in any spending reductions. 55. THAT THE MULTIPLIER EFFECT WORKS, BUT SO WHAT? If in a certain time period, someone’s real income has increased by ΔY, and his consumption, by 0 < ΔC < ΔY (supposing that the Keynes’ “psychological law” somehow holds), then Keynes calls ΔC / ΔY the “marginal propensity to consume” (MPC). Assuming that income is expended on consumption and investment with no hoarding taking place, ΔY = ΔC + ΔI. Moreover, let ΔY = kΔI, where, as a simple calculation shows, 1 – 1 / k is the MPC. Keynes’ conclusion is that “when there is an increment of aggregate investment, income will increase by an amount which is k times the increment of investment.” If MPC = 9/10, then “the multiplier k is 10; and the total employment caused by (e.g.) increased public works will be ten times the primary employment provided by the public works themselves…” (2008: 115ff) The direction of causation that Keynes has in mind is as follows: I increases by ΔI which causes C to grow by (k – 1)ΔI and Y, by kΔI. For example, let $1 million be invested into some project, to be spent on employing 100 men. Let each man receive $10,000 in income. Of this amount, he will spend $9,000 and save $1,000, as per his MPC. Overall spending will be $900,000. These funds can be used in some other line of production to employ 90 men. These 90 will spend out of their combined income $810,000 and save $90,000, making it possible to employ 81 men on yet another project. And so on, such that total employment is 100(1 + 0.9 + 0.92 + …) = 1,000 men which is 10 times the original number, and whose total income is $10 million = 10ΔI. In discussing the multiplier, Keynes switches without giving notice between the consumption / investment trade-off and the spending / hoarding trade-off. Insofar as he focuses on the latter, the MPC is an infelicitous name; it should rather be called something like the “marginal propensity to spend” or MPS, because it incorporates spending money on both consumer and producer goods. In this second case, the MPC measures both consumption and investment, and what remains is simply hoarded. I will deal with hoarding later, though I will point out here that

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this use of money is anathema for Keynes. Let me illustrate this calculation by considering a small economy. Crusoe lives on his island with Friday, Smith, and Jones. Suppose that Crusoe has saved 10 gold ounces and has hired Friday to – with alcoholic breath – hoe his cabbages. Upon receiving his wage, Friday saves 1 g.o. and spends 9 g.o. on 5 of Smith’s chicken pot pies. It does not matter whether the pies are already available, and Friday is consuming them, or whether Friday hires Smith to bake them. In the first case, time reveals Smith to have been a good entrepreneur who has correctly anticipated Friday’s demand for the pies. Smith must have himself saved enough to satisfy his present desires while he worked. In the second case, Friday is buying Smith’s cooking services by advancing to him present goods, namely, money, and receiving in exchange future goods, namely, pies. Here, Friday is the saver-investor-entrepreneur and the boss of Smith. Either way, trade is multiplied. Of the income thereby obtained, Smith saves 0.9 g.o. and spends 8.1 g.o. on Jones’ tools. And on the process goes. Now the events I have just described are perfectly great; the more exchanges are made, the better, since it means that people are finding uses for one another; they are “in sync,” producing what is demanded and benefiting from each other’s work. They could be reaping gains from specialization and division of labor: perhaps, it pays for Crusoe to specialize in catching fish and use the excess on several occasions to buy Friday’s axe, Smith’s hammer, and Jones’ pick, which would have taken him longer or been altogether impossible for him to make by himself. Observe how the introduction of money alters the situation. First, when Crusoe is trading his horses for Friday’s cows under direct barter exchange, both men may have reservation demand for their goods stemming from those goods’ use-value. As one item is exchanged for another, Crusoe’s marginal disutility of losing an extra horse grows, while the utility of gaining a marginal cow declines, and vice versa for Friday. At some point, the former will outweigh the latter, and the exchange will stop. But in the money economy, there is no reservation demand, because everyone is producing solely for other people’s consumption. If Smith is a peanut farmer and has a ton of peanuts in his warehouse, then he does not want any of them; he wants to move the entire stock. Second, though money has utility as a store of value and for economic calculation, its primary mission is to facilitate exchange. Once Smith has received money for his goods, in order to benefit from this action, he must ultimately buy something. What the multiplier means, then, is that a single exchange of goods or labor for money will beget

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other exchanges (whose number will depend on the MPC), because money has no utility: it is only useful as a means to other goods (though (I, 17) argues that things are not so simple). If one person has found it in his interest to acquire money, then it is all but inevitable that he will spend it. And so will every person receiving the gold ounces. Third, it is true that upgrading our two-person economy from barter to indirect exchange will yield little benefit. For example, eventually Crusoe will not want Friday’s money, because he knows, taking into account the use-value of his horses, that it is not worth it for him. But in an advanced economy involving billions of people, money is a means to a vast variety of goods and services; so, a person receiving money is very likely to find something on which to spend it. Unfortunately, in being so impressed with the power of the multiplier, Keynes has forgotten a much more primal problem. It is true that money does not depreciate or corrupt (= lose its essence), e.g., as apples do in the process of being eaten, and must somehow be exchanged. But what is to ensure that if I have money, then there will be goods out there for me to spend it on? And that once those goods are consumed, they will be replaced in the next round of production? And that production will be of those articles and services that are most urgently desired by money-holding consumers like me? That the social system of production is there and humming along cheerfully is just assumed. Yet the central problem of economics is precisely how most efficiently to set up human productive activities. In other words, how often or how many times a money unit changes hands is less important than the value of that money unit. Economic growth makes money more valuable by increasing the number of goods and services per capita and hence the money’s purchasing power. Economic degeneration makes money less valuable, because there are fewer things for which it can be exchanged. For example, in the Soviet Union, people often preferred to be paid in vodka for work done rather than in money, because shortages of goods frequently made money worthless. One could not count on being able to buy even vodka with the money! Hence, a reversion to barter. A reductio of Keynes would be a situation in which the average propensity to consume is 1, in which case infinite income is paired with zero production, obviously an impossible state of affairs. Now with this Keynes may agree but insist that both variables are vital. For example, if nobody is buying anything, then even a high purchasing power of money is of no use. That certainly is true, but the question then is why are goods not being sold? People have worked hard for their money; why are they not spending it? There are only two

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possibilities: (1) consumer hoarding and (2) massive entrepreneurial errors. The former occurs in a depression; the latter are revealed in a depression. The main practical task of economists then is to prevent depressions before they occur, and cure them after and if they occur. The claims I will defend in this book are (i) that the only way to avoid a bust or recession is not to ignite a boom in the first place; and moreover, (ii) that once there is a bust, the markets must be allowed to repair themselves on their own, even if hoarding takes place. Hence, the multiplier is beside the point; Keynes ignores the elephants in the room. I want to get straight that 10ΔI g.o. has circulated, but the total profit or consumer surplus is a lot less. After all, Friday had to suffer the disutility of labor, and so did Smith in making his pies, and so on. It would seem thus far that the multiplier effect is a fairly trivial corollary of the properties of money paired with a picture of circular flow of goods and services. In particular, there is nothing about government spending that uniquely invokes the multiplier. All spending has the capacity to be multiplied. On the other hand, if the four horsemen of the Apocalypse come into the world riding in full gear, then once pestilence, famine, war, and tyranny have killed off 90% of the population and reduced the rest to subsistent living, of what use will a formerly rich man’s hoard of gold be to him? If a government falls after a revolution, then who would want its defunct paper money? Can the multiplier save a society from destruction due to hyperinflation, if the state is intent on bringing it about? Indeed, hyperinflation is marked, among other things, by dramatic lowering of the demand for money and therefore, by frenzied spending and frenzied multiplying, but no one would call it a happy state of affairs. Keynes attributes to the humble multiplier the power to get economies out of depressions. Yet the depressions Keynes has in mind are, quite unbeknownst to him, due to misalignments and distortions in the capital network or structure (caused by a particular form of government interventionism). Plans are no longer well-coordinated. The number of exchanges diminishes. But it would be absurd to throw money on the problem: let, the government decrees, whoever spend as much money as can be printed on whatever. The failure of complementary factors to click into their places for producers will not go away as a result. The worthless companies must disappear, and prices and wages must adjust downward in proper relations to each other. Suppose further that there is no hoarding or at least no new

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hoarding, the sum of the marginal propensity to consume and the marginal propensity to invest is 1, and the multiplier is infinity. What follows is that… there will be exchanges made interminably! Thank goodness for that, as it at least promises that humanity will endure. It is a heartening prediction, but one more suited to a prophet than economist. No matter; obviously, our author fails to take into account the time between the exchanges. How much time will pass before the money is spent by each person who receives it? If a lot, then the depression will last a while. It seems that this variable is governed by the length of production processes in operation presently or being contemplated by the entrepreneurs. If, for Keynes, the theory of multiplier is “logical, which holds good continuously, without time-lag, at all moments of time,” (2008: 122) then of what use is it for policy and even theory? In a famous and stunning passage Keynes writes: If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again…, there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. (2008: 129) Keynes’ argument is fantastical: (1) gold mining is clearly wasteful: it “not only adds nothing whatever to the real wealth of the world but involves the disutility of labor.” (2) Precisely for that reason, it is “of greatest value and importance to civilization.” (3) But with the end of laissezfaire, there are other even more spectacular ways to waste human efforts, and those should be substituted for gold mining. (129-31) If I am not summarily to dismiss Keynes as insane, then his argument must be interpreted as follows. While the primary employment will be wasted, nevertheless, the multiplied employment has a chance of being useful which will increase wealth. It is true that the first 100 men will be employed in a pointless task of digging up the banknotes, but the other 900 men, whose labor will come to be in demand because of the multiplier effect, can be expected to do some useful work. Notice an inconsistency: the first 100 men are employed as a result of an investment; the other 900 are employed because of consumption. The initial investment is superfluous and detracts from the argument, especially if the investment produces nothing of value to the consumers. We can dispense with it altogether and change the scenario

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such that the government simply gives the first 100 men their million as a “welfare” handout. The government can tax and spend at the advice of “liberal” Keynesians, but it can also cut taxes or inflate and hope that the people will spend at the advice of “conservative” Keynesians. Here we must say that the MPS = 10 (rather than the MPC). Stripped of all the details, Keynes’ system can be reduced to the slogan “consumption stimulates production, and production stimulates consumption.” This can be interpreted in several ways. First, that consumer spending causes some companies to profit which allows them either to evenly rotate another round of production or to elect to produce something else. I have no quarrel with this point. Second, under a non-inflationary monetary regime, profits to some businessmen are generally offset by losses to others. Printing money, on the other hand, appears to entail – happily – profits for everybody! Inflation turns stones into bread, because everyone’s production can expand, and scarcity of capital is a thing of the past. Or we can reason as follows. The bust reveals a momentous misallocation of resources. Entrepreneurs were expecting profits yet are hemorrhaging money. But losses are due to high costs and low revenues. The factors of production are overpriced: workers have benefited at the expense of capitalists. Inflation overturns this trend by deceiving the workers (via lowering the purchasing power of their incomes) and increasing profits. We breathe the sigh of relief that the system works. However, first, the misallocation is genuine. The losses are not a pointless annoyance that the government can take away with spending. That would be treating the symptoms not the root cause. Those losses are telling us something, and that is that factors of production are not being employed in the best interest of the consumers. People are attempting to produce the wrong stuff. If they are rewarded for it with “profits,” then the anti-social behavior of the entrepreneurs will persist. Second, the Keynesian treatment fails on its own terms. For [i] if the inflationary credit expansion is a one-time mistake, then competition for factors of production will bid up their prices, for we are by stipulation keeping all the entrepreneurs, including the submarginal ones, on life-support via stimulation of aggregate demand. Moreover, interest rates cannot be kept low forever; as goods become more expensive one after another, the demand for credit will rise, causing these rates to float upward. As a result, the expansion will fail to take place. In the meantime, however, a business cycle is set in motion. [ii] If the inflation continues at the same pace, then when actual inflation turns into expected inflation, and prices keep rising predictably, the illusion of incredible success will disappear. “Profits” with money

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of lower purchasing power are nothing of the sort. Again lenders will charge higher interest rates to compensate for the diminishing worth of the future money with which they will be paid. Feeding the boom causes the painful adjustments of the capital structure that would have been consummated during the bust to be postponed. However, in this process, the misallocation of resources grows increasingly more severe. [iii] If the rate of inflation changes randomly every day in order to avoid [ii], then the only effect will be disruption of economic calculation and severe damage to all production activities within the free enterprise system. In particular, [iv] if the rate of inflation increases monthly or daily, then we will end up with hyperinflation and destruction of the monetary economy. These are clearly nonstarters. Third, consider a futuristic society where powerful robots are a staple of everyday life. Let Smith tell his robot: “Prepare dinner for me.” The robot obeys, and after a few minutes dinner is ready. Then the existence of the food prompts Smith to eat it. We see how “demand” stimulates production, and how produced goods provide a lure for people to consume and enjoy them. If the next day Smith is very hungry and tells the robot: “Prepare twice as much food for me as you did yesterday,” and the robot dutifully obliges, then we see how twice as high demand yields twice as much production, all of which is happily consumed. Here is another illustration. Draw a graph of the normal supply and demand curves. Call the supply curve “aggregate supply,” and the demand curve “aggregate demand.” Then increase the demand by shifting the curve to the right. Voilà! Aggregate quantity supplied has increased. Perhaps, the aggregate supply curve is very elastic, such that the price level rises very little. Prosperity inevitably follows. Again, Keynes argues that unless Crusoe is given his 10 gold ounces, he will not hire Friday who, in turn, will not buy Smith’s pies who, finally, will not spend his earnings on Jones’ tools. Worse still, if these exchanges are not made, then these items will not be produced in the first place. As a result, society will be to that extent poorer. People will sort of wander around like nearsighted cows, looking at each other but not seeing opportunities for social cooperation. It takes the government to whip people into recognizing each other as fellow human beings and initiating production and exchange. Even if the economy is working OK, it can be accelerated still more by an injection of money. It is more than a little tiresome to expose this “system” as preposterous. The contradictions with the notions of aggregate supply and demand are dealt with in (II, 5). Three further objections are sufficient to dispose of the Keynesian catchphrase.

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First, we are not dealing with men being waited on hand and foot by omnipotent robots but with social cooperation of humans. Demand does not mean merely “desire” or “need” but also the willingness and ability of the demander to satisfy his supplier. But Smith did not earn his money; he got his paper dollars from the government; he is a thief, obtaining goods and services without supplying anything in return. However, theft does not create prosperity; if it did, then it would not be illegal. Let 90% of the population be on the “welfare.” With so many resources, both human and the complementary to labor capital goods and land, doing worthless jobs like digging up banknotes, who except the most fanatical Keynesian will still maintain that this is a viable economy? When Smith exchanges his good X for Jones’ Y, both men find each other useful. Keynes is worried about the welfare of Smith, if Jones refuses to exchange with him. One person’s fearful refusal to buy seems to harm two people. He suggests that Jones be given money in order to get him to buy from Smith and kick-start more exchanges. An obvious ethical rejoinder is that mutual consent is required for any exchange. Smith may want Jones’ entire stock of Y for a penny. If Jones refuses, is Smith harmed? Private property rights surely must be presupposed before studying any economic transactions. Second, it is true that the multiplier effect will cause consumption to pick up. As goods are flying off the shelves and from the inventories, they will have to be replaced and quickly. The only way to do so is to transform more capital goods owned by higher-order businessmen. Capital depreciation will accelerate to such an extent that full replacement of the capital and consumer goods will not be possible. Projects in progress will have to be curtailed. There is not enough time to rebuild the production structure. The end result is that this structure will shorten and wither away, the process opposite to the one described in (I, 52), because that is where the money is, namely, in short production processes. The immediate consumption binge will lead to future impoverishment. Third, Keynes can be refuted by means of a three-fold argument. First, the people in an economy with a non-inflationary commodity money standard do not suddenly forget how to cooperate. The biggest Keynesian error is that such an economy is underperforming, when left by the state and Central Bank alone. An act of capitalist saving of money initiates production of novel capital goods. It is up to each individual to decide whether he will save and invest or consume (perhaps, also by saving first, if the desired consumer good is expensive). Therefore, it is the people, by choosing to become either entrepreneurs or workers, not

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the Central Bank who determine how fast an economy will grow. It is true that the two acts, (1) saving of money and (2) production of intermediate goods may not interlock perfectly. Smith may want a custom-made machine. He orders one from Jones. Jones replies that he will need 1 month to fulfill the order. Does Smith have the $1M to pay for it? Smith says that he will have the money when then machine is ready. But in fact, the machine may be ready some time before the money is saved or after. Jones may have made the machine without having the contract for it in hand. He risked that there would be no demand for it. Or how about this: when Smith began saving, he had his eyes on the machine. Unpleasantly, someone else snatches it one day before he intends to contact Jones. The very next week, however, Robinson gives Smith a call, offering a better machine at a lower price. When Smith shifts his demand from old consumer goods to new capital goods, Brown who is unemployed due to lower demand for the former is not the same person as Green who is overemployed due to higher demand for the latter. In all likelihood, Brown will not be instantly reallocated. Though Brown’s unemployment is frictional, it is still a cost to society. All these are valid possibilities. But they do not alter the fundamental “macroeconomic” fact that the saving of money and the creation of capital go in parallel. The total efforts in the economy devoted to growing it by means of novel capital accumulation respond to the public’s savings in the narrow sense, that is, to money earmarked for investment. Capitalist saving is a signal to entrepreneurs to contract certain lines of production and redirect the resources thereby freed into definite other ones. But when narrow savings are increased artificially, via credit expansion, no time is given for new capital goods to be created. We will soon see what fateful things ensue as a result. Second, such an economy is not subject to business cycles; therefore, to the bust; therefore, to the alleged need to take the Keynesian medicine of fiscal policy to recover from the bust. Third, it is precisely attempts to stimulate this economy that create the boom part of business cycle, and with it, the inevitable bust part of it. Trying magically to get something from nothing backfires. The worst possible way to view the business cycle is as a time of rapid growth being mysteriously and irritatingly replaced with a period of stagnation. In fact, the boom is not growth at all but society’s setting itself up for a monumental failure, whose reality will only manifest itself in the bust. The boom produces only cancerous growth, and

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the bust is the market body’s attempt at self-correction. Hence, if the multiplier effect has a significance, it is that if people are holding on to money because of deflationary expectations (e.g., during a depression), then recovery can begin as soon as a critical number of consumers and entrepreneurs come without error to believe that the prices and wages are generally as low as they are going to get. Then both consumption and investment can quickly get under way. There are various criteria for how low deflation will proceed, one of which is the social rate of risk preference. These criteria will be explored in further detail in (II, 10). However, if a recovery is attempted in this manner when the majority of the population are still pessimistic, the recovery may fail. This is precisely the problem with government attempts to prime the pump. When initiated at an unpropitious time, it will only waste scarce resources. And at the right time, it need not be initiated at all, because at that point, the market must already have fully corrected itself. For that to happen, it is crucial, of course, to have highly flexible commodity and labor markers. Every instance of consumption presupposes prior saving and production. Friday’s berries just before the exchange with Crusoe are Friday’s capital goods. They must have been produced via several physical and temporal stages. What Crusoe does by buying the berries with his fish is he affirms, rewards, and perpetuates an existing mode of production, an ERE. He tells Friday: “You are doing great! Keep producing what you’ve been producing in the same way.” Therefore, regardless of how many mutually beneficial exchanges our four marooned people will make, even given gains in productivity brought about by division of labor, new capital and new wealth cannot come into being by spending. It is plain that economic growth does not proceed according to the multiplier effect. The only way for it to happen is (1) in the future by somehow increasing Y and (2) in the present by increasing investment at the expense of current consumption, that is, by decreasing the MPC (that is, the ratio of consumption to income). Thus, having landed on his island, Crusoe sooner or later decides that he needs a shelter and a fence to keep some sheep which he discovers live nearby. He had better start saving. Let Crusoe catch more fish than he needs in order to sate his hunger and dry the excess fish. At some point, he will have enough saved in order to devote time to making tools, such as (to reuse an example) an axe, a hammer, and a pick. Once these are finished, Crusoe will be able to build a shelter for himself and a fence for his future sheep with much greater ease.

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A sacrifice of consumption in the present has enabled Crusoe to set up longer wealth-generating production processes which yield more consumer goods in the future as compared to a counterfactual situation of Crusoe’s refusing to give up his leisure for catching the extra fish. Of course, now Crusoe has to spend time maintaining his capital, e.g., by sharpening the axe every day. But we can suppose that he invested well, i.e., that the tools pay for themselves in his subjective estimation. Thus, at first, we have Y1 = (C1 – ΔX) + (I1 + ΔX), where I1 is 0. Then, after a period of time, Y1 increases by some amount ΔY, such that Y2 = Y1 + ΔY = C2 + I2, where C2 is not only greater than C1 – ΔX but greater than C1, which means that Crusoe is richer than before as a consumer. I2 is now composed of the tools Crusoe has made, which similarly means that Crusoe is richer than before as a producer. The savings of fish have been transformed with the help of labor into investments into capital goods, namely, the tools, and new and previously inaccessible consumer goods, namely, the shelter and the fence. Crusoe’s time preference, now that he has accumulated some wealth, will decline, pushing his economic progress further still. This progress is, unfortunately, limited by the amount of labor Crusoe can supply daily for the maintenance and expansion of capital. If his production structure is too elaborate, then he will simply not have enough time to keep all of his capital in working order. Thus, an important effect of all investment is that it “creates more jobs,” keeping up with population growth, though one should wish that there was no need for this, simply to preserve the new and more sophisticated production structure. 56. KEYNES’ “OBSERVATIONS” ON THE NATURE OF CAPITAL AND THEIR REFUTATION

[I] In his Chapter 16 of General Theory, Keynes (2008) claims that an act of saving entails a diminution of present demand and yet at the same time a failure to boost future demand. I have argued otherwise in (I, 15). Why is he proposing this paradox? The reason, as stated, is this: “An individual decision to save does not, in actual fact, involve the placing of any specific formal order for consumption, but merely the cancellation of a present order.” But is it not the fundamental task of the entrepreneurs to foresee future consumer demand? For example, present desires must have been similarly predicted in the past by a previous set of entrepreneurs. Yes, but unfortunately, “the expectation of future consumption is so largely based on current experience of present consumption that a reduction in the latter is likely to depress the former.” (210-

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1) It seems from these passages that Keynes denies that entrepreneurs can do their job. But experience refutes this idea. Savings are increased and invested, profits are made, and the economy grows quite oblivious to Keynes’ restriction. Keynes denies that “an increased desire to hold wealth, being much the same thing as an increased desire to hold investments, must, by increasing the demand for investments, provide a stimulus to their production; so that current investment is promoted by individual saving to the same extent as present consumption is diminished.” It is evident that Keynes is talking about hoarding as an alternative to both consumption and investment, because saving, as he imagines it, entails consuming “an unspecified article at an unspecified time.” (211) This is the most terrifying for him bugbear of a free society. I continue the discussion of hoarding in Book II. Our author goes on: “the owner of wealth [does not] desire a capital-asset as such, [but] its prospective yield. Now, prospective yield wholly depends on the expectation of future effective demand in relation to future conditions of supply. If, therefore, an act of saving does nothing to improve prospective yield, it does nothing to stimulate investment.” (212) Alright, now the point of investing is to receive a profit. Sometimes (or often) this means buying undercapitalized goods and squeezing superior services from them over time. But prospective yield is due not to the capital good as such but to entrepreneurial direction of this good in some production process, the teleological effector of any enterprise. An act of saving provides only the material cause, namely, objects to be used in production. But both are needed: there is no entrepreneurship without capital nor capital without entrepreneurship. Thus, we may ask: Is the meaning of the term “entrepreneur” merely an “idea man,” someone who spots profitable opportunities, or does it in addition incorporate the notion of acting and risk-taking and dealing with unexpected surprises with real capital?57 Perhaps, “entrepreneur” can be defined counterfactually: “Smith is an entrepreneur, if, were he supplied with capital, he would attempt to invest it profitably.” There are in this world neither “pure forms” nor formless matter; all forms are mixed in with matter; so, every entrepreneur is also a capitalist, because no one can produce anything without capital goods, even if those goods are “found” gifts of nature; just as every capitalist is also an entrepreneur, because objects that play no part in any actual production plan directed by an actual entrepreneur can in no wise be called “capital.” 57

Cf. Rothbard 1985.

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Moreover, entrepreneurship is more than finding opportunities that are either objectively there or not. It involves more than following an algorithm, however well-constructed. David Keirsey (1998) writes about persons of the Artisan temperament that they derive self-esteem from being artistic, self-respect from being audacious, and self-confidence from being adaptable. All these qualities are indispensable for any business leader. Victorious action or superior execution are not entailed or guaranteed by a well-thought out plan. A cowardly or inflexible person may easily fail to guide to fruition an otherwise perfectly sound investment. Failure to notice the two-sided nature of “yield” is the source of Keynes’ confusion. I discussed Paul Davidson’s investor-savers and hoarder-savers in (I, 22) and concluded that this is a distinction without a difference. There is, at any rate, a simpler way to dispose of Keynes here. For savers can either lend their savings to entrepreneurs or invest with them directly. In the first case, higher supply of present money will lower the interest rate and improve the prospective yield of various businesses. In the second case, the new projects started with the help of the savings are naturally going to have a higher expected return than all the existing enterprises. [II] I have suggested that in certain circumstances savers subsidize the consumers. Keynes inverts this reasoning, saying that “every act of saving involves a ‘forced’ inevitable transfer of wealth to him who saves… These transfers of wealth do not require the creation of new wealth – indeed… they may be actively inimical to it.” (2008: 212) It is obvious that our author has confused wealth with money. The savers gain money but explicitly deny themselves present enjoyments, i.e., real wealth. This understanding would be confirmed if Keynes was thinking that greater wealth could not come about with a given money supply. Investments may be designed to bring about a greater abundance of goods, but in the process, under stable money supply, prices of both consumer goods and factors go down, and prospective yield of any given capital good declines in nominal terms. Does that mean that these investment opportunities are destined to lose? Of course not, for the prospective yield of everything else, too, declines. Competitive pressures on every business remain more or less the same; it is equally easy or difficult to profit in a sophisticated economy as it is in a primitive one. [III] Earlier Keynes affirmed that interest was an independent variable determining how low the marginal efficiency of capital can be pushed or in other words, when investment is naturally curtailed. Here,

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he changes his opinion, saying that the interest rate depends upon how much money people are willing to invest into capital goods. (213) He thereby embraces the productivity theory of interest, which I refute in (I, 40). Keynes argues that the interest rate (IR) on money competes with the marginal efficiency of capital (MEC) which prevents the MEC from falling below the IR. If the IR were somehow to be lowered, then capital goods would become more plentiful, because their marginal efficiency (or marginal value product before discounting) could become smaller. In other words, the supply of capital goods would, Keynes proposes, increase in order to cover those efficiency gains that have been freed up by the lower IR. Finally, at zero IR, capital accumulation would become limited only by technology and the supply of labor. Here is how Keynes figures it. To his credit, he dimly understands that interest has something to do with time. In a rare moment of lucidity, he proclaims: In optimum conditions…, production should be so organized as to produce in the most efficient manner compatible with delivery at the dates at which consumers’ demand is expected to become effective. It is no use to produce for delivery at a different date from this, even though the physical output could be increased by changing the date of delivery… If, after hearing full particulars of the meals he can get by fixing dinner at different hours, the consumer is expected to decide in favor of 8 o’clock, it is the business of the cook to provide the best dinner he can for service at that hour, irrespective of whether 7:30, 8 o’clock, or 8:30 is the hour which would suit him best if time counted for nothing…, and his only task was to produce the absolutely best dinner. (216) That is the time preference theory of interest in a nutshell, keeping in mind that interest is determined by both time and risk preferences, as argued in (I, 46). It is precisely the job of the loan market to coordinate intertemporal exchange of goods and pleasures and let the consumers determine whether a better meal at 8 o’clock is or is not preferred to a worse meal at 7:30. It is too bad that Keynes forgets all about it when he writes of the “desire to postpone consumption.” (214) There is, of course, never any such desire. Let us recall our analysis of time preference. “Waiting” and the disutility thereof has two senses. First, there is a desire to bring closer or at least make reachable a definite future enjoyment, and

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relinquishing immediate consumption is a necessary evil resorted to in order to attain a greater good. Present sacrifices diminish disutility of waiting. Thus, Crusoe has a choice of whether (a) to keep evenly rotating, catching fish with a rod, and “wait” for (1) a much superior net forever; or (b) to tighten his belt and make the net in 2 months; or (c) to barely subsist but make the net in 3 weeks. His choice constitutes the practical aspect of his own time preference. Second, suppose Crusoe picks (b). But he would also like to make (2) a pen for his livestock. This task will occupy him for 1 month. He has to choose still further between (1b) and (2). The fact that he has to wait less for the pen as compared to the net is an advantage of the former, a reason pro of it. If Crusoe is to choose the net, anyway, then the utility of the net has to outweigh the utility of the pen, even given the pen’s lower cost of the time input, to such an extent that the net’s overall psychic profit is higher than the pen’s psychic profit. This is the theoretical aspect of time preference as such. Keynes is up to something rather subtle here. What happens, our author asks, if the IR is 0? Then time, indeed, counts for nothing. One would not mind postponing satisfaction until any future moment, no matter how remote, which is why we can use the most technologically advanced production processes permitted by our knowledge, regardless of how long their implementation will take. All entrepreneurs will choose the most physically productive processes available, ignoring all considerations of time. This means that technological efficiency will be identical to economic efficiency: the most productive processes as determined by our most sophisticated science right now will be adopted. But this means that the economy can no longer grow by capitalists’ investing into longer and more roundabout processes: there is “an optimum interval for any given article… – a shorter process of production would be less efficient technically, whilst a longer process would also be less efficient by reason of storage costs and deterioration,” Keynes argues. (216) Given in addition full employment and the MEC of 0, the economy is in a perfect state, in that there is for it no possibility of improvement. “Change and progress would result only from changes in technique, taste, population and institutions.” (220-1) Moreover, eliminating interest destroys an important market force which should make things easier for a central planner under socialism, for whom production is not an economic but a kind of technological problem. Keynes does not disappoint: “I expect to see the State,” he declares, “which is in a position to calculate the marginal efficiency of capitalgoods on long views and on the basis of the general social advantage,

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taking an ever greater responsibility for directly organizing investment.” (164) The perfect situation is zero saving at zero MEC. In fact, if people continue to save in Keynes’ paradise, then the only effect will be that more present goods will be converted into fewer future goods due to negative MEC. (Meaning that the cost of producing more capital goods exceeds these goods’ MVPs.) This is why Keynes argues paradoxically that a poorer community A with fewer capital goods will enjoy a higher standard of living than a richer community B with more capital goods, because the smaller stock of capital goods in A means more present consumption, and conversely, B’s larger stock of capital means destructive sacrifice of present consumption; it is evidence of previously irrational behavior. This is why Keynes recommends digging holes in the ground in order safely to dissipate or soak up the money savings and to create incentives for people not to save which will allegedly increase both employment and prosperity. General Theory sometimes reads like a book of puzzles or sophisms: the problem is to discover how deep the fallacy is hidden within the author’s paradoxical reasoning. This particular argument is both unsound and invalid. It is unsound, because it depends on two false assumptions. First, interest rates can never be zero but are positive in connection with disutility of waiting. Therefore, the cost of time will have to be taken into account, and some relatively shorter processes will turn out be most efficient on account of their smaller interest expenses, even if they would not be the most efficient if interest rates were (hypothetically) equal to 0. Numerous powerful technologies will be languishing on the shelves, prevented from being used by consideration of costs, and moreover, lengthening the production structure will always be an option. Physical productivity is distinct from value productivity, and the former may be disregarded for the sake of maximizing (according to consumer preferences) the latter. For that reason, increases in technological knowledge make the task of a socialist central planner not easier but harder, as the planner is faced with more and more possibilities of what and how to produce without any rational way of choosing between them. The market rate of interest is constructed out of the rates of time and risk preferences of all market actors. Interest is not an arbitrary surcharge that wicked lenders impose upon borrowers; it is a primordial phenomenon rooted ultimately in the painfulness of postponing satisfaction of desires for the sake of some greater gain (such as profit from

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investment or security from hoarding). If human efforts were to be forcibly directed toward construction of more capital goods, then while these goods were being built, consumers would right now be deprived of present satisfactions that they judge to be more urgent than even the greater prosperity that would await them or their progeny in the future. Meltzer (1988) supplies an intriguing interpretation. “Individuals face this premium for uncertainty but, Keynes believed, society does not. Keynes treats society as analogous to an individual with infinite life.” (304) Elimination of interest, then, is tantamount to the consummation of utilitarianism. Surely, the greatest good should be pursued for society as a whole, including the as yet unborn and unconceived. However, the present generation is not a lost one, doomed to sacrifice everything for their children (and those children, presumably, for their own children). Consumer goods are like capital goods in this regard: they are an inseparable union of nature and labor-over-time. Man must choose whether to consume now or invest for the sake of future happiness, and this choice cannot be made otiose by government manipulation of interest rates. It is certainly true that one of the greatest motives for accumulation of capital is to provide for one’s children. Moreover, though there exist super-entrepreneurs who achieve stellar success single-handedly, many more fortunes are made over the lives of many generations. This entails an extension of loving concern for one’s descendants long after one’s own death. Keynes may argue that if everyone loved each other perfectly, then maximization of utility would take place over the entire span of existence of the human species. For example, if people living 10,000 years ago had had us in their hearts and minds, then they might have consumed less, saved more, and made us much more prosperous.58 My response is that economists deal with people as they are, not as they ought to be, according to ethical or religious precepts. Economists in their capacity as policymakers seek to order society in such a way as to maximize the narrow happiness of its members. They leave nature and virtue to philosophers and priests. If Smith wants to benefit his great grandsons, then the economist would advise him to save and invest prudently; if he wants to die broke, then the economist would teach him how to do that. Even if it is asserted that people ought not to have personal time preferences at all, they do have them, and that is all that the economist cares about. Men’s preferences are taken as given and ought to be so taken, if we are to remain scientific. 58

Keynes would probably say instead that they would have set up a modern banking system and expanded credit to the max.

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Keynes’ concern seems to be relatively slower growth under laissez-faire as compared with his zero-IR system. But even in a real non-Keynesian economy, the social rate of time preference will continuously fall as the economy grows, which will enable new capital to be profitably created and used. Capital accumulation can never bring about a state of affairs in which no improvement of economic conditions is possible or can be hypothesized and tested. But this growth will be moderated by attention to pleasures of the here and now. Second, the Keynesian utopia seems illogical. It entails that any innovation X which has just been put into use in factories, no matter how productive, will be immediately scrapped the moment something slightly better, Y, comes along. It does not matter that establishing this newest invention will take ten years; as long as during its lifetime, Y promises to produce more output than X does during its, resources will be shifted away from producing and maintaining X into producing Y. And then, nine years later, another inventor will come up with Z which, let us say, is again somewhat superior to Y, and production of Y must needs stop in its tracks. Technological progress in Keynes’ world will ensure that nothing will ever get finished and apparently, the death of the entire human race. That means that Keynes absurdly assumes human technological omniscience and has humanity maximizing its collective well-being for a million years in the future or all eternity. Suppose that not only waiting but also labor is not counted as a cost. Imagine the glorious pyramids we can all build, if we joyously invest the backbreaking labor required for their construction. Nothing will be beyond our power. If this sounds silly, then Keynes’ vision does, too. In short, Keynes’ theory of the time’s “shadow,” the interest rates, is faulty, and that is why he can dream both of removing the check of the needs of present consumption on capital accumulation and of technology-fueled heaven on earth. Even if Smith were (1) omniscient and (2) everlasting, he would not be, as God is, eternal. Hence, though Smith may live forever, the time spent waiting for a good is still a cost to him. Even if Smith (3) economizes with perfect prudence, having no uncertainty to endanger his plans, he is still endowed with a limited supply of goods; he is not almighty and chooses. Smith still distinguishes between past, present, and future and must endure the dissatisfaction of not enjoying something right away for the sake of future utility. Only a fantasist would assume (1) and (2); (3) is equally implausible. Keynes goes on: “I am myself impressed by the great social advantages of increasing the stock of capital until it ceases to be scarce.” (2008: 325) This could be interpreted in a couple of ways. First, literally: capital is not scarce, when there is no opportunity

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cost of using any good in any production process. Either (a) consumption of capital is non-rivalrous, such as the recipe for scrambled eggs: Smith’s use of the recipe in his cooking does not interfere with Jones’ use of the same recipe; or (b) capital is superabundant, like air. There is a horn of plenty anyone may reach into and grab an additional capital good. MEC = 0 means that any additional piece of capital will only impoverish society by becoming an economic bad, a piece of litter. Unfortunately, this pleasant state of affairs will not result from elimination of interest; people will not suddenly become omnipotent or able to create such an environment that anything else in it will only spoil their perfect happiness. Second and more plausibly, that the marginal value product of any capital good is equal to the cost of that good. (The definition of zero MEC is that the future is not discounted when equating the cost of the capital good with its value product over its lifetime. I am trying to make sense of Keynes’ supplementary idea that in that case, capital ceases to be scarce.) Any more investment will make things worse. Of course, this is exactly what happens in the neoclassical equilibrium. Keynes seems to grasp that point, inasmuch as he counsels a “properly run community” to “attain the conditions of a quasi-stationary economy” (i.e., an economy in which any improvement comes about due only to “changes in technique, taste,” etc.). But no real economy ever reaches this state. Keynes is “impressed” with a triviality; indeed, even with given technologies and zero interest rates, disequilibrating entrepreneurship is possible, wherein resources are reallocated within the economy, such that MEC > 0. This can still happen if opportunities to combine inputs in various ways to yield outputs whose sale will be profitable have not all been noticed and taken advantage of; therefore, saving will still have a social purpose. It is for that reason that Keynes reckons “a single generation” to be necessary and sufficient to convert an economy’s into an ERE. (220) However, the economic problem is not solved with the two assumptions (everlasting economy coupled with perfect inter-generational love; as well as perfect technological knowledge) just scrutinized in place. The socialist calculation problem still stands in the way of anyone foolish enough to claim that he can reduce production to social engineering. Remember the distinction between knowledge, an intellectual virtue, assumed here to be perfect, and prudence, a moral virtue, not so assumed. Entrepreneurship must still take place, and victories and losses of individual businesses must continue to occur. As a result, Keynes’ main argument is invalid: it does not follow

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from his assumptions that a “rational” equilibrium (or “quasi”-equilibrium in whatever sense) will be established, or that capital will no longer be scarce. The latter can only occur if we argue that eventually everything needful will be built which, since time is of no account, translates into “everything needful will be build” or even, collapsing time, “everything desirable that can in principle be built, for all we care, already exists.” This is the preposterous conclusion, given also the final premise of unfailing prudence and infallible economic calculation. A real economy will not be perversely imprudent, placing too much emphasis on the present. In a million years, even under normal growth, we should expect the human society to become quite advanced. Finally, there is the matter of competition: bringing one’s product to the market as quickly as possible not only economizes on interest but also allows one to capture profits for a longer period of time. The more complex and different from everything else one’s product is, the harder it is for imitators to reverse-engineer and copy it. Therefore, a shorter process may be preferable to a more productive longer process, because under competitive conditions, Smith’s profits may be higher, if he comes up with a product quicker, because if he waits a long enough time, then Smith’s competitors might eventually create a superior (better or cheaper or both) product, and he will have labored for naught. Keynes’ argument is thus a phantasmagoria of absurd assumptions and dubious deductions. Let us steer clear of such delirium. 57. INTEREST RATE AS THE ROOT OF ALL EVIL: THE GOSPEL ACCORDING TO KEYNES If there is any truth to be found in Keynes’ ruminations on “own-interest,” then it is that interest can be obtained in any commodity that is similar in qualities to those commodities that have the best track record as media of exchange. Murray Rothbard enumerates several qualities of gold and silver that make them ideal as such media: they are already in heavy demand (which is necessary for the regression theorem to hold), highly divisible, easily portable, have high value per unit weight, and highly durable. (2008: 7) Keynes gives an example of wheat. Wheat is sufficiently moneylike to allow borrowing and lending in terms of itself. (For example, it lends itself to business calculation.) That does not mean, however, that its originary or personal interest rate will be distinct from the interest rate of any other commodity, but dealing in wheat will modify the loan market EIR from the money rate. Nor does it mean that the source of interest is anything other than disutility

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of waiting coupled with liquidity preference. Nor, again, that interest rate can be negative. Keynes gives a nonsensical example in which I can buy 100 quarters of wheat for $100 now or for $107 a year from now. Given the interest rate of 5%, he calculates that $100 now can be exchanged for $105 a year hence. This amount will buy (105 / 107) * 100 = 98.1 quarters of wheat. The choice then is between 100 quarters now or 98 quarters later which causes the “wheat-rate of interest” to be approximately –2%. (2008: 223) This reasoning is doubly incorrect. First, what I would do is buy 100 quarters of wheat now, lend it at 5% per year interest, then a year from now get it back sell it for $107. My return is (105 * 107) / 100 – 100 = $12.35. Straightforwardly, the “interest” in Keynes’ sense is 12%. Second, even accepting Keynes’ answer, an apt question is, why would I not buy 100 quarters of wheat now and consume them rather than both wait a year and pay more? The reason for these prices is not interest but could lie with the projected conditions of supply and demand a year from now and the state of the commodity futures market. Keynes defines his terms as follows: let the marginal productivity of a good be q; the cost of wastage by holding a good, c; and the good’s liquidity-premium, l. Liquidity is ease of convertibility of a good into another form of wealth; it measures how easy it is to “spend” a good and how suitable a store of value it is. Total return from ownership is q – c + l. For a house (say), this return may be q1 (because it is an appreciating asset, does not waste, and is illiquid); for wheat, –c2 (because it does not improve with time, spoils, and is also illiquid); and for money, l3 (no appreciation for holding cash, does not spoil, and is highly liquid). Need I remind our author that q is entrepreneurial profit, and –c is loss, not interest? Let me assume, however, that these can be factored into the market interest rate. In other words, for Keynes, interest is still the price spread between present and future goods but regardless of the cause of the price spread. Thus, if the spread is lower because the thing can spoil, then that is a part of the determinants of the “own-rate” of interest for this particular thing. I, however, consider originary interest to be a ratio of future to present goods, etc. which arise solely out of disutilities of waiting and fear. Keynes lists more properties of commodity money that make it unique for intertemporal exchanges. First, its supply line is vertical or almost such. Second, it admits no substitutes: there is a demand for it due to its function as a medium of exchange. Our author then compares monetary interest (in his sense) with interest as might be produced by non-money commodities such as wheat and concludes that in the

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absence of money, the interest rate would be lower. Every commodity, in fact, would have its own rate of interest, depending on its own particular q, c, and l. The very qualities of gold, for example, that make it well suited as a medium of exchange, unit of account, and store of value also generate a premium on the interest rate when lending and borrowing is done with money. He goes so far as to say that “those reformers, who look for a remedy by creating artificial carrying-costs for money through the device of requiring legal-tender currency to be periodically stamped at a prescribed cost in order to retain its quality as money, or in analogous ways, have been on the right track…” (2008: 234) This proposal would have the effect of increasing c and reducing the “own-rate of interest” of money down to l – c. In other words, it would give an incentive to people to get rid of their money, particularly, by lending it, thereby lowering the interest rate. It is certainly something remarkable to condemn the very institution of indirect exchange solely because, as expected from the meaning of indirect exchange, the medium of exchange is highly in demand. The poverty of the world, a metaphysical evil, if there was one (see (I, 36) on evil), is blamed precisely on those qualities of gold and silver, namely, high liquidity-premiums, that qualify them to serve as media of exchange. (2008: 242) Three avenues are then open to Keynes in an effort to reduce interest rates. First, he can lower q, e.g., through inflation which would decrease the purchasing power of money. Note that (a) actual and present inflation lowers the real interest rate; it eats away at the creditor’s income. (b) Expected future inflation increases the nominal interest rate, as lenders seek to protect themselves from actual future inflation. In other words, in the conditions of (1α) unforeseen inflation, the real IR can be below 0. For (2α) foreseen inflation, the nominal rate will exceed real, with both being above 0. If there is (1β) unforeseen deflation, then the real IR will be above the nominal IR, also with both positive; if there is (2β) foreseen deflation, then the nominal IR can drop arbitrarily close to 0 without going below it, because then it will pay to consume or hoard rather than lend. As an attack of (a) gives rise to (b), Keynes’ designs are frustrated. Higher sustainable investment coupled with lower interest rate is achievable only if the supply of savings rises. But creating bank credit out of thin air leads to business cycles and impoverishment. Second, by increasing c in the manner described above. This is supposed to give people an incentive to get rid of their money before it spoils or depreciates. As we will see, it does not work either.

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Third, by bringing down l. And that is exactly what our author suggests. In an almost fanatical zeal to drive down interest rates, Keynes would destroy the modern economy in favor of some “non-monetary” economy, whatever that means. He seems to forget that the primary mission of money is to serve as a medium of exchange. Every other attribute of money serves that function. Afflicting l is not really feasible, because money by definition possesses perfect liquidity, being 100% convertible into itself. Keynes quotes Marshall’s superb and concise summary of the time preference theory of interest: Everyone is aware that the accumulation of wealth is held in check, and the rate of interest so far sustained, by the preference which the great mass of humanity have for present over deferred gratifications, or, in other words, by their unwillingness to “wait” (Marshall 1964: 483), disagreeing with it and saying that poverty “after several millennia of steady individual saving” is due to “high liquidity-premiums… now attaching to money.” (2008: 242) How do liquidity-premiums cause poverty? They result, says Keynes, in higher interest rates and therefore, scarcity of capital goods, because the marginal productivity of capital cannot fall below the interest rate. People cling to their money and invest less. Keynes’ liquidity preference and my risk preference are not necessarily the same. LP determines how malleable people are to depositing their banknotes back into banks, allowing the latter to expand credit even further. LP presupposes the loathsome modern government-banking complex. RP are about human attempts to deal with uncertainty. LP is a contingent phenomenon; RP is part of human nature. The Austrian theory argues that interest rates are determined by people’s time preferences. Let Keynes be credited with identifying risk preferences as the cause of interest. We must marry the two insights. It is true that changes in individual risk preferences do influence the interest rate in the short-run. At the same time, neither demand for money simpliciter nor demand-for-money-to-be-hoarded (that is, demand for cash balances) has a foreseeable effect on individual time preferences. These demand schedules will act on both present and future goods in a way that economic theory cannot predict. In the long run, even if the overall liquidity preference is to keep no money for insurance whatever, the money supply will increase, and only time preferences will determine interest rates.

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Only changes in the amounts of money intended to be kept in hoards can affect interest rates. Such changes occur predictably only in a bust. Other times, liquidity preferences are an agglomeration of subjective value judgments of the people, not to be questioned. By ignoring time preference, Keynes allowed himself to dream of the impossible; by ignoring risk preference, the Austrian school found itself unable to respond properly to Keynes’ charges. Roger Garrison entitled his book Time and Money, and wisely so: time gives rise to different valuations of present and future satisfactions; and money as a store of value allows one to satisfy his risk preferences by hoarding more or less. Keynes argues that the rate of interest “may fluctuate for decades about a level which is chronically too high for full employment.” (2008: 204) But the state of full-employment equilibrium is compatible with any interest rate. In fact, the higher the interest rate, the slower the growth, the fewer capital goods are used in production, the more backbreaking labor will be for the workers. Let me suggest, therefore, that for Keynes, “full” employment means not “everyone is working” but “everyone is working at peak efficiency.” Full employment subsumes not only lack of un-employment but lack of under-employment, as well. We have seen in the previous chapter that according to Keynes, only a zero-interest rate economy can produce full employment in this absolute sense. Keynes thought that consumption was a “stable” element of aggregate demand. Now liquidity preference exists because of future uncertainty. Uncertainty causes one to keep a cash balance just in case, leaving it unsettled when the hoard will be spent. Then the amounts of money allocated to hoarding and investment must constantly vary, especially according to the animal spirits of the entrepreneurs. Fear dampens the spirit; courage rouses it. Thus, I have argued that the Artisan temperament, defined by its chief virtue of courage, represents the pinnacle of human spiritual growth. The Artisan flame is warm, beautiful, creative, and controlled. The Monster mobsters in movies and television shows highlight the hostile “beginner” opposite of this fiery humor: one moment the guy pats you on the shoulder, the next he pumps you full of lead. The wild and unmanageable arbitrariness of the Mafiosi – from generosity to wrath in two seconds – is an illustration of the animal spirits at their purest. Monsters are desperate thrill seekers living in a world without a conscience. Both Artisans and Monsters are unpredictable, one in creating, the other in destroying. On the other hand, the Rational virtue of prudence manifests itself in seeking not to expose oneself to danger, taking every precaution. Since neither reckless

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courage nor cowardly prudence succeed, fear, representing hoarding, and courage, representing investment, hug the sensuality-consumption from both sides. The interaction of Artisan and Rational market agents, as well as the Artisan and Rational components of each person’s psyche are the yang and yin that influence the currents of investment and hoarding. It may be that an individual entrepreneur fears his competitors, but Keynes is concerned with the general state of the economy, the overall atmosphere of optimism and pessimism. Investment is supposed to be volatile, because of competition and the fleeting nature of profits. Profits and losses in round n of production impact what will be and what will not be produced in round (n + 1) in their capacity of permitting (though not necessitating) or precluding even rotation. Now though production depends on expected consumption, consumption depends on actual production. If actual production is unstable, then a fortiori, consumption is, as well. In other words, (1) expectations of consumer demand drive (2) investment which (3) yields output which (4) offers choices to the consumers. The volatility of (1) explains the volatility of both (2) and (4). Perhaps, Keynes would admit that consumption is erratic in terms of the goods and services that are available and bought on the market, but insist that it is less so in terms of the amount of money allocated to it week after week. If Keynes believed that investment was a variable and unstable element, then any additional saving-for-the-sake-of-investing would come out of not consumption but hoarding. Lower liquidity preferences then are the only way toward lower interest rates. At the very least, a decline in consumption is no guarantee that investment will be stimulated. Hence, time preferences are irrelevant to the determination of interest; and only liquidity preferences are relevant. Meltzer (1988) confirms this interpretation: “For Keynes, the major problem was to reduce instability, thereby lowering risk and increasing investment. … Keynes believed that the level of uncertainty was greater than necessary and therefore, suboptimal.” Now if uncertainty meant, for example, that the government could expropriate anyone’s property at will, or that human civilization was in such early stages of development that dangers loomed everywhere even in daily lives, then lowering these kinds of uncertainty would be most praiseworthy. If this goal could be furthered by changing the “institutions,” on which Keynes “placed considerable emphasis,” then let us reform away. But that was surely not Keynes’ take on this matter. He must have realized that uncertainty is generated by human action itself. This is why he considered “shutting down the stock exchange” and “giving the state, acting through boards of public-spirited

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citizens, responsibility for deciding on the level of investment” in order to reduce uncertainty. (5-10) This quest for “stability” and lower “uncertainty” is the cornerstone of Meltzer’s interpretation of him. It seems that Keynes wanted to create a still world, in which almost nothing happened. Any progress would come from investments by the state which at some point, too, would cease. What bothered Marx was “anarchic production”; what bothered Keynes was that humans produced at all rather than pursued “love, beauty, truth, timeless contemplation,” and suchlike things. All of his ideas about interest rates, uncertainty, hoarding, eliminating the scarcity of “capital,” a fantastic variety of “controls” to be imposed on society, etc. were in the service of a crackpotty utopian vision in which the “economic problem” would be “solved.” (34-5) To be sure, prosperity can civilize the world. Mises, too, points out that the cause of “intellectual and moral perfection, wisdom, and aesthetic excellence” is best served by having society “provide an environment which does not put insurmountable obstacles in the way of the genius and makes the common man free enough from material concerns to become interested in things other than mere breadwinning.” (1996: 154-5) Even Marx argued that capitalism has “rescued a considerable part of the population from the idiocy of rural life.” (2008: 14) All four of famine, pestilence, tyranny, and war can be defeated or at least held at bay by economics and libertarianism. But Keynes goes too far. Heaven on earth is not a state, like some land of Cockaigne, but a process of never-ending improvement, and the market process in particular. Now consider the large number of variables that Keynes takes as “given” in Chapter 18. These are: “the existing skill and quantity of available labor, the existing quality and quantity of available equipment, the existing technique, the degree of competition, the tastes and habits of the consumer, the disutility of different intensities of labor and of the activities of supervision and organization, as well as the social structure including the forces… which determine the distribution of the national income.” With these, he aims to find out the “volume of employment and the national income.” (245) Surely, then, Keynes’ “general theory” is profoundly short-term. It is part of the very meaning of the long run that, say, capital is accumulated and new technologies appear. How can Meltzer say that Keynes has a vision of low interest rates in perpetuity throughout the universe? Let me suggest that Keynes the interventionist cared about the short-term; Keynes the socialist cared about the long-term. Eliminating hoards, such that people keep cash balances only

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when they are saving up for some particular purpose, will not lower the interest rate to zero. Therefore, even taking interest rate in Keynes’ sense, that is, as any price spread between the same good now and later, absence of liquidity “fetish” will not eliminate scarcity of capital. People will still obey their nature in seeking to obtain satisfactions sooner rather than later, and this goal will factor in their decisions to invest into differently technologically advanced and physically productive processes. People keep hoards, i.e., cash balances to be spent at an undetermined time for an undetermined purpose, also in order to be able to consume or invest in the most propitious moment. The situation of zero liquidity preference seems to entail lack of any uncertainty and therefore, all-knowing providence for future welfare. However, given the notion of uncertainty as a combination of risk and surprises, such as the complexity of 1st-grade nature, the ordinal nature of 2nd-grade human valuations, human creativity, and entrepreneurial competition, the idea that uncertainty can be eliminated is preposterous. In any case, Keynes’ paradise does not follow from his premises: an end to saving with the purpose of hoarding does not entail considerations of the remotest future irrespective of present desires. For a man famous for saying that “in the long run we are all dead,” Keynes is oddly eager to force people to wait, until the “best” of such processes finally result in a world of plenty of consumer goods. How mortal men can become indifferent to time and how unachieved goals can fail to trouble them are never made clear. It is precisely this denial of the essentials of human life in this world that suggests that Keynes should be viewed as a prophet who thought he had seen heaven and tried to duplicate it on earth. But interest – and time and risk preferences that give rise to it – are eternal categories of human action; they cannot be eliminated in the way that a superior consumer good supplants an inferior one. I discuss the “stamped money” scheme designed to create zero interest rates and endorsed by Keynes in (I, 69). In a strange passage, Keynes explains that “unemployment develops… because people want the moon; – men cannot be employed when the object of desire (i.e., money) cannot be produced and the demand for which cannot be readily choked off.” (2008: 235) This could mean one of two things. First, that people cannot be employed in producing money. Would it not be nice, if there was a huge money-creating industry that could provide employment to millions of people? I realize how crazy this sounds, but I would not put anything past Keynes. What seems to be a great blessing, namely, that almost any money supply is optimal and can serve society as well as any other money supply; and that precious scarce resources do not need to be

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expended on creating money; Keynes appears to consider to be a curse. I imagine that the existence of such an industry would make it unnecessary to bury banknotes in coal mines, etc. (see (I, 55)). Keynes’ preference, in addition, is a recipe for hyperinflation. Second, that demand for money by entrepreneurs is so great that they refuse to hire workers except at negligible wages. But of course, demand for money has two sides. If entrepreneurs refuse to part with money except for a high amount of factor services, then they will also agree to acquire money in exchange for a large amount of the goods and services they produce. Low wages will thus coincide with low prices. This interpretation makes no sense either. We are back to Keynes’ inflationism and his belief that all is fair in attempts to lower the interest rates: “inelasticity of supply” of gold is “at the bottom of the trouble.” (236) Remember that Keynes imagines a perpetual insufficiency of consumer spending and capitalist investment. These are claimed, in addition, to cause unemployment. Fortunately, as the money supply rises wildly, jobs are created. For Keynes, the government in deficit spending and the Central Bank and commercial banks in money and credit creation can do no wrong. How much is enough? We will see the natural reductio ad absurdum of Keynes’ notions in (II, 20). Keynes continues with a discussion of stickiness of wages. When Keynesians say “sticky,” they mean perversely sticky in the way that prevents equilibration. In (I, 3), I suggest several reasons why nominal wages may in practice tend to be somewhat sticky even without government intervention. Keynes mentions none of them. Money-wages are sticky, he says, because money is a stable commodity; its supply is constant. Moreover, “the expectation of a relative stickiness of wages in terms of money is a corollary of the excess of liquidity-premium over carrying-costs being greater for money than for any other asset.” (2008: 238) Again the condemnation of money for being money. Besides, Keynes proves too much. Why are wages singled out from among all prices as being sticky? Perhaps, what Keynes wants to argue is that with the money supply held constant, the “price level” will go down, and quantity and quality of goods will go up, at a fairly slow rate due to economic progress. This is true; what is more, to reiterate the point made in (I, 52), the price level may be supported by the equally slow increase in the money supply due to mining precious metals (or even cryptocurrencies) that constitute money under laissez-faire. However, even if the overall price level is not volatile, relative prices can still fluctuate at pleasure. High l makes money suitable to be (a) a medium of exchange; close to zero q contributes to (b) making economic

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calculation easy; and low c imbues the commodity with utility as (c) a store of value. But these things are a far cry from declaring the market to be crippled solely on account of the properties of various media of exchange. We thereby obtain a rare glimpse at Keynes’ ideal economy. It is socialism, in which (α) the government in producing and owning the means of production is not bothered by future uncertainty and so is infallible; (β) it is omniscient, having complete scientific and technological knowledge of all things; and (γ) it is perfectly prudent, as in provides for human happiness until the end of time. To be sure, the modern-day Keynesians are embarrassed at such pretenses, and for that, they are to be commended. Still, are they following a demon who desired to be God? 58. THAT LOWER WAGES ARE A CURE FOR UNEMPLOYMENT, PART I Keynes denies that the law of demand applies to labor markets. The “classical” argument is that “a reduction in money wages will cet. par. stimulate demand by diminishing the price of the finished product, and will, therefore, increase output and employment up to the point where the reduction which labor has agreed to accept in money-wages is just offset by the diminishing marginal efficiency of labor, as output… is increased.” This rendition is poorly phrased; what will happen is: costs of production will diminish; then new profit expectations will incline entrepreneurs to increase supply which will increase the equilibrium quantity supplied and reduce the price. In order to produce the higher quantity of the good, new workers will need to be hired. Immediately after that, our author says that “this is tantamount to assuming that the reduction in money-wages will leave demand unaffected.” (2008: 2578) Is the demand stimulated or unaffected? Plainly, in the first quote, Keynes must mean quantity demanded for a particular product; while in the second quote, he means aggregate demand for the entire economy. Dillard calls the argument Keynes criticizes “crudest” imaginable (1948: 210). But he does not cite any subtlety that would call it into question. He just trudges after Keynes with a claim that it fails to account for effective demand.

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This is not the only seeming contradiction. On p. 259, Keynes agrees that “a reduction in money-wages accompanied by the same aggregate effective demand as before will be associated with an increase in employment.” On the very next page, he denies that “a reduction of money-wages has a direct tendency to increase employment,” because “the effective demand… cannot change.” The first quote is a simple observation that when we slide down the demand curve for labor, as price decreases, quantity demanded increases. Revenues to business firms ex hypothesi stay the same; their costs of doing business have declined; as a result, some entrepreneurs will expand production and hire more labor services. The interpretation of the second quote is more complicated. Labor costs can decrease throughout the economy, either when there is a decrease in the demand for labor, e.g., in the slump part of the business cycle, when entrepreneurs’ going out of business causes “jobs” to be “lost,” or when there is an increase in the supply of labor, e.g., as a result of heavy immigration into an area. I will discuss the first case in the next chapter. In the second case, which I will be considering throughout, the question is what makes it possible for more labor sloshing around out there to be hired. Here Keynes is ambiguous. He argues that entrepreneurs will obtain higher profits (as a result of lower labor costs), only if “there is no gap between the increment in income [to the community] and the increment in consumption.” Is he talking about real income or nominal income? Both interpretations are problematic. If real income, then real income is consumption; there can be no gap between the two, because real income consists in all the goods and services consumed or in the pleasure brought about by this consumption. What Keynes might mean is that there may be a gap between the consumer goods produced and lying in inventories and the goods actually purchased. He might mean, in other words, that there have been entrepreneurial errors: companies have not been able to sell everything they made at the prices they would have liked. But that is just how human action is: sometimes it is not successful. This perfectly general observation has nothing to do with the technical question of whether lower wages can bring about higher employment. The second possibility is that Keynes has nominal income in mind. But in that case, income (“to the community”) is not guaranteed to go up. There will be more people, their numbers having been swelled by the influx of our immigrants, working but at lower wages. Entrepreneurs, too, are part of the community and may receive profits. Whether

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the total money income to all members of society has risen or fallen cannot be determined on the basis of this information alone. (Though overall prosperity may have increased due to more thorough division of labor.) But let me suppose that this income increases relative to the previous state of affairs. Then, Keynes says, all that income will have to be spent on the goods just produced, lest entrepreneurs take losses. (Remember that we have assumed that all entrepreneurs step up production due to a decrease in labor costs.) That is why Keynes writes that marginal propensity to consume must be equal to 1; that is, the entire increase of income accrued must be spent on consumer goods with nothing saved. But this never happens in reality; and moreover, we have assumed that the aggregate demand does not change. So, “the proceeds realized from the increased output will disappoint the entrepreneurs and employment will fall back again to its previous figure.” (2008: 261) This is a bad argument. In the evenly rotating economy, indeed, all income to capitalists is ultimately spent on the factors, and the factors spend all of their income on the consumer goods. In the words of Joan Robinson, “the workers spend what they get, and the capitalists get what they spend.” (1966: 341) Assuming labor to be the only original factor of production, if total income to labor decreases, then prices of consumer goods must decline so much as to make total revenues to first-order capitalists smaller even with the increase in quantity supplied. If income to labor, on the contrary, goes up, then capitalist revenues go up, as well. Whether we pick the ERE before the decrease in labor costs or after it, the economy will work exactly same, and it is that which necessitates the MPC to be 1. Keynes has not discovered anything interesting. Keynes’ alleged insight takes the form of a simple reckoning. Lower costs benefit an individual company but harm all other companies by reducing demand for their products (on the part of the workers whose wages have been cut). Lower costs to particular firms go together with lower effective demand to all firms. On the whole, benefits equal costs. If an ERE with unemployment existed before, then any new ERE will also contain unemployment and moreover, will be reached by via losses to various entrepreneurs. Why should we allow such a futile inefficiency to be attempted? Here is the reply. Let us assume that before our immigrants disembark from their ships, the ERE subsists in the state of full employment. The moment they enter the job market, however, they start counting among the unemployed. One of the meanings of disequilibration is a state of affairs in which some factors are paid less than their DMVP, but in our particular case, the immigrants are producing nothing and being paid zero for it. Keynes has a point: the economy may still be called

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equilibrated if vacuously so. Even this sense is attenuated, if we add reasonably that a SEQ is characterized by no worker’s starving to death. By what process will the immigrants be incorporated into social cooperation? This time, it cannot start with savings, because those would have to materialize from either other investments or consumption. In the first case, there is explicit contraction of existing businesses; in the second, revenues to some entrepreneurs decline, also necessitating contraction if a bit more indirectly. As a result, unemployment will not be alleviated. Let me illustrate the solution with a bit of Crusoe economics. Crusoe owns a fishing rod and employs Friday 8 hours per day to catch 1 fish per hour. The catch is split 50-50. Smith arrives on the island and wants food. His reservation wage is 1 fish per day, and Crusoe offers him precisely that for 4 hours of fishing with his rod, thereby partially unemploying Friday. Smith further announces that he would accept 1.5 fishes for the second 4-hour period. If Friday is to keep his job, he needs to underbid Smith. Suppose he offers to work at 1.3 fishes per day. Let a single price rule the market. Crusoe pays 2.6 fishes to his employees and nets 5.4 fishes himself, an increase of 1.4 fishes from the previous situation. We can see how capital goods have become more scarce and more precious relative to labor. There is also a temporary decrease in the standard of living of the native workers. In our example, the rod was continued to be used for fishing, but it need not necessarily do so. To the extent that capital goods are convertible, they can be come to be employed by people like Smith not for their original purposes but elsewhere in the economy. In their capacity as consumers, the immigrants will crave plenty of inexpensive necessities. The demand for those will rise, generating profits for firms producing them. With lower costs of labor and with some capital goods – tools, equipment, machinery of all kinds – that may flow to those industries, profits will be increased still more. Add the equilibrating forces to the picture, and we will observe a rise in the supply of these goods, such that overall, quantity supplied increases, yet prices remain about the same. The goods that will be sacrificed for this purpose will be the least socially important, such as perhaps some luxuries; the desires satisfied with the goods produced by the immigrants will be exceeding important. There will be a boom in labor-intensive industries, stimulation of capital formation, as well as precisely labor-intensive projects that produce new capital goods. The market’s efficiency cannot be doubted. As a result, the vacuous equilibrium is unstable and will tend to

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resolve into a normal full-employment equilibrium. Keynes’ premise is false; and the argument, unsound. Real wages tend to rise in a free economy due to creative advance, especially its disequilibrating part. With respect to nominal wages, there is a constant tendency toward the state of equilibrium, eradication of profits, and therefore, maximum money wages for factors of production. It is a consequence of Keynes’ theory that immigration is always futile, and that labor mobility as such is not a social virtue: the immigrants cannot without government assistance be integrated into the economy. But since people move most of the time precisely to take advantage of job opportunities in other areas of the world, Keynes proves too much. We will later see some Keynesians argue as follows. Supply and output will increase, if costs of production fall. One way to engineer the latter is lower labor costs. But this will lower aggregate demand, as well, as the purchasing power of workers declines concomitantly. Ordinarily, one would expect that each business firm should take care of its own efficiency, including contain the costs of labor. Keynes and his fellow travelers crawl out of the woodwork and propose to inflate the money supply and boost the profits, coupled, perhaps, with government spending and wage controls. Presto chango, unemployment is alleviated, and an instant surge of production ensues. Apparently, for Keynes, lower wages can alleviate unemployment, but only if the government takes it upon itself to lower them in underhanded and coercive ways. Thus, Dillard argues that Keynes’ beef with the classical theory resolved into a “practical matter”: Keynes “does not even say that wage cuts can never result in some increase in employment. What he does deny most emphatically is that wage cuts are of practical significance in restoring higher levels of employment. … Keynes sees the cure in an expansionary monetary and fiscal program designed to increase the volume of effective demand.” (1948: 210-1; 220) Again, the fact that following an influx of immigrants onto territory T, the immigrant laborers are competing with the natives for the complementary to them scarce capital goods implies that the average productivity of labor declines, reducing the real wages of the local population. That is, if prices remain at their previous level, then wages will decline; if wages remain at their previous level, then prices will rise. The immigrants still benefit, because they would not have moved unless they had anticipated a higher standard of living on T. But T’s original inhabitants lose, since for them, the ratio of prices to wages rises. Suppose now that a single firm’s, call it X, labor costs decline, e.g., due to a thorough company-wide reviews of workers’

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performances. The firm will enjoy immediate profits and also be at liberty to expand production (thus lowering the product price), including hire additional labor (in the process soaking up the unemployed without in this process bidding up the price of labor), up to the point at which its profit is maximized. There is a redistribution of wealth here from one set of consumers to another, namely, from the existing workers to new ones, to other factors of production, and to the X’s owners. The whole point of entrepreneurship is to buy factors of production that, in the entrepreneur’s estimation, are underpriced or undercapitalized and use them to create an end product for which the revenues exceed the costs of production. A businessman uses the state of general ignorance to his advantage. If the entrepreneurs consume everything out of their now higher income, then the only change is who spends more; if the entrepreneurs save and invest some of their profits, then we get the familiar situation of “less” present consumption being diverted into investment and “more” future consumption, as explained above. Lower wages entailing lower costs of production for X free up new profits for reinvestment and therefore, for purchase of more factors including labor. The labor can be the same people just working longer and harder or new people or, as per creative destruction, people working elsewhere. For example, with “full employment” in Keynes’ sense, while there will not be more employment, there will be more efficient employment. It is true that entrepreneurs destroy old jobs in the process of creating new ones. (They are also reluctant job creators, preferring rather, for any given project, to minimize their expenses including on labor.) Nevertheless, even at full employment, if the entrepreneur is bound to be successful for a period of time, then the new jobs will be better than old ones: if they were not better, then the entrepreneur could not suborn, so to speak, the factors into coming to work for him in the first place. We can assume that the disutilities of labor for an arbitrary person working on producing buggy whips with primitive tools and for the same person working on producing custom-made car parts with sophisticated tools are more or less the same, but the ends that this labor serves and satisfies are greater and greater with economic progress. Naturally, it is not true that workers and entrepreneurs are two separate castes, such that never the twain shall meet. At any time, it is open to a worker to become a capitalist-entrepreneur by saving and investing his money; and conversely, at any time, it is open to an entrepreneur to become a worker by paying himself a salary for his services as CEO out of the profits that his firm has received and consuming it. (To be sure, profits remain distinct from wages, insofar as the latter, unlike the former, may be ascertained by examining the

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business owner’s opportunity costs of managing his own company. Thus, if a small businessman does his own books, then he must subtract from his CEO-wages the amount he would be able to earn elsewhere as an accountant.) As a consequence, we cannot tell whether total investment will grow or shrink in amount, because some workers may curtail their investments in reaction to lower income, and some entrepreneurs, on the contrary, re-invest their profits. All in all, employment may increase. If there is full employment, then laborers will be lured from other occupations into the winning firms’ lines of production. Otherwise, new laborers can come in and be paid at most their discounted marginal value product made smaller by the now dearer capital. (The bounds of their wages will be determined by the competitor firms bidding the factors up and the workers’ DMVPs; as well as by competition between workers bidding them down and the workers’ disutilities of labor.) Again, (1) the new immigrants will stand in need of more capital goods, if the overall standard of living is to be maintained. Those goods will be created in time. (2) If 1,000 people arrive into an area in search of opportunities, then, while most of them will have no higher ambitions than to be workers, we should expect some of them to become entrepreneurs and provide those opportunities to others who will include both the natives and the rest of the immigrants. Even if, per impossibile, no new entrepreneurs emerge, the cheap labor is a profit opportunity for existing firms. What this means is that aggregate demand or aggregate consumption need not decrease as a result of a decrease in money wage rates, but employment can grow. A strange objection to this comes from Michal Kalecki, a noted early Post Keynesian. According to J.E. King, [a] reduction in money wages will… raise employment, Kalecki maintained, only if it induces capitalists to increase their expenditure on investment or luxury consumer goods. “Such a state of affairs is, however, extremely unlikely.” In all probability capitalists would place new investment orders only when their expectations of higher profits, stimulated by the wage reduction, had been realized. “Even if they give new orders at once, the technical time-lag between investment orders and the actual production of investment goods would prevent the latter from increasing immediately.” (2002: 44)

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Kalecki may have been thinking that if workers spend less, then capitalists must pick up the slack in order to maintain aggregate demand. But income to capitalists is delayed. Hence, unemployment will persist. However, entrepreneurs can only expect higher profits if everybody is working. The problem is solved by Kalecki’s very assumption in his argument. So far, I have been presenting my case as if all workers were the same. But in the real economy, each company faces its own unique labor situation. Each worker, after all, has a unique collection of human capital. In company X, workers A, B, and C are paid less than their (discounted) marginal value product, and workers D and E are stupidly paid more. In company Y, all workers add more to Y’s output than they cost to the owner, allowing room for expansion, e.g., by reinvesting the profits. Company Z is losing money, because most of its workers are overpaid, and it cannot get rid of them, say, because of union machinations. In short, contracts are made between individual companies and workers, and no one needs to be unemployed if he can contribute to any production process more than what he asks in return for his services. Any worker will tend to find that occupation, to which he can contribute the greatest. In other words, it makes sense to desire a situation in which wages and prices are balanced on the level of individual firms, not on the level of macroeconomy as a whole. This belies the Keynes’ claim that “wage reductions, as a method of securing full employment, are also subject to the same limitations as the method of increasing the quantity of money.” (2008: 266) The two could not be more different. If one business or industry is disadvantaged by mandated high wages, then wages in other businesses or industries will be depressed due to greater competition between workers (i.e., greater supply of labor) there. The problem with labor unionism is not that union members contrive to raise their wages at the expense of the wages of everyone else. It is rather twofold. First, many unions use unjust violence against their employers and those employers’ customers. Second, unions are unstable if entrance into the unionized industry is free. If Smith is required to pay his workers $50 / hour, yet those workers, given their present skills, could be employed elsewhere for only $30 / hour, then any new entrepreneur would obtain a competitive advantage over Smith by hiring non-union workers for $31 / hour. If, on the other hand, people are prevented either by law or union thuggery from competing with Smith altogether, then this checks creative advance in the unionized industry, fosters stagnation, and is clearly anti-social for those reasons. It is only if the entire economy is thusly regimented that the

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labor market will fail to clear, and there will be institutional involuntary unemployment. In other words, wages are determined by individual bargaining between particular workers and particular firms. Whether a given wage is too high or too low is discussed during job interviews and employee reviews. The notion of “total income to labor” is next to useless. Economists who are concerned with unemployment should focus not on aggregate demand but on the creators of jobs: the entrepreneurs. They should insist that no obstacles be placed to the authority of entrepreneurs to set prices, determine their hiring and firing policies, negotiate wages, and enter or expand within any industry whatsoever. Most important, they should demand that the government and the laws not foster the environment in which mass entrepreneurial losses and therefore, unemployment are inevitable, i.e., the business cycle. 59. WAGES, PART II In Chapter 19, Keynes proposes that we are in a depression and that wages and prices of factors are too high. One could append to this that the reason for it is that depressions are characterized by malinvestments, such that capital goods and worker skills that used to be thought useful to human beings are revealed to serve no purpose. The objects and knowledge (both “that” and “how”) are still there; they just no longer contribute to human happiness, the opposite of which was mistakenly thought during the preceding boom. Given that some of these objects are relatively non-specific, there is a chance that they can be recovered by being reallocated to different uses. But in order for that to happen, their prices must fall, sometimes dramatically. This situation is paired by Keynes with decreased demand, because people are sitting on their money and waiting until wages and prices will have hit bottom. Keynes envisions that the depression will be accompanied by wages and prices of finished goods going down in unison: “The most unfavorable contingency is that in which money-wages are slowly sagging downwards and each reduction in wages serves to diminish confidence in the prospective maintenance of wages.” (2008: 265) Thus, the slow adjustment of the absolute price level is bad, Keynes thinks. He even claims that if labor were to respond to conditions of gradually diminishing employment by offering its services at a gradually

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diminishing money-wage, this would not, as a rule, have the effect of reducing real wages and might even have the effect of increasing them, through its adverse influence on the volume of output. The chief result of this policy would be to cause a great instability of prices. (2008: 269) Apparently, Keynes reasons as follows: lower nominal wages (1) cause enterprise to be more profitable which (2) causes an increase in output which (3) causes prices to fall (after the monopolistic price discovery has taken place and later on, because competition will bid output prices down) which (4) causes real wages to rise which (5) causes more unemployment which (6) causes still lower wages which (1a) cause… First of all, higher real wages in (4) which simply means greater abundance of goods available need not result in any unemployment. Second, has Keynes forgotten about aggregate demand? If workers in their capacity as factor owners receive less income, then they can spend less on consumer goods. If higher real wages could be attained by Keynes’ artifice, then we would have a surefire way of raising the standard of living for all: just lower money wages to zero! Third, falling prices cannot fully compensate for falling wages, because there are other factors of production besides labor. In other words, wages go down faster than prices59; so, at some point they will come to be in a proper relationship. If by “wages” Keynes means prices of factors of production generally, and if his point is merely that, assuming that there is such a thing as an evenly rotating economy with unemployment, such that the unemployed ex vi termini are unemployable, this economy cannot be 59

In (I, 52), I argue that under secular non-inflationary growth, nominal wages fall slower than prices, such that real wages rise. However, this is not a contradiction, because in the present chapter, I am dealing with short-term day-to-day adjustments of prices of finished (from the point of view of the company selling them) goods and of factors of production, not with a general longterm trend of positive net savings resulting in higher physical productivity of longer processes and lower discount rate of future goods. NB: I am not here talking about the real cash balance effect, either, in which lower prices and wages are complemented with the same money supply. The argument is supposed to be that the purchasing power of people’s money increases, allowing them to buy up the unemployed labor. In fact, the whole reason for the deflation is increased demand for money. It is not the case that price deflation will cause people to hire. On the contrary, it is precisely the fact that people do not want to hire that causes the deflation.

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cured by a means of lowering the absolute wage-price level, then I have no quarrel with him. We can move the factors prices / consumer goods prices level up and down as much as we want with no effect. But why make his assumption? Since when is a depression an ERE, anyway? It is not the case that all wages are above-market, nor that all wages are too low, such that the purchasing power in the workers’ hands is too low to buy enough of the goods being produced so as to cause the entrepreneurs to profit. If any of these two were the case, then the solution, raising or lowering prices, would be self-evident and very quickly implemented. Rather, for numerous individual business firms, the still more numerous workers employed in them are overpaid relative to their DMVPs. Their wages are in such a relation with the prices of goods that these firms churn out as to make production of these goods unprofitable. Aggregating wages and prices misleads and is unhelpful. Keynes believes that if… an attempt were made to fix real wages by legislation…, the actual level of employment would, in a closed system, oscillate violently between that level and no employment at all, according as the rate of investment was or was not below the rate compatible with that level, whilst prices would be in unstable equilibrium when investment was at the critical level, racing to zero whenever investment was below it, and to infinity whenever it was above it. (2008: 269) Fixing real wages means fixing the ratio of wages to prices. The only reasonable interpretation of this passage suggests that Keynes mixed things up. Investment goes above the right point, when costs exceed revenues, in which case entrepreneurs are taking losses, and labor is overpriced; wages will be lowered; prices will be lowered as per the peg between the two; and wages and prices will chase each other down to zero. Investment goes below the same point, when entrepreneurs are profiting, in which case labor is underpriced; workers will ask for raises; and wages and prices will pull each other up without limit. But in an ERE, real wages are also fixed by the definition of this imaginary construction. Keynes then thinks that, if the ERE is disturbed, then at the very least, nothing useful will happen; and at worst, horrible things will be unleashed. In running his company during a recession, each individual entrepreneur decides when prices and wages have bottomed out: the whole point is to time the market. (Smith has no reason to continue waiting, if he feels that he can profit now.) At this juncture, the marginal efficiency

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of capital will be highest: the same amount of capital will yield the greatest amount of output, because it will be paired with more and cheaper labor. In other words, more labor can be employed with the same amount of capital, so the capital goods themselves are at their most productive. If, however, the expectations are that wages will still go down, then people will forgo hiring at the moment, and the MEC is reduced from lack of complementary labor. Only when wages are at the bottom of the abyss, is it the time to hire. This is Keynes’ point #4 on p. 263. Point #5 is less successful, because, as we have seen in (I, 46), a change in risk preferences, contra what Keynes asserts, will not predictably affect the interest rate. Now I come to the critical stage in the argument. Keynes claims that the best way to bring wages in alignment with economic fundamentals during a depression is not by lowering the wages but by raising the price level through inflation. Ideally, Keynes says, it would be great, if wages could be brought down to the bottom immediately without a period of time during which they slowly creep downward. He need not worry, for expectations speed up wage and price adjustments. If people expect prices to fall, then they abstain from spending, causing demand for money to pick up which increases the money’s purchasing power and lowers prices still more and still faster. The time it takes for the wage rates to decline can be very short. Note that the economy’s self-healing interferes with the working of the inflationary stimulus, such that the two together will proceed no faster that either one alone; at any rate, the self-adjustment can get the economy out of a depression quicker than the Keynesian inflation. What Keynes wants in a perfect world is to “secure a simultaneous and equal reduction of money-wages in all industries. … But this could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining.” (2008: 2645) His solution? Inflation, because “a change in the quantity of money… is already within the power of most governments.” (2008: 267-8) The idea is simple: inflation dilutes the purchasing power of money, leading to a decline in real wages which increases the quantity of labor supplied and therefore, reduces unemployment. Hence, the famous Philips curve of the alleged trade-off between inflation and unemployment. By way of reply, first of all, inflation does not work as Keynes thinks it does. Money is not neutral in the short term which means that during a money supply inflation new money is injected in the economy at particular points, causing local price increases. Those who get the new money first benefit, because they get to spend it before the general

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increase in prices commences, while those who get the new money last, such as individuals on fixed incomes, lose, because they have to contend with higher prices now everywhere. Hence, those prices that will rise first will have nothing to do with how wages ought to be structured. How does Keynes know that those prices will increase where labor is overpriced, compensating for this state of affairs? Inflation is an unpredictable and uncontrollable phenomenon. Who gets the money first is never known in advance. There is no such thing as a “gradual and automatic lowering of real wages as a result of rising prices.” (2008: 264) There is no “gradual” lowering of real wages, because prices rise unevenly. There is no “automatic” lowering of real wages, because price increases are a result of human action. Spurred by inflation, those entrepreneurs who happen to be the lucky first recipients of new money bid up the prices of the factors, as they spend that money; so, when factors prices rise, only those companies which can afford to price their products higher will survive. Other companies, which might well include precisely those that were supposed to be helped by inflation, will have to fire workers, shrink, or go out of business altogether. Another question to consider is why we are in a depression in the first place. It is precisely inflationary credit expansion through the Central Bank and the fractional reserve banking industry that generates artificial booms and busts. Lower wages are part of the cleansing correction of the bust. To recommend more inflation is to prolong the depression. Suppose now that inflation could, contrary to reality, raise all prices by the same percentage. Would that have the desired effect? There are a myriad of wages all fluctuating relative to each other. It is impossible to replicate their mutual self-adjustment by such a crude mechanism as monetary policy. If inflation could succeed at bringing down the wages by 5%, then the misalignments would still persist. Down to exactly what values should wages be brought; i.e., which wages are too high and by how much? Some are too high; others are too low; still others are just right. For example, inflation would unbalance things by lowering the already low wages. There is no escape from the need for wages and prices to adjust relative to each other. There is a semantic point here, too: the ability to change is essential to prices. Rigid wages are not really wages. Mises points out: It is the very essence of prices that they are the offshoot of the actions of individuals and groups of individuals acting on

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their own behalf. The catallactic concept of exchange ratios and prices precludes anything that is the effect of actions of a central authority, of people resorting to violence and threats in the name of society or the state or of an armed pressure group. In declaring that it is not the business of the government to determine prices, we do not step beyond the borders of logical thinking. A government can no more determine prices than a goose can lay hen’s eggs. (1996: 397) In other words, Keynes starts out by assuming that “in the beginning” (of his causal story), the wages are correct. For some unknown reason, however, they become too high. What is to be done? To a “foolish,” “unjust,” and “inexperienced” person (2008: 268-9), it would seem that Smith, whose wage is too high, should be, if his boss knows what is good for him, either fired or forced to take a pay cut. But no, says Keynes. The government should rather print out lots of $100 bills, throw them from a helicopter, and hope that Smith’s employer will catch some. This is not, I hope, a parody of Keynes; it is what he actually believes. Further, what about businesses that are honest-to-goodness failures, depression or not? Showering them with money will cause their owners to rejoice, but the net effect will simply be uneconomic use of scarce resources: the failing entrepreneur must let go of his factors or retool his business radically, and the found money prevent these from happening for at least another round of production. In other words, a loser remains a loser, whether he is surrounded by an unusually high number of other losers (in a bust) or not (in a free economy). Society is harmed more when numerous losers are coddled than when only a couple of politically powerful businesses get unjust favors from the state. Keynesian medicine is poison to the social body. Keynes may reply that given sufficient stimulus, on average, numerous business losses will turn into profits. There are short-, medium-, and long-term aspects to inflation as a proposed depression cure. To repeat the point made in (I, 55), losses, even mass losses, are not an unmitigated evil; they are a sign that resources have been woefully misallocated. Fever feels bad, but it may be useful as a sign of infection and even remedy for it, and fighting fever is rarely a priority; in fact, it may be counterproductive for the organism. Yes, entrepreneurs suffer and workers suffer with them, but the economy does not revolve around either but rather around the consumers, though, of course, every worker is also a consumer. That these latter were being poorly served is revealed in the bust. Feeding business firms with money allows them to

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keep operating at the expense of general welfare. It engenders an end to entrepreneurial rationality and retrogression, making the nation poorer. The other two aspects are split between whether credit or fiat money is created. The medium-term aspect for the former is that people come to expect inflation. This causes interest rates to rise and increases costs of doing business to all long production projects. Inflation will need to be continuously ratcheted up and moreover, in an unpredictable fashion in order to have any effect (we will deal with this point later). For the latter, suppose that the government simply printed enough money and directly subsidized the failing entrepreneurs. That would be a disaster, as people would be able to hold onto scarce resources even if the market signals them otherwise. If there is more spending due to fiat money creation, then factors prices will be bid up in the short order and all the difficulties will reappear. The long-term effect regarding credit expansion is the need to choose between allowing the economy to cleanse itself, hyperinflation (if inflation is predictable), and complete economic chaos (if it is not). Regarding the fiat money creation, it is the need to choose between consumer and government sovereignty. The state cannot take over consumption. Thus, inflation patches up the symptom of economic illness only in the short run; is altogether ineffective in the medium run; and is destructive in the long run. In addition, if price and wage stickiness in the economy is due to government interventions, then any particular spasm of inflation will be a short-term remedy. The problem will come back. What is needed is social progress toward laissez-faire, not a primitive trick like fooling unions with inflation. Again, to the extent that inflation becomes a standard policy, people will sooner or later catch on and nullify its effects. Let me also wonder why workers would resist wage decreases, while consumers must docilely acquiesce to price increases? Why is it easier for companies to raise millions of prices than to negotiate down millions of wages? Perhaps, because prices are set by a single party, namely, the entrepreneur, while wages are negotiated by two persons not one. Doing the former would, according to Keynes, seem to lower transaction costs: wage adjustments would “probably [be] completed only after wasteful and disastrous struggles.” (2008: 267) As I note in (I, 3), there is an element of loyalty between the firm and its employees. Lowering their wages is tantamount to despising what are, perhaps, years of faithful service. Moreover, a company might “invest” in its labor force by training it. A worker may possess special technical knowledge of the product

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on which he is working which constitutes his “human capital” and so, may be difficult to replace. Consumers, on the other hand, are fickle and have no loyalty to any producer in the first place. This is a cultural peculiarity; its analysis does not belong to economics and therefore, is out of place in General Theory.60 At any rate, Rothbard disposes of this argument as follows: It may appear, he writes, that “only the sellers (or buyers) are setting the price. Thus, a good might be sold in retail shops, with prices simply ‘quoted’ by the individual seller. But the same process of bidding goes on in such a market as in any other. If the sellers set their prices below the equilibrium price, buyers will rush to make their purchases, and the sellers will find that shortages develop, accompanied by queues of buyers eager to purchase goods that are unavailable,” etc. (2004: 118) It is certainly not the case that “a change in the money wage for a particular skill or other subgroup of workers… represents an obvious change in the position of that group relative to other workers,” while “a change in product prices… affects everyone, whether they work to produce the affected commodities or not.” (Chick 1991: 150) Changes in product prices affect not “everyone” but only those people who buy those products. Now the basket of goods that Smith buys is unique to him and perhaps, to a few other people. Lower wages for Smith’s skill set affect Smith and a small group of other workers; higher prices for Smith’s preferred basket affect Smith and a small number of other consumers. The symmetry is quite fetching. It seems equally probable that 60

Shortly after my family and I moved to the US in 1993, I tried to get my grandfather, Isaac, a credit card. Though none of us had credit history, I was a university student at the time and had no trouble getting one myself. (I imagine that the banks presumed that, given a low enough credit line, my parents would be my de facto co-signers.) He, however, was stuck with a catch-22: in order to get a credit card, one needed credit history, and vice versa. I applied on his behalf to half a dozen banks and was rejected by all but one, Citibank. What Citibank did was offer Isaac a “secure” credit card, wherein he was obliged to send them $800, which they would put on a CD, and the credit line on the card would be this amount, as well. If my grandfather had turned out to be a thief, then Citibank would have been well protected: it would have confiscated the $800. Everything went well, however, and in 18 months, Isaac received his money back with interest; his credit card was transmuted into a plain ordinary unsecured kind; he got a credit line increase; and he acquired credit history. I have been loyal to Citibank by using its credit card myself ever since, in gratitude for this impressive bit of cleverness on their part. It is not the case that customer loyalty is non-existent.

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Smith will be unlucky in one way as in the other. Finally, Keynes’ mention of a social injustice of flexible wage rates is probably due to his view that those whose wages are contractually fixed should not benefit relative to those whose wages can easily adjust downward. First, I am not at all outraged that such a thing is possible. Keynes gives no ethical reason to resent it, and it is hardly selfevident. Second, it merely presents an incentive to employers to try to keep all the wages flexible. Third, it is precisely adjustment to inflation that is “long and painful… [and] creates inequities, perversities, and inefficiencies. Retired workers and others on fixed incomes suffer, wages lag behind prices for workers locked into multi-year labor contracts, and the price system in general functions poorly.” (Garrison 2001: 114) In sum, it is not true that “a flexible wage policy and a flexible money policy come, analytically, to the same thing, inasmuch as they are alternative means of changing the quantity of money in terms of wage-units.” (2008: 267) Unforeseen inflation may, indeed, cause more businesses than normal to obtain nominal profits. But an inflationist policy will simply raise the nominal interest rates, as per higher c in Keynes’ formula (which is equivalent to saying that profits will be received in the form of money of lower purchasing power); therefore, increase the costs of doing business (i.e., of the time factor of production); therefore, have no effect on profitability. Inflation is a poor substitute for freedom of contracts between an employer and his employees. To summarize: (1) inflation fails on its own terms as a mechanism for reducing unemployment. (2) Prices acquire meaning only in relation to each other or in participation in the totality of the web of all prices. (An unfortunate neoclassical mistake is the idea that prices measure something. They do no such thing.) (3) Inflation misallocates resources. It is grotesque to try to influence the vast abstraction of “price level” via inflation. Civilization, Richard Weaver pointed out, requires making distinctions. Laissez-faire makes them and constitutes the differentiated market body; “monetary policy” treats society as homogeneous syrup. There are only three logical causes for unemployment: 1. when the supply of labor goes up; 2. when the demand for labor falls; and 3. an ERE with unemployment, if there is such a thing, in which a considerable number of people can find, no matter how hard they try, no place within the market process.

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The first case was considered in (I, 58); the second, in this chapter. Finally, the last case is implausible without economy-wide government price and wage controls. Under free markets, the unemployed are a gold mine for entrepreneurs. The unemployed are up for grabs at bargain rates. No businessman can resist something like that. 60. THAT “FORCED SAVING” IS LESS FORCED THAN FRAUDULENT AND LESS SAVING THAN CONSUMPTION AND INVESTMENT

The Hayekian notion of forced savings must be rightly understood. It applies most straightforwardly to the modern world with its highly peculiar banking industry and this industry’s dubious concern for the property rights of its own clients. Keynes writes: “Thus ‘forced saving’ has no meaning until we specify some standard rate of saving.” (2008: 80) Very well, let me do just that. The standard rate of saving is that which corresponds to the aggregation of individual decisions of every member of society of how much of his income he wants to spend and how much, to save. But the Central Bank and commercial banks lead the people into a situation in which it appears that there is much more savings that the public actually chooses to set aside. Time preferences and interest rates are made to seem lower than they really are. The banks, by extending credit with money they do not own, disregard consumer choices. They have taken over the community’s decision of how many present goods will be available in the economy. They have despised the will of the people and in a sense trampled on their autonomy. In other words, the situation is as if the banks’ customers have loaned to the banks much more money than they actually have loaned to them. The society is forced by the nature of the banking industry without the consent of the citizens to regard their rate of savings (of that money which they put into banks) as much higher than it really is. Though this state of affairs is socially vicious, the banks themselves take advantage of it voluntarily and happily; as Rothbard writes: “The banks do not chafe under central banking control; instead, they lobby for and welcome it. It is their passport to inflation and easy money.” (2008: 134) There is a crucial and ancient distinction between loan banking and deposit banking. Loan banking is concerned with channeling money brought to the bank into loans for productive or consumptive activities, such as starting a business or buying a car. The bank lends out the money at a higher interest rate than what it pays the person who gives that money to the bank. Banks charge for their services as intermediaries or

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middlemen who connect savers with borrowers more efficiently than could be done without them. In this sense, banks are similar to, e.g., job headhunters who help companies find employees and professionals, find work. Deposit banking, on the contrary, is more like putting one’s money for safekeeping. Now it is the bank’s customer who pays the bank for guarding his property in a money warehouse, e.g., the bank’s vault. The key difference is that in loan banking, it is the bank that becomes the owner of the money, which it promises to repay the customer with interest at some specified later date; whereas in deposit banking, the customer retains the ownership rights, and to him money is due at any time on demand. Neither type of banking in its pure form is inflationary. What is inflationary, however, is when deposits are treated as loans to the bank. There is indeed a great temptation of a bank (warehouse) owner to treat them as such. In the case of commodity money, if the banker correctly estimates the amount of gold that will be redeemed, then he can print a number of fake warehouse receipts for the rest of the gold in his storage and lend them out. In so doing, he will be creating money essentially out of thin air by letting these fake receipts circulate equivalent to cash. This is how banks pyramid credit on top of deposits. Instead of keeping 100% reserves (i.e., the amount of cash in the bank’s vaults ready for instant redemption), he will be keeping less, thereby engaging in fractional-reserve banking (FRB). This is the standard way banks today operate, notwithstanding the fact that fractional-reserve banking is inherently fraudulent and is a type of embezzlement, precisely because there is not enough cash in the bank to satisfy the legal rights of all of its customers. The bank’s assets are due to it at some later dates, whereas its liabilities are in the here and now. The situation has deteriorated to such an extent that there is no longer such thing as deposit banking for money; even checking accounts today usually earn interest. Although banks, of course, still provide safe deposit services to their customers, people do not store money in their boxes but only unique valuables. Since new money at the moment of its creation may be considered to be representing banks’ own hoards, forced saving is actually forced dishoarding and forced use of deposits for consumption or investment. The money can be considered to be savings only from the point of view of the banks, whose owners are prevented from consuming the money they create but must instead loan it out: the fraud would then be too conspicuous and outrageous. This comparison bears further discussion. What if, indeed, the bankers consumed the money entrusted to them by their customers by buying mansions and yachts and jet planes? How would that be different

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from the present practice of loaning the money out at interest? In both cases, the banks, in a perfectly immoral manner, keep only a small percentage of their deposits in reserve, keeping their fingers crossed against a bank run. That bankers cannot spend their depositors’ money is an accident of law; if they could, then this would be merely fractional reserve banking taken to its logical conclusion. The answer is that though there is no legal difference, there is an ideological difference: inflationary credit expansion is thought to be in the interest of the whole society. I intend to demonstrate in this book that this ideology is false. Fisher (1926) makes a distinction between insufficiency of cash and insolvency. (43) Now it is true that a bank that is being run on may be able to sell its loans (or mansions, etc.) to another bank in order to generate quick cash. There are two situations in which this will not be possible, and insufficiency of cash will lead to insolvency. First, if credit is already expanded to its allowed limits overall, and there is no reserve left in the system to accommodate credit contraction due to withdrawals of the cash that serves as base for the expansion. However, it is likely that some reserves will exist. It seems, therefore, that second, only global distrust in the entire banking industry, wherein runs on numerous banks occur, can cause a financial collapse. This is an instance where the economic argument buttresses the moral one. Expansion of credit with money created out of thin air generates the business cycle. When there is a bust, banks’ assets become toxic, i.e., worthless. They keep fractional reserves yet are unable to convert their defunct loans into cash. It is both impossible and senseless from any (including ideological) point of view to give one or two banks the privilege to keep fractional reserves and withhold this privilege from other banks. Either every bank acts fraudulently or no bank does. In the first case, every bank is unjust to its customers. But the fact that everyone sins does not absolve any individual sinner from guilt. I will put the argument another way. Let it be objected as follows. It is true that commercial banking as a business model has disappeared. On the other hand, it is perfectly alive and well. I have a safe deposit box at my bank in which I keep my gold coins. I could easily store all of my cash in $100 bills in it, as well. If I needed then to pay my rent online, I would go to the bank, deposit the required sum from the box to the bank, go home, and make the payment. My money would thereby be 100% secure against the fractional-reserve practice. Why are not I and many other consumers doing just that? And if we voluntarily surrender to the fractional-reserve system, then where is the fraud? A reply could be that FRB is a legal “monster,” because more

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than one person become exclusive owners of the same money. But why is that important? Fraud is failure to deliver according to contract. So far, my bank, though FR, has discharged its obligations to me with admirable consistency. If Smith sells thirsty water-inflated cows to Jones, then one does not need to be an economist to smell a rat. But with FRB, one must accept the Austrian business cycle theory and have reflected on the classics deeply in order to conclude that eventual fraud is inevitable at some point in the life of a society with unsound money. One might hesitate to accuse people of serious crimes based on a roundabout story like this. Very well, allow me to rephrase. The argument becomes: FRB is a vicious economic system. It impoverishes society. As an extra consequence of this badness, it is bound to result in a cascade of fraudulent behavior by the banks. In other words, when fraud occurs, it will be not by one conman of an old lady but massive in scope, involving millions of people and billions of dollars. That fraud is veiled in economic complexity does not strip it from its essential character qua fraud as a result. The economics and ethics of banking are connected. If it were not for business cycles, the only way banks would end up committing crimes is during a nationwide bank run. That this would ever happen is implausible. However, the economic bust, itself inexorable, reveals and forces out in the open the hitherto concealed immoral conduct of the bankers. Again, the banks can be bailed out when they go bust. If the government does it, e.g., by buying banks outright, then this is socialistic. It is true that under socialism, private property rights amount to little. But socialism is dead. If the banking system is a remnant of socialism, then it must be immediately reformed as a moribund fiend. Moreover, socialism by its nature involves a grave injustice by trampling on people’s natural rights. If the Central Bank does it, countering credit money deflation with fiat money inflation, then it is both inflationary and futile. The people may get their money back this time, but (1) it will be money of lower purchasing power, and (2) the day of reckoning is merely postponed. The fraud remains. Fractional-reserve banking is extremely easy to conceive of and model. At its simplest, Smith gives $1,000 to Jones for safekeeping, telling him that he is going away for a little bit but may come back anytime. Jones promptly uses this opportunity to loan this amount to Robinson who then spends it on Brown’s goods who then spends it again on Green’s goods, etc., such that the money becomes impossible to trace. There: Jones is not just a fractional- but zero-reserve “banker.”

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Smith thinks he has the money but is mistaken. In the closed system involving only Smith, Jones, and Robinson, fraud has been committed against Smith but not yet detected by him. When Smith after a few months comes back and demands his money back, if we open this system up a bit, then (a) Jones might be able to borrow money from another banker (in the form of a true loan) to generate reserves. Open it up some more, and (b) Jones would be able to sell his asset (Robinson’s debt, future money) quickly for present money and pay back Smith. If one bank has been unlucky, and many of its Robinsons have defaulted, then it has no recourse to (b). But (a) is still available. If there is mass insolvency, then (a), too, becomes problematic: no bank can lend to another, because that will entail still further diminution of the lender’s reserves, something precisely every bank is in need of during the crisis. If mass insolvency is further augmented with a collapse of confidence in the banking system, and there are bank runs, then the final symptom of the disease appears: insufficiency of cash. In an open fractional-reserve system, the fraud is disguised, because not only does it not get detected until the collapse of the whole system, but it is not known which of the banks’ customers will get the short end of the stick. Who whom; and so much for the harmony of interests that would prevail under laissez-faire. If we define natural law for human beings most generally as “you shall not do evil,” then I admit that in the normal course of the life of a society with dishonest banking, it may be hard to conclude unequivocally that natural law is perpetually being violated, e.g., that “a bank is always inherently bankrupt,” in Rothbard’s terms (2008: 99). But positive law, defined as “you shall do good” is certainly not heeded by the legislature, insofar as FRB as a whole is anti-social. In short, I am attributing to the people an ideological naiveté (in this particular sense), failure to look after their own collective interests. This judgment is not meant to humiliate the masses, most of whom possess robust common sense. Still, for example, it took centuries fully to discredit the idea of socialism despite its intellectual bankruptcy and practical demise. It may take just as long to wean the public off Keynes. The pyramided credit can be extended either for purchasing consumer goods or for investments. Therefore, it is more “forced consuming” or “forced investing.” In other words, the banks, by creating credit, override actual individual choices over the distribution of income, their time preferences, and their risk preferences. As Jesús de Soto (2006) argues, FRB harms third parties and can for that reason be condemned.

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Keynes objects: “there is no special virtue in the pre-existing rate of interest, and the new money is not ‘forced’ on anyone…” (2008: 328) I must demur: yes, there is; because the natural rate governs the intertemporal allocation of factors of production. The “forced” rate checks the actualization in the economy of the public’s time preferences. This means that it is coercive over those preferences and therefore, hurtful to the people, as all violence naturally is hurtful. Since Keynes denies that interest rates are influenced by time preferences, he would not care for this understanding: “a forced deficiency of saving is the usual state of affairs,” (2008: 80) deficiency to be overcome by credit expansion via the state’s monetary policy or even by socialism. Recall that under modern banking, abstention from consumption (and hoarding) does not seem to be necessary for the generation of investment funds. On the contrary, investors’ requests for loans of banks call forth “savings” in the form of bank credit out of thin air. Notice also that banks are in a manner of speaking not autonomous institutions. They collectively depend on the Central Bank for the supply of money61 and on their customer-borrowers for the demand for present goods. Consider the idea of a price-taking firm, used in some textbooks to illustrate the concept of equilibrium and perfect competition. If such a firm sets a price below that of its competitors, then it will lose money; and if it sets the price above that value, then it will lose all its customers. In the real world, price-taking is a complete abstraction. A person considering where to invest studies how close each industry is to a SEQ, and how fast it is moving toward a SEQ. If an industry is showing lackluster growth, then other lines of business and other firms will likely entice him with expectations of profits. This shift in investor attention in itself lowers the equilibrating pressures on that industry. If a company finds itself a price taker, then it can exclaim, mad at its own foolishness, “That it should come to that!” A price taker in the books of the neoclassicals is uniquely helpless. He is neither an innovator nor an imitator; he does not act at all; he is not human. Not for mainstream economists is the heroic entrepreneur. They revel in the alleged irrelevance of the individual personality in human affairs. Robert Paul Thomas asserts confidently that “individual entrepreneurs, whether alone or as archetypes, don’t matter!” (1969: 141) According to Thomas, even stellar entrepreneurs are eminently replaceable. If Henry Ford had vanished in a puff of smoke in his teens, something more or less recognizably like Model T would still have been 61

Though not completely, because individual savers decide how much of their wealth to keep in the bank and how much, in banknotes.

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invented and mass produced. Someone else, perhaps only a wee bit less qualified, would have taken Ford’s place. Ford was first to sieze the opportunity and in so doing deny it to others; but if not he, then easily another man. Similarly, the reason why Ralph Rackstraw is the meanest slave that crawls the water must be that Sir Joseph Porter and everyone in between them, such as Captain Corcoran and his daughter, arrived to their positions a few seconds earlier. Had it not been for them, it would be Ralph who would be First Lord of the Admiralty. An obvious objection is that without his (alleged) betters, Ralph would be the only person on earth, and there would be no such thing as the Admiralty, Great Britain, or indeed, Gilbert and Sullivan to give him life. Imagine now 6 billion people suddenly getting worse – dumber, uglier, less loving, and less loveable than even the poor Ralph – and imagine our sailor in command of this throng of barbarians. Would Thomas be prepared to say that this society would be as successful as the present one? Now the market moves by and is lived in the lives of individual human beings. It is an abstraction in three senses. First, the market and its flux of innovation and imitation are an ideal description of real human actions. An idea, a thought are not reality. Second, the market is a universal, describing general patterns that human actions follow. For example, a summary of the Austrian teachings could be “the market provides the guidance and incentives to each person constantly to improve the way in which he serves society.” Third, incentives are created by men in their capacity as voters and are obeyed in their capacity as entrepreneurs. Smith sets up an incentive for Jones who then responds to it. The reason why economists focus so much on incentives is that those are their natural Rational-temperamental preoccupation: an Artisan agent “wants” to act, to seek his happiness; a Rational lawgiver “wants” precisely not to act, hoping that the sticks and carrots, i.e., the public promulgation of threats and promises, will do their work as expected, without anyone failing to be affected by them. The best condition of the government’s executive branch is indeed complete passivity: ideally, no one defies the law and causes investigations and prosecutions. Let it execute nothing. The outrageous statement uttered by some extreme Rationals is that the incentives in and of themselves are sufficient for the market to work and for progress and improvement to materialize. In the first place, economists unduly restrict the meaning of “incentives” to valid laws of the land. There are, indeed, the government’s “5-15 years in prison for stealing cars” and suchlike which permeate society as a whole and are the same for all citizens. But in fact, every day

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each person faces a unique set of incentives provided by the specific people and events clustering around him. Maybe Ford was dealing with an unruly nephew or suffered from indigestion, and these somehow sneakily in many various ways contributed to his success as an entrepreneur. Ford was uniquely positioned in his life. We can further define personality in an economistic way as the precise mode or fashion in which an individual responds to incentives or would if placed in them. If the price of widgets went down by $2, then Smith would buy 2 more, and Jones, 4 more. This difference reflects what sort of people they are. Ford then also had a unique personality. Moreover, both the external circumstances and one’s personality change every day. It may be argued that there is a wide set of pairs that would behave identically. How should we evaluate this claim? Four possibilities present themselves. 1) There were 1 million actual contemporaries of Ford who would have duplicated him had he not lived. Smith1 would have replaced Ford; Smith2, Smith1; Smith3, Smith2; and so on in a very long sequence. This seems deeply implausible. Even Smith1000 would likely not have produced a car that would rival Model T. 2) There were 100 actual people who would have taken Ford’s place with little damage to society. This is the most speculative claim, and I have no opinion on it. 3) There are presently 1 million people who, had they been placed in Ford’s circumstances, would have done as well as he did. Let me suggest that there is a bell curve of human achievements. On the low end, for unskilled jobs, say, chopping wood or whatever, there would be numerous people who could replace the person but would not want to. On the high end, say, for Ford, there are numerous people who would want to replace him but could not if they tried. In the middle (picture some paper-pushing middle manager), numerous people both could and would replace him. If I am right, then (3) is false. 4) The number of such potential replacements is around 100 in the entire world. This, finally, seems like a reasonable statement. Take the present heads of the Fortune 100 companies; I see no reason why they could not replicate Ford’s success if carefully set up and led. However, this does not diminish Ford’s glory for two reasons. First, 100 out of 6 billion is still a tiny number. Second, these people are scarce and needed where they are, anyway. There is no one to spare to replace Ford. Think of it this way. If Ford is pushed out of existence, and his

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company never gets started, then let us say society loses 1,000 utils of happiness. If the replacements occur, with Ford’s next best X replacing him, X’s most suitable successor Y replacing X, Y’s second-in-command Z replacing Y, and so forth, then each of these 100 companies, now in the hands of a slightly inferior leader, will deny 10 utils of progress to society, with the overall damage remaining, however, at 1,000. Regarding equilibrating entrepreneurship, there is rarely cash on the table, i.e., unseized opportunities, for long. Being an entrepreneur is attractive to people because it allows them to make money without laboring. Equilibration is even more fun, because one does not have to think too hard, either. But regarding disequilibrating entrepreneurship’s creative advance, there is always cash on the table lying there for undetermined periods of time in a vast variety of forms. Which “opportunity” will be taken, when, and how, which particular distinctive shape economic progress will take depends precisely on each individual’s personality and circumstances. As argued in (I, 10), “opportunity” as such is not something that exists independently of being seized by someone uniquely positioned to seize it. Yet again the failure to compare and contrast the participants in the economic battle of the sexes leads some economists to dismiss their hard-to-understand temperamental opposite. Again, a distinction must be observed between discoveries and creations. Newton’s laws of motion have “always been there,” and it is indeed likely that they would have been discovered by someone at some point. If not Newton, then someone else sufficiently intelligent. But there is no sense in which a business has always existed. It is built or created from ground up, formed from raw matter. It is a veritable extension of the personality of its creator, the entrepreneur. It is true that the consumers ultimately determine the course of production. But they are passive, ranking only definite entrepreneurial attempts at producing things. No consumer ever tells any individual to go into business and manufacture such-and-such good X. The consumers hope that the incentives of capitalism will be sufficient to ignite human creativity and bear actual fruit. Economists study and propose the general incentives. Entrepreneurs, responding to these incentives, come up with particular products. In so doing, each business owner puts upon his entire firm an indelible mark of his personality. What is produced, how, the marketing, and management style – our semi-holy quadriformity – are determined by him. A sculptor, in Rothbard’s words, “places the stamp of his own person on the raw material, by ‘mixing his labor’ with the clay.” (1998: 48) But the differences between entrepreneur and artist are inessential. Like a sculpture, a business firm is selfexpression. In fact, the very success, or rather victory, of an entrepreneur

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has this entrepreneur’s personality as first cause. He wins and garners profits precisely because ultimately his spirit is in some sense superior to those of his competitors. The “clay” is mostly the same for all. The richness of his surroundings matters, too, in terms of the inchoate “opportunities” extant therein, but those resolve basically in the generic “moderate scarcity.” The entrepreneur’s unique abilities are far more significant. Again, an opportunity is not “out there,” as though an “autonomous individual” were free to pick it up at will and at leisure, such that even time is of no account. There is no such thing as methodical and thorough scientific testing of the market to determine the next step. What is profitable for Smith depends intimately on what every other entrepreneur in connected markets does. The “opportunity” uncovered by Smith has originated from and been shaped by the actions of Jones, Robinson, and the rest of the bunch. If Smith fails to be “alert,” then this opportunity will disappear tomorrow, to be replaced with something brand new. It is wrongheaded to say: Here is an objective opportunity; put any man with sufficient intelligence in its vicinity, and the opportunity will be exploited. The economist cannot even identify an opportunity in isolation from any particular living and breathing Smith who has taken advantage of it. He cannot even say: Smith got rich by selling X; anyone as smart as Smith would have done the same. Personality is rather more than, and cannot be reduced to, raw IQ. The person who would have done the same as Smith is simply the exact copy of Smith in every respect. QED: Smith is irreplaceable. Opportunities then are transient, man-made, man-taken, and man-destroyed. There is not even such thing as mass production: there are under capitalism vast opportunities for individual production that make possible mass consumption. Production may be for and even of the masses, but it is by individuals. It may be noticed with some venom that I seem to be moving from one extreme to another in considering an entrepreneur to be at one time a hero, and at another, a coward. On the one hand, a student of history may come away from his studies with the idea that the best way to be noticed by historians is not through something like Christian glory but through worldly notoriety. One must be a tyrant, a conqueror, an expropriator, an empire-builder through endless wars. If he likes, one can also be a socialist, an inflationist, a taxer, a welfare-state builder through endless interventions. In short, the way into history books is found by making large numbers of people miserable or by slaughtering them altogether. An entrepreneur,

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whatever his moral stature – and it varies tremendously from person to person – at least brings happiness to his fellow men. A great entrepreneur does so on a large scale. That I consider heroic. On the other hand, an entrepreneur is driven by one powerful desire: to be liked and to be popular. A big company wants most of all the good will of the folks it serves. Walmart generally cowers before every despicable decree issued by the state, because it thinks that by doing so, it can win the gratitude and acceptance of the “people” in their capacity as legislators and through that, the people in their capacity as customers. In any case, look, what is it supposed to do in the face of a threat of state violence? Rebel by packing their things and going on strike? It has numerous competitors who would love that. Walmart is a public company, and its shareholders would let it know pointedly and immediately what they thought of an action like that. Even workers, when they strike, do so together, en masse. But a coordinated nationwide entrepreneurial strike is both implausible and irresponsible, insofar as businessmen must continue to serve the consumers through thick and thin. Ultimately, that entrepreneurs rarely challenge authorities is a red herring. People are deluded in thinking that they are “soaking the rich” or sticking it to “big corporations”; in the long run, by hampering the ability of businessmen to produce, they are only harming themselves. In sum, then, entrepreneurs are indispensable both as archetypes and individually. Neoclassicals always refer to “impersonal market forces.” There are three ways of interpreting this idea. First, that the market does not respect persons. In buying from Smith, I do not care who Smith is, what kind of person he is. He may be a saint, but if Jones the sinner offers me a better deal, then I will buy from him. In this sense, the market may be called impersonal, because it assists humans in their search for narrow happiness rather than search for virtue. (On the other hand, family and even local community respect persons intensely. If John is your child, then he is not interchangeable with any other child. Same with Smith who is your friend and Jones who is your neighbor, such that perhaps your and Jones’ children play together.) Second, that the market is “automatic.” This conflates physical causation with teleological causation. Mises points out that in the market, “there is no automatism; there are only men consciously and deliberately aiming at ends chosen. There are no mysterious mechanical forces; there is only the human will to remove uneasiness. There is no

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anonymity; there is I and you and Bill and Joe and all the rest. And each of us is both a producer and a consumer.” (1996: 315) Neither the entrepreneurs nor the market as a whole are machines. The regularities and economic laws of the market process arise due to human actions not robotic actions. There are manifest consequences of the fact that human beings make choices, but the science that studies such consequences, praxeology, is distinct from physics. Teleological causes produce definite effects, but they do so in ways that are different from the operation of a mechanical device. Third, that both the abstract laws of functioning of the market process and its concrete content are impersonal. I have argued that this proposition is false and that the role of individual personalities in building up a civilization is crucial and indispensable. The market is not impersonal in the latter two senses. Recall that firms compete by (a) developing new products and (b) lowering costs of production. (a) splits into (a1) actual goods and services and (a2) marketing, branding, advertisement, creating goodwill – in short, every way of exciting consumer interest for (a1). (b) can be effected by means of (b1) cheaper factors or (b2) cheaper or more efficient techniques. (b2) can, in its turn, be subdivided into (b2.1) building things and (b2.2) managing people. To get back to our main topic after this rather lengthy introductory discussion, in most industries (e.g., phones), both (a) and (b) take place; in an idealized wheat industry, say, competition occurs through (b) only. But in money creation, there is neither (a) nor (b). One cannot improve upon a number in a database that signifies account balance, and the cost of producing money is zero. (Though banks can improve their discernment of more or less creditworthy borrowers.) Now phone vendors sell phones, and wheat farmers sell wheat, but banks sell not money but “time,” i.e., instant gratification. Nevertheless, given also that the amount of money that banks can create is limited by their reserve requirements, i.e., by law, if one bank fails to expand credit to the max, then the interest rate will rise only by a negligible amount, which means that banks are determined in the quantity supplied of money: their individual profit maximizing strategy is to expand in such a way that the overall group expansion is by the entire money multiplier (equal to one divided by the reserve requirement ratio). On the other hand, the interest rate depends fully on consumer demand, such that that rate must be discovered by the banks, at which all the new money finds borrowers. So, banks are price takes, as well.

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61. HOW BUSINESS CYCLES OCCUR, PART I: INTRODUCTION The business cycle I am interested in explaining is not one of the many benign cycles such as seasonal fluctuations in business activity; or the coming and going of holidays; or those that can be attributed to unique though possibly repeatable events like wars or natural disasters, in which the alleged boom is simply the process of long-term growth unfortunately interrupted. Nor can “creative destruction” be likened to a business cycle, as Schumpeter apparently believed (2008: 83n), the creative part being the boom, and the destructive part being the bust, because both disequilibrating and equilibrating kinds of entrepreneurship are, when successful, socially virtuous, moving resources to their most valued uses; and moreover, the creation and destruction occur at the same time. It is equally implausible that any technological improvement, no matter how groundbreaking, can raise the economy of a nation or the world as a whole to dizzying heights of fruitless onanistic activity and then plunge it down to terrifying lows. A new and promising technology can cause minor overinvestment, such that a number of goods produced will fall through the cracks due to intense competition and have to be disposed of below costs. This, however, is merely the daily yang and yin seeking balance. A boom is like agitation due to a mental illness; excitement over an interesting method of production is like jitters from drinking a little too much coffee. The former is dangerous to health; the latter is not. Things like Kondratieff cycles are mystical hand-waving; no credible cause has ever been given for them to occur. Nor, again, can a surge in investment at the expense of present consumption be a cycle, with the increase in production a boom, and the time after the consumer goods mature a bust, because it is not a cycle at all but secular growth. What I have in mind are endogenous within the political economy man-made cycles that viciously misallocate scarce resources and impoverish society. The cycles are due to a kind of human self-hatred, self-condemnation, in which a community (i.e., a people under a government) deliberately wills evil to and harms itself; and identifying business cycles is essentially a study in man’s self-destructive behavior as expressed in the process of production and in legal institutions, especially as government against the economy. The boom, though seemingly a happy time, is an illusion; it constitutes not sustainable growth but wasteful use of factors of production. Numerous projects are started, most of which have no chance of being

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completed at a profit (though this is not apparent during the boom) and will inevitably be abandoned halfway through. The boom is bound to be revealed as uneconomic, be reversed, and result in a recession and painful readjustment of labor, capital, and land. This cycle is fundamentally injurious of prosperity; moreover, the entire cycle is a to blame for malinvestment and similar ills. It is not the recession that is to be feared; the preceding boom itself should be avoided, if economic destructionism is not to commence. In (I, 43), I identify three kinds of interest rates: the originary “pure” interest rate or OIR, the “personal” interest rate or PIR, and the loan market “equilibrium” rate of interest or EIR. The first two are different for every person, while the EIR has the tendency to be the same for everyone. I claim that the business cycle originates with credit expansion primarily through the Central Bank’s easy money policy and the practice of fractional reserve banking. Exactly how the process of money creation works is explained in full detail in Rothbard (2008) and Jesús de Soto (2006). It is fraud on the scale of trillions of dollars raised to an art form. The basic sequence is this. First, the Fed buys an asset (Rothbard’s desk in his example) on the “open market,” gives the seller a check, and this way new fiat money is created. Second, the check is deposited into a commercial bank, and the bank pyramids new credit money on top of the new reserves. This second stage lowers the interest rates. However, Dudley Dillard (1948) argues that the creation of fiat money, too, has the power to lower interest rates. For if the Fed buys bonds (government or corporate), then it bids up the prices of those bonds. But higher bond prices entail lower interest rates. Is he right? Certainly not. For example, government debt is continuously monetized; the very fact that the Fed stands ready to buy this debt presents an incentive to the government to borrow from the Fed. The Fed does not buy bonds for income or to speculate on the bond market but in order to facilitate fiscal and monetary policies. It is not the case that there is a limited amount of bonds out there, and when the Fed buys them, it raises the demand for them and ups their price. The Fed’s demand triggers the government’s supply, for which the costs of production are zero; and when supply increases, bond prices drop, and interest rates tend to rise. Overall, no predictable effect occurs. What happens is that banks end up having at their disposal a great deal of money, far more than is actually saved. Since they cannot consume this money, and since their business in their capacity as loan institutions (again, keep in mind the distinction between loan and

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deposit banking) consists in lending at interest (greater than that which they pay to their own lenders in order to make a profit), the economy becomes awash with credit. This lowers the EIR and increases quantity lent / borrowed without, however, changing the PIRs of the general public. This is an essential observation, because normally the changes in the EIR are a consequence of PIRs fluctuations.62 Lowering the EIR through the monetary policy bypasses the “free market” channel of lowering it and for that reason has profound consequences. The evil of credit money inflation was clearly understood even in the 19th century; e.g., Marshall (1964) fingers “the instability of credit” as the culprit behind “introducing disturbing elements into modern industry,” (573) going as far as to say that “reckless inflations of credit” is “the chief cause of all economic malaise.” (591) For example, the “swollen tide of credit, which culminated in 1873, had undermined solid business, impaired the true foundations of prosperity, and left every industry in a more or less unhealthy and depressed condition.” (478) When Hayek writes that “in a money economy, the actual or money rate of interest… may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks,” (2008: 215) he confuses the issue. Interest rate as a percentage value is in this case expressed as a ratio of two amounts of money and in a state of equilibrium. Though the natural rate is determined by the synthesis of individual PIRs, this rate cannot be known; it is merely the price that would prevail under 100%-reserve banking. Therefore, we are dealing here with a contrast between a PIRs-only-determined equilibrium rate between the demand for and supply of present money in terms of future money and a PIRs-and-banks-determined such equilibrium rate. For example, let the natural EIR (i.e., the EIR that would prevail without credit expansion) be 15%. It is lowered first to 7% and then to 3%. Let the PIR of both Smith and Jones, that is, their rate of discounting the future, be 6% (per year). Smith, let us suppose, perceives a business opportunity that will yield to him a return of 5%; Jones can invest at 12%. Thus, we have 3 (e1) < 5 (iSmith) < 6 (p) < 7 (e2) < 12 (iJones) < 15 (e3). At EIR = e3 both Smith and Jones will be lenders; at EIR = e2 Smith will lend, and Jones will borrow and invest; at EIR = e1 Smith will 62

Changes in time preferences are not the only reason for changes in the intertemporal allocation of resources, but it is sufficient for my purposes that they be acknowledged as one such reason.

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borrow and consume, and Jones will borrow and invest. As such, as the EIR drops with most people’s PIRs remaining the same, there will be both more consumption and at the same time more investment. But this is contrary to all reason. Investment into longer production processes with the purpose of creating more future goods must occur at the expense of consumption or the happiness resulting from obtaining the present goods. In this normal case, resources are reallocated from relatively short and already existing processes into those longer processes, as marginal companies with the short production structure shrink or go out of business due to lower consumer and derived demand for their products. In so doing, they release their factors of production which are moved into (that is, bought by) firms that are undertaking projects that take a longer amount of time. The lower interest rates (both the PIRs and the EIR) signal the new producers that the consumers are more willing to wait relative to the previous state of affairs. The incomes to the time factor declines, reducing the cost of doing business to time-intensive projects. Business cycles arise as a medium-term consequence of credit expansion. While wages and prices are still low, the new money obtained by freshly minted entrepreneurs is used to slurp up the factors of production. In response to this outrage, consumers, the firms operating in the late stages of production, and the factors employed in those stages are stupefied. “Wait a minute,” they say. “We do not remember authorizing you to take these factors off the market for your own use. We want them back, because we want to consume now and are not, contrary to all appearances, willing to wait until your (admittedly more productive) projects are ready.” This marks the second part of the business cycle, introduced after a period of time, which might be called “Consumers Strike Back.” As the new money spreads to the factor owners, those owners bid on the consumer goods, causing their production to become profitable again. This means that the factors of production can be lured back into the short processes which raises the prices of the factors. It becomes obvious that there are too many disequilibrating entrepreneurs in business, demanding scarce resources, and only the best of them can succeed. The others have no choice but to go bankrupt. There are not enough complementary factors of production to satisfy all entrepreneurs. These factors are too scarce and become too expensive for all the projects to be completed at a profit. Cochran writes: “It may, at first, seem paradoxical that the concept of equilibrium would be viewed as the proper tool for the study of

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what are disequilibrium phenomena…” (1999: 160) In the first place, “disequilibrium” is defined as lack of equilibrium; hence, in order for the first term to be of any use, “equilibrium” must mean something and be relevant to the problem, too. Secondly, it is not at all paradoxical if we approach this study my way, namely, by looking at how intensely an initial ERE or a laissez-faire economy not racked by earth-shattering exogenous shocks (such as literal earthquakes) is disturbed by drunk-withcredit disequilibrators during the boom. If the monetary and on its heels real disturbances are too great, then unpleasantness ensues. Stated differently, credit expansion is an attempt at magic, that is, at trying to get something from nothing. Now in response to the argument that most plant and animal species that have ever existed are now extinct, some “environmentalists” answer that, unlike most times before human beings, we are experiencing now a man-made mass extinction. Whatever the merits of this reply, the (perhaps, somewhat strained) analogy with respect to trade cycles is that what happens is a war between the factors – other than time: capital, labor, and land – which numerous companies are earnestly trying to use in both short and long projects, as demand seems to tell them. Their prices rise rapidly, demolishing the expectations of profits. This is not normal entrepreneurial competition but rather something quite unique, namely, a mass failure. This phenomenon may be called malinvestment or overconsumption. But these terms specify the winner in the marketplace, namely, the present producers, whereas it is impossible to tell whether the longer or shorter production processes will end up being more profitable (offsetting the rise in the prices of the factors). The best way to put it is that during a boom the production structure is being stretched or torn apart. Credit expansion takes the economy away from its production possibility frontier. As soon as the happy entrepreneurial forecasts by everyone involved into the boom, whether the established producers or the eager newcomers, are revealed as faulty, present mass losses both (1) result in and (2) are exacerbated by low confidence and insecurity and inaugurate the end of the boom. (Losses both feed and are fed by pessimism.) The bust or depression is the process of cleaning up the mess. There are two components to credit expansion: (1) money supply inflation followed by price inflation and (2) lower interest rates. They are individually necessary and jointly sufficient for the business cycle to arise. Lower interest rates without inflation may be a normal situation of an increase in the supply of genuine savings created by abstaining

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from consumption. Inflation without lower interest rates would be a simple transfer of money income and wealth bought with its help from the last recipients of new money to that money’s first recipients. But the two together cause the mischief known as the business cycle. In the simplest of terms, inflation stimulates consumption; credit expansion stimulates production. More elaborately, banks create credit out of thin air. This lowers the interest rate from i1 to i3. In response to the lower rate, the people save less, raising the rate to i2, such that i1 > i2 > i3. They redirect these savings to consumption. As a result, there is more of both. However, these are contradictory impulses that cause the productive forces within society to clash with and exhaust each other. The increase in both investment and consumption in money terms is an “absolute” effect. There is both over-investment and overconsumption. The fact that the over-investment is induced by the Central Bank policy and is contrary to the interests of the consumers – who will not stand for it for long and will bring about the bust – qualifies to call it “relative” mal-investment or un-utilitarian misallocation of resources. Skidelsky argues that Keynes endorsed budget surpluses to restrain demand when needed. Moreover, “an important contribution of Keynesian fiscal policy to the golden age was to keep inflation under control by methods which did not bring about the collapse of the boom.” (2010: 127) So, the banks, both Central and commercial together, start a boom by inflationary credit expansion. One way to avoid a bust is somehow to defuse inflation. Enter Keynes’ government budget surpluses. The government taxes and hoards in order to drain or mop up the excess money that would otherwise be consumed. Investment is stimulated, but consumption does not pick up. We have a virtuous sustainable boom! Think about the delicious irony. First, the Austrian business cycle theory is implicitly accepted. Second, the crude economy-wide policy instruments are substituted for a subtle aggregation of numerous individual decisions of how much money to consume, invest, and hoard. Finally, even if the policies work perfectly, and the bust is avoided, the people are harmed, because the state rides roughshod over their time preferences. The masses of people, in their capacity of consumers and savers, would prefer one rate of growth, but the state forces on them a different rate. We must judge the coerced boom to be detrimental to the happiness of the commonwealth. When I say that credit expansion begets business cycles, I can mean several things. First, that credit expansion due to a change in the law that required 100% reserves to permitting fractional reserves will

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trigger a boom. Second, that creation of fiat money by the Central Bank will also result in more credit expansion and in a business cycle. Third, that the state of affairs of credit’s being expanded is, though a background condition of the economy and present in both booms and busts alike – though crucially to a different extent – will cause a steady series of booms and busts. This condition is like a sea on which a boat, i.e., the economy, wobbles from side to side: a boom is created when the waves and the wind move the boat in one direction, and a bust results when the boat under its own weight rocks back in the other direction. Now credit expansion increases the supply of credit, but once its inflationary consequences have worked themselves out, the demand for credit rises, as well, because everything is now more expensive, thereby raising the interest rate back to its natural rate. At first glance, this would seem to exhaust the effects of cheap credit. However, credit is expanded in a boom and contracted in a bust. Both conditions are thereby fulfilled: in an expansion interests rates are still grotesquely low, and the bouts of inflation continue unabated made possible by bouts of deflation that precede them. 62. BUSINESS CYCLES, PART II: A CONSUMPTION BOOM The inner cause of the business cycle is the divergence between the personal and the equilibrium interest rates, artificially brought about by credit expansion. For illustration purposes, let the PIRs cluster around some huge number such as 50%, and the natural EIR be somewhat close to that. Considerable fiat money inflation has enabled banks to flood the economy with cheap credit, resulting in the lowering of the EIR to 3%. An enormous amount of cash must change hands in order for that to happen. Given the high time preferences, most of that money will be spent on expensive consumer goods such as houses, in so doing causing psychic profit for the borrowers. For, ex hypothesi, most people are unwilling to part with their present goods except for the sake of an extremely high return in the future, which is why they will tend to borrow quite a lot at mere 3%, which they will spend on their own pleasures. Bubbles occur when the borrowed money goes into a particular sector of the economy, such as technology stocks (in which case we are dealing with an investment boom) or real estate (which gives rise to a consumption boom which is the subject of this chapter). The key variables are (1) who gets the new money first in an

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inflation and (2) how this money is spent or invested. It is likely that there will be a bubble somewhere, as some sector of the economy is bound to exhibit more activity than all the rest, and it is that sector that will burst first, paving the way for general depression. Consumer non-durables, including “necessities,” are bought habitually, constituting autonomous consumption that is somewhat more independent of income. During expansions, income to factors of production increases, and people consider this to be “found money,” due to fortune, something above and beyond the level of their permanent income, something that will not last. Perhaps, people are now better able to spot the booms. Therefore, consumer durables are wont to be more in demand at that time. Houses could host the bubble, because houses generally tend to appreciate in value, unlike, say, cars – in particular, they straddle the line between durable consumer goods and investments; because to evaluate them requires only average competence, unlike, say, artwork; and because they are big ticket items: most people need to borrow money in order to buy houses, the very activity that credit expansion stimulates. In addition, the housing market has inelastic supply, which means that an increase in demand will significantly raise prices. This contributes to the bubble. At the same time, I must object to “theories of consumption” on Austrian grounds. Just as the Keynes’ “psychological law” is neither, so postulating patterns of consumer expenditures is futile. Consumer desires and spending are simple and atomic ultimate givens, not amenable to any analysis. That Smith spent his bonus on a new car today does not mean that he will spend his next-year bonus on another car, another consumer durable, or anything at all rather than save it. Nor does it mean that Jones will mimic Smith in his purchases. Sometimes I wonder whether the neoclassicals have lost their minds when they assume that “given an individual’s education and wage history, expected income over that person’s lifetime should be stable.” To be sure, Hall adds that this is so only “barring unexpected events like an accident that causes permanent disability or being discovered by a television producer to star in a soap opera.” (1990: 57) But every human life presents to its owner both numerous pitfalls to be avoided and numerous opportunities to improve his well-being and income in particular to be seized. That is the veritable essence of living! Carpe diem and all that, after all. Life is an adventure or should be; unforeseen “accidents” are an inescapable feature of everyday life, and one “discovers” something new within and without himself all the time. No predictions of Smith’s future destiny can be made by an economist even

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after a thorough scrutiny of Smith’s life up until now. How sad at the same time that very apropos disappointment in the neoclassical synthesis drives some people, such as Robert Skidelsky (2010), into the arms of Keynes instead of Mises. If much of the new money goes into houses, then housing prices and the prices of the factors that enter into constructing those houses will increase and eventually go sky high. They will go up in the first phase of the cycle until the point where (a) it is no longer profitable even for people with extremely high PIRs to borrow even at an extremely low EIR such as 3%. This event is fully in accord with the law of marginal utility: the marginal present dollar loses utility as present goods are obtained, while the marginal future goods sacrificed increase in utility as debt accumulates. Given the very large spread between the two kinds of interest rate in my example, housing prices can go from mere hundreds of thousands of dollars to millions or even tens of millions of dollars. This is “demand-pull” price inflation, just as in an investment boom, to be investigated in the next chapter, there is “cost-push” inflation. During the evolution of the bubble, there will arise three classes of people. First, those, call them the “consumers,” who will create the time preference boom and borrow all the money. This class will be extremely sensitive to changes in the interest rate. Second, there will be the “speculators” who add fuel to the fire. They speed up the rate at which the bubble inflates. The third group is the “investors” who most naïvely believe that there is no such thing as the bubble, and that the prices of their houses will appreciate forever. They, as well as the relatively incompetent speculators, are the main victims of the successful speculators. The boom is started by the consumers, continued by the investors, and spurred on by the speculators. It is true, of course, that no one will borrow more than what he can pay in interest: if a mortgage worth $1,000,000 is taken out at 7%, then the owner had better make at least $70,000 a year, much more, if he is required to repay the principal at the same time. (One can rent the house, of course, but at such prices, finding customers may prove difficult.) There is nothing economically wrong with being “house poor” or with speculating. But my example assures that even those who earn close to that wage may decide to borrow great amounts of money: the temptation is too strong with their time preferences so high and the EIR so low. The bust due to the popping of the bubble can occur in three ways. First, if there is, in addition to the bubble in a specific sector, general price inflation elsewhere in the economy. The new money will spread there as house sellers and speculators spend their profits on other

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goods. In that case, three causes will cooperate to bring about higher interest rates. First, actual inflation will raise the demand for credit. Second, expected inflation will prompt lenders to raise the EIR in order to recoup the losses associated with the lower purchasing power of the money with which loans are repaid in the future. Third, the Central Bank may tighten the money supply in order to cool off the economy, initiating credit contraction and therefore, lower supply of credit. At this point, there are two possibilities. If a consumer obtained a variable-rate loan, then his monthly mortgage payments hit the roof immediately, and he is forced to get rid of a house at a loss. If he, somewhat more luckily, has a fixed-rate loan, then it makes no sense for him to continue paying for an asset that is now worth a fraction of its previous value. He may end up abandoning his house and moving far, far away. Second, if there is a depression in the economy that is occurring for reasons other than the bubble. Companies will be closing, and employees will be losing their jobs which will cause people to be unable to meet their obligations to their lenders. Third, even if all the new money has temporarily gone into houses, then for a while, as prices climb upward, it is possible to buy a house and profit by reselling it later. At some point, namely, when borrowing has diminished, because it has reached the limit indicated in (a), however, the consumers stop buying, though their actions have already raised the housing prices considerably. But speculating has not ended, and moreover, the investors continue buying, still banking on an upward trend in housing prices. The investors almost willy-nilly become caught up in the consumption boom, even when the latter has run its course. The reason is that it is never clear exactly when the consumers have had enough, and the boom continues on its own inertia even after the prices, by all reason, should have reached their zenith. But as prices go up still more, even investors become more cautious. The speculation tapers off and fizzles out when it becomes clear that no speculator can pay the premiums, even at the EIR = 3%, and again, no inept speculator or investor can get rid of a house at a profit (all the suckers have wised up). Housing prices collapse to the level at which they can again be consumed and soon enough below that value, as per the first two ways. Good investors have left the market in time; the current owners end up holding assets, for which they paid a very high price, and of which they could dispose only at a deep loss. The banks lose enormous amounts of money and curtail lending and raise interest rates which drives the prices even lower. Either way, we will have the beginning of a bust.

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It will be instructive to discuss Paul Davidson’s account of the housing bubble. He defines something called “orderliness” which is some arrangement to “convince holders of the traded asset that they can readily liquidate their position at a market price close to the last publicly announced price. In other words, orderliness is necessary to maintain liquidity in these markets.” (2009: 86, italics removed) He and I are in full agreement that surprises in the life of an entrepreneur happen as a matter of course; more generally, that the future is uncertain; and that therefore, assets are never fully safe. But the conclusion he draws from this metaphysical condition is erroneous: “the primary function of financial markets that trade in resalable assets is to provide liquidity.” (2009: 88) In fact, the primary function of financial markets is to guide ownership of real assets, capital goods, commodities, land, and so forth into the hands of those who will be most capable of using these things for serving consumer welfare. I agree with Davidson and Keynes that “a capitalist system needs liquidity to function.” (2009: 104) But I deny that liquidity is something imposed on the free market from the outside, say, from the non-market Central Bank or the government. Liquidity is an attribute of any piece of property when it is somehow in demand. It is simply the ability to sell an item for money. There is nothing that ties liquidity to financial markets in particular. Whether a thing is liquid or not at a given price is determined by the interplay of supply of and demand for that thing. Now to be sure, if nobody is buying or selling anything, then there is neither market nor social cooperation. But such a state of affairs is deeply implausible. Division of labor ensures that exchanges will continue to be made forever. I also realize that it is an important problem for those who run a trading floor how efficiently to put buyers and sellers, merchants and customers in touch with each other. But whether the solution is an ancient bazaar or modern online trading, this is merely a technological problem not an economic one. Davidson claims that the problem with exotic derivatives that were traded during the housing boom was that highly individualized mortgages were combined, divided, packaged, and sold as generic securities, such that “there was no possible way that investors or rating agencies could evaluate the worth of financial assets that combine many mortgages into one investment vehicle.” (2009: 99). Here, as in a number of places in his book, Davidson ascribes irrationality to market agents. Why would people buy stuff whose return on investment they cannot even guess? My answer is that investors did evaluate the securities quite

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competently but counting on the continuation of the boom, were hoping to beat the market, namely, to escape before the bubble popped. Once again, this behavior is individually rational and unavoidable. Stupidity of investors cannot be an explanation for the housing bust, because a bust requires mass stupidity, mass errors, and there has to be a cause of such universal delusion. That millions of people simultaneously made numerous entrepreneurial errors is implausible, unless there was an institutional factor that somehow deceived all of them. At any rate, there is a simpler and this time decisive objection to Davidson’s argument. Does he not realize that every stock is individualized, as well? Every company is unique. Yet mutual funds that combine various amounts shares of numerous corporations thrive and receive no condemnation from our author. The securitization of mortgages went bad because of the business cycle and the particular form that the consumption boom took, not the other way around. Ordinarily, there would be nothing wrong with such an innovation. Liquidity has a common meaning for all goods: an asset is liquid, only if it is a good store of value. It either appreciates or at least is not subject to inflation (if it is money) or keeps up with inflation (if it is a good). Liquidity for money then means safety from inflation and from collapse of the government that prints this money (which entails the loss of this government’s ability to prevent counterfeiting and enforce legal tender laws, in which case the Gresham’s law no longer operates, and good money displaces bad). In (I, 57), this was labeled q. It also has an extra meaning for goods other than money, namely the ease of their convertibility into money, or l. A rare artwork may be “priceless,” but if finding a buyer at the preferred price is time-consuming, then the artwork is not necessarily liquid. A complication is that there are numerous national currencies. This can make holding a stock, say, safer than holding a particular government’s money. This is because the stock can be sold for any currency, yet the government can inflate its own cash away. Finally, degree of liquidity includes carrying costs, c, i.e., the extent to which the good decays in a hoard. In short, liquidity is measured by q – c + l. It was exceeding clever of Keynes to define it this way. In the first place then, an asset can lose “liquidity” if there are no buyers for it at the price that the seller would prefer. Of course, the seller would prefer to sell at as high a price as possible. If an asset becomes “toxic,” then the seller has to lower his asking price. Why is that perfectly ordinary market situation somehow beyond the pale for Davidson? Suppose further that I am a buyer of securities and would like to buy at a low price. However, the asset is expensive, as I judge it, and

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I choose not to buy. Is this situation abnormal, as well? The point is, there is symmetry between buyers and sellers. Davidson would arbitrarily privilege the sellers relative to the buyers by having the Federal Reserve, say, stand ready to buy their junk whenever they cannot find customers for their securities. Now to this Davidson might reply as follows. “Buyers are themselves ‘by nature’ privileged relative to sellers. The former have perfectly liquid money; the latter, much less liquid assets and property. My aim,” he would continue, “is to equalize the system, so that sellers enjoy the same power over their assets as buyers do.” I am afraid this will not do at all. The things that buyers and sellers hold are not identical except for their degree of liquidity. Money is just a medium of exchange; stocks are claims to real property. The former is liquid but useless in itself; it does not even earn interest. The former are, indeed, less liquid but can increase in value. The trade-off cannot be avoided. Any investment is risky and uncertain but possibly profitable, to which an alternative is to hold money which is safe but unproductive. At any rate, if the Fed or the government routinely props up the prices of assets, then we are no longer dealing with a free market but with a socialist system. The buyers have a diminished incentive not to make mistakes. If the Fed can print up trillions and buy all the worthless assets, then the entrepreneurial capitalist system actuated by the stock market ceases to exist. “Illiquidity” is simply a condition of an investor’s having made an entrepreneurial error in his trading. It happens all the time, is perfectly normal, and the market has a way to deal with such miscreants by taking their money away from them. Without this natural punishment, the stock market is a socialist joke. Davidson goes on: “The central bank can either directly or indirectly make the market for securities by reducing the outstanding supply of securities available for sale to the general public. The public can then satisfy its increased bearish tendencies by increasing its money holdings without depressing the market price in a disorderly manner. Until, and unless, the public’s increase in bearishness recedes, the central bank and the market makers can hold that portion of outstanding liquid assets that the public does not want to own.” (2009: 91) Now as of the moment of this writing, I have an old printer that I would love to get rid of. Unfortunately, it is “illiquid,” which means nothing more than that I might not be able even to give it away. If Davidson has his way, then, if I had any political clout, then the Fed could bail me out by buying the printer from me. Is our author willing to go that far? What can happen is that the companies being traded can go out of business altogether and the Fed will still be buying their trash at high

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prices. Whatever Davidson’s scheme is, it is not capitalism. In simple terms, if I am assured of profits for the low-quality junk that I produce, then what will be my incentive to improve my service to the consumers? A thing is illiquid for a reason. But what is Davidson’s rationale for bidding the authorities to buy stuff that nobody wants? It is to avoid “deflation” during a recession, to prop up prices of companies “too big to fail,” regardless of how toxic their assets become. He wants to pull the wool over the eyes of the people, to mislead them into thinking that the boom is not over, that resources have not already been severely misallocated. Davidson dares to say that the “determination of the price” at which the government should buy the toxic assets is “beyond the scope of this book… Clearly the price should not be so low as to cause a collapse of the entire banking system, nor should it be so high as to reward management and stockholders despite their errors.” (2009: 100) In other words, this price is arbitrary, and such questions are “political rather than economic ones” anyway. (2009: 104) If I may continue his line of thought, perhaps the price should not be so high as to cause the present political regime to lose power in the next election from irate voters who will rightfully smell a rat. How irrational is that? Davidson reads like a dictator. We must “shut down financial markets that do not have a market maker institution.” But, he himself objects, this will cause investors to go abroad in search of higher profits. Very well, “a modern-day version of the Keynes Plan would prevent U.S. residents from trading in foreign financial markets that the United States deemed detrimental to American firms that observed SEC rules while foreign firms did not.” Moreover, the government must “force financial institutions to be either ordinary bank lenders creating loans for individual customers in a private financial market or underwriter brokers who can deal only with instruments created and resold in a public financial market.” The SEC should “prohibit securitization that attempts to create a public market for assets that originated in private markets,” (2009: 97ff) even though any time a company goes public, it does just that. Shut down this, prevent that, force the other, prohibit something else; like a bully, Davidson likes to push people around. How this squares with his desire to preserve capitalism is not clear to me. For our author, orderliness of the stock market simply means absence of busts. But there are busts, because there are booms. What is he going to do about them? The key is total control. In a pathetic imitation of a sadistic prison warden, such as in the movie Fortress (Davis Entertainment, 1992), Davidson imagines moral hazards everywhere

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and tries to plug holes in human actions so as to prevent irresponsible investing. But as soon as one hole is plugged, people will seek their happiness in yet another unapproved by Davidson way. Nothing short of complete regimentation of the capital market and therefore, socialism of the German pattern (in which ownership of the means of production is nominally private but control of them is exercised by the state) will “work.” The “orderliness” of such an economy is the order of a wax museum. Like some ancient Marxist, Davidson has not reconciled himself to the “anarchic” production of capitalism and to the fact that liberty is the mother not the daughter of order. The real reason for the problems Davidson decries is the control of money jointly by the government and the Federal Reserve. With depressing predictability, he blames laissez-faire for the deeds of the state. 63. BUSINESS CYCLES, PART III: AN INVESTMENT BOOM The investment boom like the one that occurred in the 1990s into technology stocks has a somewhat different dynamics. For one, the initial PIRs cannot be so large; and moreover, the expectations of high profits have to be kindled by something like a hot new bundle of technologies which seem to promise great productivity gains, unheard of consumer happiness, and basically, the moon. Once again the trouble comes from the deep gulf between the PIRs and EIR. The amount of “forced” or fraudulent savings available greatly exceeds the true amount. The only way for these savings to be used is by lengthening the temporal structure of production. The low EIR assures the entrepreneurs contemplating such an expansion that the costs of the time factor will be, for the time being, relatively low. Projects that would otherwise be unprofitable because of high interest payments suddenly cease to be submarginal and come within the range of cognizance of the businessmen. Consumers do not mind waiting for more physically productive processes to be rolled out. Or do they? In reality, this is only an illusion, because consumption does not decline, a fact necessitated by the high PIRs. This sets off a tug-of-war for the factors of production between consumption in the lower stages of the temporal production structure and consumption in the higher stages, the setting up of which has been stimulated by the lowering of the EIR. There is, in a manner of speaking, a production possibilities frontier between present and future consumption. It is impossible sustainably to leave the curve and move beyond it (in the long run) without

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positive voluntary net saving and curtailment of immediate consumption. The effects of an attempt to do so are catastrophic: a cluster of errors, and the inevitability of mass losses and bankruptcies. Greater future consumption is attempted to be provided for without a reduction in present consumption. That overall consumption of both final and intermediate goods in all stages of production increases means that demand goes up, and prices rise in order to ration the goods. Sales revenues of the entrepreneurs producing these goods go up, as well, as people spend their stock market generated cash. Production is stepped up, and soon factors prices catch up. But investments into more physically productive roundabout projects compete for the same things employed by the firms operating closest to the consumer. Factors prices finally skyrocket. There are not enough resources within the economy to satisfy both the desire for more pleasures now and the desire for more pleasures in the future. Capital, whether real or human, is, after all, scarce. As I had occasion to emphasize earlier, capital is a fluid concept. Why cannot the new producers pick up their capital from nature, as suggested by the new technologies, for example? For we are surrounded by “stuff.” Why can they not invent new capital and attach new and so far unheard of subjective essences to things yet unused? Why must the new firms necessarily demand the same capital used by the old firms? If such things can happen, then the increase in productivity is indeed a free lunch. It will not spark a business cycle. But after all such innovations are for the time being exhausted, there will still be opportunities for multiple uses of old capital goods already working in the later stages of production. Credit expansion ensures that this situation will occur. To phrase it in terms Keynes would accept, cheap credit increases the marginal efficiency of capital by lowering the rate of interest. This, however, is an exceeding clumsy way of putting the matter. What is increased are (1) expectations of profitability of projects that take a longer amount of time to yield their fruits (2) that use hitherto uneconomic technologies (3) that involve various old and new capital goods, (4) which now, given the lower rate or interest, contribute to those projects more than they cost. These particular goods may be said to yield higher DMVPs due to the lower discount rate. But the crux of the issue is futile dreams of overall profits, not the fate of any particular piece of machinery. It is a necessary condition of an unsustainable boom that factors prices rise unevenly and especially within a certain sector of the economy. If money supply inflation could cause price inflation by raising all prices at the same time by the same percentage, then there could be no

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business cycle. After all, any money supply, given enough coins or bills to facilitate daily transactions, is optimal for a society; it is only changes in the money supply that are not neutral in the short run. Given the tempting technologies, such as the Internet, dot-coms are flooded with investor cash. This allows these companies to bid away existing labor and capital from the respectable old guard. Unfortunately, the competition from below (in the production structure) is not weak, as it would be under a laissez-faire monetary system, but rather fierce, given the consumers’ actual unwillingness to spend less. As Achilles says in the movie Troy (Warner Bros. Pictures, 2004), “Someone has to lose.” The bust comes when lengthening the production structure has reached a limit set by the amount of new money infused into the fastestgrowing industry. Each temporal stage, indeed, adds an interest payment. Even with a lower EIR, there can only be so many new stages. The longest production processes will come to be on the margin, their profitability most sensitive to increases in interest rates. I have suggested that credit expansion works together with inflation to create the boom. We see now that both act to destroy the boom, as well. (a) Credit expansion ensures that numerous factors of production other than time become overpriced. Competition for factors from the shorter consumer goods industries will sooner or later so raise the factors prices as to decimate the profits of all but the most sagacious businessman who decided to expand by using the new set of technologies. Again, there are too many competitors vying for the same resources. Low interest rates end up not helping in the face of a shortage of capital goods, including human capital. (b) General inflation ensures that interest rates sooner or later rise, too. Consequently, prospects of high profits for the high-tech firms will be dashed, resulting in a loss of confidence, a now revealed malinvestment and impoverishment, and end of the boom. We will see why credit expansion cannot go on forever in Book II in connection with the state’s monetary policy. In other words, when Smith decides to start a flower business, the following things occur. (1) Smith saves, reducing demand for Jones’ cheese. (2) In response, Jones winds down his business, releasing his resources. (3) These resources are picked up by Brown who is increasing production of those capital goods that he is anticipating Smith is planning to buy. As we can see, the process of saving money is occurring at

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the same time as production of new intermediate goods.63 However, when the cash that is given to Smith is produced out of thin air, there is money but no products. No time has been allotted for them to be created. This puts added pressure on existing capital. Let us now identify the reasons why people fatefully set themselves up for losses, if the banks allow so many of them to dispense with (1) for themselves. First, often entrepreneurs buy factors of production in succession, and when they buy them for their early production stages, they fail to foresee that the factors in the later stages will increase in price dramatically with time. Thus, an entrepreneur does not borrow $12M and pay his factors for a whole year worth of services. Rather, he borrows and spends $1M every month or plans to, except that in month 10, he is dumbfounded to realize that he needs to borrow $1.5M at a startlingly higher interest rate to pay his workers. The cause is the inflationary effects of the previous months’ payments by other capitalists who, like him, were hoping to profit with cheap credit. Inflation is ratcheted up with time; so is consumption; and so is the competition for (a’) factors and (b’) present money or credit. This is the lag that causes unrealistic expectations to persist for a period of time. Since entrepreneurs know exactly neither where in the production structure they are, nor how inflation is planning to fan out throughout the economy, these cost increases are largely unanticipated and surprising. We can see how this lack of knowledge turns the stock market into a casino and entrepreneurs into gamblers. The entrepreneurs’ social function – to serve the consumers – is put into jeopardy, as their profits and losses come to depend on sheer luck regarding the exact path the continuation and collapse of the boom takes. The situation is not helped by raising the prices of finished goods, hoping that the increased amount of money out there will generate sales. The contention here is that these goods will never be finished. It is physically impossible to satisfy everyone’s demand for the required factors of production. There is only so much real and human capital available. The prices of factors, like all prices, are a sign of the factors’ scarcity relative to the demand. Prices ration the factors among the entrepreneurs. High prices of factors are simply the market’s way of denying these factors to some entrepreneurs. Such entrepreneurs will have to 63

We may continue the process as follows. (4) Having saved, Smith may lure other factors of production away from Armstrong’s lawnmowers business. (5) Having created the product, he draws demand away from Robinson’s lamps. (6) Finally, Smith spends the profits on a Green’s car, restoring the aggregate consumer demand (lowered in (1)).

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give up and liquidate their projects in midstream. If we replace a single firm executing a long project with multiple firms in different stages of production, then late-stage firms that were expected to buy the newly created capital goods refuse to do so, as inflation has made these goods extremely expensive. The earliest-stage firm that would suffer a loss, if it started producing, destroys the whole production structure (because losses make even rotation impossible), and the still earlier-stages firms are taken with it into oblivion. Second, due to winner’s curse, in which the winner of an auction (such as our auction for factors) is often the person who is forecasting the highest profits and is most optimistic about the value and productivity of the factors, on which he and others are bidding. But cockeyed optimists risk more and are more prone to losing. With an unusually high number of entrepreneurs contending for the factors under credit expansion, the winner is betting that he is more correct in his entrepreneurial vision than all of them and so is that much more likely to make a mistake in his assessment of profits. In other words, (p) the more entrepreneurs are in the game and the more projects are thought by these entrepreneurs to be viable, the more real the possibility of a significant erroneous overestimation of the market value of a factor becomes, and every entrepreneur will need to outbid that fellow, the one who is trying mightily to curse himself, in order to get the resource. (q) Even if there are no obvious errors, there is a fine line between optimism and recklessness. Thinking oneself a businessman superior to everyone else is not always the most prudent thing to do. Yet easy money strengthens the incentives for people to do exactly that. Third, if we get away from the idea of an instantaneous auction, then it is possible that resources will be shifted from companies involved in short projects into those involved in longer projects and back a number of times, each time costing more. All these reasons entail that many projects will be started but never completed for profit. Notice the crucial change from the consumption boom: in the previous chapter, the boom was both in houses and in house-building with an emphasis on the former; here, the boom is both in future goods and in creating future goods with an emphasis on the latter. A hoary old objection to this account is that it neglects “rational expectations.” The reply is twofold: first, in order to have rational expectations, it is necessary to be guided by the correct economic theory, and there is a great deal of disagreement about that even among economists.

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Second, entrepreneurs are neither omniscient nor totally ignorant. (The former, according to Roger Garrison, would deny “the existence of an economic problem that requires for its solution a market process”; the latter would deny “even the possibility of a market solution to the economic problem.” (2001: 82)) The reality is that our entrepreneurs are thrown into an economic cesspool: they must either compete or disappear: Even if entrepreneurs have “perfect” knowledge of events to come, they cannot shy away from the effects of an expansion of credit, since their very profit motive will inevitably lead them to take advantage of the newly-created money. In fact, even if they understand the dangers of lengthening the productive structure without the backing of real savings, they can easily derive large profits by accepting the newlycreated loans and investing the funds in new projects, provided they are capable of withdrawing from the process in time and of selling the new capital goods at high prices before their market value drops, an event which heralds the arrival of the crisis. (Jesús de Soto 2006: 536-7, italics removed) It is possible to succeed in any situation; peace is good for business, but war can also be good for business, etc. There is no escaping attempting to outcompete other entrepreneurs both during the boom, when the economy is overflowing with cheap credit; and during the bust. Therefore, accusing banks, say, of reckless behavior during the boom makes no sense: it is true that an opportunity to exploit easy money is not identical to actually exploiting it, but taking advantage of the opportunity for any market actor is (x) legal (in fact, ideologically sanctioned) and (y) unavoidable and a dominant strategy, whether everyone else will do the same, or even and especially if they do not, as per the prisoner’s dilemma. If a company “cooperates,” i.e., fails to expand, then the other market actors will leave it in the dust for the duration of the boom. For example, Enron cooked the books because it wanted to make itself more attractive to investors at the time when those investors were stuffing cash into dot-coms. The Madoff’s Ponzi scheme took advantage of the boom by promising unrealistic returns, and it did deliver, for a while. Note, however, that it was the market not the government’s Securities and Exchange Commission that brought Enron stock down to zero, and it was the market not the SEC that exposed Madoff. At any

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rate, there is a fine line between fraud, such as failing to abide by the terms of the contact, and poor entrepreneurship, wherein one is to his own ruin seduced by promises of high profits. Contracts are formal transfers of property titles and are enforceable; promises are neither; yet they resemble each other in all other respects. It may not be necessary to feel pity for Madoff’s victims, except insofar as they share in our common fate of a depression following a boom. Mises concludes: There are no rules according to which the duration of the boom or of the following depression can be computed. And even if such rules were available, they would be of no use to businessmen. What the individual businessman needs in order to avoid losses is knowledge about the date of the turning point at a time when other businessmen still believe that the crash is farther away than is really the case. Then his superior knowledge will give him the opportunity to arrange his own operations in such a way as to come out unharmed. But if the end of the boom could be calculated according to a formula, all businessmen would learn the date at the same time. Their endeavors to adjust their conduct of affairs to this information would immediately result in the appearance of all the phenomena of the depression. It would be too late for any of them to avoid being victimized. (1996: 870-1) Again, only one’s performance relative to other entrepreneurs matters. Some market agents’ expectations will be more rational that others’. One cannot avoid testing his own “rationality” (in my terms, prudence and courage) in the real world against that of his fellows regardless of the circumstances. Even if only very few can win, every entrepreneur thinks that he will be one of those few winners. It is perhaps “human nature” to hope in the face of impossible odds. Unfortunately, the objective conditions of the economy demand an unusually high rate of loss. Keynes seems to understand business cycles in a topsy-turvy fashion. In my Austrian theory, when interest rates are forced down by the expansion of credit, all sorts of “entrepreneurs” smell the sweetness of these rates and crawl out of every nook and cranny to borrow money. For Keynes, however, this effect is nugatory. The Great Depression, he thinks, was caused by “an extraordinary willingness to borrow money for the purposes of new real investment at very high rates of interest.” In a boom, “investments which will in fact yield 2 per cent in conditions of full employment are made in the expectation of a yield of, say, 6 per

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cent, and are valued accordingly. When the disillusion comes, this expectation is replaced by a contrary ‘error of pessimism,’ with the result that the investments, which would in fact yield 2 per cent in conditions of full employment, are expected to yield less than nothing. … A boom is a situation in which over-optimism triumphs over a rate of interest which, in a cooler light, would be seen to be excessive.” (2008: 321-2) He holds that investors collectively are subject to waves of irrational over-optimism and over-pessimism. The former implies that they would borrow at too high an interest rate; the latter, that they would not borrow even at too low a rate. I do not accept this explanation. Keynes suggests no cause that reliably produces in investors mass delusions, hallucinations, hysterias, or whatever of the same kinds. Livingston’s (2011) proposal of dealing with the business cycle is really a doozy. When capitalism was young, he says, “increasing private investment in new plant and equipment made capital formation the engine of rapid growth. That increase in investment was funded from business profits – income withheld from consumption.” (42) This is unlike today, when “incentives to private investment – say, tax cuts on capital gains or corporate profits – are not only unnecessary to drive economic growth; they are also destructive. They don’t lead to productive investment; instead they create tidal waves of surplus capital with no place to go except speculative bubbles that cause crises on the scale of the Great Depression and the recent catastrophe.” (47) Livingston seems to argue that it is OK to allow an expansion of fiat money credit, as long as it is supplemented with high taxes on profits. For the former lowers interest rates and makes it more attractive to invest; while the latter on the contrary makes investing less worthwhile. The two effects cancel each other out, and business cycles will be ipso facto averted. I do not think that a healthy mind is capable of coming up with a scheme like that: it takes a whole other level of folly to do so. First, this fails on its own terms: there are no profits in a boom; only investments that are aborted without bearing fruit, either goods for the consumers or profits for the entrepreneurs. Second, this is a case of treating an (admittedly serious) illness by killing the patient. The problem, of course, is that the two incentives are issued to different groups of entrepreneurs. Lower interest rates stimulate investment into longer projects. Higher taxes on profits deter particularly risky investments by upping the risk to reward ratio. There is no reason why for any project, the two must coincide. A long project may be safe; a risky project may be short. Thus, lengthening of production processes will occur despite the second incentive; businesses based on good ideas will not be started despite the first one.

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Livingston is an economic fascist, though he does not recognize this as the ideology to which he himself subscribes; or rather he would be, if his book were not a tissue of so much confused, rambling, and angst-ridden nonsense. The redeeming feature of Against Thrift is that underneath it, there is an intriguing question: given the three realities of the world mentioned in (I, 34): suffering (S), struggle (T), and happiness (H), in making the world happier, do we not make T less intense for our children? Livingston considers the “neurosis at the heart of human nature, the ‘compulsion to work,’ the urge to change the world.” (146) If gold is tested in fire, will the future generations be “passive consumers,” forsaking their calling to make the world a still better place? Such worries are unfounded, not to mention premature. For even if the active life can be abolished by means of “machines and robots,” (155) people would have the leisure to develop their speculative virtues and lead lives of the intellect. According to St. Thomas, such lives resemble most clearly our heavenly existences. (ST, II-II, 182) The Catholic Encyclopedia concurs: “for Aristotle, the highest happiness is to be found not in the ethical virtues of the active life, but in the contemplative or philosophic life of speculation, in which the dianoetic virtues of understanding, science, and wisdom are exercised.” (“Happiness”) As we have seen, this is true for all temperaments. So, I think that future generations will still have their work cut out for them. Perhaps, Livingston would resist being characterized this way. All he is doing is pointing out that the economic problem in developed countries has been “solved.” Hunger has been abolished. Everyone can afford the necessities of life. Why not use our newfound “freedom from fear,” as he puts it, to have fun in life, to “consume”? He thinks that the vast majority can get the money needed to live it up via “redistribution” of aforementioned “surplus capital.” This is too preposterous to be analyzed as a serious doctrine. Let me limit myself to reiterating that it does not follow from economic progress that leisure should gradually come to be more in demand. Mises puts it this way: “It is true that all this straining and struggling to increase their standard of living does not make men any happier. Nevertheless, it is in the nature of man continually to strive for an improvement in his material condition. If he is forbidden the satisfaction of this aspiration, he becomes dull and brutish. The masses will not listen to exhortations to be moderate and contented; it may be that the philosophers who preach such admonitions are laboring under a serious selfdelusion. If one tells people that their fathers had it much worse, they answer that they do not know why they should not have it still better.”

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(1985: 190) Hayek expresses a complementary sentiment: “What matters is the successful striving for what at each moment seems attainable. It is not the fruits of past success but the living in and for the future in which human intelligence proves itself. Progress is movement for movement’s sake…” (1960: 41) In short, I doubt that Livingston’s advocacy of an end to economic creative advance will garner him a lot of converts. The Austrian theory, then, takes into account neither psychology alone nor the “real” factors alone but notes that business cycles are caused by (objectively) false (subjective) expectations or objectively unrealistic subjective plans of action. In other words, we are dealing with situations of false expectations on the part of a sizable part of the businessmen, especially false optimistic expectations when reality is otherwise. 64. BUSINESS CYCLES, PART IV: THE BUST Recovery from the mass failure of the bust takes time. Wages must come down and new skills, learned by workers; some capital goods will turn out to be economic bads which must be destroyed for a price; capital goods of varying specificity must be recovered, possibly only in part; possibly moved to a new location; possibly moved back in the new structure of production. A better economic system would never have allowed such gross misallocation of resources, such that now people just have to make the best out of a great many bad things. Again, during a bust we experience an inevitable collapse of a large number of companies, far greater than the normal rate of economic attrition. A corporation may have invested into a nice facade of its building, reflecting the nature of its business. If that company goes broke, that facade will be to a great extent unsalvageable. Even if another company moves into the building, it will have little use for that particular ornament. If the facade is specific enough, it may have to be torn down entirely, becoming a pure economic bad. In this sense, the business cycle is tantamount to deliberate environmental pollution, turning goods into trash. Trucks that were bought by some dot-com enterprises in hopes of delivering various goods directly to one’s home can likely be reallocated. But the market participants are faced with a new reality. They do not even know how to price the trucks now. By how much should they lower the price? Testing the market takes time, and this time is especially

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long when there are mass losses, and numerous people are trying to liquidate their capital and inventories at the same time. Problems abound: in finding customers for the trucks, where should their owners advertise? Cement used in the construction of houses during a housing boom will surely fall in price. Again, by how much? Who would now want it? How much would moving the cement from one location to another cost? It will take time for workers to lower their expectations, find new jobs, and sell their houses in order to move. Moreover, they, too, face an uncertainty. In the depression economy, with plenty of unemployment, which jobs are most in demand? If both real and human capital were perfectly non-specific and like a homogeneous blob of goo, oozing with some speed from one project to the next, then their reallocation would, indeed, present few problems, and the bust would be a minor blip on anyone’s radar. But the antecedent is, of course, false. Thus, the marginal efficiency of numerous capital goods (or those goods’ quasi-rents or their DMVP) drops precipitously, to which the only remedy is for their capitalized or rental prices to fall. My own stint at computer consulting at ridiculously high prices in New York City lasted for 2.5 years and came to an end in 2002. At that point, it took me 6 months to find new work, no longer as a consultant but full-time employee and at half my previous wage. I am not saying that quick wage deflation (due to bankruptcies of firms and worker competition) and price inflation (due to impoverishment and therefore, lower demand for money) will end the depression at once. Starting new enterprises takes time; and confidence is not restored in a day. If interest rates are healthily high, then the new more time-intensive techniques that were used during the boom (pointlessly, as it turns out) will be unavailable at all during the recovery. Still, it would help. It is immaterial whether any consumer goods were created or not. If they were not made, then the durable capital equipment must be liquidated; if they were, then they have to be sold below cost. This is not because there is something necessarily wrong with the products themselves but because the costs were so high. This destroys any hope for even rotation and therefore, for future rounds of production. These examples underscore the fact that an economy in depression is broken. What broke it is the preceding boom. The economy lies in pieces, uncoordinated; the factors, useless. Who is the culprit behind this mischief? I lay the blame at the feet of the Central Bank and fractional reserve banking which allow credit expansion and the wide separation between the personal and the loan market rates of interest. These

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generate false optimism. Now it may seem that there is a difference between “normal” bust, in which the errors of the boom are revealed, and excessive depression due to false pessimism. In Roger Garrison’s opinion, “a crisis of confidence can cause an economy to spiral downward to a much greater extent than was made necessary either by artificially cheap credit or by the externalization of risk.” (2001: 120) Keynes provides no explanation of false pessimism; he attributes it more or less to bad luck, to the waning of animal spirits, a process which is also left unexplained. Perhaps, to him all pessimism is false; there is never justified reluctance to invest or extend economic activity: “The right remedy for the trade cycle,” Keynes continues, “is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.” (2008: 322) He does not know how right he is: with sound money, we can have sustainable secular growth simply by reason of accumulation of capital or a “quasi-boom.” Perhaps, a good way to understand Keynes is to think of him as a society’s psychologist: he recommends a perpetually cheerful attitude as most conducive to happiness. Even if one’s father or dog just died, party on! For Paul Davidson (2009), inflation occurs when “the economy becomes so prosperous that workers and managers believe that, in a free market, they can raise wages and prices without losing customers.” (146) It is hardly possible to fail to apprehend the essence of the business cycle more spectacularly. The boom is not a time of prosperity but of the Central Bank’s laying a trap for the people to make them poor and miserable, when the bust wriggles its way through the government interventions. From his own Keynesian point of view, Davidson may be understood as saying that it is the full employment that causes prosperity. But employment is a means to an end, namely, creating goods for the consumers. Since the investment business cycle is characterized by numerous projects that are eventually abandoned midway, full employment is beside the point. It never bears fruit. There is full-employment poverty or full-employment motion toward poverty. Davidson has not really reconciled himself to the fact that booms always implode; like Keynes, he is determined to attempt to keep us in a “quasi-boom” forever. However it is generated, with false pessimism, the government could indeed re-inflate, forcibly reversing the pessimism, in which case we will be guided by the Keynesian theory. But the fact that there is really no Keynesian “bust-boom” theory but only boom-bust theories by

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various economic schools of thought shows that Keynes’ own theory has only limited applications. We are deep in the throes of a severe and unjustified, as far as the more enlightened minds believe, depression. We can get out of it by applying the Keynesian medicine. There are, however, three problems with this scenario. First, it is precisely the alleged “enlightened minds,” the soidisant benevolent dictators who want to run the world who got the economy into depression in the first place. One would be well-advised not to trust them to make things better. The dictators’ opinions about the economy are surely of little value; haven’t they done enough damage already? Second, dealing with false pessimism is as far as Keynes’ theory goes: it is, therefore, a highly special not a general theory. Otherwise, reflation will only postpone the inevitable bust and make it worse. For that reason it is logical to consider the business cycle to consist of three and not two stages: the boom, recession, and liquidation / revival, the last one being the natural part of the bust’s healing process but only if permitted, for the boom can be restarted and recession postponed for a little bit, only, of course, to return with a vengeance. Third, it is true that credit contraction and its accompanying effects can raise the interest rate above its natural level. Still, there may not be such thing as false pessimism at all, if, as I will show later, pessimistic expectations can help to cure a recession. Even an abnormally high interest rate can be “shock therapy” for a broken economy. When Paul Krugman asserts that despite bad investments and wasted capital during the boom, “there is no obvious reason why bad investments in the past require an actual slump in output in the present,” (2009: 68) he shows only his failure to understand that the economy cannot redeploy resources to new and better uses instantly. We are not dealing with the neat supply and demand curves that shift at the economist’s will but with economic reality that has rendered numerous resources seemingly worthless. Production has been curtailed and will resume only after a time-consuming purge of all illusory entrepreneurial visions and consumer caprices. No one said the reason had to be “obvious.” The mass failures entail as part of their meaning the fact that starting new companies is not attempted during the bust. We may attribute this to investor and consumer pessimism. This loss of confidence is not arbitrary. Investor pessimism (i.e., fear) is due to the objective conditions of the economy, namely, (a) high costs of specific capital: durable, circulating, and human, and (b) higher interest rates. Consumer pessimism (i.e., pain) is due to the uncertainty surrounding

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workers’ livelihoods which increases sharply in a bust, as jobs disappear along with business firms. In addition to mass entrepreneurial failures, there are failures of those banks that loaned money to those entrepreneurs, as well. Because of their fractional reserves, the banks take an especially big hit from a bust. Instead of insuring deposits and bailing out failed banks, I would recommend enforcing 100%-reserve requirements and keeping a distinction in the legal code between deposit and loan / investment banking. For example, it is not necessary to prohibit commercial banks from investing and investment banks from accepting deposits; all that is necessary for the financial health of society is to enforce the relevant property rights of all parties and for all transactions. 65. THAT A BUSINESS CYCLE CAN ALSO OCCUR DUE TO (1) MORAL HAZARDS IN BANKING AND (2) CHANGES IN GOVERNMENT POLICY BUT NOT (3) SHEER BAD LUCK The first premise of the first theory is that the banks are protected from collapse or bankruptcy by the Fed as the lender of last resort and the FDIC. Moreover, they are required to keep only a small percentage of the loans they advance as reserves, and they also tend to make longer-term loans. These generate a moral hazard, such as by making the dream of every businessman – capitalist profits and socialized losses – come true. This system is much closer to socialism than to laissezfaire, even though pundits of every stripe fail to realize that and blame capitalism for interventionist perversions. Just as under socialism nobody knows how to produce anything in an economic way, so with this moral hazard, there will be economic hustle and bustle, but it will be constantly frustrated, and the excessive entrepreneurial errors will result in impoverishment even under the guise of frenetic activity. There will be a perpetual boom, during which society is getting poorer. What happens is that, given their privileged status, greater risks are taken by the banks that would be sanctioned by normal prudence. Profits can appear from lengthening the structure of production as much as from a new technology. Thus, if there are profits to be had, then that is where one invests. Unfortunately, the risk is out of all proportion with the reward, so plenty of investments will be made which would be shunned in a more responsible industry. This will create a cluster of errors in the early stages of the production structure. Cassidy (2009) recognizes interventionism as “the worst of all

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worlds: a financial system dominated by a handful of firms that are ‘too big to fail,’ but that can take on as much risk as they please, secure in the knowledge that if things go wrong the taxpayer will be there to bail them out. Such an arrangement would amount to crony capitalism writ large…” (346) Cassidy’s mistake is taking interventionism to be “free market.” He does not realize that the government in a devious plot with the banks has captured one of the commanding heights of society, namely, creation and evolution of money, and that the entire financial system revolves around a state-controlled monetary system. He points out, reasonably enough, that, “although operationally independent, the Fed is really just another branch of the federal government.” (320) But he still considers the financial industry to be “free-market” which again and again “fails” which allegedly proves that the defenders of the market practice “utopian economics.” Lovers of freedom understand that interventionism is an internally inconsistent, self-contradictory system. This Misesian point must be rightly understood. It has been objected that the dominant form of economic organization today is interventionism which shows no signs of disappearing or collapsing on itself. This objection misconstrues the insight. Mises points out: “There are two different kinds of social cooperation: cooperation by virtue of contract and coordination, and cooperation by virtue of command and subordination or hegemony.” (1996: 195) To paraphrase Ayn Rand, anyone who cannot tell the difference between these two, “deserves to find out.” The person on the receiving end of the hegemonic bond still decides whether to obey or to rebel. But having chosen to obey, he is no longer an acting man. He is a pawn, a thing used according to the designs of the hegemon. Under capitalism, a man enters into new contracts every day of his life, thus making continuous use of his freedom, often in novel ways. A subordinate under a totalitarian regime chooses once and stops choosing thereupon. If we define economics as the science of the fact that human beings choose, then economics has little to instruct us on regarding the conduct of the vast majority of people under socialism. Interventionism, however, poses its own set of problems. To what extent are minimum wage laws, say, hegemonic? Suppose the government tells Smith: “You are to employ Jones for $10 / hour. You will lose money, but if you disobey, then we will shoot you.” This is clearly a working out of a hegemonic relationship between the state and Smith. But let the government say instead: “If you, Smith, are to employ anybody – and you do not have to – then you must pay them at least $10 / hour.” Smith still is not in full control of his business, but the hegemony is less pronounced. Smith has

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the freedom to choose whether to employ Jones in the first place. The semi-free economy is marked on the one hand by the efforts of the state to cut off avenues of human action that it considers anti-social, and on the other hand by individuals’ – as long as full socialism is not yet established – finding escapes from government decrees through the “loopholes” inevitably left open. If there are degrees of coercion and different ways of coercing, then the hallmark of interventionism is unintended consequences. As a result, “interference produces results contrary to its purpose, … it makes conditions worse, not better, from the point of view of the government and those backing its interference.” (764, italics in the original) The state is softer on the people than under full-blown socialism, and it is this indecisive “weakness” – the champions of interventionism rarely have the stomach for the requisite brutality to carry their programs to their logical nadir – that results in the unique dynamics of the mixed economy. Mises does not mean that an interventionist society like the US cannot exist for an indefinite amount of time. He does not mean even that the most absurd regimes like the Soviet Union are bound to fall apart in the short-term, though he considers it likely: “The chiliastic empires of dictators are doomed to failure; they have never lasted longer than a few years. We have just witnessed the breakdown of several of such ‘millennial’ orders. Those remaining will hardly fare better.” (153) The paradoxes and inconsistencies of interventionism are logical first and practical only second. That legal regime A is better than regime B does not entail that people must of necessity substitute A for B. It does not even entail that 20,000 years from now or after however long, A will finally prevail. “Neither a low standard of living nor progressive impoverishment automatically liquidates an economic system. It gives way to a more efficient system only if people themselves are intelligent enough to comprehend the advantages such a change might bring them.” (860) A person can live his whole life facing severe inner turmoil in his feelings, thinking, and acting without either resolving those problems and achieving “inner peace” or allowing them to destroy his life for good. A society can similarly twist slowly in the wind for centuries without discovering either the wheel and carriage or the utility of libertarianism. All Mises means is that if a person took praxeology and economics seriously as intellectual disciplines; steadied his mind, as if logic were a martial art; and tried to work out how to achieve the greatest prosperity for the greatest number (or happiness given decent nature and virtue), even of himself and his children in the long run, then he would be forced by the power of his own pure reason to decide in favor of

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laissez-faire. Mises does suggest ways in which the interventionist contradictions may manifest themselves in practice, such as in the “exhaustion of the reserve fund” (855) of civilization; the particular results that socialism may actually generate; and the like. Moreover, he is insistent that “truth has an inherent power which could make it ultimately prevail solely by virtue of its being true.” (879) But he is wise enough not to trust “truth” to do all the work itself. There are no such things as “the irresistible power of reason, the infallibility of the volonté générale, or the divine inspiration of majorities.” (865) Ideas have consequences, but it is people who must study, deepen, and teach economics. I used to be puzzled at the suggestion that freedom is indivisible. Surely, the government can tax X and leave Y untaxed. Also, I may allow Smith to borrow my pen and use it but require him to be careful with it and return it, thus partitioning the bundle of rights to the pen however I please. That Smith is free to use the pen in one way does not prevent him from being restricted in its use and obligated to me in other ways. That freedom is indivisible must also be rightly understood. If principle A justifies policy B, and B is evaluated as bad or inappropriate, then according to laws of logic, A must be false, as well. But in obedience to its nature as a general rule, A likely justifies not only the particular B but also numerous other freedoms and practices. And if A is no good, then those freedoms, etc. are undefended and may well no longer be reasonable. Thus, not only B but also C, D, E, and all the rest of the ideas and institutions that A legitimizes fall, too. An excellent example is Mises’ polemic against the Drug Prohibition: “Opium and morphine are certainly dangerous, habit-forming drugs. But once the principle is admitted that it is the duty of government to protect the individual against his own foolishness, no serious objections can be advanced against further encroachments. A good case could be made out in favor of the prohibition of alcohol and nicotine. And why limit the government’s benevolent providence to the protection of the individual’s body only? Is not the harm a man can inflict on his mind and soul even more disastrous than any bodily evils? Why not prevent him from reading bad books and seeing bad plays, from looking at bad paintings and statues and from hearing bad music?” [C, D, E] The question to be resolved first is not whether certain drugs are to be banned (and others, perhaps, forcibly administered?) [B] but whether “government derives its authority from God and is entrusted by Providence to act as the guardian of the ignorant and stupid populace.” [A] (733-4) The real intellectual choice then is between pure laissez-faire, under which (1) the government does not manage the money supply and

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(2) the commercial banks are honest, and pure socialism. Cassidy rejects socialism; hence, he must logically embrace laissez-faire, which I believe he would do (and I would wager be a mighty paladin of freedom, so good he otherwise is in his writings), if only he understood that it is government command and control that failed not the markets. Now if someone expects another to pay for his mistakes, then the harmony of interests between that market actor, such as an individual or firm or, in this case, banks, and society vanishes. The pursuit of private profit no longer jibes with the common good. Therefore, banks are regulated by law in order not to permit their moral hazards, i.e., incentives to reckless behaviors, to lead them to ruin and cause society to pick up the tab. Unfortunately, that means that there must exist detailed and minute rules for numerous transactions contemplated by the banks. Someone has to determine whether a given deal is “reckless” or “reasonable”; and if the banks are not trusted with this task (since the cost of making mistakes to them is reduced), then the government must take over. But the government is not competent to allocate capital and decide which persons or organizations ought to get how big a line of credit with which bank. By regulating business decisions, the state has turned private entrepreneurial firms, i.e., commercial banks, into quasi-bureaus. The greater the extent of moral hazard, the greater the scope for regulation, until the legislature comes to be fully in charge of lending, and banks have been effectively nationalized. My own hypothesis is that the cycle due to poor banking incentives will occur when there is a change in the policy creating the hazard. If the state of affairs has already persisted for some time, then the result will be a continuous boom without any positive results for consumer happiness. In the particular case of the recent depressions, the change was the so-called “deregulation” of the financial industry engineered between 1970s and 90s. Non-bank financial institutions were permitted to offer close substitutes of the traditional bank products, and banks were in turn partially liberated so as to be able to compete against these upstarts. It has become apparent that some banks even want to go back to the old days, when they did not have such dangerous competitors. This reveals yet another side of regulation which is that government red tape distorts the marketplace. The cost of complying with the rules is higher for some companies and lower for others, generating a competitive advantage for the latter. It is usually naïve to imagine regulation to

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be in the interest of the common good; in many situations, it is a weapon wielded by the market leaders to clamp down on existing competitors and deter potential newcomers into the industry from even trying their skill. I will make an educated guess that, for example, Philip Morris is not upset over the taxes on and regulation of tobacco products. This is because exactly the same regulations hamper their competitors, as well. Can anyone imagine starting a cigarette business today? The hoops one would have to jump through would be insurmountable. Despite the costs, Philip Morris can rest easy, for it is well protected from being unseated from its lofty position by anyone else. Thus, e.g., the innovations in credit instruments and the testing of these innovations in the loan markets by banks were to be cheered rather than derided as “too complex” or “too risky.” Indeed, they were both, but that is a fault of interventionism not of the inventors. The idea of deregulation was wonderful, but its execution was not up to par. Let me give an analogy to the situation by looking at the state of American health care. The medical industry is constricted by numerous regulations. I will mention just a few: (1) one-size-fits-all government licensure; (2) restrictions on the number and kinds of medical schools; (3) price fixing by the American Medical Association; (4) patent monopolies for drugs; (5) lack of a functional market in individual health insurance; (6) insurance that pays even for routine procedures; (7) insurance that pays for illnesses whose outbreak is under the control of the insured; (8) employer-provided insurance; (9) Medicare and Medicaid “welfare.” We do not have a free market in health care today. For example, with regard to (1), a medical license is not an indication of quality. For some branches of medicine it is too stringent, cutting off the supply of decent doctors, whose competition would lower prices. For others, it is too lax, lulling the consumers into a false sense of security. Practitioners of alternative medicines are marginalized and persecuted, if they become too bold. All licensure must be immediately privatized, as it is in, say, the computer and software industry: many computer companies, such as Microsoft, Sun, and Cisco, offer numerous private certifications of widely varying difficulty that individuals can acquire to enhance their reputation and therefore, chances of being hired and their salary. We need the same kind of system in health care. I expect that doctors will apply to the most restrictive (private) accreditation board whose tests and training regimen they can withstand. Under free market the fear that “we” must “control costs” would disappear altogether. For it is the consumers who control costs by refusing to buy, when they deem prices to be too high. Patients would balance quality and price, as they do in every other

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market every day. It is true that alleviation of pain and avoidance of death, unlike pleasures like a candy bar, usually bring high consumer surpluses or gains from trade at “reasonable” prices. Even if candy makers could restrict competition and enjoy monopoly profits for an extended period of time, their exploitation of the consumers would hardly be extensive. On the other hand, I once broke a tooth on a Friday evening on the eve of the Independence Day. After a sleepless night, I spent the morning calling every dentist in the phone book, until I found one who was working. I would have paid him a lot more than I actually did to fix my tooth. Thus, the demand for relief from agony and for staying alive is both high and inelastic which means that restriction of competition would be lucrative for the doctors. This is exactly what has happened. The government, having blithely sanctioned the anti-competitive practices, responded to the public’s clamor for “something to be done” in the face of high prices by having the taxpayers foot the bill for health care. But this, of course, has not only unjustly looted the taxpayers for the sake of the corrupt medical men but also increased the demand for medical services, raising prices even more. In other words, we have done and continue to be doing the exact opposite of what we really want on both the supply and demand sides of the equation. Now just as a single vice can ruin one’s happiness, so even a single intervention can not only distort the workings of the market to such an extent as to make it very inefficient, but also generate a case for further interventions. In other words, there is a dynamics in the system such that the initial intervention produces results contrary to the common good and to the publicly stated aims of its very supporters; people are displeased and threaten to vote the regime out of office; and the result is either a repeal of the intervention and a return to the unhampered market or passage of further interventionist legislation. Therefore, interventionism, the alleged “third way” between capitalism and socialism is internally inconsistent. Think of it this way: when one is healthy, he does not suffer; and when one is dead, he does not suffer. One suffers only when he is alive and sick. Pure or laissez-faire capitalism, in medicine and in any other business, is being healthy; socialism is being dead; and interventionism is being sick, in which case one may want either to be cured or to die. Lingering in agony is highly unpleasant. Interventionism is sustained by means of a three-pronged attack on what is good and true by the state, the special interest groups, and incorrect ideas. Thus, criticizing the state, Mises agreed that “for ambitious kings and generalissimos the very existence of a sphere of the

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individuals’ lives not subject to regimentation is a challenge. Princes, governors, and generals are never spontaneously liberal.” But added that “they become liberal… when forced to by the citizens.” (1996: 324) Criticizing private business, he pointed out that “the nineteenthcentury success of free trade ideas was effected by the theories of classical economics. The prestige of these ideas was so great that those whose selfish class interests they hurt could not hinder their endorsements by public opinion and their realization by legislative measures.” (1996: 83) And criticizing bad ideologies, he countered: “If modern civilization were unable to defend itself against the attacks of hirelings, then it could not, in any case, remain in existence much longer.” (1985: 153) Schumpeter (2008) even argues that an important source of socialism’s allegedly greater efficiency as compared with capitalism is the absence of a vast network of legislation that interferes with business and of the cost of private enterprise’s complying and resisting these interventions, particularly by employing a horde of lawyers. “But not inconsiderable is the social loss from such unproductive employment of many of the best brains.” (198) Schumpeter had apparently despaired of the possibility that the problem of interventionism can be resolved by going the other way, namely, toward laissez-faire by means of the working out of the right ideology. Schumpeter must have liked the army-like “simplicity” of socialism: orders are given, and they are obeyed. Those who disobey are cleanly disposed of in ovens or concentration camps. For example, there is no “administrative apparatus” that “does nothing but struggle with the bourgeoisie for every dollar of its revenue.” (198) There is no struggle between individual and the state, because the state has won decisively. Men are now little more than tools and machines used by the central planner as he sees fit. Schumpeter saw distinct gains to society from this peace of the grave, toward which in medicine, as of this writing, we appear to be heading: politics, he avers, “would be purified.” (302) The analogy with the banking system is that “deregulation” preserved the perverse state of interventionism into the free market. It brought the patient back to life but kept him sick. How can an industry plagued by the inherent fractional-reserve fraud, the Central Bank’s available round-the-clock printing press, the preposterous “insurance” of some deposits, legal tender decrees which trigger Gresham’s law, the courts’ routinely abrogating contracts demanding payments in alternative currencies, and central planning of the monetary and fiscal policies, be considered “free market” or “deregulated”? One obvious consequence is incentives to banks to excessive risk taking and therefore, poor

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use of capital. Of some interest is the financial innovation called “credit default swaps” (CDSs) pioneered by J.P. Morgan. Cassidy relates that this involved securitization of loans “with a twist. The investors – insurance companies and other banks, mainly – didn’t get to own the loans, which remained on Morgan’s books; they merely agreed to take on the risk of Morgan’s borrowers defaulting. In return, Morgan agreed to pay them what were effectively insurance premiums. As long as the borrowers kept making their interest and principal payments, the investors would receive a steady stream of income… But if some of the borrowers defaulted, the owners of the [special-purpose vehicle] stood to make up the full value of the loans.” (2009: 280) Cassidy quotes one of inventors of CDSs, saying ecstatically: “For the first time in history, banks would be able to make loans without carrying all, or perhaps even any, of the risk involved themselves.” Now the CDS scheme is economically absurd. Murray Rothbard recognized that decades ago. You cannot insure entrepreneurs because they engage in uninsurable risk,” he said in an interview. “You can reasonably predict how many fires there will be in New York; the unlucky few who get burned can dip into the pool of resources. But entrepreneurship is heterogeneous; it is completely unpredictable, and each attempt is non-random. The entrepreneur assumes the risk. If an insurance company insures it, it becomes the entrepreneur. Who then insures the insurer? In the case of banks, either they don’t need insurance, since they are 100% covered, or they are uninsurable because they are taking entrepreneurial risk. (1990) It should have been obvious to the CDSs investors that they were creating an outrageous moral hazard by insuring the banks: what incentives did the latter have not to fail? The investors took over the all-pervasive threat to J.P. Morgan from future uncertainty and from the actions of its competitors but did not end up running the banks. For investors “the promise of receiving cash without locking up capital is extremely attractive: with the economy humming, and credit defaults at historic lows, it proved irresistible,” Cassidy continues. (2009: 282) Skidelsky (2010), too, very properly finds fault with insuring “every type of risk… We talk of ‘political risk’ when we should be talking about political uncertainty. We simply do not know what the probability is of future direction of Russia’s economic or political policy.”

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(41-2) In fact, numerical probabilities cannot even be assigned to such events. The CDS affair was bound to collapse most readily and energetically as soon as the bubble burst. It is stunning how the corrupt government-induced boom was able to take away people’s sanity even in matters regulated by economic logic itself. Truly, those whom the gods would destroy they first make mad. The ingenious second theory is found in Garrison (2001) who notes that the government pursues a wide variety of borrowing schemes to run a deficit but not all at the same time. An unpredictable switch from monetizing debt with the help of the Fed (which leads to inflation) to borrowing from domestic savers (which raises interest rates) can quickly annihilate the profits of the companies engaged in work on longer production projects. Adds Garrison: “Long-term, or capital-intensive, undertakings are inherently more risky than short-term undertakings precisely because more time must elapse before such undertakings can prove their profitability – more time that increases the likelihood of some major change in deficit accommodation or some attempt at deficit reduction that can turn expected profits into losses.” (119) Once again, the intertemporal structure of production is shown to be valuable in understanding business cycles. Another, and this time false, theory is proposed by the law-andeconomics maven Richard Posner (2009). According to him, even prudent investing can result in a depression. He writes: “events that are catastrophic to a corporation if they occur but are highly unlikely to occur, and therefore, if they do occur are likely to occur in the distant future, will not influence the corporation’s behavior. A bankruptcy is not the end of the world for a company’s executives, or even for its shareholders if they have a diversified portfolio of stocks and other assets. But a cascade of bank bankruptcies can be a disaster for a nation.” (28) Why would the cascade take place? Posner accepts the idea that “asymmetric schemes in which compensation tied to stock value is combined with a generous severance package may be in investors’ interest[, because they encourage the executives to take risks]. But such schemes may not be in the interest of the nation as a whole if they enhance the risk of a depression – and they do.” (97-8) Has our author never heard of the invisible hand? Why do individually profitable decisions lead to group misery? And are not the shareholders with their “diversified portfolios” part of the nation? Posner provides a hint by saying that “financial catastrophes… tend to be rare events.” (2009: 99) My understanding is that he attributes business cycles to sheer bad luck. A vast number of individually prudent

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decisions turn out to be, for reasons unknown, horribly bad. But this is implausible. Each company is in its own unique situation and does not depend on everyone else so completely that if one company goes belly up, then a “cascade” is automatically triggered. If my supplier goes broke, then I will have to find a new, perhaps a more expensive, one, but that event does not necessarily entail a loss to me. A random coincidence of bad luck so tremendous that it causes a global depression is so unlikely as to be entirely irrelevant to a phenomenon that repeats itself with remarkable regularity. The Austrian business cycle theory (ABCT henceforth) herein defended and the first two theories described in this chapter provide reasons for the mass failures. Posner’s theory does not, and that is why it is uninteresting. 66. THAT DEPRESSIONS CANNOT BE FOUGHT WITH (I) BAILOUTS The practice of “bailing out” troubled businesses, as part of the government’s “fiscal policy” (see Book II for more detail) during a depression, has several properties. First, bailouts represent special privilege to particular market players to protect them from bankruptcy. This insulates these firms from the market forces, such that they remain afloat whether they do well or poorly at satisfying consumer wants. Resources cannot be reallocated from what have been revealed as useless projects to more urgent ones, again, as determined by the consumers. The government is channeling the money into unprofitable for society uses. This privilege, since protection cannot be extended to every single firm without resulting in a particularly absurd form of socialism and in complete calculational chaos, is the definition of injustice. It is destructive of the impersonal order that is the free market. It is true that business and production are quite personal; e.g., if one knows what he is doing, then one invests into an individual entrepreneur with a specific idea. But consumption is not. On the market, it is never about “who you know”; it is almost always about how much money you have in buying and the quality and price of your product in selling. The free market does not respect persons or firms. Good will is hard to obtain and easy to lose. Under hampered market, on the other hand, there arises a class of Mafia-like “connected” companies with privileges bestowed on them by the coercive power of the state. They are personal friends of the political elite. They are exempt from the discipline of the market which

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beats and decimates its every member who fails to please the consumers. This favoritism, I want argue, is not merely uneconomic, though it is that; it is unfair. Government cannot pick winners in the marketplace – only consumers can; but losers surely pick the government as their refuge from the rigors of free enterprise. These special privileges resemble Soviet блат or the ability to obtain goods and services through personal connection to the powers that be, nepotism, exchange of favors, and the like. Thus, if one knew someone who worked at a meat factory and could routinely privatize government property by stealing, then the несун or “carrier” who could get the valuables past the guards (such as by bribing them) could do a favor to him by selling him the meat. If one was in a position to return the favor, then a long-term relationship would be established. The alleged equality of the Soviet regime was nothing of the sort: those who were thusly connected enjoyed a somewhat better standard of living. Perpetual shortages of goods pitted buyers against each other, creating hatreds and inefficiencies. Social classes were delimited based on who could obtain some of the goods that the Westerners took for granted, including necessities (indeed, toilet paper), and who had no such privileges. This encouraged envy for those “above” and contempt for those “below.” The nomenklatura and the Communist party elite were “made guys,” but there were quite a few more “connected guys,” to use more familiar terms à la the movie Donnie Brasco. People who emigrated from the USSR to the US often report the joy of feeling the equality of dignity with their fellow men, such that they no longer have to grovel for favors from (slightly) better-positioned citizens. The United States’ big government with its corporate welfare, regulatory capture, and all that is блат lite. Second, bailouts represent subsidizing failure. And when you subsidize something, you get more of it. What incentives will the failing companies have to strive for profit through faithful service to their customers and for standing on their own feet? This is the question that haunts all protectionism, whether through bailouts or tariffs or subsidies or monopoly grants. If the purpose is to make a firm or industry strong or able to compete in the market, then protecting it only makes it weaker. One must throw each company out into the “dog-eat-dog” competitive environment and through these pressures force it to improve and excel. Nor is there an analogy from protecting human children and the elderly to protecting “infant” and “senile” industries. If an industry is foreseen to be profitable only after it matures, then investors will still put money into it now. The government cannot find out which industries or firms

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ought to be kept alive and which, aborted; it is a terrible entrepreneur; its own enterprises, such as the Post Office, can be depended on to lose money with remarkable reliability and are kept in operation only by means of taxpayer dollars and the force of law, such as, indeed, laws establishing a monopoly. And if an industry or firm is no longer profitable, and its prospects are dim, as far as the investors believe, then the utilitarian thing is to let it “die.” Third, bailouts represent socialism; in other words, they give socialists a case for outright nationalization of banks and other industries. For, truly, why must society secure losses while still allowing private profits? Cassidy correctly notes that “in America the only respectable socialism is socialism for the rich.” (2009: 331) The (long-term) harmony of interests vanishes. Taleb complains that “when ‘conservative’ bankers make profits, they get the benefits; when they are hurt, we pay the costs.” (2010: 43) This system is not a strange accident; it was brought into existence entirely by design. Nor is it any sort of secret or conspiracy; on the contrary, the scheme is openly glorified as being in the interest of the commonweal, for the greater good, entirely conducive to economic progress and general prosperity, and the like. But if this function is socialized, then any failure of the government to turn a profit will be covered by the taxpayers. In the case of banks, this will remove every incentive of the bureaucrats to discriminate between loan applicants. Money and resources will go into absurd enterprises. There will be politically correct causes and politically connected firms which will receive preferred financing. Private banks will be put at a disadvantage, if companies’ futures depend not on them but on the decisions of the American Socialist State Bank, because the State Bank’s investments would be guaranteed. Finally, this will create a case for overall central planning, as, given the arbitrariness of government investments, the structure of production ceases to be rational in connecting higher-order capital goods with lower-order capital goods and with consumer goods. It is true that bailouts may be necessary in order to avoid a collapse of the flimsy and unstable banking industry on which the financial system is built. On the other hand, commercial bank runs and investment bank failures are more political actions than economic ones. It is only the government that is forced to act, lest the deceiving empire both propping up and in turn being propped up by the Central Bank “falls of his own weight and breaks into pieces.” (de La Boétie 2008: 47) My own initial mistake in thinking about the 2009 bailouts – including the auto industry bailout – was to seek patterns in government actions. According to what rule did they choose on what to spend the

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taxpayer money? In my naïveté, I failed to realize that there was, of course, no rule. For the most part, the politicians “simply” reward their friends and punish their enemies. They save the politically connected elite, whether than elite reside on Wall Street or in Detroit, and whether they are CEOs or unions. Electoral politics may well play a role, insofar as the bailout was intended to buy key votes. These are cases in which the political for the government is personal. When the bailouts began under the pretext of fighting the 20089 recession under the Bush administration, the President claimed he wanted to “ensure that only viable companies would get longer-term federal help.” How could he possibly ensure that, when he just partially liberated these companies from consumer sovereignty? They now depend less on what the buying public wants and depend more on the bureaucrats. Pleasing their political masters, including the yet to be named “car czar” or the auto industry central planner, will be more important to them than pleasing their customers. If private investors think these companies are trash, then why would the government’s opinion be any more correct? Again, if such investors thought that GM and Chrysler would get their act together some time in the near future, then they would eagerly buy their stock and lend them money in anticipation of better performance and therefore, dividends and capital gains. The fact that they are not doing this indicates that things are about to get worse. If these “Big Three” were really about to be successful, then they would not need government loans in the first place. In my eyes, Bush made himself into a laughingstock when he said: “These are important companies, but on the other hand, we just don’t want to put good money after bad.” Some companies are profitable and because of that grow and become important; others lose money and because of that shrink and lose importance. The consumers decide by their buying and refusing to buy who will be important and how. This is the essence of the market process which is as natural as potatoes, and it seems that the American auto industry is on the decline. We are aware of what is seen: the big automakers stay in business for a few more months. We are not aware of what is not seen: resources that are now stuck in apparently worthless (as judged by the market) enterprises cannot be reallocated to their more urgently needed uses. We do not see the other companies, including those that do not yet exist, that might have benefited from these resources and grown in importance themselves. But the government cannot know where to channel the capital; therefore, its decisions are bound to be economically foolish. In short, bailouts are realpolitik within the country; they fail as

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a treatment for depression by propping up businesses that must be liquidated and whose factors of production must be released and are therefore, merely legal plunder and waste of scarce resources. “Political realism,” Mises points out, is “that hodgepodge of cynicism, lack of conscience, and unvarnished selfishness.” (1983: 98) 67. … WITH (II) PUBLIC-WORKS PROJECTS Keynes assumes three things. First, that wages are sticky downward. Second, that the economy is in a depression. Third, that there is unemployment. The cure for these unfortunate conditions is, according to Keynes, either inflation or government spending or both. Now the first assumption I have called a mere cultural peculiarity of Keynes’ time. It need not be true; an ideological change can easily correct this perversion of a business practice. The second assumption, in and of itself, lacks an explanation of the cause of the depression. If a major cause of depressions is inflationary credit expansion, then more of the same thing will only prolong the depression. The third assumption is also heedless of the possibility that the cause of unemployment and generally of imperfect resource utilization in a depression is the unsustainable malinvestment during the preceding economic boom. Here I will focus on government spending. The Keynesian idea is this. Even if we suppose for the sake of argument that it was government policies that cause the boom and bust cycle (though Keynes does not accept that), still, the government may be able to cure it. The way to do so is to boost “aggregate demand” or C + I, i.e., consumption and investment. The ways to boost the former, of which Keynesians cannot get enough, are either tax and spend or borrow and spend from either the public, the Central Bank, or the foreigners. Here is the dynamics. The government has tied up the economy into an interventionist straightjacket. Interference with commerce debilitates social cooperation. The standard of living stagnates or gets worse. The people are upset. The government, unwilling to free the market, decides to “stimulate” the economy with monetary policy. As we have seen, both consumption and investment get a shot in the arm. Since this is contrary to the nature of the economy for C and I to move in the same direction in the short run, the boom thereby created is unsustainable. A bust slithers its way in. Mass losses cause unemployment. “Depression economics” apparently counsels the state to spend in order to prevent collapse of failing companies and loss of jobs. Again the economy seems to be underperforming and below its production

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possibility frontier, though for a different reason than before. Here is the crucial part of the argument: this sort of government activity does not, it is claimed, take resources away from the private sector but mops up idle things, such as unemployed labor. To be sure, it represents a forced transfer of wealth from the presently employed to the presently unemployed, thereby becoming a “welfare” handout. But overall, the total pie grows, because the unemployed will do some useful work as opposed to staying home and presumably twiddling their thumbs. Both the monetary and fiscal policies should be halted only when full employment is reached, and there is true inflation. This argument is wrong on a number of levels. The first thing is that it is probably impossible to pull labor solely out of their idleness. Some workers will be lured away from profitable private employment. Second, these laborers will require complementary capital goods and land to work with, and it is even more implausible that those items will come out of the assets that the bust has rendered at least temporarily useless. So, those, too, will be bid away from the private sector. Third, there is the delay in figuring out when a genuine recession is under way that limits the effectiveness of public works. Fourth, taking the case in which the government gets its resources by taxation, the taxpayers are harmed, because this is not a mutually beneficial transaction; moreover, it creates a moral hazard, in which the successful are penalized for their very prudence in finding such steady jobs that are not cut during a depression. One could argue that the tax money, too, is taken out of “idleness,” because it would otherwise be hoarded. However, as I will show in Book II, hoarding is a non-malignant activity, both individually and socially. Fifth, the government does not know into which projects to funnel the money. It is quite possible that, for example, it will put the unemployed to absurd ends, such as use them as soldiers in wars of conquest, thereby solving the unemployment problem by getting the unemployed killed. One possibility here is to fund those projects that have been already authorized but frozen due to lower tax revenues during the depression. But is there any doubt that the selection of government projects to be undertaken will be politically motivated and have little to do with the common good? Moreover, it presumably makes sense for public works to take place in those areas where unemployment is greatest; in particular, because labor mobility is somewhat restricted by the disutility of individuals’ and especially families’ uprooting themselves. But this means that the main criterion for selecting where to begin governmentrun construction is not the usefulness of the work to any community but

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rather a kind of make-work featherbedding. In other words, the rationale for public spending for the frozen projects is to produce public goods that a city deems important enough in themselves to resort to something as economically inefficient and morally dubious as taxation; communal wealth, such as it is, is created, and this ipso facto entails that costs to the taxpayers including the cost of “jobs” created are minimized as much as possible. For Keynesian projects, it is to boost consumption; no one really cares what to produce, and the more expensive the project, apparently, the better. The two could not be more different. No, this idea will not work either. Keynes himself, contemptuous as he is of “orthodox finance,” would not have approved of it. Sixth, setting up production takes time as much for the government as for any private entrepreneur. The consumer goods, such as roads and bridges, may be far from ready when the depression is over. If the point of deficit spending is to get out of a depression quickly, then on its own terms, lavish public spending may not be feasible, since grand projects (pyramids for bureaucrats, etc.) naturally take a long time to complete, especially when the government is running them. Of course, for Keynes, the point always is to get the money spent. As long as this is done, a time-consuming project may well be abandoned unfinished, halfway through. A public project is just a way of distributing “welfare” checks, only one that conceals its offensiveness a little better. Seventh, the projects in which the unemployed labor will be used must utilize the same skills that the workers already possess, for otherwise the position of those workers will be indistinguishable from that into which the market has put them. This is unlikely to happen: will road construction require the same human capital as even house construction? All these, however, are minor points. The arrow into the heart of the government’s priming the pump is sent with a simple question: How much should the government pay its workers? There are only three possibilities. (1) If it is a “low” wage, then wages are not sticky downward after all, nullifying Keynes’ first assumption. The idea that the wages of civil servants are somehow less sticky than those in the free economy is not worth discussing. Any high-ranking official who tried to cut a subordinate bureaucrat’s salary understands how difficult a task this is. Equally implausible is the claim that the market will not offer low-paying jobs. On the contrary, job creation goes on all the time, and most new jobs on the market during a recession will be precisely low-paying. (2) If it is a “high” wage, then again, the taxpayers would be

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better off with those resources lying idle. There is nothing wrong with doing nothing, if the alternative is losing money and making one’s situation worse. Even more important, high wages keep workers’ expectations high, thereby prolonging the time until reality sets in the minds of these newly minted government employees. People will still be thinking the boom is going on if the state pays high wages. Why lower one’s expectations at this point? Stated differently, worker idleness is self-penalizing by depriving the worker from income. The worker feels the sting which serves as an incentive to him to find a new job. This undermines Keynes’ second assumption: we must not really be in a depression, if there is a boom in the “government industry.” At this point, a Keynesian surely will reply that the whole point of deficit spending is to prop up both aggregate consumer demand and wages. But this spending (a) substitutes government sovereignty for consumer sovereignty, thereby undermining capitalism still further (that is, beyond the beating the free market has already taken from artificially cheap credit); and (b) creates jobs that produce few benefits to the public. These are true, my hypothetical Keynesian will go on, but these offensive goings-on will persist only until the depression is over. Unfortunately, “the whole point” of a depression is to cleanse the bad investments and with time, reallocate resources to productive uses, not to pile up new bad public investments on top of existing bad private ones. Even the Keynesian multiplier will be useless, since when the economy is in shambles, and people are learning to be poor, there is little to multiply. Massive economic discoordination is part of what “bust” means, discoordination that has no creative component but only the destructive one. If I saw the government taxing and spending, then I would be much more fearful for the economy than if that government embraced laissez-faire. I will deal with the fiscal policies in Book II. (3) Finally, if it pays the “right” wage (that is, if it somehow stumbles upon the right wage), then the private sector will in due course offer the same wage, as well. This destroys Keynes’ third assumption, namely that there is unemployment. But even with a single one of his three assumptions gone, Keynes has no case. 68. … WITH (III) (MORE) EASY MONEY There is little to be said about this form of attempted depression cures. It merely injects into the patient more of the same poison that fell him in the first place. In a depression, the supply of credit, that is, of

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present goods, is low, because people hoard, but the demand for credit is also low, because of the (hopefully, temporary) high prices of the consumer goods such as houses and of factors of production such as labor, and because so many people are already in heavy debt. Both risk and time preferences rise. Investment opportunities are few and far between. Banks may not be able to lend much, if no one is borrowing, and the banks themselves, given the uncertainty, may want to increase their reserves and retire some of their debt. Quantity borrowed / invested declines. Enough inflation can probably reverse the depression for a short period of time, or it may not, if the public gets suspicious that the Central Bank in conspiracy with the government is manipulating the situation in such a crude fashion. Regardless, the amount of inflation sufficient to get lending started again may also be sufficient to ignite a hyperinflation, in which case all bets are off. The economy will be harmed far beyond the limit to which the projected depression was imagined to harm it. And a depression should not be viewed as harmful anyway but as a natural, if unpleasant, process of self-recovery for the economy. In addition to all that, inflation can be bad for banks themselves; in fact, there is a kind of schizophrenic thinking going on in the minds of bank owners: banks inflate by creating credit out of thin air, but inflation lowers the purchasing power of the future money that the borrowers will be repaying to the banks. In other words, each bank benefits from its own power to inflate but is harmed by other banks’ power to inflate. If entrance into the banking industry is relatively free, then competition among banks will lower profits to their average levels, thereby making the banks’ privilege to defraud by keeping fractional reserves otiose. (By “average,” I mean only that the banking industry is not in any way special in comparison with other industries. There are no monopoly privileges or barriers to entry or subsidies that would cause the various firms in that industry to enjoy permanent unusually high profits.64) Even a thief will be affected by competition from other thieves. In

64

It is possible that due to dangerous or sinister happenings, such as rumors of wars, a high number of potential entrepreneurs are deterred from entering a particular industry. As a result, those firms already operating in that industry experience an above-normal rate of profit. However, this is so only because the profits that did materialize, such as because the war did not occur, were counterbalanced by a high risk of abovenormal losses that fortuitously or due to unusually keen perception or precise

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this case, fractional-reserve banking harms society, has no effect on bank profits, but does benefit the state which gets an unlimited line of credit with the Central Bank, allowing it, for example, to run a global evil empire, as is the case with the US. The dual power to tax and to monetize debt makes the state nearly omnipotent. Furthermore, it may not “work” for the Central Bank to increase commercial bank reserves. Here is the sequence of events: the Fed buys Treasury bills; because the federal Treasury is the only honest 100%reserve bank in the US (how ironic that the looters should be so scrupulous), it will spend the money; the recipients of this money will deposit it into their bank accounts; banks will pyramid credit on top of these new reserves but, scared, will end up buying more “safe” government debt with the new money rather than loaning it out for productive activities. So, the Fed must buy the debt of private entities (i.e., lend to business firms) directly. But in this case, it will end up owning a part of the economy. Here we can see how control of money, a crucial commanding height of any society, by the state can bring about, at least in theory, fullscale socialism. Paul Davidson (2009) apparently has never seen an inflation he did not like. He is a believer in the idea that government deficit spending, financed by the Central Bank’s buying government bonds, “can and will create profit opportunities and therefore, induce business firms to expand output and employment.” (66) For that reason, he holds those who would have the US Federal Reserve target a particular inflation rate in utter contempt. For sometimes, aiming at such a target requires tightening of money and credit. This depresses the economy and “endorses an incomes policy based on fear: of loss of jobs, sales revenues, and profits for firms that produce goods and services domestically.” (77) The advocates of inflation targeting, Davidson explains, think that workers need to be shown their place in the scheme of things and so, enjoy striking the fear of the Fed into them. To add injury to insult, the same elitists would abolish the “social safety net to protect the unemployed.” These things Davidson calls “barbarous,” “not very civilized actions” that bring about numerous “casualties of war.” (78) In the first place, it is odd how Davidson describes “income inflation.” His opinion is that the masses of common people have revolted against the “tyranny of the free market.”65 (74) They demand higher and footwork failed to materialize. Banking can, I suppose, at times be very profitable for that reason, but here, too, it is similar to all other industries. 65 An ugly phrase, to be sure. What is next, people rebelling against the freedoms permitted by a tyrannical government?

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higher incomes without any concern for the welfare of the companies employing them and thus, the common good. Surely, there is a limit to how high wages can get without destroying the economy. But the masses could not care less. Therefore, the Fed must put the squeeze on the economy and teach workers a harsh lesson. Now as Mises points out, “where there are selfish interests pro, there must necessarily be selfish interests contra, too.” (1996: 82) A worker may want to be paid as much as possible, but his employer wants to pay him as little as possible. Then there is competition among workers, as much as there is competition among firms. If worker demands cause income inflation, then by the same logic, must business demands cause income deflation? In the end, there are negotiations, bargaining. Davidson is talking nonsense. There is no such thing as a “wage-price spiral” without actual money supply inflation (unless demand for money falls, but that will not cause a spiral, either). A worker who asked to be paid more than he is worth would be unemployed. At the same time, an entrepreneur does not have to wait until his costs of production rise to raise the prices of his products: if he could do that, he happily would regardless of costs. Even in a socialist society, the government can simply refuse to pay more to the workers, and Keynesian policies are inapplicable to socialism, anyway. It may be that long-term contracts are set up with the expectation of inflation such that in the beginning, the worker is overpaid; in the middle of his contract, he is paid “correctly”; and in the end, when price inflation hits, he becomes underpaid. Even in this case, the wages do not push up prices on average over the entire period. There is rather a consumer demand-price-wage spiral triggered by general price inflation. But there is nothing mysterious about that. People’s net worths in terms of money increase, which causes them to embark on spending sprees, which causes heightened competition for consumer goods. Companies ration these goods by raising prices for them. … Finally, costs of factors of production, such as incomes to labor, catch up, as business firms’ futile attempts to expand bring this about. What our author really wants to say is that his beloved money supply inflation causes price inflation, including inflation of wages. He seems vaguely uncomfortable with this. What to do? Davidson proposes an “anti-inflation policy called TIP – a tax-based incomes policy.” This is essentially a price control which will “penalize the largest domestic firms if they agreed to inflationary wage demands” (2009: 79) and therefore, is as anti-social as government interventions (resorted to in order to “correct” to consequences of previous government interventions) get. (Do not the firms penalize themselves by paying higher wages?) This he

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judges to be not based on “fear” and hence, presumably, more humane. Happy are we, therefore, who are able to enjoy the benefits of money supply inflation (such as the aforementioned profit opportunities) without paying the costs of price and wage inflation. Why inflation? Perhaps, Davidson thinks that the revolt has the shape of unionist price fixing, minimum wage laws, hiring and firing restrictions, the Americans with Disabilities Act, and the like, all of which result in institutional unemployment. Well, Davidson reasons, let us start the insanity. We cannot help it if the masses go bonkers. The most we can do is to make the government benevolent and foresighted enough to counter the mad thrashing about of the mob with inflation. If Davidson had any honor left in him, then he would have devoted his life to teaching the masses of people their common interests rather than (a) despair that their ideology can be improved and (b) advise the state on how to attempt to redirect their alleged manic selfishness to /dev/null. One can point out to Davidson that it is precisely inflationary credit expansion that causes the business cycle and the slump part of the cycle in particular. Were it not for the Fed’s initiating the inflation, there would no need for it to curb this inflation, when its disastrous consequences come to the fore. The more the Fed eases, the greater the misallocation of resources in the economy. Therefore, first, nobody “revolted” against the “free market”; workers naturally and reasonably respond to the diminishing purchasing power of money by asking for raises. Second, this misallocation is a much more perverse result of credit expansion than the mere rise of the price level. I am prepared to call the latter economically uninteresting. As an aside, I might suggest that it is philosophically unjust, because the friends of the political elite receive the new money first, while the rest of the people suffer higher prices. If that is what Davidson means by his claim that “free market” is marked by a “struggle over arbitrary and inequitable distribution of income,” (80) and moreover, by “institutional power struggle for higher incomes,” (74) then I might concur. To imitate Mahatma Gandhi’s famous quip, unfettered free market would be – in my opinion – a “good idea.” But I would expect even a novice in economics to grasp that income under free enterprise tends to be “distributed” to each individual according to how well he promotes the welfare of his fellow men in their capacity as consumers. Coming to own and enjoy private wealth is not (1) arbitrary, because it reflects the size of one’s prior contribution to other people’s happiness; and it is not (2) inequitable, if can be shown, as I believe it can, that each person deserves his income. Third, Davidson must disagree with Keynes who is of the

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opinion that lower wages cannot remedy unemployment. Both Keynes and Davidson recommend inflation; but Davidson in addition would have us hold down wages by government coercion and compulsion. What an original way to improve upon Keynes’ already holy writ. Naturally, this will prevent equilibration and create everlasting profits for the same entrepreneurs, an economically monstrous state of affairs. Keynes himself preferred money supply inflation to deflation, stable prices (whatever that means) to inflation, and abolishing interest and alleviating unemployment to stable prices. Keynes was a monetary crank, but there was a bit of method to his madness. Davidson further recommends supplementing inflating (by means of credit expansion) in an attempt to lead the economy closer to full employment with wage controls. Alternatively, the Central Bank’s credit expansion is used to stimulate investment, and the government then attempts to check the inflation due to the Fed’s policy, such as by raising taxes to suck out the new money. Since both are required to usher in the bust, apparently, this way, we can have a quasi-boom which need never end. Like Zeratul beholding a protoss and zerg hybrid, we can wonder, stunned and outraged, “Gods, an abomination! Who created this atrocity [of an argument]?” Even if the taxes are set correctly, i.e., regressively hitting the poor and middle class most to lower their consumption (since the wealthier folks tend to save more), all that is achieved is that there is more investment and less consumption, a clear violation of the people’s sovereignty as consumers and investors. The “boom” deprives the public of immediate pleasures which they value more than the increase in future bounty, a trade-off that is coercively imposed on them. This policy mix seems to “work” on the macroeconomic level. When looked at more intently, it reveals itself only as a criminal act to misallocate resources intertemporally. The rationale behind the non-fearful spending is twofold. First, the policy based on “fear” is condemned probably because higher risk preferences may lead to more careful spending by the people, i.e., an increase in voluntary hoarding. Second, Keynesians in their subconscious seem dimly aware of the phenomenon of mass losses following on the heels of an unsustainable boom. In a kind of childish naïveté, they reason that these losses can be ameliorated by government spending (which increases the money supply from forced dishoarding), turning them into profits; or by Central Bank inflation (which increases the money supply by means of printing money and more credit expansion), producing new credit to be used as money capital. These ought to fix the depression!

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Once again, however, losses are a market signal that something is very wrong. The underlying reality is poor allocation of precious scarce capital. Complementary factors do not snap into place, do not click; projects are abandoned halfway through; goods fail to satisfy. Papering over this with fiat cash and more credit will continue to impoverish society. Perhaps, the government can create profits by buying up the goods and burning them or distributing them through lottery. But it is scarcely possible to come up with a more thorough “greatest misery for the greatest number” principle than that. The solution is not to create temporary “economic activity” but to cause people to produce those things that are most urgently needed by their fellow men, to cause no human effort to be wasted in pointless pursuits. In fact, man does not “engage in economic activity,” such as presumably buying and selling, at all; rather, in whatever real activity he does engage in, he economizes. Rather than stimulating activity, inflation does the exact opposite of checking economizing and generating waste and absurd busywork. Credit expansion causes good people to be like those losers who never finish anything. For goodness’ sake, even the Bible warns us in Lk 14:28-30 about this sort of thing! The key is precisely to squeeze the most output and utility from the least amount of work and waiting. Human labor is a holy thing; it is not masturbation but a sacrifice for the sake of building something glorious, a civilization, which is something that we will not have, as long as we are guided in economic theory and policy by Keynesism. Speaking of “arbitrary and inequitable distribution of wealth,” I would question Davidson’s interpretation of Keynes as believing that those are one of the “two flaws” of capitalism. (6) Where is Keynes’ discourse on political philosophy? There are in both Treatise on Money and General Theory few traces of any philosophy, let alone a defense of a proposition as ambitious as that. I have never seen Keynes referred to as a political philosopher. There is Keynesian economics, such as it is, but no Keynesian philosophy (or even sociology), the way, say, there is Rawlsian philosophy (A Theory of Justice), Rothbardian philosophy (The Ethics of Liberty), or Marxist philosophy (The Communist Manifesto). But these are different issues altogether. In sum, (more) easy money in, for instance, the depression of 2008-10 would be catastrophic for the economy. The monetary policy will also be considered in detail in Book II. 69. THAT A “STAMPED MONEY” POLICY WILL PRODUCE RESULTS OPPOSITE TO THOSE KEYNES WANTS TO ACHIEVE

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On p. 357 of General Theory, Keynes mentions the plan of stamping money in order to drive down interest rates for the second time. “According to this proposal, currency notes… would only retain their value by being stamped each month, like an insurance card, with stamps purchased at a post office.” Notice again how delivery of mail, another commanding height of society, when controlled by the state, encourages reformers to dream of using it in their totalitarian schemes. He ultimately rejects the idea, because, he feels, there will be massive individual resistance to this program and evasion. He fails to realize that the idea is completely untenable on its own terms. Suppose, in fact, that all transactions are conducted with cash only and avoiding the government-induced depreciation of cash is somehow impossible. For illustration purposes, let me consider a stamp tax of 20% of the value of cash held per week payable to the government’s Post Office. Now remember, as per (I, 20), that a person can save for any of consumption, investment, and hoarding. The most obvious result of Keynes’ proposal will be a great increase in the velocity of circulation of money and a decrease in amount of each person’s cash balance kept due to lower opportunity cost of such immediate consumption. Saving, aside from the amount that can be saved in a week, will be strongly discouraged; and long-term savings, dissipated. Remember that when one saves over a long period of time, production is ipso facto redirected from making consumer goods to making expensive capital goods which increase the marginal productivity of labor. If money savings cannot be accumulated, then neither can real capital goods. Keynes has in mind something like the following. Suppose that Smith needs to pay rent equal to $500 a week from now. It pays him, in this case, to loan $556 to Jones for exactly a week at –10%, if it will be Jones on whom paying the stamp tax will fall. Instead of losing $100 by keeping the money under the mattress, a week from now Smith will have lost only $56. Voilà, zero or negative interest rates! Keynes should have known better. For what could drive Jones to borrow Smith’s money and subject himself to the tax? Obviously, high time preference. And what do high time preferences mean? Just as obviously, high PIRs. The stamped money policy will result in an increase of interest rates. Disregarding profit opportunities and therefore, the producer loan market, interest would rise to at least 20%, if one has to pay the 20% tax on the money received back with interest. Again, it may be repeated, what if Smith can get rid of his money and let the borrower pay the tax? Then it still makes sense for him to consume immediately as opposed to

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receiving the same or less later. In short, Keynes has confused the effects of actual vs. expected inflation. Only the former will lower the real interest rates down to or below zero. Once the policy is in place, however, people will adapt by charging at least 20% interest on all loans. Indeed, that is why negative nominal interest rates are impossible. They would no longer present one with a choice between consuming “less” now vs. “more” in the future; but on the contrary, consuming “more” now as opposed to “less” in the future, and this is an easy choice. Far from lending money at a negative interest rate, one would rather consume it now. A different interpretation of this idea is that it is supposed to dissolve hoards and redirect the money that would have been hoarded into consumption and investment. Every banknote might have an electronic clock and value on it, such that every week the value would drop by 20%, unless the note is exchanged for a consumer or producer good or service; then the value would reset to its original number, and the clock would reset to zero, allowing the new owner a week to keep the note before it lost value for the first time again. Perhaps, the banknotes would be able to read a person’s mind, such that if one saves for the purpose of buying an expensive consumer good or starting a business, then the note will not depreciate, but it will lose value, if he saves for reasons of security-seeking. Disregard the practical unworkability of this scheme. What is interesting is that it will result in a business cycle. The purpose of accumulating hoards is to secure oneself against uncertain future. People who hoard are afraid to invest, even though holding money does not even earn interest for them. Their personal confidence rate is low. But the government forces them either to consume or to invest. Since a consumer good is less likely to be liquid than a security, investing is the only way to maintain the semblance of liquidity. Unfortunately, the kind of people who now invest more are the marginal cowards. They are deathly afraid but have no choice. But again, fear is a burden that dampens or negates one’s entrepreneurial agility. If one is unsure of himself and quaking in his boots, then he has no business competing with the more confident. These fearful individuals will likely lose and fail in their businesses. The result is again mass losses and a bust and recession. Thus, a business cycle can occur not only due to failures of prudence but due to failures of courage, as well. Now to be sure, in public companies there prevails a partial separation of ownership and control. Smith may invest, and his own fear may be irrelevant to the success of the enterprise. However, he may choose to invest in the most conservative businesses, yet a business must

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either grow or shrink; it is almost impossible for it to evenly rotate for any significant period of time. In other words, a shareholder is an entrepreneur, insofar as he, uncertainly, chooses a CEO who will act on his behalf, as though giving him the power of attorney. Some investments will be in personal businesses. Regardless, there will be more fear in the economy. We can bring the futures market to bear as an analogy to the loan market in the standard Austrian business cycle theory. The futures speculators are deceived about the equilibrium confidence rate or ECR. They observe increased investment and consumption and lessened hoarding and figure that people’s confidence rates are higher than what they really are. When making futures contracts, they offer higher prices to sellers of commodities (e.g., farmers), despite the fact that those sellers are scared of their own shadows and would actually accept a pittance in order to be relieved of their worries. If a speculator predicts the future prices incorrectly, then he will always take a loss, because the seller will buy cheap elsewhere on the market and sell dear to the speculator according to the contract. If he predicts correctly, then his profit margins are already low, because of the illusion of high confidence. In addition, numerous “cowards” will both fail to deliver when the time comes and claim to have no money to deliver by buying on the market and reselling to the speculator. They will declare bankruptcy. This will lead to losses to the speculators overall. Fortunately, the speculators are not fractional-reserve; they are not deeply overextended and unbecomingly fragile. But there will be a bust nevertheless. Given that tax reforms are rare, and deficit spending is easy, the fiscal policy usually takes place by means of borrowing and spending. The percentage of cash balances held as a store of value diminishes, lowering the apparent ECR. It remains to be seen how important this reason is as a cause of business cycles. In the United States, for example, fiscal policy is viewed with more suspicion than monetary policy. The Fed is idolized and supported as an essential institution, providing “opportunity” to the “little guy” by showering that guy with credit, whereas the government is more limited in its ability to tax and spend. Upon the establishment of the stamp tax, with consumption rising at the expense of saving, the supply of present goods will diminish, raising the interest rate and lowering the quantity lent and borrowed. Investment will be concomitantly curtailed and standard of living, fall, after a massive bout of capital consumption has destroyed all but the most primitive production processes. I doubt that Keynes had these effects in mind when calling this preposterous design “sound.”

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Keynes’ work suffers from the author’s abject failure to understand interest rates and the time market and to countenance the structure of production. He lets his fancy run wild in believing that the scarcity of capital can be abolished. His theory of business cycles is non-existent, and he does not understand the prevalence of risk preference as a primordial phenomenon which cannot be abolished by any means. He has no confidence in entrepreneurs, contrary to the experience of our daily lives. His policy panacea is inflation, precisely the cause of booms and busts. All in all, as the father of today’s intellectual bodyguards of the state, our author is far less imposing than might seem to someone uninitiated into the Keynesian mysteries.

Book II The Disciples 1. THAT INDIVIDUALISM REMAINS THE PROPER METHODOLOGY OF ECONOMICS, CONTRA SOME POST KEYNESIANS Edward J. McKenna and Diane C. Zannoni ask how an agent is related to the “social structure.” They propose that methodological individualism claims that the structure is determined by individuals. Methodological collectivism, on the other hand, makes the social structures the determinant of individuals. “A hallmark of the Post Keynesian concept of agency is a rejection of both of these views. For Post Keynesians, individual agents are born into a social structure that deeply influences, indeed partly constitutes, the very nature of the agent. However, it is equally true that the actions of agents help to reproduce and transform the social structure. Thus, agent and structure are mutually dependent upon, but not reducible to, each other.” (King 2003: 2) The authors misunderstand the argument at hand. Human beings are, indeed, partly in act and partly in potentiality in more ways than one. They are in potentiality even with respect to their purely spiritual properties. They learn new things and in learning, they change. They change in holding which behaviors will most promote their happiness. They change in the extent and quality of their knowledge of reality. Nobody has ever denied that people influence each other mutually, e.g., via dialog or conversation, or that there is an interaction between individual and society. Even entrepreneurial competition entails that people seek to excel over their rivals and therefore, plan their own actions by looking at what other people do. The thing to remember, however, is that whenever there is any such influencing going on, it is of one individual human being on another. A collective whole does not act other than via an individual belonging to it. Any influence of a whole is attributable to some individual acting and persuading on behalf of that whole and driven by the ideas and conceptions held by the people who, in common with him, make up the whole. Human beings count themselves as members of numerous communities, numerous wholes. As such, they behave in manners that represent the natures of those communities. Both members and non-

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members of any collective must recognize the special status of the former and a non-special status of the latter, and it is that recognition that a collective makes. Only by taking account of the meaning that a person attributes to his own actions can one understand both that person and the community, of which he is an intermediary, and on behalf of which he acts. When a city cop arrests a suspect, the cop understands himself to be acting in an “official” capacity, as a representative of the city government. The suspect meekly complies, something he would not do if the person arresting him were not an authority. The government, in turn, derives its essence from the fact that a great many people believe that this organization holds a monopoly on violent punishment within a particular area. Why do they believe that? Because they foresee that the government will crush them if they commit a crime. Why do they not attempt to change things around? Probably because they sensibly consider such monopoly to be in their own interest. The government, then, is a collection of individuals who act in a “governmental” manner, presuming it appropriate, for example, to imprison lawbreakers. They attach special meaning to their actions and moreover, depend upon other people’s attaching to these actions exactly the same meaning. These actions and their interpretations reveal to which collectives they belong or think of themselves as belonging. For example, a Ruritanian government soldier deployed somewhere in the world argues that he is serving his country and is entitled to gratitude and respect of those he claims to be protecting. He is a good citizen; in fact, a better one than the “civilians.” He fights for what he believes in. In response, Smith tells him that if he really loved his country, then he would not be dishonoring it by killing people unlawfully. He would not be obeying without thinking the wicked orders of the chief bureaucrat who pompously calls himself generalissimo. Therefore, Smith continues, he must judge the soldier to be no better than a foreign mercenary, for whom money matters more than righteousness. In so doing, Smith is denying him full-featured membership in the collective whole called “Ruritania.” It is plain that any such membership is a matter of one’s attitude. Again, as a naturalized US citizen, I have a right to vote and hold any public office other than US President or Vice President. Other US citizens have judged me worthy of joining the club but with limited privileges. They must have thought that the country would benefit from the exercise of my vote and my possible attempts myself to be elected. Both my joining the body politic as a citizen and my being allowed to join are actions of individuals. True, these actions are rule-governed, and

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the rules have existed for a long time, but the ultimate control lies with the people regardless. There certainly exist folks who are dull and indolent and easily swayed to accept different opinions and ways of living. We may oppose them the pioneers and independent thinkers who test every stimulus they receive and consciously either permit or deny it its influence. Such individuals “soul-make” others and are more careful to let others “soulmake” them. But all that is beside the point. What matters is that collectives are in the minds of their members and of those who are willing to recognize or construct a collective. Thus, I might hold a peculiar belief of the special significance of all those people whose last name begins with the letter “C.” If, because of that belief, I act differently, it is not the collective that influences me. It is the meaning that I find in my own membership. When a theologian describes the nature of the Trinity, he may be thinking of himself as representing the Catholic Church. There is nothing abnormal about this. But it is he, the theologian, who is thinking and acting. The Church is constituted entirely by its members’ beliefs of how they are related to each other and by other people’s willingness to recognize those relations as reasonable. It is true, moreover, that love of friendship described in (I, 27) can unify “selfish” individuals into a genuine whole not reducible to the sum of its parts. But economics excludes such love from consideration at the outset. Here I can only indicate a possible line of inquiry. Consider the strange idea of “economizing” on or conserving virtue. The argument seems to be that people ought to love and do good to each other. One has a holy duty to benefit and succor his neighbor. Let Smith have an apple, and Jones have an orange. Out crawls the moralist and says that the right thing to do is for Smith to bestow his apple on Jones, and for Jones to give up the orange for the sake of Smith. But, we immediately concede, people are morally lax, immature, even vicious. They should love their fellow man, but they do not. However, we, being good people, should have mercy on these poor sinners and patience while we are improving their character. We should be compassionate and forgiving of them in their weakness. Since we want the apple and orange to change hands as per Smith and Jones’ moral duty to each other and to “love,” i.e., we want this thing to “get done” one way or another, in majestic charity, we allow these people a different way of arriving at the correct situation. Let us use a “shortcut” by allowing Smith and Jones to benefit from the exchange, to act in their own selfinterest. Such a transaction, of course, has no moral value, and our friends will not become better people as a result of it, but at least the

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external event has occurred. It is an imperfect solution, but perhaps, it will prove useful at some point, anyway. It is a beginning of sorts. That is the argument. And it is utterly mistaken, even disgusting. The first problem with it is that the two transactions, one motivated by self-interest and the other, by duty, are not identical. In the former, Smith prefers the orange to the apple, and Jones prefers the apple to the orange. In the latter, Smith wants the orange more than Jones wants the orange, and Jones wants the apple more than Smith wants the apple. Clearly, these are distinct comparisons and rankings. The second problem is that the “moral” exchange involves interpersonal utility comparisons which are possible only through love of friendship. This love integrates the lovers’ values scales into a single scale, in which Jones’ happiness may be compared with Smith’s. Call this composite being with a single will incorporating the values of both Smith and Jones, SJ. In the beginning, the scales are: Sorange | Sapple; Japple | Jorange. The self-interested exchange between Smith and Jones becomes possible, and after it, Smith has the orange, and Jones has the apple. Let SJ’s values scale now be as follows: Japple | Jorange | Sorange | Sapple. The happiness of SJ requires that both pieces of fruit be transferred from Smith to Jones. Note that the “duty” account of this transaction does not fly, because SJ is motivated by its narrow happiness, the very same thing by which Smith and Jones are motivated when they do not love each other but merely find each other useful. SJ actuates the transfer of goods voluntarily; no moral sacrifices are demanded from any member of the union. The results suggest that the “self-interested” (SIT) and “loving” (LT) transactions are again distinct, with neither being a replacement for the other. Observe that an SIT followed by an LT is equivalent to an LT alone. More precisely, the outcome of an LT does not depend on the initial allocation of goods. Further, if in some cases, an SIT will produce different consequences from an LT, then this may be chalked up to the metaphysical inferiority of SITs. Suppose now that Smith foresees the apple going to Jones and objects: “I grew the apple for myself. Why should the mere presence of Jones necessitate that I relinquish the apple to him? Why must I do this?” The answer is that Smith does not have to. One either loves, or he does not. It is difficult to teach love and impossible to describe it other than as a transformative experience. It is a discovery that one must make entirely for himself. Notice how profoundly charity differs from altruism: altruism

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is defined as “unselfish regard for or devotion to the welfare of others.” But charity is ultimately perfectly selfish; it is just that it seeks the profit (whether in virtue or narrow happiness) of a united will, ideally, of the entire vine and branches. Jn 15 and 1 Cor 13:3 illustrate. Love requires no sacrifices from the lover beyond those of ordinary choice. United values scales exist in the hearts of both lovers, but likely a different one for each person. Now if loving uploads the beloved’s desires into the lover, interspersing both of their values, then as long as these desires are unsatisfied, they bring only pain. If a person acts to satisfy the beloved’s desire, then his own feeling cannot be simply generic happiness at beholding her pleasure, because such happiness is in essence merely relief, in which case the pain in the lover is replaced by absence of pain. If that were the situation, then loving would be a bad deal all around. It would be merely dull and pointless worrying. However, “I feel your pain and pleasure” is not just a vapid sentiment. In short, the lover must feel the exact particular flavor of the joy that the beloved is experiencing as a result of the satisfaction of her desire without yet “losing himself” by forgetting who the original desirer is. This is probably one of the most difficult spiritual exercises of them all. Clearly, then, we are not entrusting to the market those transactions that would otherwise, if people were “better,” be more properly done via love of friendship. In fact, the “loving” exchange is so different from a self-interested one that it is hard to know to which discipline its study belongs. Perhaps, the study of happiness belongs in part to economics; of virtue, to ethics; and of love, to metaphysics. In that case, it seems appalling how the most interesting and practical problem of metaphysics, namely, how individual human beings can, through love, intertwine with each other to form gestalt wholes, social bodies, etc., has been entirely neglected. Note that human wills are fully private but in a stunning reversal, capable of merging into a single combined will. Individual values scales do not lose their significance but are united. Bodies, material things are fully public but remain under private control and ownership. The error of religious communists, and such people have existed, and modern communitarians of various sorts is that they take the ineffable and almost mystical union of immaterial appetites to entail the coarse union of bodies and property. Joining of wills, such that the lovers care for the welfare of the whole, does not mean that the people’s bodies suddenly grow multiple heads that bicker with each other, or that private property ought to be abolished or restricted. For example, in giving the apple to Jones, Smith lovingly transfers to him the title to his property. Jones now owns the apple. If Jones

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tried to seize the apple by force, then Smith would be justified in calling the cops. Not the least stroke of the pen commanding people to respect private property rights will disappear from the natural law until the only thing that all people will want for themselves is the infinite God. Lastly, intellects are in between: they, too, remain privately activated and used, but in working together, they influence, assist, and enrich each other. The utopian socialists then confused the glory and ecstasy of coalescing or fusing of wills with the shame and misery of communizing property; the alleged scientific socialists failed to detect the dual nature of creative advance in the market process, such that the yang part of it is checked 100%, and the yin part is severely crippled (since the vast national or worldwide government “firm” is unmanageable) under socialist system. Again, there are two major concepts which permeate (and instances of which dot) the entire creation: unity-in-variety and changeamidst-permanence. The utopians defiled the former; the “scientists,” the latter. In short, the utopians were bad philosophers; the scientists, bad economists. Left-liberals (as opposed to classical liberals or modern-day libertarians), too, think that being spiritually advanced in love (insofar as they can actually claim this glory) justifies for them theft. They feel that it is OK to take money from those who allegedly do not deserve it (like the fat and greedy merchants who no doubt lead the lives of vice, debauchery, and dissipation) and give to the poor in spirit “needy,” to aid whom is our holy duty. Of course, that does not follow, even if the characters of these people were correctly described which they are not. (For example, people who imagine that they are entitled to receive stolen goods are not in any likelihood particularly humble.) First, theft, both private and public (via the state or perpetrated by the majority), would be morally wrong, even if the rich were corrupt, and the poor, angelic. Second, society as a whole and everyone are hurt in the long run as a result of “redistribution.” There is no reason to undermine our productive power; neither the rich nor the poor will benefit from less efficient markets and less overall wealth. Mises is right that execution of a human action is individualistic in nature. But not willing or thinking. There is a sense in which man is a rational animal; and there is a sense in which man is a lover and a beloved of other people and God. In loving another, one can will to him all three of metaphysical, moral, and physical goods. E.g., it is certainly permissible and even praiseworthy to desire requited love.

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Even if LTs exceed SITs in perfection, nevertheless, though we must love everyone (i.e., will good to them), we (a) actually do not; and cannot either (b) know the values scales of or (c) do good to everyone (e.g., due to geographical separation). LTs are wonderful things, but they are impractical on any level beyond the immediate family. Fortunately, for love to triumph it is not necessary that everyone loves everyone else; it is sufficient that ∀(A) ∃(B, C) [A loves B & A is loved by C], that A is within the circle of love. A man has a metaphysical duty to love others and a metaphysical right himself to be loved. Consider the metaphysics of the family. C.S. Lewis writes that “If marriage is permanent, one or other party must, in the last resort, have the power of deciding the family policy.” In particular, the relations of the family to the outer world – what might be called its foreign policy – must depend, in the last resort, upon the man, because he always ought to be, and usually is, much more just to the outsiders. A woman is primarily fighting for her own children and husband against the rest of the world. Naturally, almost, in a sense, rightly, their claims override, for her, all other claims. She is the special trustee of their interests. The function of the husband is to see that this natural preference of hers is not given its head. He has the last word in order to protect other people from the intense family patriotism of the wife. (2002: 64-5; Mere Christianity, Bk. III, Chap. 6, “Christian Marriage”) The immediate question is: Will not the husband be tempted to abuse his powers? If the ultimate authority rests with him, then what stops him from refusing even to listen to the wife? Of course, one answer is that if he does not listen, then his wife will nag him to death. A better suggestion is that Lewis presupposes that the husband and wife love and care for each other; these seem to follow from the definition of marriage. Giving the man the decision-making power would be dangerous if the husband and wife were two self-interested individuals who could not negotiate a deal rather than a single composite being. In such a case, the husband’s privilege advocated by Lewis, indeed, would be a means of enslaving the wife. Hence, there need not in marriage be such things as painful “compromises,” self-abnegation, power struggles, memorizing favors done, and all the rest of the seamy underbelly of a loveless union. What is required for marital bliss is spiritual interpenetration, such that the profit of each is found in, however

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corny it may sound, the profit of the whole. A man may fall in love with a woman, because she complements or completes him in certain ways. For example, an ENFP girl could, if theory holds, be a good match for an INTJ guy. Love then does not depend so much on having common interests as it does on caring for whatever values, both 1st- and 2nd-order, the other person himself holds dear. Keirsey describes the Jungian “shadow” as “all that one is not, or rather, all that one has not developed, expressed, or lived out in oneself. And so, in being attracted to our opposite, it’s as if we are looking for that rejected, abandoned, or unlived half of ourselves.” (1998: 209) Marital love allows one to experience that other life. If one is fascinated by his complementary opposite, then feeling with them makes their goals, joys, and sorrows one’s very own. Nor is love any sort of “general will” allegedly embodied in some dictator. Brotherly love expresses itself most prominently not in agreement on public policy or common ends, not even in works of mercy which are to some extent supererogatory, but in treating one another justly according to natural law, including not plundering or oppressing minorities, be they the rich or some other unpopular group. To be sure, there are self-interested aspects of marriage: domestic division of labor, joint complementary effort to bring up children, sexual matters, and suchlike. But they pale in comparison with the fact that the husband and wife live for and in each other. That is why divorce is not merely termination of a contract (perhaps better, covenant or compact) but an act of literal tearing apart and up that which God has joined together. It is a demonic sacrament of destruction of love. Further, love (and its effects as identified by St. Thomas in (ST, II-I, 28)) is not perfect. Suppose that the husband wants to travel to A for a vacation, and the wife wants to go to B. Then if their love were immaculate and flawless, with each spouse loving the other as him- or herself, then they could simply compare their utilities interpersonally and agree which choice would be superior for the two overall as if for our “SJ.” But if the agreement cannot be reached, and time is of the essence, then, Lewis says, let the husband pick the destination. Why the husband and not the wife? If it can be shown, as seems reasonable to me, that normally, the man loves his wife more than the woman loves her husband, then Lewis’ conclusion will follow. The man is able to take into account his wife’s values scale better than the woman, her husband’s or the common good of the family. In addition, connected with love is the doing of good. Regarding this, there are two points. First, it is the husband who is expected to sacrifice himself for the wife and family, not vice versa.

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Second, the father’s task of guiding his children toward goodness (of all three types) and toward success is more important than the mother’s job as unconditional nurturer; or rather, the latter is subordinate to the former, just as health is an essential condition of and means to contemplation. The man’s authority follows upon his greater responsibility. Equalizing the rights of men and women to own and dispose of property is an important libertarian plank, already achieved in most civilized countries. But the woman’s ultimate emancipation in marriage is properly attained through love, not through the beheading of the household. However, I am not averse to the idea that even if “foreign policy” is to be conducted by the husband for the reasons C.S. Lewis alludes to (the man’s greater justice and greater scope of affections), it may be best if the wife participates much more fully in the family’s “domestic” policy due to her natural yin-specialization in prudence. Again, if heaven is characterized by perfect love, then it uniquely combines diversity with equality in happiness. Insofar as each person feels himself, there is diversity: “star differs from star in splendor.” (1 Cor 15:41) Insofar as each person feels the whole united by love, there is equality. The metaphysics of love, then, seems to be a strangely ignored area of philosophy. Now I will grant that “recognizing” a whole involves attributing a kind of identity to it. Picture a musical band with four members called “Keynes on the Brains.” With time, each founding member leaves and is replaced by a newcomer. After a while, there are no original members left, but the band retains its name and is known by that name to the public. All of a sudden, the four original musicians meet and decide to play music together again. They sue the present band and demand that they relinquish their name to them. How should a judge resolve the dispute? Or consider a conquered state like Iraq in 2009. It has an all new government and even all new form of government. Should it be liable for Saddam Hussein’s public debt? If a whole has an identity, then questions about its generation, persistence through change, and corruption inevitably arise. But such questions can only be tackled if we take each whole to be constituted by its members’ self- and others-understanding. The way to study collectives then is to focus on the four permutations of relations between a typical member and non-members, e.g., of a member toward other members, of a member toward non-members, and so on. It is the difference between how people treat each other (such as which rights and duties they acquire by joining a group) that gives collective wholes their particular flavors. But the treatment remains of

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one individual for another. 2. THAT BUSINESS CYCLES CANNOT BE BLAMED ON CHANGES IN THE VOLUNTARY SAVINGS RATES

At least three kinds of supply-and-demand-for-money graphs can be distinguished. First is DI in Figure II.2.1 or demand for and supply of money for an individual, call him Smith. Demand for money for Smith is all those goods and services that Smith is willing to give up in order to acquire N units of money for all N. In other words, if Smith’s demand for money increases, then he (1) is willing to part with more goods to obtain a unit of money (representing an increase in the purchasing power of money held by Smith’s suppliers) and (2) is demanding lower prices for goods, if he is to part with a unit of money (representing an increase in the purchasing power of Smith’s own money).

FIGURE II.2.1. DIFFERENT KINDS OF SUPPLY OF AND DEMAND FOR MONEY GRAPHS

Second is aggregate demand for and supply of money shown in panel DA of Figure II.2.1. Note that Smith’s demand is for the money he does not yet have, while the aggregate demand is the demand to hold cash balances already in people’s possession. The DA’s supply curve is vertical, signifying that the total money supply does not change, whereas the DI’s supply curve is normally shaped, indicating that people will bring in more or less money to exchange with Smith either (1) depending on its price or (2) in the state of equilibrium depending on changes in Smith’s demand for money. In DA, at the price above the equilibrium, the total demand to hold cash is less than the total money supply M, because the demanders want to obtain only a few dollars, while the suppliers want to get rid of a lot of their dollars. At the price below the equilibrium, the total demand to hold cash is greater than the total money supply, because (the quantity

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already owned by the demanders + quantity demanded + the quantity the suppliers want to keep rather than sell) is higher than M. Only in equilibrium is the total demand to hold cash balances equal to the supply of money. The connection between the DI and DA panels is now readily seen. The demand curve in DA is the total demand to hold, Qod + Qd + Qos – Qs = M + (Qd – Qs), where Qod + Qos (quantity originally held by the demanders + quantity originally held by the suppliers) = M, Qd is quantity demanded, and Qs is quantity supplied. All variables represent aggregate values, where aggregation is of graphs like DI for all people in the market. The total supply of cash to be held, of course, is constant and a vertical line graphically. Above the equilibrium, in DA, there is a surplus of money: the purchasing power is too high; people want to hold less than the total money stock. They disgorge cash and spend, in so doing raising the price level and lowering the purchasing power of money. Below the equilibrium, there is a shortage of money: people are demanding to hold more than is available. They spend less, and as a result, entrepreneurs lower their prices in order to give the public an incentive to buy which initiates a movement of the purchasing power of money upward toward equilibrium. Third is demand for and supply of savings or present goods in exchange for future goods, often called the market for loanable funds, pictured in the DS panel of Figure II.2.1. It is a cross of the previous two graphs. It features an upward sloping supply curve, implying that people will save and lend more at higher interest rates. The reason for that is that the higher the rate, the greater the opportunity cost of consuming or hoarding a marginal dollar. The quantity demanded / supplied is only that subset of the total money stock which people want to exchange for future money as opposed to all the various goods on the market. The purchasing power in the third graph, thus, encompasses not the entire price level but only the price of waiting to receive a higher amount of future goods than was lent in the form of present goods which is precisely the interest rate. In this case, it is of note that higher demand for money can co-exist with a preference to wait to receive the actual cash for the sake an even greater payoff in the future. Consider DA again in Figure II.2.2. If demand for money goes up from D to D’, then the situation is as if people wanted to hold in their cash balances more money than before. Unfortunately for this desire, the quantity supplied remains the same. Therefore, instead of having $q’ of money with the same purchasing power as before, namely, equal to ppm’, the public will have to be content with the same amount of money

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q but of higher-powered money with greater purchasing power, namely, equal to ppm’’. The same amount of money will do “more work” and be able to buy more things.

FIGURE II.2.2. DA EXPANDED

The business cycle theory described briefly in an introductory textbook (Bade 2009) is this. Autonomous consumption is defined as that consumption which would occur even if one’s current income were zero: “This consumption expenditure would be financed either by spending past savings or by borrowing.” (2009: 358) “An expansion is triggered by an increase in autonomous expenditure.” In other words, savings are spent, the multiplier effect comes to the fore, and this boosts the expansion still further. On the other hand, a decrease in autonomous expenditure must needs cause a recession. (2009: 374) I can think of two ways to interpret this. First is to focus on a single firm. A firm adapts to an increase in the demand for its product in three steps. First, it raises prices so that existing inventories can be cleared out in an orderly fashion. Second, excess capacity within the firm is filled. Third, if the change in the demand is foreseen to be permanent, provisions are made to boost production for good. It is claimed that the second step initiates the boom part of the business cycle. If there is a decline in demand, then the sequence consisting of the opposite steps occurs, and we have a bust. Second is to look at the economy as a whole. Given the equation MV = PT, when the velocity of circulation of money increases, the first two steps are the same. Inventories are again purged, and excess capacity is utilized. But lower demand for money by the consumers is complemented with lower demand for money by the workers. Hence, in the longer run, productivity falls (because workers are unwilling to exert themselves as much for a given wage), or wages rise, catching up with

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prices. Producing at the limit becomes too expensive, as workers demand higher wages to forgo leisure. Costs increase, and supply is lowered. The shot in the arm of production wears off. Thus, T goes up temporarily in the short run, while in the long run, P goes up permanently (barring future changes in V), and T goes back to its previous level, thereby moving in a kind of an arc. The same phenomenon occurs if money supply M increases as a result of dishoarding. Similarly, when the velocity of circulation of money decreases, the price level does not adjust downward instantly but is preceded by a decrease in output which, as P moves down, again at some point rises to its previous level. In other words, changes in V affect the demand for money and through it, the price level only in the longer run. These paroxysms of demanding money more or less, and of hoarding and dishoarding, it is argued, are a direct source of business cycles. Consider, given the Austrian business cycle theory outlined in Book I, that sudden changes in time preference might occur but only rarely (mainly as a result of wars, natural catastrophes, etc.) and would, indeed, trigger an economic recession. Similarly, sudden and large decreases in the demand for cash balances can set off a boom. The boom can be cut short by an equally unpredictable and large increase in the demand for cash balances. A boom can also be triggered by changes in risk preferences which convert hoarded money into consumption and investment or vice versa, affecting the supply of money. This theory fails for three reasons. First, demand for money does not change often, rapidly, or by a great amount especially in the world economy on the global level; so, it does not explain actual business cycles. All change happens on the margin, as explained in (I, 37). The margin can be smaller or larger, but it is rarely great enough to be depression-causing. Insofar as risk preferences change, greater anxiety follows on the heels of objective mass losses. It does not on its own cause the losses. Second, with respect to a single firm, if the demand for its product comes at the expense of the demand for the products of other companies, then this consumer-generated reshuffling of the production hierarchy can in no wise be called a business cycle. If the demand for everything wafts (eventually), such as due to dishoarding, then expansion in the crucial third step above will be checked by the scarcity of the factors of production. Remember that an increase in the money supply causes prices to rise unevenly and arbitrarily, subject to no rule other than people’s spending desires. An increase in demand for P will comes at the expense of an increase in costs for the maker of Q. The second

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step means simply that factors and workers will (perhaps, temporarily) be asked to work longer hours and enjoy less leisure. This is not important enough to worry about even in the short run, and there will be no cycle either. With respect to the macroeconomy, companies may, indeed, expand and then contract, depending on the “frequency” and “amplitude” of the oscillation of T. But there is nothing here that indicates an uneconomic misallocation of resources. The boom is harmless, light, and so is the recession (in which as P rises, T falls, because factors are becoming more expensive and to be employed less with excess capacity restored to its previous level). There is no cluster of errors anywhere in the structure of production, nor reason for mass losses and bankruptcies. We have rather merely normal entrepreneurial adjustment of the production structure, processes, output, and prices to changes in consumer tastes, in this case, tastes regarding the consumers’ choices of allocating their money holdings toward consumption, investment, and hoarding. There may not even be any real changes in the underlying business reality: the whole point of having some unused capacity in one’s firm is to be able to deal with fluctuations up in demand; and of having some cash on hand or access to credit, to deal with fluctuations down. Finally, the alleged cause of the cycle here is exogenous, generated by a change in subjective preferences of the buying public. There need not be any pattern to it: the “booms” and the “busts” will occur entirely randomly and chaotically, something which is not true of real business cycles, for which we can discern (barely intelligent) design. I must conclude that this theory is of little interest to economics. 3. THAT THE MONEY SUPPLY CURVE UNDER FIAT MONEY CAN BE HORIZONTAL

It is useful to distinguish between commodity money, fiat money, and credit money. Under “sound money,” that is, at least a noninflationary gold standard, the supply of money is vertical or can be usefully represented as such, especially because an increase in this supply confers no social benefits; it only dilutes the purchasing power of money. This means that the supply of money is or can be with reason assumed to be perfectly scarce: the quantity of money supplied cannot increase or decrease, such as in response to changing demand for money. (In real life, higher demand for money, if money is made from gold, will make gold mining more profitable and increase the money quantity supplied.)

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Under a fiat money regime, on the other hand, money is not only not perfectly scarce but, in fact, superabundant, because the cost of printing a banknote is low, and the cost of printing a $1 bill is the same as the cost of printing a $1 trillion bill; moreover, it does not cost the Central Bank anything extra to increase a commercial bank’s account balance in its computer by $1 trillion rather than by $1. Now if the monetary authority believed that this superabundance was a boon to society, then it would print googols of cash and distribute it among the populace. Of course, that would destroy the system of indirect exchange altogether and be a catastrophe rather than a blessing. Consequently, the money supply is made scarce artificially. The people are prohibited from “counterfeiting,” and a Central Bank is appointed to watch over the money supply. Since the Central Bank is at liberty to increase bank reserves in any way it pleases, it itself must have a rule according to which it will create money. Otherwise, the Bank chairman might simply print an enormous amount of cash and give it to his golfing buddies, thereby making them very rich and everyone else very poor. Hark back to the second and third graphs distinguished in Figure II.2.1, namely, the graph linking the purchasing power of money to the quantity of money, and the graph linking the interest rate to the quantity of present money being used as loans. Both have their respective supplies and demands represented. These would be perfectly correct under sound money. But under fiat money, these graphs look rather differently. This is because the Central Bank’s policy has usually been either (1) stable prices (as per monetarism) or (2) stable or low interest rates (as per the Keynesian contempt for interest as such). If it is the former, then the supply of money curve in the second graph is no longer vertical or even upward sloping but perfectly horizontal. This means that if the demand for money changes, such as from D to D’ in Figure II.3.1, then the monetary authority will adjust the money supply from Sc to Sc’ in such a way that the change in the quantity of money will offset the change in the opposite direction in the demand and preserve the purchasing power of money, resulting in curve Sf. Since the tendency under free market is toward mild price deflation due to stability of the money supply and economic progress (unless counteracted by mining of precious metals), the government might be able to maintain “stable prices,” meaningless though this target is, by inflating a little bit every year, just as monetarism prescribes. If it is the latter, that is, if the Central Bank “targets” the interest rates, then the supply curve in the third graph is horizontal, because if the demand for savings changes, then the Bank will alter the reserves of the commercial banks such that, when the banks pyramid new credit on

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top of these reserves, the money supply is such that the equilibrium interest rate remains what it was before the change in the demand for present money took place or even whatever the Bank desires.

FIGURE II.3.1. HORIZONTAL MONEY SUPPLY CURVES

Now the lessons of the normal graphs in Figure II.2.1 are not lost on the central planners; for example, the Bank knows very well that an increase in the demand for money will raise the money’s purchasing power, but an increase in the supply of money will lower it. So, the supply curve is horizontal in the first part of Figure II.3.1 because of a government artifice, because the Central Bank is not a market institution. The Central Bank could not exist unless commissioned, licensed, and protected by the state. In the US, the government enables the Federal Reserve to exist by enforcing legal tender laws, prohibiting private counterfeiting, insuring demand deposits, sanctioning fractional-reserve banking, and failing to uphold contracts in gold and silver. If the federal government did the job that its founders assigned to it, then the Fed, even if it was still around, would collapse in a matter of days. Good money would quickly displace bad, as good everything on the free market outcompetes bad everything, and this cartel of banks would fall apart. Both targets are arbitrary and protect no intrinsic good. There is nothing important about the preservation of the status quo prices or interest rates. On the contrary, those must adjust in sync with the public’s preferences; maintaining them is tantamount to price controls and is detrimental to the commonweal. As a practical issue, the Central Bank is rarely independent of politics. Cheap credit is always popular, which is why the Fed’s “targets” are seldom adhered to. The exposition so far has described the differences between (1) commodity money and (2) fiat money. (3) Credit money is something

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that is added onto these, representing the creation and destruction of money by commercial banks facilitated by fractional-reserve banking. It is so called, because it is created in the process of being lent to someone at interest. We might thus make two distinctions: hard (commodity) vs. easy (fiat) money and dear (100% reserve banking) vs. cheap (credit expansion) money. These are independent of each other: we could have hard cheap money or easy dear money. Keynes was a proponent of cheap money, thinking that it was necessary and often sufficient for prosperity and full employment. Unfortunately, (a) cheap money results in a business cycle which diminishes prosperity and employment overall vs. dear money which is, on the contrary, utilitarian. (b) It is impossible to keep interest rates down in the long run, anyway, unless one is dead set on preventing a recovery from a slump. The price of “money” (i.e., time) should be determined by the people in their capacity as consumers, investors, and hoarders; not by the bankers. (1) alone is normal honest banking, abandoned long ago. (1) + (3) is called free banking, and Rothbard (2008), for example, believed that it was a workable system which would naturally resolve into something close to (1) alone. Rothbard thinks that a crucial restrain on inflation under free banking is “the limited clientele of each bank.” In the limiting case of only a single client per bank, “there would be no room whatever for any fractional reserve credit. For the borrowing client would immediately spend the money on somebody who would by definition be a client of another bank.” (119) Against this opinion I must object. Central banking (a) sets the reserve requirements for commercial banks, (b) controls the fiat reserve money (e.g., through the FOMC), and (c) lends to the banks in trouble through the discount window. However, the Fed only helps to forestall bank runs; the “limited clientele” of each bank remains and has no effect on the extent of bank-generated inflation, being a background condition of the economy both under free and central banking. In both systems, credit is expanded up to the money multiplier. In addition, the reserves bank A loses to bank B may well come back to it from bank C. The total reserves are unchanged, no matter where the gold flows. Even without the Central Bank, banks would be able to borrow on the free banking version of the federal funds market. (2) + (3) is modern banking. (1) + (2) is impossible due to Gresham’s law; and (3) alone makes no sense, because banks must have some reserves brought in by their customers. (2) alone presents a fascinating case. There is nothing

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theoretically impossible about it. We could have fiat paper money with 100%-reserve banking. This, however, is politically unfeasible for two reasons. First, honest banking would have to be paired with (i) a freeze on all open market operation by the Fed and (ii) the Fed’s ceasing to be a lender to the banks, because otherwise banks could replicate FRB with borrowing vast amounts of money from the Central Bank (the Fed would, presumably, never initiate a run on a member bank). Similarly, the state gets the ability to run any deficit it wants by borrowing from the Central Bank without even paying interest to it. (It is limited only by political consequences of inflation.) It is not likely to let go of this highly convenient source of funding: after all, taxes beyond a certain limit are never popular and have been known to lead to revolutions. But second, the state, the political elite do not want to seem altogether unfair and so give something to the masses, namely, cheap credit. The masses happen to be in thrall to the inflationist ideology and have been this way for almost a century. The people do not rebel over such oppression as the enormous government debt and deficits impose on them, because they think that they benefit from (2) + (3), as well. They are mistaken, but the illusion has proven hard to shake: the booms seem to justify the busts, goodness only knows why. These exhaust all possibilities. Our age is no more and perhaps much less depraved than any other age, but each age is depraved in its own unique way. The chaos of our monetary system is our way of being wicked. It is as if we almost revel in the perversion of the quasi-abundance of easy and cheap money. We are shameless: “You want cash? We’ll print some for you.” We enjoy being untrammeled by any responsibility despite our knowledge that our behavior is self-destructive. We have blithely prostituted our financial health and honor for the sake of a few fleeting thrills. 4. THAT GROWTH STIMULATES INVESTMENT ONLY IN SPECIAL SENSES “Growth stimulates investment” is asserted by Paul Samuelson. “An investment will bring the firm additional revenue if it helps the firm sell more product.” Investment is determined by several factors, one of which is “the overall level of output (or GDP)… When factories are lying idle, firms have relatively little need for new factories, so investment is low. …investment is very sensitive to the business cycle.” (2005: 119)

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Notice how Samuelson shifts from the point of view of an individual company to the point of view of a macroeconomist looking at the economy as a whole. Apparently, what our author means is that during a depression, there is less investment than there is during a boom. From Samuelson’s own Keynesian point of view, this is true: in depressions, aggregate demand which is composed at least of consumption and investment is low, though for reasons unknown. From the Austrian point of view, this is quite obvious, as well, given that a depression is marked by liquidation of bad investments. Samuelson goes on: “According to the accelerator principle, rapid output growth stimulates investment. High investment in turn stimulates more output growth, and the process continues until the capacity of the economy is reached, at which point the economic growth rate slows.” (2005: 130) What a jumble! With respect to (a) a single firm, when producing more output is profitable, e.g., given at least that the demand for the firm’s product increases or that costs decrease due to greater internal efficiency of operation by the time the output is cooked up, the company will invest into new factors of production. [I] Expectations of profits cause investment which, if the profits are realized, may result in greater output for longer than a single round of production. With respect to (b) the economy as a whole, I must be dogmatic and assert that the causal arrow goes in the opposite direction: [II] growth itself depends upon (1) savings which (2) are channeled into real investments into longer production processes which (3) turn out to be profitable. The “capacity of the economy” is determined by its level of population, size of the connected market, people’s time and risk preferences, technology, the quality of the entrepreneurs, the state of capital accumulation, and government policies. [III] I grant that growth due to disequilibrating entrepreneurship stimulates investments by imitators and therefore, equilibrating entrepreneurship. [IV] In addition, during the boom phase of the business cycle, unsustainable growth feeds upon itself, giving an incentive to people to invest in hopes of timing the market just right, so as to reap the profits before the crash inevitably comes. This is the stimulation of investment by growth that Samuelson has in mind, but it is a vicious one and has no place in a healthy economy. The growth will be reversed; and the investment, shown to be misdirected. Moreover, the process of secular economic growth need never slow, given positive net savings and no business cycle even without technological progress.

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Samuelson goes on to describe the technology stocks boom in the 1990s in the most naïve way imaginable. There was, he says, “speculative frenzy” incited by promising new technologies: “people were lining up to buy shares in companies that were incurring large losses and sometimes had virtually no sales.” Why people were so irrational is unclear. Mysteriously, however, “investors became skeptical about the real value of many of these firms. Losses piled up on top of losses. The urge to buy the stocks before they rose higher was replaced by the panicky desire to sell before they fell further.” That is it! An unexplained and unexplainable surge and then waning of the animal spirits. That is what caused the 1990s business cycle. The problem is that this is a pseudo-explanation. One is left desiring more. Samuelson explains neither why the boom commenced, nor why it fizzled out. (1) Technological progress always outstrips economic one; there is always a bundle of hot technologies out there, whose use for the time being is uneconomic. Why would the Internet spark a “frenzy”? (2) There is nothing in the Samuelson’s theory that necessitates that the optimistic expectations of the entrepreneurs must be eventually upset or turn into pessimistic expectations. The Austrian theory presented in Book I adduced reasons why a boom brought about by artificial credit expansion cannot last: it is self-unwinding, containing in itself seeds of its own destruction. Its essence is neither psychology alone nor real factors such as technology alone but a confluence of actual mass losses and bankruptcies due to the impossibility of further rising of asset and factors prices given even artificially low interest rates and a crisis of confidence accompanying these events. For more on this, see the following chapters. In a similar spirit, Paul Krugman (2009) attributes the Argentine crisis of 1995 to the onset of the Mexican crisis, despite the fact that the two countries had “few direct trade or financial links.” (48) The relevant connection for Krugman is pure investor irrationality. “Nervous” investors were apparently unable to distinguish between the Mexican peso and the Argentine peso. This is yet another attempt to ascribe mass folly to people who have been entrusted with managing billions of dollars’ worth of assets for no reason whatsoever. There is absolutely no evidence that such massive entrepreneurial errors can happen simultaneously by a sheer coincidence. The alleged imbeciles who treated Mexico and Argentina the same way would have been a huge profit opportunity for the more discerning investors. The accelerator principle mentioned by Samuelson is a curious beast. It states that increased demand for consumer goods causes a more-

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than-proportional increase in the demand for capital goods, and therefore, there is no need for voluntary savings! (Keynesians do not trust the market with supplying the right amount of savings.) Consider Samuelson’s own example: let it be that company X maintains its capital stock consisting of 20 machines at 2 times the total sales and replaces 1 machine used to produce its output per year. Thus, if the revenues are $30 million, then $60 million is invested into capital goods, and gross investment is $3 million / year. If revenues increase from one year to the next by 50%, say, from $30 million to $45 million, then the number of machines ordered in that year must also increase by 50%, from 20 to 30, and therefore, 11 machines will be ordered (rather than a single replacement machine), a 1000% rise in this derived demand! I am afraid that this just will not do. If there is “full employment of capital,” then these extra 10 machines will simply be bid away from other companies Y, Z, and W, the demand for whose products will decline. If we look beyond the year in which the revenues for X have gone up (because it is an entirely arbitrary time period), and consider what happens in 20 years, then if there is no further boost in our company’s revenues, then first, on average, the demand for lower-order capital goods will have increased to merely 1.5 / year. The derived demand for X’s capital will go back to replacement levels. Second, Y, Z, and W, experiencing lower demand for their output, will fail to replace their machines as they wear out. In the long run, there is zero sustainable accumulation of capital and wealth, except insofar as the changed consumer tastes have been successfully satisfied. The only solution is continuous rise in aggregate demand. But even Keynesians know that at some point a rise in this demand will translate solely into higher prices. If, on the other hand, there is excess capacity in the economy, such that X can demand its new machines without raising their prices to such an extent that Y, Z, and W can no longer afford them, then this capacity must needs have been brought about by and only by savings. X cannot simply “demand” anything, unless the things it demands already exist and are for sale or at least can be profitably produced. And this can occur only if some of the income to the members of society was not consumed but was saved aside specifically for the purpose of building capital goods. Perhaps, Samuelson thinks that X’s profits will be used as investment, alleviating the need for explicit saving. But profits ultimately are supposed to be consumed and enjoyed. There is no law that says that profits must be re-invested: the scenario’s conditions, such as specifying

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the precise relationship between the sales revenue and investment, are artificial. Hence, X will still consciously save and plough $33 million back into its business. In addition, X will order the machines only if it forecasts that the next year’s revenues will be a mirror image of the present one’s. If it thinks that this year’s boon was a one-time fluke, then no increase in investment will take place. If there is especially dense uncertainty surrounding the future, then X may want to consider renting the machines rather than buying them outright. This will slash the derived demand dramatically. That is not all. For suppose that X is producing consumer goods, and the demand for them has increased, as many other things as possible being equal. This could signal a rise in time preferences; in other words, a greater preference for present consumption at the expense of future consumption. As a result, savings will decrease and interest rate, move upward, making marginal time-intensive projects unprofitable. We already know the consequences of such an event: unmaintained capital, less overall investment, and lower growth rate. It is true that in the late stages of the production structure, that is, in the stages closest to the final consumer goods, the derived demand effect dominates the higher interest rates effect. What is seen is higher investment into those later stages, including, indeed, by our company X. What is not seen (and we all know that taking into account opportunity costs, “what might have been,” or economic possible worlds is a sign of a good economist) is less investment in the early stages of the production structure and less gross investment on the whole. The accelerator principle is now revealed as not only otiose but nonsensical, as well. 5. THAT THERE ARE DIFFICULTIES WITH THE CONCEPTS OF AGGREGATE DEMAND, AGGREGATE SUPPLY, AND AGGREGATE EQUILIBRIUM Samuelson cautions the reader that the microeconomic demand curve for a particular product differs in meaning from the macroeconomic aggregate demand curve. (2005: 134-5) The graph of the latter still features a familiar downward-sloping curve with “price level” on the y-axis and “real GDP” in dollars on the x-axis. Immediately we can spot the first difference: the micro demand curve has quantity on the xaxis, but the macro curve cannot have that, because, it is natural to ask, it would have the quantity of what? Heterogeneous goods cannot be aggregated, unless we use something like “the total amount of money that

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changes hands” or “dollars’ worth of goods.” Unfortunately, this makes the contrast between the two curves even more profound. In the micro curve, the total amount of cash that is spent on the good being represented is price * quantity or the x-coordinate times the y-coordinate of any point on the curve. In the macro curve, this entire product is placed on the x-axis, producing a notable disanalogy. The second problem is that money does not “measure” goods. If one were told that the GDP of Ruritania in 2010 was 1 billion rurs, then what would he possibly do with this information? Even saying that Ruritania’s GDP has increased from 2009 to 2010 by a billion rurs or that the GDP of Ruritania is greater than the GDP of Waldavia by a billion rurs is of no interest, unless in addition we bring in the money supply and demand. Even then we would have no way of determining the overall consumer surplus. What, then, does the x-coordinate of the macro curve tell us? The difficulties with the concept of aggregate demand have only just begun. For let the price level go up, whether because of money supply inflation, or because people are demanding money less. (Of course, “price level” is an abstraction. If at t1 $1 costs 1/100 of a printer and 5 pens, and at t2 it costs 1/50 of a printer yet 3 pens, has the “price level” gone up or down?) This is supposed to cause the total spending to decrease. But the price level includes wages and incomes to other factors. If prices of consumer goods have gone up, then, perhaps, so have the prices of the factors of production. Surely, this will increase the total spending. Samuelson seems dimly to understand this point; that is why he writes that the reason for the downward slope is that “there are some elements of income or wealth that do not rise when the price level rises. For example, some items of personal income might be set in nominal dollar terms – some government transfer payments, the minimum wage, and company pensions are examples. When the price level goes up, therefore, real disposable income falls, leading to a decline in real consumption expenditures.” (2005: 134) But these are merely happenstance, accidental. These payments could easily be indexed to the price level. And what of simple wages, rents, and interest which constitute the bulk of the incomes to factors? The minimum wage, etc. are hardly significant. Another problem is Samuelson’s treatment of the reason for the price level change studied in the previous paragraph. Taking the equation MV = PT, I understand his “real money supply” to be M / P. Our author wants to assure himself that as P drifts upward, real GDP falls. So, P’s rising with M remaining constant is, Samuelson reckons,

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equivalent to M’s falling with P remaining constant. Therefore, things are as though the money supply has fallen which means that each dollar’s purchasing power increases and total spending, on the contrary, is reduced, because the same transactions can be carried out with less cash. It should be obvious that this reasoning is odd. It is much more natural to think as follows: if we assume that the nominal money supply is constant, as Samuelson does, then the price level will increase only with a decrease in the demand for money. But in this case, if all prices rise, then more money will change hands, if the same exchanges are made than before the rise. After all, all prices are now higher.1 Another cause of a fall in the demand for money is lower T. Price rise, because there are fewer goods and services available on the market. In that and only that case, I agree that real GDP will fall. Finally, Samuelson believes that the diminution of the real money supply (via a rise in P) causes an upswing in interest rates and a decline in investment and consumption. Now demand for money is a somewhat non-trivial notion; so, let us spell it out. First, as seller of goods and buyer of money, the fall in my own demand for money means that money has less utility for me, and therefore, I will ask for more money in exchange for my goods. Equivalently, the prices I will charge for my goods will rise. Lower demand for money in general entails that in order to acquire the same amount of money, I have to sacrifice fewer goods. If the money is interest income, then the good is present or instant gratification. The same i% interest can now be obtained by loaning out less money. Hence, the supply of savings decreases. At the same time, lower demand for money can be rephrased as higher demand for goods; thus, in order to acquire the same happiness in the present, I have to pay for it a higher interest rate. So, the demand for loans goes up. Thus, lower demand for money increases all prices, including the price of not-having-to-wait to save money measured in the interest rate. So, the first part of Samuelson’s statement is true. But the second one is not, because the demand for present money increases (people are willing to pay more to save the same amount of time), but the supply of present money decreases (people ask for more money as compensation for postponing their own consumption). Hence, the equilibrium quantity borrowed remains the same. Investment stays on the same level. But if 1

For example, in his capacity as an employee, if Smith demands money less, then he is willing to work less hard for a given amount of money. If Smith’s boss wants to keep him as productive, he will need to offer him a higher wage.

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price times quantity goes up, then “dollars’ worth of goods” bought or real GDP is increased. Again, the contortions that Samuelson has to perform are a bit fantastic. P↑ → (M / P)↓ ↔ M↓ → money supply deflation occurs → investment and consumption are dampened. Even if this outrageous derivation is taken at its face value, the decline in investment and consumption due to “tighter” money is not in “real” terms but merely nominal terms. As Rothbard taught us many years ago, outside of hyperinflation, any money supply is optimal and sufficient for any economy. Under sound money, M increases due to mining of gold and dishoarding and decreases due to wear and tear of gold coins and higher risk preferences. P increases if people demand money less: through either a higher velocity of circulation of money or lower T such as due to general impoverishment. The daily fluctuations of the supply and demand for money can change the real money supply. But these grand (and rather nebulous) aggregates are more effects of human actions within the market process than causes of any events within it. For example, interest rate is a ratio between future goods and present goods, such that a sacrifice of the latter, resorted to in order to diminish disutility of waiting, is just compensated by a relative increase in the former, adjusted for liquidity preference. The change in the money supply has a discernible effect on this ratio, only if the money supply is reduced by the Central Bank through its fractional-reserve commercial banks via destruction of credit money, in which case the interest rate may rise in the short term. Government’s borrowing and spending are supposed to negate private hoarding and boost consumption through either higher M or lower D, depending on the who the lenders are. On the other hand, if P↑ ← D↓ ← V↑, then it is no longer true that “a fixed dollar money supply must be rationed among those who need money by raising interest rates, tightening credit, and reducing total spending.” (135) On the contrary, the “rationing” problem becomes easier, if people seek precisely to get rid of money by buying things on the market. What need “rationing” are goods, and that is why prices rise. The foregoing calls into question the meaningfulness of the aggregate demand curve. The aggregate supply curve is plotted on the same graph as the aggregate demand curve, and its short-term version looks like a regular micro supply curve. It must, therefore, relate the price level to output or GDP = dollars’ worth of goods. But what is the causal link? Why do higher prices cause greater output? Well, say the Keynesians, when the Central Bank increases the money supply, interest rates decline, aggregate demand increases, according to the workings of the multiplier,

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which, in turn, raises output and prices. It would seem then that both the price level and the output are functions of yet a third variable, namely, the money supply. This is very different from the micro supply curve, in which the fundamental law of marginal utility explains why higher prices lead directly to greater quantity supplied. Therefore, the aggregate supply curve as drawn in most textbooks must be represented as a set of two parametric equations: price level = f(t) and output = g(t), where t is the money supply. To be sure, the long term aggregate supply curve is a vertical line, indicating that changes in the money supply are reflected solely in changes in prices (as opposed to both prices and output).2 The Keynesian view is that outside full employment, short-term inflation can boost both employment and the GDP. I argue otherwise in (I, 68). Another difference between the macro and micro supply curves is that the latter can represent a momentary state of the market during the instant of an exchange, whereas aggregate supply “refers to the total quantity of goods and services that the nation’s businesses willingly produce and sell in a given period.” (2005: 75, emphasis added) Production must take time; but exchanges can be instantaneous. Gordon (2009) interprets the (short-run) aggregate supply curve as follows. Let the nominal wages be fixed. Then at higher price levels of the firms’ products, more workers will be hired, and more goods will be produced, raising the GDP, though real wages will fall. (205-6) The idea is that prices of everything go up except the price of labor. Of course, this is an arbitrary supposition and a self-evident result. Consider another possibility: a superabundant, convenient, and practically free source of energy has been discovered, putting most oil and gas companies out of business. Consumers enjoy higher real incomes, and firms enjoy lower costs of doing business. Firms can now invest into more energy-intensive projects, increasing output. In addition, the newly unemployed factors are trying to find work, which means that companies can pick up those resources cheaply. Notice that this is the same as saying: let energy prices be stable, and the prices of everything else rise. But what of it? Why exclude labor or energy from the price level? Again mysterious short-term wage rigidities must be appealed to. If real wages fall, then income is redistributed from workers to entrepreneurs and other original factors: wages to the former turn into 2

Money may be neutral in the long run, but a lot tends to happen in the long run to make the state of the economy with inflation different than it would be without inflation even in the long run. The long run, given inflation, is like the equilibrium: the economy tends toward it but never reaches it.

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profits and income for the latter. Hence, first, aggregate consumer spending need not change, because we do not care who spends the money, as long as this money is spent; therefore, we cannot conclude that higher profits will be received and that production will expand. There is no reason to slide up or down the aggregate supply curve, and no reason for the quantity supplied to rise with the rise in prices. Second, the increase of his own revenue, from which any particular entrepreneur benefits, will be partially eaten away by the higher prices he has to pay for the products of other entrepreneurs, including the prices of raw materials and machines. Third, if “a decline in the real wage [due to higher prices] induces firms to hire additional workers,” then competition between firms for workers will bid up the workers’ wages even in the short-run, quite unlike the micro supply curve for a particular product. After all, scarce labor has to be rationed, and higher prices is how the market will ration it. Could Gordon’s idea be simply that if the government prints a few trillion dollars and starts devouring goods on the market, then prices of inventories will rise, while wages will temporarily trail behind, creating profits which would seem to allow business firms to expand? Surely, such an incredible idea, namely, that the state’s looting the economy can stimulate production, could not have occurred to a real economist? It is not as if the supply of labor has increased, lowering the price of labor. It is assumed at the outset that the cause of low wages is perversely rigid (in fact, sticky upward for reasons unclear) wages. But even if Smith’s wage is “fixed,” because the company he works for offers employee reviews only once a year, surely a different company can lure him with promises of a higher wage right now. Gordon simply affirms the Keynesian point that, given unemployment, if the government dilutes the purchasing power of money with inflation, causing a drop in real wages, then companies will receive profits, reinvest them, hire the unemployed, and produce more goods. He thereby assumes that the economy is in a depression, though it is not apparent from the text. Once again, however, I must protest that the government cannot be the preeminent consumer in the marketplace. The local government is a defender of the people against criminals; the federal government is a defender of free trade throughout the realm. They consume only as much as is necessary for the fulfillment of these functions which in actual fact is a tiny percentage of the GDP. In short, unless we go with Davidson’s idea of government wage controls, the assumption of fixed wages in any period, short or long, is untenable; and even then, expansions will fail due to shortages of labor. Gordon’s interpretation, too, bites the dust.

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Consider a situation in which the price level is above the aggregate demand / aggregate supply “equilibrium.” In the micro world, it would mean that the price is too high for the market to clear and that more mutually beneficial exchanges can be made at some lower price. In the case of barter, when horses are exchanged for cows, say, each item has both use value and exchange value, and this fact restricts the number of exchanges that will be made. In indirect exchange, any amount of cash can be spent on numerous sets of goods all competing with each other for this amount. But the meaning of our macro graph is far more obscure, if it exists at all. The price level comprises all prices. It is only the relative differences in the prices of goods and services that underlie the network of exchange, opportunity costs, and the like. But there can be no opportunity costs in the macro framework, such as use values (in barter) or other goods on which one’s income can be spent (in a money economy). What does it mean to say that at price level equal to 200 (whatever that means), there will be $3,500 billion dollars’ worth of goods brought to the market but only $2,500 billion bought? If not all goods are sold, it means that their prices relative to other goods are too high. It does not mean that the overall price level, if there is such a thing, is too high. The absolute price level is of little consequence; let me repeat that money prices do not measure value or utility; money merely assists as a unit of account in comparing or ranking with respect to how well they relieve human “uneasiness” a vast variety of baskets of goods.3 It is true that prices depend upon the money supply: if some mischievous imp were to multiply the prices of all goods and services by 1,000 without immediately alerting the goods’ owners, then great distress would be created. But even if such an implausible situation were to occur, prices would come down to their previous levels in a very short order. The commotion would die down fast. The absolute price level would be irrelevant, on the other hand, if all prices, wages, rents, and cash balances were to increase 1,000-fold at the same time. The process of secular deflation described in (I, 52) would seem 3 For example, if Smith earns $1,000 and spends it on some basket {P, Q, R}, then (1) he demonstrates his preference of this basket over any other the same amount of money could buy; and (2) other people, collectively, taking into account everyone in the economy, and assuming an ERE, were willing to exchange even this most highly favored by Smith basket in return for Smith’s own contribution to production for them.

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to suggest that the absolute price level is important. Not so. The fact that prices fall is a consequence of the same money supply’s being used to service more wealth. What is crucial, however, is not this but that the fall in the level of prices of consumer goods resulting from economic growth outstrips the fall in the level of wages, making workers richer. Again, it is the relative changes in wages and prices and everything else that make this phenomenon noteworthy. Our situation would be equivalent to a trade between two people, one of whom had all the goods, and the other, some paper dollars. The unanswered question, however, is why the actual goods owner would want to exchange (all of) his stuff for worthless paper. There is no such thing as an excessive global price level at which aggregate supply exceeds aggregate demand. Consequently, AS and AD are just everything that has been produced in a given year, and everything that has been consumed. Barring microeconomic surpluses and shortages, these values are exactly the same. If we are dealing with the aggregate demand for and supply of, say, labor (as opposed to everything), then we might be able to make statements like “wages are too high relative to prices,” and therefore, the quantity supplied of labor exceeds its quantity demanded. Even that, however, is hardly meaningful: it is not that the “price level” is misaligned with the “wage level” but that various individual wages are not justified by the individual prices of goods, toward whose making the various particular workers have contributed. Furthermore, what should be measured on the x-axis? “Quantity of labor” surely cannot mean “calories expended” or even “man-hours worked,” as I argue in (I, 7). If labor is reducible to (a) human capital and (b) ability to solve problems, be creative, and learn, then it is most heterogeneous, and our graph, once again, collapses into nonsense. Finally, if we call the AS curve the set of points relating the price level and the GDP to money supply, then the AD curve, in order for it to have any meaning, must be defined differently, as well. I am not ingenious enough, however, to rescue AD from its apparent absurdities. 6. THAT ANOTHER KIND OF AS-AD DIAGRAM ILLUSTRATES THE ALLEGED INFLATION-UNEMPLOYMENT TRADE-OFF There is another Aggregate Supply-Aggregate Demand graph that links “income” to amount of employment. The graph looks as pictured in Figure II.6.1.

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The economic meaning of these macro curves is distinct from that of the micro curves, which would plot (price * quantity) against employment of factors within a firm. In the micro world, the shapes of the supply and demand curves would stem from the laws of diminishing marginal utility and increasing marginal cost. We already know that for a single firm, as it hires workers, two things happen. (1) The quantity supplied of its product (widgets) increases, which necessitates that the firm lower the price of each widget. Hence, the marginal product of each worker, i.e., the amount of revenue that a marginal unit of work yields for the company, declines. (2) The marginal cost of a worker increases, because workers are plucked out from increasingly more important uses in other parts of the economy. At some point, the marginal revenue will be equal to the marginal cost, and that is the equilibrium.

FIGURE II.6.1. AS-AD AND EFFECTIVE DEMAND

It follows that the supply curve slopes upward at an increasing rate, representing the LIMC (more workers * higher wage), and the demand curve slopes upward at a decreasing rate and may even come to slope downward, depending on the elasticity of demand, representing the LDMU (higher quantity * lower price). The first point is that it would be illegal to use the two microeconomic laws to justify our macro curves. For example, we may be tempted to argue that high level of investment (on the AS curve to the right of Ne) creates many jobs but causes there to be insufficient revenues (on the AD curve underneath the point on AS), such that there is an excess of losses over profits in the

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entire economy. Analogously, “underinvestment” entails many missed opportunities, in which case total profits outnumber losses. These wake up the equilibrating forces which move the economy into a state in which profits and losses are in a balance. The problem with this is that the level of investment does not determine whether an economy is progressing or retrogressing. Profits and losses are due to entrepreneurship or direction of investment, not the raw amount of money savings slated for investment (or volume of investment). In addition, the equilibrium is supposed to be a balance between some form of “yin” and “yang,” yet here, profits and losses accrue to different companies and are both disequilibrium phenomena. The alleged balance is an illusion. We might at first reason as follows. For the AS curve, with more people working, the volume of output will increase. But what about prices? Are not all prices relative? Are we talking about the general price level? But given a stable money supply, more people + more goods will result in higher demand for money, lowering the price level. What gives? For the AD curve, some writers like Hamouda (2009), refer to “diminishing returns” and leave it at that, making it unclear whether they understand what they are talking about. “Diminishing returns” to what? Is the idea that as society grows richer, every increase in the standard of living is felt to be smaller than the previous one? I have already dealt with this argument and found it unconvincing. In (I, 11) the term “hiring path diminishing returns” is mentioned. This may be interpreted as the point that more efficient workers are worth disproportionately more to the company than less efficient ones. We already know the reason for this: more competent workers make a given amount of product with less of both consumption and depreciation of complementary to them capital goods. Such workers also tend to lower intrafirm management costs. That does not mean, however, that for any type of job and any skill set, more efficient workers are hired first. Everyone’s skills have a price at which they will be bought. (One exception is minimum wage laws, under which the least efficient folks are barred from entering social cooperation.) Hence, this does not explain the AD curve either. Lastly, labor seen from the point of view of the human capital involved in it is heterogeneous and cannot be meaningfully aggregated. In figuring out the economic meaning of AS-AD, I did not appreciate at first the full extent of the Keynesian depravity. For the ASAD paradigm as just presented makes sense only within the Central Bank’s monetary policy. For AS, credit expansion, according to the Keynes, causes

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employment to pick up. Entrepreneurs invest in hopes of reaping profits. Their expected income from the sale of their products determines how much employment they will extend. (It is not necessary and in fact, is not the case that their expectations are realized.) Credit expansion goes along with inflation. However, there are diminishing returns to the increase in hiring achieved through the inflationary stimulus. As inflation is ratcheted up, it takes increasingly more inflation to get an extra worker hired. For AD, the capital-intensiveness of production, or the state of capital accumulation, or the amount of intermediate goods per capita is held to be equal. As previously unemployed workers are hired, the same capital goods are getting more scarce relative to labor. As the proportion of capital (both real and human) to labor diminishes, the returns to society from an extra person working go down. It may even worsen the general welfare. (We assume that “society” consists of only those people who are participating in social cooperation, that is, those who are employed.) Here, employment determines the actual income in terms of goods consumed and enjoyed to society as a whole. More labor paired with no greater capital results in progressively smaller increases in output. The equilibrium point represents the decision of the Central Bank (the “Fed”) to create so much inflation that the harm to society from an extra dose of inflation is equal or is just outweighed by the benefit to society from a marginal worker hired. Keynes calls this point “effective demand.” We see immediately how equilibrium in this particular sense can co-exist with unemployment. For in order to achieve full employment Nfull, the Fed has to create an unacceptable amount of inflation. At the same time, too little inflation will result in too much unemployment at point N1. The golden mean is the point of effective demand Ne. There is no need to rehash the arguments already laid out that unemployment results precisely from “inflation,” i.e., from the bust that is an inevitable consequence of the boom brought about by credit expansion. Nor is the boom necessary to alleviate some initial mass unemployment. A laissez-faire economy performs optimally, particularly in allocating goods over time, and is superior to a hampered economy. The only pretext for cheap credit is precisely prior interventionism, under which the economy grows so slowly due to the government’s own interference with business that this same government (spurred, perhaps, by social unrest) decides to resort to credit expansion in a futile attempt to escort the economy out of the very rut into which it itself has led it. Chick (1991) mentions why output in the AS-AD scheme

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positively correlates with employment: because “the production decision is, with the rare exception of the moments when new capital is brought into use, made in the context of a given capital equipment.” (62) This is a full admission that this system is purely short-run. The Fed is unable to bring about genuine capital accumulation. So, it is tasked with balancing inflation and unemployment in the here and now. That it is a good idea to leave (Nfull – Ne) number of workers unemployed may be cashed out as a case against immigration. But surely, it is an overkill to entrust immigration policy to the Fed. Now goods undergo the market test of the judgment of the consumers. Ideologies undergo the political test of the judgment of the voters. But the Fed’s policy is supposed to be “scientific.” It is explicitly, as a socialist institution, isolated from the vagaries of consumer interests. The Fed is also nominally independent of politics. How then is it supposed to find the right combination of Ne and De on the level of the nation or world as a whole? Who could possibly instruct the Central Bank’s chairman on whether he is right or wrong? 7. THAT KEYNESIANS LOVE SAVING TOO MUCH IN A BOOM, WHEN IT IS CHANNELED INTO CONSUMPTION OR INVESTMENT, AND TOO LITTLE IN A BUST, WHEN IT TENDS TO BE HOARDED Consider two out of the three reasons for saving: investing and hoarding. Recall [I] Keynes’ abhorrence of high interest rates. Credit expansion, and with it, forced savings, are justified precisely on the grounds that they would eliminate the scarcity of capital goods. Instead, they only produce business cycles and general impoverishment. Who could have imagined that disregarding people’s preferences and shoving “economic growth” down their throats against their will could do harm to the economy as a whole? Thus, Keynesians love savings so much that they would shower the world with cash, in order for it to be invested. In a bust, when resource misallocations – as judged by the consumers – are revealed, Keynesians cannot help stopping worrying about investing and become deeply concerned about hoarding. This they absolutely hate: remember further [II] Keynes’ contempt for “liquidity preference” or the demand for goods or cash balances as stores of value. Of all commodities, money, being perfectly liquid, fulfills this function to the highest degree and is promptly excoriated for just that (see (I, 57) for more on this; apparently, Keynes likes to see to it that no good deed, like the invention of a medium of exchange, goes unpunished). Thus, they prescribe artificially induced investing to start a boom and

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artificially induced spending of any kind to avoid an inevitable recession. As defined in (I, 20), the difference between the total money supply in people’s possession and that part of the money supply that can be called a “hoard” lies in the intention of the money holder. If the goal is to accumulate enough cash to consume or invest into something, then the balance being amassed is not a hoard. Only if the money is there for “insurance” against unexpected and sudden events, to satisfy one’s risk preferences, can it be called a hoard. Demand for money presupposes willingness to exchange goods or labor for more or less money. Individually activated changes in the money supply reflect the essence of hoarding better, because this money is normally not to be touched or exchanged; therefore, it is as if the money supply has shrunk. Hoarding has a double effect: first, it increases the cushion of the hoarder used to soften the blows with which future surprises might assail him; second, it increases the purchasing power of money which benefits present consumers and investors. Hoarding might, therefore, seem to be an anodyne process, but according to the typical circular flow of goods and money diagram presented in every macroeconomics textbook, if consumers were to lower their expenses, then firms would have less money to spend on factors which would lower factor incomes and again lower consumer spending even further in a kind of vicious circle. Now one would expect that the prices / factor incomes race to the bottom will proceed until the desired level of hoards has been achieved, and then it will stop. After all, the more one saves, the greater the marginal disutility of abstaining from present or future consumption is, because the desires one has to leave unsatisfied become more and more urgent. Hoards will be accumulated, until the double renunciation of consumption and of investment opportunities becomes too dear. This might be so, according to the Keynesians, if it were not for wage stickiness. In a recession, in particular, there is unemployment, and when consumers stop spending, this aggravates unemployment, again, because the wages do not go down. The first Keynesian solution is for the Central Bank to cut interest rates even more in order to stimulate investment. Inflation may certainly curb the Fed’s enthusiasm. In an economy in a “liquidity trap,” banks themselves which are supposed to lend the newly created money fail to do so, out of fear of (still more) defaults. The banks begin hoarding money; and so, the liquidity is “trapped” behind the unwilling lenders, or so the Keynesians believe. The nominal interest rate cannot, of course, be lowered below zero, and it is lower than the real rate, because price deflation causes the money loaned to appreciate beyond that amount, by which the nominal interest

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rate increases it. This high rate may not “stimulate” the economy enough. At this point the only measure left to the government is to either induce or take over completely spending, a colorful example of which would be, according to Milton Friedman, throwing money directly to the people (and bypassing the financial intermediaries) from a helicopter. Thus, if nothing interesting happens as a result of reflating, e.g., if the economy has been roughed up by cheap credit beyond caring, then Keynesians resort to their second trick: having the government “tax and spend” a considerable amount of money. A portion of people’s incomes that would otherwise be hoarded goes back into “circulation,” and hoards are dissipated. This mollifies the effects of wage stickiness. If the Fed is powerless, the Keynesian hope might be that the profits obtained by more intense consumer spending will be reinvested, causing an expansion and job growth. It all comes down to the fact that voluntary savings, whether for the purposes of investing or hoarding are, in the Keynesian world, fundamentally bad. To fix the alleged market failure, the government uses two “instruments” or “tools”: monetary policy and fiscal policy. Monetary policy is unleashed when savings are consumed, in order to generate the funds to be invested instead. That is what the government uses to ensure that savings are invested poorly. (I explain what I believe to be the correct business cycle theory in Book I.) The monetary policy aims at increasing the “marginal efficiency of capital” via lowering of interest rates in order to induce investment. Fiscal policy is unleashed when savings are hoarded. That is what the government uses to ensure that savings fail to supply the needed security to the public. Again, hoarding both has utility for the saver, namely, to reduce the perceived threat of future dangers, and serves a social purpose, because as a side effect, it brings about lower prices for those who instead choose to consume or invest. Such people ought to love hoarders who produce much but consume little. The fiscal policy is aimed at increasing the “propensity to consume.” It is not true that saving constitutes a private virtue but a public vice. On the contrary, fear can be morally wrong if it incapacitates a person, and conspicuous consumption raises prices for other people. Together, the policies seek to raise aggregate demand. In other words, Keynesians think that there is lack of maximum investment for two reasons: from below, so to speak, because of high interest rates; and from above, because of volatility of the animal spirits, investor nervousness, lack of confidence, and suchlike psychological reasons. The monetary policy tries to boost initial investment into the first round

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of production; the fiscal policy tries to let the entrepreneurs profit in the same round by government deficit spending on their output. When properly used, these policies are supposed to ensure full employment in every round of production. Fiscal policy can in principle both (1a) tax and spend in order to keep prices high and (2a) tax and destroy money in order to accelerate deflation. Monetary policy can both (1b) lower the interest rate to stimulate investment and (2b) tighten in order to prevent over- and malinvestment. Keynes is fully committed to both to both (1a) and (1b): “There is room… to promote investment and, at the same time, to promote consumption, not merely to the level which with the existing propensity to consume would correspond to the increased investment, but to a higher level still.” (2008: 325) The monetary policy attempts to promote investment without sacrificing consumption, and the fiscal policy promotes consumption at the expense of hoarding, or try to. Unfortunately, there is no such thing as free lunch. We cannot get something from nothing. As we will see in (II, 21), there exist specific conditions under which both, one, or none of these can be attempted. I suspect that by “promoting” these activities, Keynesians simply mean increasing the money supply. I will say nothing more about this remedy in this chapter, since this entire book is dedicated to exploding inflationist fallacies. I am ambivalent on whether Keynes was (i) a Keynesian or a Fabian socialist who sought to diminish “uncertainty” by having the government take over the (ii) direction of investment, (iii) volume of investment, or both. For example, (i’) Keynes (2008) finds himself “somewhat skeptical of the success of a merely monetary policy directed towards influencing the rate of interest.” (164) “It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment.” (378) Using the monetary policy, even the “most enlightened,” is “dangerously and unnecessarily defeatist. It recommends, or at least assumes, for permanent acceptance too much that is defective in our existing economic scheme.” (327) It looks as if Keynes considers monetary policy to be useful but also a concession to laissez-faire, mere interventionism as opposed to the tougher-minded socialism that he obscurely favored. (ii’) Keynes writes: “I see no reason to suppose that the existing system seriously misemploys the factors of production which are in use.” (379) On the other hand, he concludes that “the duty of ordering the current volume of investment cannot safely be left in private hands.”

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(320) (iii’) Keynes goes on: “It is in determining the volume, not the direction, of actual employment that the existing system has broken down.” (379) He never explains, however, how the state is supposed to be able to manipulate the volume of employment / investment without resorting either to the monetary policy or to socializing the direction of investment. It seems that Keynes had no understanding of the differences between capitalism and socialism, such as outlined in (I, 48), other than that in the capitalist world, there is in some sense more undesirable “uncertainty.” I find it most plausible that Keynes’ flirtation with socialism ended with his fastening fiscal policy, such as public projects, on top of monetary policy. The reason for the confusion is that both the monetary and fiscal policies have both the interventionist and socialist aspects. Monetary policy bamboozles the entrepreneurs, causing them to embark on antisocial production endeavors, but still relies on the market to produce. However, it also allows the Fed and the commercial banks, in creating money at will, theoretically to buy every private business, nationalizing everything. Fiscal policy prevents those anti-social endeavors from going belly-up after they have been revealed as unprofitable, again keeping resources misallocated but again also within the market. At the same time, it has the potential completely to subvert consumer sovereignty by transferring all purchasing power from the people to the state. Rothbard wrote humorously that the federal government’s foreign policy, brought to its logical conclusion would entail “invading the world.” It is to be hoped that their monetary policy is not going to be brought to such a conclusion, namely, to buy up the world. Keynes suggests that “an open-market monetary policy is not capable, unaided” of achieving full employment (267, italics added). Since socialism is a replacement for monetary policy, the “aid” to it can only logically be fiscal policy. Further, Keynes acknowledges “force in the argument that a high rate of interest is much more effective against a boom than a low rate of interest against a slump.” But he qualifies this by saying that a slump may be resisted by “taking drastic steps, by redistributing incomes or otherwise, to stimulate the propensity to consume.” (321) This is just another way of referring to the government’s fiscal policy. Keynes’ ideal economy, a ridiculous full-blown socialism described in (I, 57), is a logical consequence of his views but probably something that Keynes himself was not even aware of. On second

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thought, perhaps, Keynes was a crypto-socialist, after all. These then are the “tools” with which the government mismanages the economy. I am not criticizing any particular ways in which the “tools” are used but rather the fact that they are used at all, rather than having privately minted dear and hard money establish both the interest rate (the market’s “monetary policy”) and the purchasing power of money (the market’s “fiscal policy”) naturally via the free market. For example, recessions are times for radical reallocation of resources, following upon an unsustainable boom with its mass losses. The policy of taxing and spending does not synchronize the right prices and wages; it only creates a boom in the “government business,” as per (I, 67), prolonging the uneconomic use of scarce resources. In brief, the Keynesians’ hatred of “high” interest rates causes them to recommend inflationary credit expansion. This causes the boom. Which sooner or later turns into a bust. To which people respond in part by hoarding. To which the Keynesism-inspired government in turn reacts by borrowing and spending, compounding the economic chaos. The famous “tools” turn out to be too primitive to plan the economy successfully. 8. THAT KEYNES UNWISELY TREATS HOARDING AS UNECONOMIC There is more to be said about hoarding. Keynes’ reasoning appears to me to be something like the following: preference for liquidity, i.e., demand for cash balances as a store of value, causes fewer exchanges to be made. This hinders trade and causes people to find each other less useful. Ultimately, the “liquidity fetish” makes social cooperation less intense and less valuable for all or most members of society. Consider a Crusoe-Friday economy, in which both persons rear horses and cows. They could each produce for themselves. Or they could specialize and trade, which, according to the law of comparative advantage, would increase the total fruits of their labor. If Crusoe, however, perversely hoards his horses and refuses to exchange them, then the system breaks down, and both are seemingly poorer. The ideal solution (now in the real economy) must be feverish economic activity, living from paycheck to paycheck, spending and investing the entirety of one’s income immediately upon receiving it. And then there is the multiplier, electrifying the economic hustle and bustle still more. I must protest, however, that it is individual preferences that dictate whether one will or will not exchange his goods. What is required for an exchange to take place is mutual consent. Only thus will

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the utilitarianism of welfare economics be served. Moreover, Keynes’ worry proves too much: if refusal to trade is now evil, then must we outlaw vacations and mandate 80-hour workweeks? To summarize what I have already discussed with respect to money as a store of value: (i) hoards in the “wide” sense of the term, simply as cash balances, are unavoidable, because for all units of money, it is the case that each unit is at every moment in time owned by someone. (ii) Hoards in the “narrow” sense of the term have utility as a source of security, and the amount of money hoarded by each individual is a function of his risk preference. A particular amount of money in one’s possession is a hoard in the narrow sense if its purpose is to protect its owner from unforeseen and unplanned for future events. Hoards have utility to the hoarder as a de facto claim on society; money has the unique potential to be exchanged at any moment for a vast variety of goods. (iii) Hoards in the narrow sense also have social utility, in that they increase the purchasing power of non-hoarded money held by other people. It is true, of course, that if everyone were to dishoard at the same time, then this social utility would come to a swift end: everyone would scramble to buy, and there would be initial shortages, until prices adjusted upward and diminished the usefulness of everyone’s savings as a store of value. But such an event is surely implausible. It may be argued that hoarding does not encourage production. Well, neither do walks in the park. Hoarding does not deserve its infamy. Hoarding signals that the hoarder wants to spend less, but the market still clears, as prices fall. It is certainly true that if the public’s desire for greater hoards is unanticipated by the entrepreneurs, then some entrepreneurs will have to sell some of their goods below cost, losing money in the process. But since increases in hoarding that have a noticeable effect on the economy occur only in depressions, a failure to foresee such an increase is merely a corollary of the failure to foresee the bust. Abolish the business cycle by means of hard money, and we abolish the deleterious effects of hoarding, if, indeed, any such there be. The only question is whether hoarding has the power to aggravate a depression. It is also true that hoarders stand ready to take goods off the market at their pleasure, but they relinquished other goods in the past to the consumers. Nothing either uneconomic or unjust is going on. Thus, people hoard money in order to deal successfully with surprises both in their capacity as consumers and in their capacity as producers. In the next two chapters, I will explain what is entailed by consumer security seeking.

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With respect to surprises in investing, however, Keynes believes that this problem can have a much better solution than for people to demand to hold cash balances to a greater extent. “Investment based on genuine long-term expectations is so difficult today as to be scarcely practicable” for private investors, he writes (2008: 157). His startling prescription is to outlaw competition. In his ideal society, the government takes over much of the investment activities. Precisely because it will not need to deal with unpredictable actions of other businessmen which, as I point out in (I, 12-13), are directly responsible for the very phenomenon of future uncertainty, the state can plan and work alone without encountering needless contingencies and surprises. Permit me to reuse the Keynes quote on p. 164 of General Theory, first introduced in (I, 56): I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organizing investment. Schumpeter (2008), who should have known better, concurs: One of the most important difficulties of running a business – the difficulty which absorbs most of the energy of a successful business leader – consists in the uncertainties surrounding every decision. A very important class of these consists in turn in the uncertainties about the reaction of one’s actual and potential competitors and about how general business situations are going to shape. Although other classes of uncertainties would no doubt persist in a socialist commonwealth, these two can reasonably be expected to vanish almost completely. (186) In the [capitalist economy] endless moves and countermoves are necessary and decisions have to be taken in an atmosphere of uncertainty that blunts the edge of action, whereas that strategy and uncertainty would be absent from the [socialist economy]. (194) Schumpeter never understood Mises’ theorem of the impossibility of socialist calculation. (Not to be unfair to him, Keynes did not either.) E.g., Schumpeter writes that “consumers in evaluating… consumers’ goods ipso facto also evaluate the means of production which enter into the production of those goods.” (175) Mises retorts that it is “hardly possible to construe the market process in a more erroneous

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way.” (1996: 357) Schumpeter did not realize that consumers do not determine the prices of the factors of production but merely affect them and only via the intermediation of entrepreneurs who both demand and supply those factors. Consumer spending is sandwiched between disequilibrating and equilibrating entrepreneurship; the former predicts it; the latter reacts to it; both shape the prices of the factors. Without market prices for those factors of production, the state most certainly cannot calculate in the sense of determine when its actions did and when they did not increase consumer happiness the greatest. Aleatory actions and the possibility of entrepreneurial loss can be eliminated only along with the possibility of victory. The state can try to plan and act alone, treating the citizens as inert resources to be moved to and fro, but with no one to compare its actions with, it ends up groping blindly in the dark. It is curious, finally, how Schumpeter argues that the transition to socialism would be much smoother under the initial conditions of “mature” rather than immature capitalism. This is because, according to our author, in the course of the evolution of unhampered capitalism, “the technological, organizational, commercial, administrative, and psychological prerequisites of socialism tend to be fulfilled more and more.” (219) Somehow, Marx was right in his conclusion: that socialism is the inevitable conclusion of capitalism’s development, but wrong in the details, namely, how socialism is best to arrive. Schumpeter supplies what he thinks is the missing mechanism. What might seem a paradox follows ineluctably: “Socialists have an interest to further the development that works for them, hence to unfetter capitalism rather than fetter it still more.” (228) Interventionism is fool’s gold; allowing laissez-faire to run its course then holds the greatest prospects for the socialists. Let me provide an interpretation of Marxism that vindicates this opinion. Marx’s argument relies on two premises. In the first place, Marx must have been deeply struck by the theological problem of evil. Children die from plague; unjust people are laughing, chaffing, nectar quaffing; living conditions of the masses are awful; and what of Darwin’s incredulity that “a beneficent and omnipotent God would have designedly created parasitic wasps with the express intention of their feeding within the living bodies of Caterpillars”? Yet Marx believed in the Creator God and maybe even in the Redeemer God. What comes out of this combination? Consider the modern human concern with biodiversity. If people think about wildlife at all, then they are interested in preserving endangered species. No one in his right mind cares about the fate of individual tigers or eagles or viruses. The God of an unsanctified

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world – both the Father and the Son – similarly does not care about individual human beings but only about the goodness of the whole universe. But what is the whole? Well, it may as well be society. And what is the most important part of society? The economy and the market. Already the source of Marx’s obsession with economics becomes clearer. Perhaps, Marx was a “quantum mystic” of some sort: in this branch of physics, the behavior of individual particles follows only statistical regularities, but macroscopic bodies obey strict laws; similarly, individuals are both unpredictable and irrelevant; society is both predictable and all-important. The Christian religion is ultimately a religion of the Holy Spirit: the very point of the union of God and humanity is so that God’s Light can flow to and nourish the individual members of the corpus Christi. The bizarre theologies of Whitehead and Hartshorne share with Marx’s opinion failure to do justice to the Third Person of the Trinity. Marx’s second move was to imagine the most primitive human community which existed at the instant when first human beings (by whatever means) came into existence. He may have thought that this human herd was characterized by original equality. The cavemen differed from each other at the most in size and strength. What happened next? However kick-started or booted, the human society began rapidly to differentiate. People started to divide labor and create permanent social bonds. The cavemen acquired skills that complemented each other. They perceived the benefits of specialization, trading, and peaceful cooperation. They created wealth, built cities, and civilizations. The initial seed-like equality was “transcended” through a process of social becoming into a flower that featured numerous different interdependent parts. The Biblical Ezek 27; 28 offer a strikingly beautiful paean to commerce and international trade. In those days, already, it was understood what amazing things human beings can do. St. Paul compares the functions of the Church to the diverse functions of the different members of the human body. (1 Cor 12) St. Thomas likens the human inequality to “works done by art; for the roof of a house differs from the foundation, not because it is made of other material; but in order that the house may be made perfect of different parts, the artificer seeks different material; indeed, he would make such material if he could.” (ST, I, 47, 2, reply 3) Sophocles’ Antigone celebrates human achievement: “Wonders are many, and none is more wonderful than man. … Cunning beyond fancy’s dream is the fertile skill which brings him, now to evil, now to good.”

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In Marx’s conception, the initial equality was pure and innocent, the right state of the human family to be in. Unfortunately, it is extremely undeveloped. A mature human society, as it is especially under capitalism, has developed marvelously, but it has brought about inequality. Cannot there be a yet third possibility: a society that is both sophisticated and equal? If God is both the Alpha and the Omega, then must not the states of society’s coming out of God and having lived and died, going into God be in some crucial sense alike, even if the reunion with God takes place on a vastly different, new, and higher level? (Remember that our author’s “salvation” is collective.) That was Marx’s dream. Now Mises summarizes the Marxist ideas on the subject as follows: Godwin thought that man might become immortal after the abolition of private property. Charles Fourier babbled about the ocean containing lemonade instead of salt water. Marx’s economic system blithely ignored the fact of the scarcity of material factors of production. Trotsky revealed that in the proletarian paradise “the average human type will rise to the heights of an Aristotle, a Goethe, or a Marx. And above this ridge new peaks will rise.” (1996: 71) Clearly, the transformation was to be accomplished by means of yet another transcendence of developed inequality into developed equality. Schumpeter seems right to point out that on this vision, if the longed-for revolution takes place, then it must come about at the pinnacle of both capitalist civilizational success and capitalist inequality. His argument that Marxists should welcome and enable the wealth-creating aspect of capitalism so as to bring the time of the revolution closer at hand, is nothing short of than brilliant. The reunion of mankind and God can, on Marx’s system, commence only at a very high level of human economic development. By piling up government interventions, socialists only check the very “productive forces” that are supposed to wax triumphant at the twilight of this age. They postpone the “revolution.” Georges Sorel (1916) is entertaining in this regard. Sorel notices that the middle class (by which he means, I think, mostly small business owners) and the capitalists are “cowardly.” Any time the labor unions and other like “syndicates” demand something, the capitalists always yield. He is vastly exaggerating, but let us proceed. Does not this alleged fact indicate that the workers could obtain heaven on earth, if only they

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were stern enough and violent enough, striking sufficient fear into their enemies, to squeeze the capitalists to the max; indeed, there is no max, because production is “inexhaustible” (“which is one of the postulates of the [Marx’s] theory of class war”) (65). The pathetic capitalists already dig their own graves by submitting to their employees constantly; all that is needed is for the workers to become arch-ruthless with them, after which transformation… well, the rest is foggy: “No effort of thought, no progress of knowledge, no rational induction will ever dispel the mystery which envelops Socialism,” probably because production is “the most mysterious part of human activity.” (164) Sorel goes on: “A social policy founded on middle-class cowardice, which consists in always surrendering before the threat of violence, cannot fail to engender the idea that the middle class is condemned to death, and that its disappearance is only a matter of time.” (71) (Our author pictured the contemporary society as a “a field of battle in which the proletariat attacks the middle class.” (177)) Interestingly, this would be unfortunate, namely, if “on the contrary, the middle class, led astray by the chatter of the preachers of ethics and sociology, return to an ideal of conservative mediocrity, seek to correct the abuses of economics, and wish to break with the barbarism of their predecessors.” (87) Revolution can be avoided only upon “simultaneous ruin of the capitalistic and the revolutionary spirit.” (88) Appeasement, attempts to promote “social peace” are or should be useless: “the middle classes must not be allowed to imagine that, aided by cleverness, social science, or high-flown sentiments, they might find a better welcome at the hands of the proletariat.” But there is hope. Thankfully, “proletarian violence confines employers to their role of producers, and tends to restore the separation of the classes, just when they seemed on the point of intermingling in the democratic marsh.” This way the class war is naturally intensified. “If a united and revolutionary proletariat confronts a rich middle class, eager for conquest, capitalist society will have reached its historical perfection.” (89-91) “The dependence of the revolution on the constant and rapid progress of industry must be demonstrated in a striking manner.” (150) Sorel has no kind words for interventionism equating it with economic “decadence”: “If our contemporary social policy were examined closely, it would be seen that it also was steeped in ideas of jealousy and vengeance; many regulations have been framed more with the idea of pestering employers than of improving the situation of the workers.” (186) After the revolution, workers will be “free”, i.e., “capable of running the workshop created by capitalism without any need of masters.” (183) Referring probably to the “class” of the government tax collectors

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and regulator-bureaucrats and contrasting his “Syndicalist general strike” that abolishes the State (as of then controlled by the middle class) with a “political general strike” which simply redistributes power, he suggests that “these new masters would very probably be less able than those of today; they would make more flowery speeches than the capitalists, but there is every evidence that they would be much harder and much more insolent than their predecessors.”4 (202) Ideologies make strange bedfellows. It has been pointed out to considerable effect that immiseration of the masses brought about by increasing inequality (i.e., ever greater poverty for the many in the midst of ever greater plenty for the few) that was supposed to ignite the proletarian revolution never happened. But Marx made crucial errors with his metaphysics, as well. First, human pre-history is admittedly irritatingly obscure. But human beings seem to have “worked their way out” of the initial primitive equality, slowly and in an evolutionary manner. There was no “bang” that lifted men up from primeval destitution into any sort of decent starting conditions. Pagan myths talk about powerful beings who stole fire from the gods and gave it to men. The Bible mentions the Nephilim, “sons of heaven,” differentiating them from “daughters of humans.” (Gen 6:4) These ideas seem reasonable: imagine the insuperable difficulties a first human infant would face when born into a family of apes. For example, this child would need to learn how to speak, but apes do not speak. Without teachers, he would not become a rational individual. Still, unless more comes to be known, we should not postulate divine help. Second, it is not clear that perfect equality is compatible with any sort of individual greatness. There is, after all, only one God. Every human being is delightfully unique; men are equal in dignity but not in substance, in which they are complementary. Equality coupled with 4

Sorel is described by his translator as a “pessimist” who thought that man was “by nature bad.” This already glosses over the distinctions between metaphysical, moral, and physical goods we discussed earlier, such as in (I, 36). But OK. What bearing on the problem of the most efficient system of economic organization does this view have? Well, if there is no hope for man gradually to build up a civilized world, a decent enough and continuously if slowly improving place to live for himself; if “progress” of this most general sort is thought impossible; then advances in the standard of living must come about via radical and titanic social upheavals. No evolution + the desire for improvement = improvement via revolutions. It is a mathematical certainty. But what kind of revolution? Well, why not the fashionable one of his time: socialist, what with the specter haunting Europe and all?

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human flourishing and perfection seems to be an impossible combination. Just as the first transcendence did not actually happen; so, the second transcendence is repugnant to reason and cannot happen at all. Now C.S. Lewis argues: “Why else were individuals created? … If [God] had no use for all these differences, I do not see why he should have created more souls than one. … Your soul has the curious shape because it is a hollow made to fit a particular swelling in the infinite contours of the Divine substance, or a key to unlock one of the doors in the house with many mansions.” (2002: 428-9; The Problem of Pain, Chap. 10, “Heaven”) This argument must be rightly understood. That Smith = Jones = Robinson may make Jones and Robinson superfluous to God, such that He would not create them in the first place. But once Robinson exists, he is not superfluous to himself, even if he is equal to everyone else. Perhaps, the Marxists thought that human society actuated by mutual usefulness and therefore, complementarity in every aspect of individuals’ characters, skills, etc. would be dissolved entirely after the revolution. Every human will be unrelated to and uninfluenced by everyone else, enjoying his perfections in utter solitude. St. Thomas, too, argues that in the heavenly abode, “fellowship of friends is not essential to Happiness; since man has the entire fullness of his perfection in God. … Wherefore if there were but one soul enjoying God, it would be happy, though having no neighbor to love.” (ST, II-I, 4, 8; reply 3) This brings us to Marx’s third error. Which is that Marx’s vision is entirely mystical. The human mind cannot imagine his world. Even if that world is possible, it is certainly not conceivable. An early communist Joachim of Fiore, Rothbard writes, “dispensed with the problem of production and allocation under communism very neatly and effectively, more so than any communist successor. In the Third Age, he declared, man’s material bodies will disappear, and man will be pure spirit, free to spend all of his days in mystical ecstasy chanting praises to God for a thousand years until the Day of Judgment.” (1990 [2]: 139-40) If Marx had kept the faith, then there would be little to object to in his teachings. Unfortunately, he decided to spent his life trying to figure out how the transition to communism is likely to take place both by human action and human design. Was Schumpeter, therefore, writing satire? Was he trying to trick his opponents? Or am I, a supporter of laissez-faire, a mere handmaiden of the handful of academic Marxists still clinging to their old religion?

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9. THAT CYCLICAL UNEMPLOYMENT IS ONLY ONE OF THE ALLEGED KEYNESIAN MARKET FAILURES The free economy, says Keynes, is flawed in two ways. First of all, it is plagued by perpetually high interest rates. As a matter of fact, for Keynes, there is no rate of interest that is low enough; in order to satisfy him, this rate has to be zero. This causes the economic system to remain in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse. Moreover, the evidence indicates that full, or even approximately full, employment is of rare and short-lived occurrence. … an intermediate situation which is neither desperate nor satisfactory is our normal lot. … we oscillate, avoiding the gravest extremes of fluctuations in employment and in prices in both directions, round an intermediate position appreciably below full employment and appreciably above the minimum employment a decline below which would endanger life. (2008: 249ff) In other words, the secular direction of the economy under laissez-faire is barely adequate. On top of that, there is also the exhausting business cycle and cyclical unemployment and depression which rotate around this already poorly performing economy. My studies have led me to conclude that laissez-faire delivers the goods better than any alternative; but government interventionism and corrupt banking practices foster the cyclical boom-bust nightmare which can be corrected by still more laissezfaire, i.e., by elimination of such interventions. Keynesians would have none of that. As far as they are concerned, business cycles are inbuilt into the free enterprise system, and the government has to manage them carefully. Moreover, the free economy as a whole and in the long term, when left alone, underperforms as compared with an interventionist economy. Laissez-faire, therefore, fails twice, according to Keynes and his students: it grows slowly, due to artificial scarcity of capital created by above-zero interest rates; and it is manic-depressive by virtue of fluctuating risk preferences and the people’s propensity to hoard money which, say the Keynesians, dampens trade and enervates social bonds and social cooperation. I wish to underscore what I mean here by the term “market failure.” The first sense of this term is neoclassical and illusory; the second sense is Keynesian and real. For example, Cassidy (2009) considers

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“global warming” to be a market failure, because it is a negative externality. Assume that all the present alarmism about this problem is sound. Still, pollution and global warming are not market failures; they are failures of the market to arise due to transaction costs of bargaining and difficulty defining and enforcing property rights. This is, perhaps, a semantic point, but let us keep it clear: in these cases, there exists no market in first place which can fail. What is more, the problem is not “Pigovian taxes versus cap and trade.” It is much more fundamental. One can engage in economic calculation of costs and benefits, profits and losses only within the market. There is no such thing as “environmental economics,” only environmental politics, precisely because one cannot calculate the “social costs” or social benefits and “correct the divergence between private costs and social costs.” One cannot economize, when he cannot quantify benefits and costs. It is no surprise that “there remains little consensus on how far to restrict future greenhouse gas emissions, or – and this comes to the same thing – how high to set the carbon tax.” (123) Any such decision is going to be arbitrary from the market point of view and politically determined. For example, a politician who runs for office promising to tax polluters has not invented a wonderful new technology to produce the same amount of goods yet pollute less in so doing. The tax will discourage both pollution and production, and the presumed problem is to find an optimal point at which further reduction in pollution is not justified by reduction in material prosperity. The politician, then, is taking a side in an unpleasant choice. This choice is not made by each consumer for himself but by the people collectively or by the organization that manages the air commons, such as the government. However the decision is made, almost everyone will be disappointed: some people would have preferred more production than was ultimately decided; others, less pollution. Moreover, the market responds to changing preferences in real time, daily; opportunities to change the rate of the tax come far less often. There are more problems. When the purpose of taxation is for the government to raise revenue, there is at final accounting a point of diminishing returns a la the Laffer curve. Tax rates beyond this point actually decrease revenues. But if taxing is meant to discourage a harmful activity, then there is no such equilibrium. An ambitious and fanatical bureaucrat can decide that no pollution at all is best. But every industrial process emits waste or contributes to climate change. The power to tax polluters is the power to destroy the economy, if the government chooses to set the maximum allowed pollution to zero. Further, we cannot give the government the power to regulate every company in the

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realm under pretext of pollution control. The government in conspiracy with big business can cartelize an industry, all the while publicly claiming that they are saving us from pollution. But what can we do? As long as air is owned in common, there will be neither justice in society nor peace. The market is not at fault; the absence of the market is. Similarly, consider overfishing. The oceans are a commons, and as such, though seemingly huge, are starting nowadays to suffer from the tragedy of the commons. The key about this devastating phenomenon is that I have a reason to grab as many resources in the commonly owned pool before others do the same. Those others think that I will consider them greedy and grasping, that is, narrowly self-interested, and so will try to capture the best stuff first, before they get to it. But why would I consider them such? Precisely because they consider me such; and so, responding to my expected narrow self-interestedness, they will tend to act on the incentive to try to outdo me in seizing as much as possible. Moreover, if they are wrong about me, such that I am in fact eager to cooperate, then so much the better for them, in that I will not even be in the competition. There is a mutual suspicion going on, such that no actor can afford to treat others as innocent. “If I fail to move, the other guy, (falsely) thinking me quick and amoral, will attempt to counter me, even if I am actually passive and so will take everything. He can’t afford to trust me, because if he trusts me, and I turn out to be actually quick and amoral, then he gets zilch. Therefore, if I am to have a chance to acquire anything, then I’d better move and move fast.” The resulting race to the bottom will predictably end up with depletion of the resources in the commons. This is a form of prisoner’s dilemma with the payoff schedule looking like Table II.9.1.

B: Moral B: Amoral

A: Moral 10 / 10 0 / 20

A: Amoral 20 / 0 1/1

TABLE II.9.1. PAYOFFS TO FISHERMEN

Whatever B is like, A is better off being amoral and exploiting the commons to the max. And the same is true for B. As a result, they both end up with 1, when they could each have obtained 10. There is no economizing here, since everyone tries to snatch as much as possible, before others get their hands on it; and moreover, no economy, because an economy, in order to be rational, has to serve the consumers, and overexploitation does not serve the consumers in long run. Tragedy of

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commons also tends to feed on itself. The fewer fish remain, the lower the supply, the higher the price, the greater the incentive to catch the remaining fish. Again, this formidable problem exists, because no one as yet has figured out how to privatize expanses of water, watery depths, and the seafood in them. Since there cannot be a true market without rights to private property, this again is the illusory sense of market failure, because the market does not exist and therefore, cannot fail. It is possible with considerable effort to locate genuine market failures. They might take the form of “Smith sacrifices $20, so that Jones might get $100, and vice versa. Both would thereby benefit, if each had an incentive to give up the $20.” For example, Landsburg (8/3/1997) considers the case of car anti-theft devices and concludes that the Club merely redirects thieves away from one’s own car protected by the Club toward the neighbor’s car parked next to it that is unprotected. It is like “hiring an exterminator to drive all the vermin next door.” This device “encourages thieves to prey more heavily on those who haven’t bought one. From a social viewpoint, if the total number of thefts does not change, then the expenditure on alarm systems is pure waste.” On the other hand, a device like LoJack which is “a hidden radio transmitter that can be activated after your car is stolen, to lead police to the thief (or, better yet, to the chop shop that employs the thief)” is superior. “The transmitter is hidden randomly within the car, so thieves cannot easily find it and deactivate it. … But from a social point of view, the LoJack has the huge advantage of helping your neighbors rather than hurting them. The Club convinces thieves to steal someone else’s car instead; the LoJack convinces thieves not to steal.” In short, LoJack for cars is like concealed-carry for people. In the first place, Landsburg should carry his reasoning to the end. Suppose that Clubs work as expected. The more people have them, the more time and effort an average thief has to spend looking for cars without one. As some critical mass of Club-equipped cars is reached, the costs of stealing cars increase sufficiently to drive marginal (i.e., least efficient) thieves out of business. The likelihood of this happening increases precisely due to the incentives generated by other Club-users. There is a snowballing effect: as the number of cars secured with the Clubs increases, people without the Club will feel that they are in greater danger and be more willing to buy Clubs themselves. Landsburg provides yet another objection: “it’s possible that [former car thieves will] seek employment as, say, arsonists or killers for hire.” Yes, but we should expect those “industries” to be already saturated with existing arsonists and killers, so new people entering the illegal professions will likely be caught or cause more incompetent than

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them arsonists, etc. to be caught or again, exit the “market” voluntarily. Moreover, the loser thieves who change occupations would probably be stupid enough to end up as loser killers. To be sure, normal industries are similarly saturated, as well. We should then expect that on average, some former car thieves will get into other criminal work, while others will choose a lawful profession. As a result, overall crime is lowered. Hence, Landsburg’s conclusion that the Club ought to be taxed does not follow. On the contrary, taxing it when there are still few Club-protected cars can prevent their proliferation and effect on crime when most cars are protected with them. Another subtle point is that as Clubs are becoming widespread, the incentive to thieves to devise means of countering them is increased. So, depending on their actual effectiveness, the Club’s ubiquitous use may actually end up destroying its utility for everyone. But this possibility is just part and parcel of the endless technological arms race between good and evil, and taxing Clubs due to the expectations that thieves will win seems like giving up the fight at the outset. As for subsidizing LoJacks, notice first that their deterrent power depends on the perceived threat to a thief of getting caught. If the government publicizes a statistic, say, that 30% of all cars are protected by LoJacks, and this statistic is believed, then there need not be any actual LoJacks installed in any actual cars. The government lies or produces disinformation, but thieves are deceived and deterred, since they cannot tell which cars are and which are not LoJacked. Now it is pretty unlikely that car thieves will find the threat credible, unless a substantial number of their brethren are caught and imprisoned. So, the intimidation should probably be backed up by actual LoJacks out there, by criminals caught explicitly with the help of this device, and by the other criminals’ still at large being made aware of this fact. Still, the point stands: in principle, the government might be able successfully to bluff. I admit that the market might underproduce LoJacks. But the first question is, where will the government get the money for the subsidy? Surely, by taxing the very consumers it is trying to help. It is unclear whether or not the human desires forced to stay unsatisfied due to the taxation will be outweighed by the benefits of a smaller number of cars stolen. Who should be taxed, and how much? It seems that the problem of economic calculation by government is insoluble. It will not do glibly to reply that the money to deal with positive externalities like those produced by LoJacks will come from taxing activities that produce negative externalities like those generated by Clubs. There is no reason to believe that the two amounts of money will be the same. The purpose of taxing Clubs is not to generate revenue for the state but to discourage

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their use, anyway. For all we know, the latter can be accomplished with a trivial amount of the tax, insufficient to finance any subsidies. Second, let LoJacks be subsidized; perhaps the government pays some of the costs of their production. We may imagine the story unfold somewhere along the following lines. LoJack exists for a while and becomes an established company on the free market. At some point the government notices the positive externalities of this product and legislates a subsidy in order to spread these externalities far and wide. Suppose a new entrepreneur, Smith, invents an improvement to the LoJack, call it 0Jack. How is Smith supposed to compete with LoJacks, given the subsidy? Despite their higher quality and comparable to LoJacks cost to the consumer as it would be in the free market, the subsidy makes 0Jacks too pricey. As a result, Smith’s company never gets started in the first place, which deprives the public of an important innovation. For no entrepreneur embarks upon a business venture and begins to manufacture a product, the indispensable condition for whose success is first to change government policy, in particular, to convince the bureaucrats in change of taxing and subsidizing things to withdraw the subsidy from LoJacks and extend it to 0Jacks. Business does not work this way. Third, let us undergo a reality check and consider that fighting car thieves is the task of cities. Indeed, the authors of the study Landsburg cites “have examined the effects of the LoJack in about a dozen cities over the past 10 years.” This only supports my view that city governments are useful and even essential, unlike governments of a larger size like US state and federal. Most if not all of public goods, externalities, spillover effects, etc. can be properly controlled on the local level. Moreover, some cities have high crime rates which may justify the subsidy; others will have low crime rates, such that subsidizing LoJacks will be a waste of resources. When Smith loses $20, it matters whether Jones gets $100 or $10. Now of course, a high crime rate city that subsidizes LoJacks and lowers crime rate for that reason may drive thieves to neighboring low crime rate towns. But this does not justify a state government subsidizing LoJacks over the entire territory of the state. Only if the problem with car thefts in a city becomes severe is it time to react to it. Overreacting helps nobody. Cities are the optimal level at which to resolve any such externalities problems. Both the market on the level of individuals and the government on the level of the state fail here. Suppose I am driving, see an ugly car, and get dispirited because of that; then I pass a garden in someone’s front yard and cheer up. Again, Smith may never visit the Grand Canyon, but he derives an “existence value” from it, i.e., some sort of serene wistful contentment from knowing that it is there, the opposite of weltschmerz: all is well with the

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world, as far as he is concerned. Should these externalities in principle be counted when crafting economic policy? The fact that economists lose sleep over such things indicates nothing more than their Rational-temperamental uneasiness with basic luck. Luck is the life of their hostile opposites: the entrepreneurial Artisans, and our economists are ill at ease with it. No exigent circumstances shall interfere with the economist’s admirable foresight. Luck is downright disgusting, an affront to decency. Off with its head by having the government tax ugly cars and subsidize gardens. This is a reductio of the tax-and-subsidize strand of economic thought, but the more general argument is that it is impossible outside the market to know just how severely to tax and how profusely to subsidize any given thing. The only test is political: if Smith, who loudly extols the virtues of his favorite tax or subsidy, wins a city council race against Jones the libertarian, then in some sense he was a better political entrepreneur, and his scheme may be rational. But so primitive is this test that I would advise against such reckless experimentation – riding roughshod over basic property rights and market discipline – even on the local level. The moral is that true market failures are so rare and startling that economists pay an inordinate amount of attention to them precisely because of their rarity. They are the exceptions, the awareness of which separates naïve from seasoned scholars. These latter may be eager to prove their lack of “bias” toward the free market but go too far, succeeding only at neutering themselves as effective public intellectuals. Keynes’ market failures are real in the sense that they make no reference to externalities or public goods or asymmetric information; the markets are assumed to be fully enabled but still fail to yield full employment and maximum productivity. I disagree with this claim, as well, but at least Keynes is not talking nonsense. High interest rates are unacceptable to the Keynesians. But we have seen that attempts to drive the rate of interest below its natural value initiate the business cycle. Artificially low interest rates are unsustainable. Hence, the bust is characterized by both high interest rates and hoarding. Efforts to inject the economy with a growth hormone backfire: the economy ends up shrinking, such that its overall productivity during the entire cycle is lower than it would be under laissez-faire. In other words, the first Keynesian mistake lies in holding that a free economy is not growing fast enough. In matter of fact, it is growing at precisely that rate that is most agreeable to the sovereign consumers. In order to go over the consumers’ heads, Keynesians tinker with people’s time preferences. Their second mistake is, when the business

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cycle inevitably rears its ugly head, to begin tinkering with people risk preferences in an attempt to check voluntary hoarding. As a boom has worn itself out or after a bubble has popped, the trouble for the Keynesians begins with a collapse of the loan market. Somehow, perhaps due to the influence on their animal spirits of the stars, people are refusing to borrow and invest. (Of course, the ABCT denies any celestial shenanigans.) Production slows down, making society poorer and reducing consumption. Supply of credit is restricted, putting upward pressure on the interest rates, though this pressure is moderated by three factors. (1) Money supply deflation arising from the destruction of credit money by the banks. This causes money to appreciate in value and reduces the explicit compensation demanded for forsaking present enjoyments. (2) Low demand from new entrepreneurs who are contemplating investing. They face fewer profitable opportunities, since the factors of production are overpriced; companies are going out of business; there is too much discoordination already. (3) Low demand from entrepreneurs already producing who may fail to replace depreciating capital goods and may even sell some of their assets. As a result, the economy is underperforming in creating both present and future goods; it is producing less than it could with kinder fates. Just as the multiplier accelerates trade, when consumption increases; so, it also decelerates it, when consumption and investment spiral down. Income to factors of production goes down still more. Finally, because wages are sticky (either absolutely and nominally, along with prices, or at least as real wages, in relation to prices), there is unemployment. Now unemployment is at the same time an economic, individual, and social problem. It is an economic problem, because it entails poor utilization of the available scarce resources, namely, labor. It is an individual problem, because the unemployed are outcasts, living on their savings and eventually on alms, a soul-destroying lifestyle, failing to make themselves useful to their fellow man. It is well known that substance abuse, suicide, marital strife are more common among the unemployed. And it is a social problem, because the unemployed are a threat to laissez-faire capitalism which they unwisely blame for their plight, the real reason for which is actually interventionist measures resorted to by the state. Crime may also increase with the rising of the number of the unemployed.

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It is unclear which of these problems Keynes emphasizes, but since this is a book on economics, I will focus on the economic aspect of unemployment and will consider labor to be a means to an end, namely, a factor of production used to create and increase wealth. Unemployment is a problem, because it makes society less prosperous. Even worse is the effect of consumer hoarding or increase in “liquidity preference.” New jobs are created by means of increased investment; old jobs are preserved by more or less stable consumption, whether by the consumers or entrepreneurs, though, of course, demand is always changing. Depression devours both kinds of jobs. However, neither the government nor the Central Bank can ameliorate the situation in any useful way. Dillard (1948) argues that this understanding shows that time preference is not active either outside the business cycle or in a recession, not influencing the rate of interest. For in both cases, there is involuntary unemployment. At first, there is no need to create voluntary savings by abstaining from present consumption, because the Fed and the banks can create any amount of credit they wish, apparently supplying entrepreneurs with an unlimited amount of money capital. In the second case, in a recession, there is again no need to reallocate money from consumption to investment, because it should be possible to pick up the unemployed factors for a pittance and make whatever we wish, including future goods by means of more roundabout methods. Meltzer (1988) concurs, saying that in Keynes’ economy, “output is not limited by factor supply, [and] investment is not limited by saving.” (15) As we will see, however, the reason for unemployment “in a chronic condition of sub-normal activity” is the fetters that the government has placed on the economy. Minimum wage, hiring and firing regulations, labor unionism, even the Americans with Disabilities Act cause institutional unemployment. If there is an underclass of the unemployed even outside the business cycle, such that entrepreneurs cannot collect them, then these people are not merely unemployed; they are unemployable. Macroeconomic monetary policy to “stimulate the economy” and get those unfortunate people finally hired does not simply palliate microeconomic interventionism. Two wrongs do not cleverly contrive to make a right. The policies of labor unionism and inflation through credit expansion do not fit together like hand and glove which, when properly combined, allegedly mimic the market with surprising briskness and authenticity. In the short term, they just create monstrously distorted prices and production structure. In the long term, they do not work at all, as union leaders catch on to inflation and demand still higher wages. In short, the use of monetary policy in response to “chronic”

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unemployment and slow growth fails precisely due to the neglect of the time preference theory of interest. Dillard argues further that time preference does not explain why interest continues to be paid in the slump. The reason why there is not enough money capital to scoop up the unemployed must then lie in the second cause of interest which is liquidity preference. Dillard is right that low interest rates in a recession may not produce a crop of new entrepreneurs, because people discount profits by the rate of risk preference, as well as time preference. It is both too risky to invest; and people are dazed and confused by the mass losses happening around them. Even if the market for labor in a cyclical downturn could clear by a readjustment of wages relative to prices of output of firms, nevertheless, Keynesians argue, the weak economy in general would persist. Moreover, an attempt to revive the economy by means of monetary or fiscal policies (the former would “fight” high interest rates; the latter, the predilection of the public for hoarding) would end up causing the need for wages to adjust yet again. The expansion of the boom is inflationary; the contraction of the bust is deflationary; but if the government could both (1) abolish the business cycle and (2) increase economic performance by means of its “policies,” then why bother with flexible wages and prices when this flexibility serves no purpose and only takes us away from the ideal state of affairs? It does not matter where the wages are in the Keynesian theory; inflation plus taxing and spending can always fix them; what matters is insufficient aggregate demand for both consumer goods due to hoarding and capital goods due to high interest rates which, again, keeps the economy below its potential GDP. The dynamics is simple: insufficient demand met with lower prices will also reduce wages which in turn reduce demand even more. Flexible prices not only fail to help; they make things worse. This is nonsense, of course; I showed in (I, 59) that wages and prices will deflate in the manner that ensures that sooner or later they will be properly adjusted relative to each other. I will show in the next chapter that even in a severe depression, the price deflationary spiral will peter out fairly quickly entirely on its own. Finally, the individual risk preferences change significantly as a result not cause of an economic depression, and even then their satisfaction by means of voluntary hoarding is a good thing, despite the additional damage it does to entrepreneurs and debtors. In fact, given that a boom is characterized by the “too intense” a competition between “too many” entrepreneurs, as suggested in (I, 61), ruining the marginal, i.e., worst, entrepreneurs during the bust is precisely what the doctor ordered.

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To the extent that laid-off workers during a recession at first are unwilling to lower their demands when searching for new jobs, their unemployment is voluntary. The real reason for involuntary unemployment is not sticky wages but overpowering economic discoordination signifying subpar resource allocation. Jobs are lost, because numerous entrepreneurs go out of business. Just as the number of entrepreneurs competing for scarce resources is higher in a boom than would be in a free economy, so that number is lower in a bust that would be sans the business cycle. Aside from freeing the economy, activist government policy cannot do anything about the latter. I already commented on the supposed power of inflation to cure unemployment in (I, 58-59) and concluded that flexible prices are a must. In addition, I will make three observations on the Keynesian understanding. First, if the labor market clears, then deflation will have adjusted all prices down to their correct levels. The quantity demanded of labor may initially go down, as demand for labor diminishes, but this difficulty is alleviated by the shift of the supply curve for labor rightward, indicating the greater purchasing power of money. In addition, the public has attained greater security via its hoards. There is little to complain about. Second, I have suggested that the notion of aggregate demand itself is at best unclear and at worst meaningless. Until the Keynesians define the AD / AS curves satisfactorily, their economics will make no sense. For example, they might consider demand for consumer goods as versus capital goods and oppose the effect of derived demand to the effect of changes in interest rates upon the structure of production. (The Keynesians cannot evade this job by trying to assert that these effects simply cancel each other out, for they most certainly do not.) But that, of course, would be moving toward the Austrian approach. Finally, and most important, what Keynes is doing is condemning both consumers for their “capitulation,” to use a term from an article by Paul Krugman (9/31/2008), a Keynesian, if there ever was one5, and entrepreneurs for their cowardice. This aspect of Keynes’ thought goes far beyond economics and concerns the fundamental properties of human nature. Recall from (I, 31) that the human appetite is divided into unconscious and conscious; the latter, in turn, into sensual and intellectual; and the sensual appetite, called “passions,” is further subdivided into the concupiscible and irascible. 5

For Krugman, “General Theory is nothing less than an epic journey out of intellectual darkness.”

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The concupiscible passions are sensations, like touch and taste, that are instinctively attracted to pleasure (as opposed to intellectual joy) and flee from pain; the irascible passions are those aggressive and defensive habits and virtues, such as daring, tactical prowess, fast reflexes, courage, and hope, with which man resists dangers and achieves his goals. At the beginning of a bust, consumers (who correspond to the concupiscible part of the soul), Keynes alleges, have stopped seeking their own happiness. They are somehow paralyzed with pain. On their part, entrepreneurs (who correspond to the irascible part) are running scared; they have ceased to be cunning and bold, pursuing their profit and victories with ruthless self-determination. Fiscal policy can at this point be brought in to restore consumption, if not by the people than at least by the state; and the monetary policy, to whip the entrepreneurs into shape. (Again, monetary policy “encourages” investment (thereby allowing entrepreneur Smith to set up a round of novel production) without a sacrifice of consumption; fiscal policy encourages consumption at the expense of hoarding (and therefore, permits Smith to earn profits). I have argued that the credit expansion-fueled boom constitutes malinvestment, destined never to bear fruit; and that fiscal policy impoverishes the population by transferring purchasing power from the people to the state. Monetary policy taken to its logical conclusion results in hyperinflation; regarding fiscal policy, the more believable the government’s promises that entrepreneurs will still make profits during the bust, the more such “entrepreneurs” will crawl out of every corner of society, until everyone expects his guaranteed dough, and the state is the primary client of all businessmen. The government’s power to prevent entrepreneurial losses is the power (ineptly) to socialize the economy.) This assumes from the beginning that the cause of business cycles resides in the psychology of the consumers and producers. In fact, psychological attitudes do play a role, but it is a strictly subordinate one. Let me grant, however, for the sake of argument that private vices can become public evils. What of it? Must we now sink into despair or, worse, despise the free market? How is the substitution of government management for private initiative supposed to solve the problem? Perhaps, Keynes will contend that as production processes lengthen, they become more uncertain; hence, ever greater powers of entrepreneurial foresight and discernment are required in order to “defeat the dark forces of time and ignorance.” (2008: 155) Perhaps, so; but (1) speaking empirically, capitalism has not collapsed under a

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Summa Against the Keynesians growing mountain of entrepreneurial errors, even with the state’s near-total control over the money supply: the capitalist system is damaged by the business cycle but not yet mortally so;

(2) the state creates some of the unneeded uncertainty, as pointed out in (I, 65) which relieves laissez-faire of at least some guilt for it; (3) sudden and prolonged worsening in consumer or investor confidence is not common under peaceful free markets; and under government interventionism they are not uncaused: there can be, as I have argued in Book I, solid reasons for both consumer sloth and entrepreneurial fear, reasons which cannot be obviated by the government’s and Central Bank’s overbearing meddling and must instead be overcome by the people themselves; (4) the playing field is level; entrepreneurs need only to be better than others who are faced with the same uncertainty; (5) uncertainty has diminished, and confidence rates have shot up, as a result of continual growth of our collective human ability to coerce or bend nature to our will; limitations on government arbitrariness; globalization, economic interdependence, and a seeming end to massive wars; conquest of famines, much of disease and child mortality; and the like; and (6) the Keynesians have not come up with an alternative. Keynesians would have us rely less on the fickle consumers and inconstant entrepreneurs and put our destinies into the hands of the state. The state knows what is good for us and how best to produce those good things; as indicated in (I, 57), in Keynes’ vision, the state is infallible, omniscient, and omnipotent. The next chapter elaborates on this idea. 10. THAT A DEFLATIONARY DEPRESSION HAS A NATURAL LIMIT TO IT Keynesians fear that any recession would be characterized by falling wages and prices, such that both consumption and investment decline. There is an interplay of three factors to which I want to bring attention that determine the time-span of the bust and extent of the deflation.

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First, which I will call the “objective” factor, is that just as during the boom too many entrepreneurs were fighting for the same resources, now in the bust there are too few entrepreneurs, and the demand for the factors of production has slackened, lowering their income and level of employment. The factors will again become embroiled in some businessmen’s production endeavors only when their prices fall. Second, and let me call it the “subjective” factor, is securityseeking. If I see factors around me becoming unemployed, then I will worry about my own solvency and increase hoarding. It was seen that there are three and not two possible employments of money; hence, consumption and investment are replaced with hoarding. Hoarding itself is undertaken when the risk of losing one’s job or business is believed to have increased. But security, like every other good, is subject to diminishing returns. An extra gold ounce of security brings less happiness, the more security one already enjoys. At the same time, the disutility felt from reallocating a marginal dollar from consumption and investment toward hoarding increases. Therefore, the deflationary spiral will go on until enough security has been attained by the public. Remember that expected profits are discounted not only by the rate of (a) interest (or time preference) and (b) inflation but also by (c) the rate of fear (or risk preference). Low confidence entails high fear discount. Hence, the “liquidity trap”: even low interest rates maintained in a recession by the Central Bank may be unable, if people are fearful, to restart a boom. The cause of this fear is, as just stated, both objective due to high present prices of factors and factors owners’ unrealistic wage and price expectations; and subjective due to the public’s anxiety from seeing the world crash and burn around them. Third, and this will be called the “catalyst,” consists of two parts. (3.1) If I anticipate that numerous other people’s risk preferences will rise, then I might refrain from spending also in order to take advantage of lower prices in the future. This accelerates price deflation and hastens recovery. (3.2) (Unexpected) deflation benefits (present) creditors at the expense of debtors. If debtors, in order to meet their now harsher obligations, curtail their consumption to a greater extent than creditors will increase it, a likely scenario, then deflation will be sped up. The spiral on the other hand may be moderated by what are called the “Keynes effect” and the “real cash balance effect” which are really two different ways of expressing the same point. The former says: lower prices may be treated as if people have more money which is as if the money supply has gone up which is as if the LM curve shifts to the right, lowering the interest rates and raising aggregate demand. (See (II,

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20) for the explication of the IS-LM model.) The latter says: lower prices may come with lower incomes, but the total money supply in people’s hands remains the same; so, people with savings enjoy higher purchasing power of their existing money holdings which stimulates autonomous consumption, i.e., the consumption that would take place even at zero income. The idea is that demand for money eventually decreases in a depression which puts an upward pressure on prices. The problem here is that mass losses have two effects. First, there is wage-price deflation; second, there are credit contraction and money-supply deflation. Insofar as these proceed together, the Keynes and real balance effects may not be significant after all. The phenomenon of a depression can be split into two questions: first, why companies collapse en masse; second, why new companies do not hurry to be established in their stead. We might answer the second question by saying that people’s “animal spirits” are down. But that alone is not sufficient to prove that there are good reasons for it, that there is no anti-social aspect to hoarding. We must add that it really is reckless to invest in the first stages of the bust. The “spirits” will be lifted again (a) when people feel that they are sufficiently protected against the uncertain future, (b) when the prices of (specific) factors have declined sufficiently to permit new profitable investments into them, and (c) when interest rates go down to their proper level. Then folks will slowly begin venturing out of their dens, as it were, and resume consuming and investing. Keynesians call this phenomenon the “paradox of thrift.” To them, the utility to individual savers of greater security is outweighed by the social viciousness of hoarding. It, say the Keynesians, (α) prolongs the depression, (β) decreases output, thereby lowering each individual’s share of the society’s consumer goods (contrary to the express purpose of not consuming to increase it), and (γ) causes unemployment, pushing people out of social cooperation. The alleged paradox is that if one person hoards, and no one else does, then the harm to the economy is negligible. But if this behavior spreads, then the result is the equivalent of mutual non-cooperation in prisoner’s dilemma: maximizing individual self-interest harms group self-interest. The reason is, again, that the money supply decreases, but the supply of goods goes down, as well, which defeats the purpose of

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hoarding in the first place. As we will see, however, all these charges are false. First of all, hoarding must be exonerated from one accusation against it, namely, that it causes higher interest rates in the long run. On the contrary, the holding of both present and future money is preferred; in other words, the supply of both present and future money diminishes, since some consumption and some investment are redirected into hoards. The ratio of these values, when all is said and done, need not be affected predictably by an increase in the desire to hoard. Secondly, it is true that when people save money, they often abstain from consumption now in order to consume later. In the meantime, they incur the capacity of suppliers of present goods, and they supply these goods to factors of production by investing (either directly by themselves or by loaning the money to investors). A decrease in consumption, therefore, comes with an increase in investment, in particular, investment into longer and more productive projects. Moreover, if I save some money now, then it may be because I want to take a vacation six months from now, a desire the prediction of which is the job of entrepreneurs. I buy less now only to buy something expensive later, be it a consumer or capital good.6 But I understand the paradox of thrift to apply particularly in a situation, in which hoarding displaces all three of (i) consumption now, (ii) consumption later, and (iii) investment now. The question then is whether hoarding is socially evil, as Keynesians allege. The answer is fairly simple. Everyone agrees that in the long run, all wages and prices will be adjusted to each other to the levels desired by the consumers. But what of the short-run? All prices fluctuate daily in response to changes in consumer tastes, technological advance, consumer product innovations, time preference and choices of how much to save and invest as opposed to consume, government policies, and so forth. So, let me incorporate another reason for price changes: to adjust the public’s desire for security vs. risk by varying the purchasing power of money. Again, there is nothing inherently illegitimate about that preference, is there? Consumer desires reign supreme under unhampered free market, even a desire not to consume. Then a Keynesian cannot object that prices are sticky: if he does so, then he will be asserting too much, namely, that all relative price adjustment are painful and costly and do more harm than good. But again, it is the heart of prices that they are flexible. A frozen economy is not an economy at all: it is the state of all-around social death. I do not by this imply that prices and wages are not fairly stable 6

All these, and other, reasons for saving are outlined in (I, 20).

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in the short period. This is because much of the real economy evenly or approximately evenly rotates, and entrepreneurial shocks to it, whether disequilibrating or equilibrating, are moderate both in quantity and in extent. But this is an empirical observation and a far cry from the a priori claim that prices are “rigid” and fail to adjust toward equilibrium via the market process. With respect to (α), hoarding does not prolong the depression but on the contrary, hastens recovery. The objective factor, subjective factor, and the catalyst driving the deflation / depression work together to make it deeper and therefore, last a shorter amount of time. Stated differently, the most efficient way of recovering from a bust is to permit (or even induce) hyper-deflation. Interesting how the very thing that Keynes considered to be an economy’s bane, namely, deflationary expectations, is actually the source of its salvation. It is repugnant to reason to want a less painful depression which lasts longer, because that keeps resources un- and underutilized longer. The faster the depression will end (assuming no more credit expansion), the greater will be the prosperity achieved in all the years following it as compared to a longer yet “milder” depression. Indeed, a mild depression only continues the illusion that everything is sort of OK. On the contrary, truth will set us free: everybody must be clear on how to behave in order to redirect every available resource toward genuine service to consumers and bring about to sustainable growth. Hoarding is economic shock therapy. I discuss Minsky’s (1982) idea that stagnation or permanent mild depression as the normal state of affairs is the price we pay for avoiding heavy depressions in (II, 13). It is true that once the catalyst has served its purpose, it is no longer necessary and becomes a liability. Fear is not healthy either for an individual or for society. (1) For the former, a hoarding mentality destroys both enjoyments which money can buy and that risk-taking that carries with it a chance of victory. “Cowards die many times before their deaths; The valiant never taste of death but once,” Shakespeare wrote. But to argue like this is to leave the realm of economics and indulge in ethics, a fine affair but beside this point here. (2) For the latter, an increase in the rate of hoarding may depress the entrepreneurial spirit. But what if the government has ruined the economy, such that less entrepreneurial spirit is now called for? Thus, hoarding heals the economy in several ways. First, people stop buying luxury goods, such as expensive coffee or cigars or organic fruit. That the purveyors of luxury goods suffer is

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entirely in tune with reality, since it signifies that the economy is returning to some point on its production possibility frontier (PPF). This means that all deception of incredible wealth is being purged from the people’s mind-set. The motion of the economy back onto its PPF from a depressionary state is assisted by two seemingly contrary effects of hoarding. On the one hand, and second, as already mentioned, the prices of capital goods fall which gives an incentive to individuals who want to try their hand at being new entrepreneurs to recover them and use them in new business ventures. On the other hand, and third, interest rates rise due to hoarding in the short run, because each individual will need a greater incentive to forgo the security brought about by hoarding and invest. This imparts a good deal of responsibility to those new entrepreneurs. Once, when I was living in Manhattan, I was buying a suit, and the proprietor of the store recounted how his business suffered during the 1990s boom: people stopped wearing suits to work, even in established companies. Such a happy and optimistic atmosphere was felt by everyone, and society was so awash in money, that managers did not feel that the sense of business responsibility needed to be maintained by requiring employees to dress well to work. Hoarding puts a stop to such nonsense. Capital goods become less precious, but money capital becomes more precious. The first effect drives the economy down to the PPF but may overshoot and drag it below it, as well, for a spell. The second effect assures that the economy will not remain below its PPF for long, and that recovery will occur. Production will resume and with it, consumption. With the third effect, society is saying that we want (1) less wild risk-taking and (2) more responsible investing. We want people to come up with business plans that will actually and reasonably project some kind of profit in the future. Only to such people will the hoarders agree to loan money. There are stricter expectations of success and of profits. This helps to ensure, unless fouled up by the government for the umpteenth time, that there will be no repetition of the boom, and that the economy will not again proceed above its PPF. Fear has its uses. With respect to (β), therefore, it is not true that the economy is underperforming during a bust, as I had the Keynesians assert above: on the contrary, it is being saved, both figuratively and literally. Hoarding decreases output only in the very short-term; otherwise, it is a reaction against the mania of the boom and preparation for (a) more entrepreneurship and (b) more responsible and therefore, successful entrepreneurship which will in time bear fruit and restore prosperity.

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The preposterous (in hindsight) projects started during the boom have already naturally folded; hoarding does not make matters worse but rather conserves and eventually replenishes whatever capacity for growth still remains in the economy. The economic yang has discredited itself temporarily; as payback, yin must devour the losers in order to be placated. Again, the “obvious” argument is that hoarding causes more businesses to take losses. But we can be more subtle and argue that the combined losses from the bust plus hoarding are really on the whole no greater than the losses from the bust alone, except that those losses are then suffered over a shorter length of time. The depth of the recession may well be the same, but both its nadir and the condition of healthy growth are reached faster when hoarding takes place. Now even if Smith has lost money in one production period due to hoarding-induced diminution of the money supply, he may still be able to evenly rotate, if no more deflation is expected, because the prices of the factors have also fallen. Deflation hurts production, insofar as entrepreneurs refuse to invest a higher amount of present money only to receive less future money in sales revenues. So long as deflation is expected, and the more serious it is imagined to be, the cleansing process to that extent becomes more grueling and rigorous. However, it does so in the shortest possible run, and the overall human discomfort will be about the same. Call this a reasoned doctor’s opinion. Note further that even if one disagrees, there is no alternative; government interventionism will make things worse. This is because the only way to rid the public of fear is either to recover naturally or to restart the boom. Deficit spending is the antithesis of the former, and its stated goal is not the latter but rather to make the recession less painful. But at this goal, it fails. This is because allowing failing companies to remain afloat by injecting into them artificial government spending-generated revenues only makes society poorer without relieving the need to liquidate and remake the structure of production. It is the people who are supposed to consume and in so doing steer production not the state. With respect to (γ), with hoarding, workers and other factor owners are forced to face a more grim reality. But if they are smart and flexible enough to adapt to the post-boom environment, then there need not be more unemployed factors than under a less severe depression; the factors will have to endure lessened income, but there is no reason why the number of those not working at all should necessarily increase. Skidelsky has Keynes believing that “capitalism suffered… from a surfeit of fear.” (2010: 113-4) This, perhaps, is one out of two major planks of the Keynes’ “general theory.” Fear due to uncertainty

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of the future lessens aggregate demand, causes people to treasure money as a store of value, and the economy tanks as a result. As we have seen, however, getting afraid is a consequence of the collapse of a self-destructive boom. Mass entrepreneurial losses represent economy-wide imprudence, a colossal failure to achieve happiness. The fear of the consumers and investors at this disaster is unavoidable. The public cannot just be reassured or taxed-and-spent; recovery must come naturally. I will admit that this fear may in some cases become pathological. Normally, however, hoarding in a depression is a valuable defense mechanism. It can be overdone but usually does more good than harm. It is true, also, that increased “social hoarding rate” effects a redistribution of financial wealth from those with only income who do not save to those with savings. But so does secular deflation due to economic growth (see (I, 52)). Keynesians would be inconsistent, if they condemned the former but not the latter. Moreover, the redistribution is entirely due to voluntary individual choices made within the market; so, it would be unscientific for a Keynesian to question those choices. 11. THAT KEYNESIANS CANNOT GET EVEN TOY ECONOMIES RIGHT OR KRUGMAN GOES STALINIST Paul Krugman (2009) thinks that he has to come up with “fresh insights,” for which task he needs to be “whimsical.” (7) I have nothing against whimsicality per se. But Krugman is horribly wrong in holding that, to be relevant, he, like an entertainer, must keep coming up with something “fresh” every day. The point of doing science is not to woo the masses during one’s fifteen minutes of fame with dazzling displays of sophistical cleverness and “fresh” insights but to produce true insights, whether they are fresh or in fact, ancient. I will not make much of it, though; it is an occupational hazard of an “economic pundit”; so, I will give Krugman all the benefit of the doubt. Our author presents a “model economy,” a baby-sitting co-op. Each member was issued in various ways a number of coupons, each of which entitled its holder to a one-hour baby-sitting session from other members. Apparently, what happened then was that co-op members began accumulating coupons, because they wanted to spend many of them in one spree. Krugman writes that “the details aren’t important: the point is that there came a time when relatively few coupons were in circulation – too few, in fact, to meet the co-op’s needs.” (17) Here then is the first problem: that the co-op “went into a recession” does not follow from the behavior of the members. For the couples with children still wanted to

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spend their money; they just wanted to spend lots of it every once in a while rather than small amounts but more often. 150 couples is a large enough number so that despite this tendency, the spending would be distributed more or less evenly, such that there would always be opportunities to baby-sit. Each person will have his own demand for and supply of money-coupons. Since the price of baby-sitting in terms of coupons is fixed, the market will sooner or later stop clearing, resulting in shortages and surpluses of baby-sitting services. But Krugman’s claim goes beyond that. Since this model is supposed to illustrate economic reality, let me pick hoarding as the cause of trouble; therefore, and second, Krugman must postulate a vicious spiral of insecurity resulting in fewer opportunities to baby-sit which caused people to treasure their coupons even more (knowing that earning new ones would be difficult) which resulted in still less spending, and so on. The supply of coupons would keep diminishing, and the demand for them, increasing, generating an ever wider distance between quantity supplied of coupons and quantity demanded. The dynamics seems plausible, but how did the cycle boot itself? Was there a bout of hoarding that just triggered the spiral? The details may not be important, but they would certainly be enlightening. There are two notable disanalogies between the model and the real economy. Third, the general rise in the hoarding of money is not in the real economy the cause of the business cycle or of its slump phase. Hoarding may accompany a recession; hoarding may even accelerate a recession, as argued in the previous chapter; but sudden and dramatic increases in risk preferences simply do not occur, at least not without a cause. Remember that risk preferences measure people’s confidence in themselves, in their capacity as entrepreneurs. Mass losses can undermine people’s self-confidence. But folks rarely turn into scaredy cats without a cause. The second disanalogy is the most crucial. Fourth and finally, hoarding effected “coupon supply” deflation. In the real economy, such a deflation usually results in price deflation which allows the deflation to work itself out without any negative consequences. (This is not because money is neutral, of course, but because voluntary deflation is usually only a mild change in the market data.) But in the case of the coop, there was no price deflation! It was written on each coupon that it was worth one hour of baby-sitting, no more, no less. Smith could not, therefore, say to Jones: “Baby-sit for me one hour for half a coupon.” Or: “Baby-sit four hours for three coupons.” The prices were rigid and could not adjust. No wonder, there was trouble. I would expect that the difficulties began very soon after the co-

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op’s creation. And I fully admit that the solution Krugman praises, one that would supposedly naturally occur to “economists,” namely, printing more coupons, “fixed” the problem. In the immediate run. The market process that would have dealt with the deflation “automatically” by increasing the purchasing power of each coupon was not allowed to work. And without flexible prices, the officers of the co-op, the would-be socialist central planners, were then stuck with fine-tuning the coupon supply so as to keep the little economy functioning. I am not optimistic about how good a job they did at it; the outrageous unfairness of giving coupons to some and not others would by itself be enough to do the coop in. Therefore, if the “neoclassical synthesis” has it that recessions are due to sticky wages and prices, then it is entirely trivial. Rigid prices are usually not market phenomena; and moreover, it does not take a Keynesian to figure out that they can be economically vicious. Krugman may, of course, interject that this toy economy is not realistic. Apparently, for our author, it is OK to play with toy economies, only when they yield Keynesism-friendly results. In the process of illustrating the phenomenon of liquidity trap, Krugman postulates a seasonal pattern to the supply of and demand for baby-sitting. In winter, few people want to go out but lots would babysit; in the summer, the opposite situation prevails: high demand for going out occurs concurrently with low supply of baby-sitters. Krugman proposes that the co-op create a “central bank” which would charge low interest rates in the winter and high interest rates in the summer. It would create money when lending and destroy money, when it is repaid. Krugman is mistaken in holding that it is “monetary policy” that would be required in the co-op. For in winter, I have already accumulated a coupon balance, which I am waiting to spend in the summer. Why would I borrow additional money in the winter, even at low interest, when my hoard is already large, and if I have to repay the money in the summer when I need it the most? There is no analogy to the real economy here in which credit expansion is supposed to boost production by deceiving the entrepreneurs about people’s time preferences. There is already lending and borrowing with voluntary savings, and the Central Bank wants to stimulate this activity. Producing baby-sitting involves no lengthening of the production structure; it uses no factors of production at all except the bodies of the baby-sitters; and no one borrows coupons in order to finance his baby-sitting operation. Incidentally, this policy would soon result in coupon supply deflation, because the amount of money destroyed would exceed the

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amount created, because the money is repaid to the central bank with interest. On the contrary, the only way to keep the co-op working in the face of rigid prices is “fiscal policy.” In the winter, the management taxes the hoards and spends the coupons on fake baby-sitting, providing unproductive worthless “jobs.” In the summer, the management taxes the coupons that would otherwise be spent and hoards this money itself in order to dampen the demand for going out. Of course, the “fiscal policy” can never even approach the efficiency of flexible prices, but it is the only thing that can save the co-op the way it is set up from falling apart. Krugman’s suggestion, moreover, has no analogy to the liquidity trap in the real economy. Our author goes on: “one thing that can get an economy out of a liquidity trap is expected inflation, which discourages people from hoarding money.” (75) Now it is understandable that if deflation is expected, then people may hold on to money in order to take advantage of lower prices in the future which accelerates actual deflation. Similarly, expected inflation causes prices to rise and people to buy now so as to avoid paying more later which this time accelerates actual inflation. But in fact, people start getting rid of savings for real only in the last phase of hyperinflation, in which there may occur a “flight to real values.” Spending is also stimulated by inflation directly, simply because at least a part of the new money created will be allocated by the consumers or entrepreneurs toward spending. However, I do not understand how inflation, which in the modern world is usually started by means of the Central Bank’s open market purchases and credit expansion, can be set off when the interest rates are already close to zero, as they were in Japan in the 1990s. The only possibility is for the Bank to buy government bonds; but in this case this “monetary policy” is almost entirely equivalent to taxing and spending, i.e., straightforward fiscal policy. It is just that in the second direct case, money is transferred from the citizens to the state by means of non-inflationary “theft”; while in the first indirect case, it is transferred by means of inflationary “fraud.” Krugman considers a global fiat currency, the “globo,” manipulated by a world Central Bank. Seemingly an attractive to the Keynesians scheme, he finds it flawed in that when one part of the world “needs” an easy-money policy, another part may need tighter money. Hence, “although careful management of the globo could prevent a boom-bust cycle for the world as a whole, it could not do so for each piece of the whole.” (103) Very well, so, why not consider another extreme: each town issues its own fiat paper money. Surely, that would be

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utter chaos. So, a middle ground needs to be struck by having each nation manage its own currency. It is arbitrary, but it is the best we can do. The odd thing is that Krugman considers “the closest thing” to a globo to be “the pre-1930s gold standard.” Let me abbreviate the non-inflationary international gold and silver standard as IGSS. Is IGSS really identical to the globo? Krugman goes on: There are three things that macroeconomic managers want for their economies. [1] They want discretion in monetary policy so that they can fight recessions and curb inflation. [2] They want stable exchange rates so that businesses are not faced with too much uncertainty. And [3] they want to leave international business free – in particular, to allow people to exchange money however they like – in order to get out of the private sector’s way. What the story of globo and its demise tells us is that countries cannot get all three wishes; at most, they can get two. (2009: 106) It could no doubt be pointed out that IGSS would deprive national governments from access to monetary policy. An obvious rejoinder is that recessions are an inevitable result of inflationary booms. The “macroeconomic managers” themselves start the inflation and credit expansion which then ineluctably produce recessions. The business cycle is a Keynesian-interventionist atavism. Thus, [1] is entirely unnecessary under IGSS. The market process could, of course, easily injure a particular town or industry while benefiting the world’s consumers. But there is no escaping that, if any kind of economic progress is to be had. That it could injure an entire nation is much less plausible. Because national currencies, if they still existed, would be merely references to weights of gold or silver, e.g., $100 would mean 1 ounce of gold, and 100€ would mean 1.5 ounces, [2] would be enforced automatically and perfectly. And [3] would be a trivial matter and moreover, would check domestic inflationism. If, in addition, national currencies were abolished, and banks, though being required to maintain 100% reserves for all demand deposits, could issue their own notes, then this would make things even easier, insofar as no government would be able to print money even in the presence of IGSS, thereby causing inflation in its original sense, namely, an increase in the amount of paper receipts that are not backed by commodity money, and with that, all manner of international strife.

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If we call the version of IGSS marked by no national currencies (i.e., by private coinage), no central banking, and 100% reserve requirements “Pure Gold” or PG, then, whereas prevention of inflation by governments under IGSS would be a political matter and therefore, highly inefficient, enforcement of PG would be merely a legal imperative and just another part of any government’s mission to protect people from aggression and fraud. It appears that IGSS is superior to the globo in every respect. Note also that the conclusion that any community may “need” an easy-money policy is based on the false premise that an economy under laissez-faire money underperforms, and that this unfortunate condition can be cured by credit expansion. As a matter of fact, free economies perform or grow at the precise rate that is most agreeable to the consumers. Now what about the fact that the US and the European Union have one-size-fits-all monetary policies? Krugman argues that for such a feat to work, there needs to be high labor mobility either as a necessary or sufficient condition (I am not sure which), such that “workers can and do move rapidly from depressed to booming regions.” (2009: 106) I disagree that imperfect labor mobility can break IGSS. This is because “depressed” and “booming” regions will not be occurring like clockwork according to the business cycle theory defended in this book. Further to understand the difference between the two kinds of gold standard, let me consider Krugman’s tale of the 1998 speculative attack by a number of hedge funds on the Hong Kong currency. Hong Kong, though first in the indexes of economic freedom, was still suffering from the recession that afflicted its Asian neighbors at the time. The Hong Kong government maintained a fixed exchange rate of 7.8 HK dollars per 1 US dollar. What happened was that the hedge funds shorted $30 billion worth of Hong Kong stocks, which means that they borrowed the stocks, sold them for HK dollars, and traded this money for US dollars. “In effect,” Krugman explains, “they were betting that one of two things would happen. Either the Hong Kong dollar would be devalued, so that they would make money on their currency speculation; or the Hong Kong Monetary Authority would defend its currency by raising interest rates, which would drive down the local stock market, and they would make money off their stock market short position.” (129) The US dollars were being drained from the Central Bank’s reserves; the defense of the currency would consist in reining in the supply of the HK dollars, as well. This would bring about deflation, as credit normally pyramided on top of the reserves by commercial banks was contracted, and aggravate an already severe recession.

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But if the Bank inflated the supply of HK dollars in response by buying assets and lowering interest rates, then the HK dollar would become overvalued. People would rush to exchange HK dollars for US dollars, and quickly enough, they would find no private entity willing to sell them a US dollar for exactly 7.8 HK dollars. So, they would turn to the Central Bank. But that would cause a still greater outflow of US dollar reserves from Hong Kong. Eventually, just as private persons would not want to sell $1 US for $7.8 HK, the Bank, having run of out the reserves, would not be able to sell at the same rate, and with that, the peg, i.e., the fixed exchange rate, would collapse, necessarily causing a devaluation. By trading their US dollars back for HK dollars, the hedge funds would benefit from the inflation by obtaining the new money first. It is clear from this story that even IGSS would not be bulletproof. For full laissez-faire protection against such an attack, we need PG. Krugman defines something he calls the “shadow banking system.” By that, he refers to bank-like institutions which, like investment banks, channeled capital to various projects but were unregulated and offered higher interest rates than regular banks.7 For example, he describes an arrangement known as an auction-rate security. “Individuals would lend money to the borrowing institution on a long-term basis; legally, the money might be tied up for thirty years. At frequent intervals, however, often once a week, the institution would hold a small auction in which potential new investors would bid for the right to replace investors who wanted to get out.” (158-9) Seemingly, this parallels the devilish enticement of regular banks which confused deposit and loan banking: a person would both receive interest and be able to get his money at any time on demand. However, the likeness is deceiving. For (1) the shadow banks were not fractional-reserve; (2) they were unconnected with the Fed, the FDIC, and the rest; and the investors were fully aware: (3) that the money they had put in did not legally belong to them; and (4) that they could get their money back only if other people were willing to buy them out. 7

I do not mean to imply that “unregulated” means “shady.” On the contrary, unregulated means free-market which in turn means socially virtuous. Regulation of business by government aims, due to the nature of the regulatory process, to protect not the consumers but rather the profits of the dominant firms in the regulated industry precisely to the detriment of general welfare.

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The shadow banks were legally clean and economically non-threatening. The banks which to Krugman appear sinister were in fact contractually honest free-market arrangements that could never on their own power create a business cycle. Far from it; they were a testament to the market’s ability to function and compete even under the worst possible political regimes, in this case, the regime that sanctioned and protected the privileged and insidious government-banking complex. Thus, the inherent instability of fractional-reserve banking coupled with “the rise of financial globalization, with investors in each country holding large stakes in other countries” (177) ensure that economic crises will come with disheartening predictability and that this time, they will be global in scope. Krugman seems to prefer fiscal policy to monetary policy, at least in the present crisis. He will take government activism over that of the Federal Reserve. And, as befits a bright person who is also a fanatic, he takes his ideas – which are monstrous – to their logical conclusions. Thus, during a crisis, he proposes to (1) nationalize the financial industry (“temporarily”); (2) have the Federal Reserve buy up the assets of private corporations (and not just government bonds), nationalizing everything else in America; and (3) pour money into “developing countries,” acquiring finally the rest of the world. (186-7) And after this, he dares to accuse his potential opponents of “getting tied up in ideological knots”! (186) Surely, Mr. Krugman would not object to a reform as modest and pragmatic as outlawing fractionalreserve banking, monetizing gold and silver, and ending the Fed. Or is he a mad enough Keynesian to communize the world instead? 12. THAT THE MONETARY AND FISCAL POLICIES ARE AT WAR WITH THEMSELVES

The figurative meaning of an economy “being saved” is that the prices of many goods, including human capital, that seemed valuable during the boom but now, in a recession, appear useless must be driven downward sufficiently in order to give to those goods a chance to be redeployed. As that is happening, and given the greater purchasing power of savings, it is as if entrepreneurs suddenly have more resources at their disposal. In this, there is an analogy between barter and money economy saving. Prices change both absolutely and relatively. At this point, Keynesians would no doubt interject that the longrun effect of this greater capacity of savings due to these adjustments of prices can be duplicated quickly by inflation. The transaction that

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creates the inflation is interesting in that a government’s borrowing from the Central Bank and spending the money is part of the government’s fiscal policy, while the Central Bank’s lending the government the money is part of the Bank’s monetary policy. (The difference is that the fiscal policy is conducted by issuing new bonds; while the monetary policy can be accomplished by buying bonds that investors already own. Of course, the state can prosecute both policies in other ways that need not interlock.) Government deficit spending lowers the demand for money, while the Central Bank’s activities raise the supply of money. Both lead to price inflation. Alternatively, money can, indeed, be dropped from a helicopter which will come to the same thing. The Keynesians claim that instead of the price level falling with the money supply remaining the same, we are better off with the price level remaining (roughly) the same with the money supply rising. They thus charge that the Austrians neglect the painful short-term effects of price deflation. I, in my turn, however, can counter by arguing that the Keynesians neglect the long-term effects of such an inflation that will nullify their efforts. Both the absolute and the relative adjustments are needed in a recession, but neither of the two can be simulated by money supply inflation. The former, because inflation is unpredictable, and it is not generally true that those who get the newly created money first are precisely those who would voluntarily hoard it. The state of the economy with a higher money supply and higher price level would always be different from the state of the economy with a stable money supply and lower prices. In other words, wrong people get the money. Hoarding, just like saving and investing, is a highly personal decision. The government papers over an important problem, namely, people’s increased risk preferences, which is why it can succeed at generating economic activity in the short run but not in the long run, when the real cash balance effect (which builds upon the idea that in the long run any money supply will perform as well as any other) has worked its way out. At some point, each moment will be the long run of some prior decision to inflate and will, in addition, be a locus of an inflationary depression. As mentioned in (II, 10), hoarders will tend to be particularly careful into whom to invest, and their newfound conscientiousness is precisely the social purpose of our subjective factor of the recession cure. The Central Bank, on other hand, sends its money onto both the bad and good entrepreneurs alike. Normally, Keynesians assert, there is a trade-off between unemployment and inflation. In the short run, inflation tends to accelerate

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trade, increase profits, and cause more people and resources to be hired. At full employment, inflation no longer serves any purpose, because then it only results in higher prices. Inflationary depression or stagflation, however, is a phenomenon that is poorly accounted for by the Keynesian school. Recall that the Keynesians insist that the everyday economy, to which we are used, is performing poorly. The Keynesians are right about that, but their reason, namely, high interest rates, is misplaced. Economic stagnation is due to government interventionism into the economy that has resulted in what we know as the welfare, imperial, regulatory, and tax-eating state. Imagine the prosperity we could have had right now, had the market been fully enabled even as late as, say, 1970s. We could atone for our failure by implementing some of the following most important libertarian economic reforms on the federal level. 1. Abolish the standing army, and navy, and air force, and standing everything else. 2. Privatize money-creation by making it Pure Gold (see (II, 11)). 3. End all payroll taxes and eliminate Social Security and Medicare. 4. Legalize all drugs and end all medical monopolies on prescribing any and all controlled substances. 5. Take away all regulatory powers away from the federal government other than to enforce free trade among the states, as suggested in (Introduction, 2). 6. Privatize its judicial branch altogether. American founding fathers made a grievous error in their design of the federal government by making judges employees of this government. In fact, the judiciary should be not merely independent of the other two branches of the state on whatever level but entirely private. Aside from obvious efficiency gains from market competition and discipline, it is only this way that a citizen will be able to count on fair consideration when he sues a government. Do these, and the standard of living of Americans will skyrocket, and society will immediately become happier and more virtuous and will grow in these goods faster than ever before. I could ask my reader, if he enjoys his car, then how would he like it if it were twice as sophisticated and half as expensive? He could be delighting in this fact now. The world works in such a way that our labor succeeds at making us happier, and divided cooperative labor, at building civilizations. Keynesians rob

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us of our birthright, i.e., of our ability to accomplish goals with the maximum efficiency that human nature permits. All these economic perversions have one thing in common: they transfer consumer sovereignty from the individuals to the state. They recruit resources to serve the government and not the people and divert the conduct of businessmen away from satisfying consumer wants in the best possible manner. The fiscal policy is one manifestation of this ugly development. Again, Keynesians think that an economy that is not booming is an insult to central planners. Monetary policy lowers the interest rates, produces inflation, and stimulates business activity. But a bust comes reliably. At this point, the fiscal policy is launched which prolongs the recession but appears falsely to moderate it. Fiscal policy, i.e., taxing or borrowing and spending, is a crucial part or “tool” of the interventionist program. In particular, if fiscal policy replaces private consumption, then it is pointless and evil for destroying consumer sovereignty; if it replaces investment, then it is at war with monetary policy; and if it replaces hoarding, then it is harms recovery by keeping prices high. In short, (1) primary interventionism, sustained by permanent taxes, regulations, trade barriers, etc. on the side of production or wealth creation; and by labor unionism, minimum wage laws, and so forth on the side of employment or job creation, seems to move the mind toward stimulating the economy with (2) monetary policy. This is yet another instance in which interventionism is shown to be unstable and tending toward complete collapse. One bad intervention seems to require another one to fix it. When the fix makes things worse, new equally futile interventions are attempted. The inevitable bust and impoverishment that result drive the mighty intellects of government officials toward the secondary interventionism of (3) the fiscal policy. The reason why some economic progress still occurs is the “inefficiency of the law-givers and the laxity, carelessness, and corruption of many of the functionaries. … While governments, political parties, and labor unions are sabotaging all business operations, the spirit of enterprise still succeeds in increasing the quantity and improving the quality of products and in rendering them more easily accessible to the consumers.” (Mises 1996: 859) The only group of people benefiting from this state of affairs consists of those individuals who have a competitive advantage in violence and deception. Instead of becoming criminals and con artists, they are redirected into government work, where they plunder society legally. Depressions must be cured with shock therapy of tight money and hoarding. Inflating on the heels of a recession will either prolong

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the boom for a bit longer, only to worsen the recession that will not be staved off for long; or prevent recovery, keeping resources misallocated longer. Ultimately, continuous inflation will cause people to become inured to it and take it into account in negotiating all prices, including prices of factors of production such as labor. Inflation then, if it is to have any macroeconomic effect, will have to be ratcheted up. Inflating in a recession will only keep society in the slump part of the cycle longer and reduce the people’s standard of living more. The stagflation of the 1970 can now be explained as being due to a conjunction of (a) runaway monetary policy and (b) both primary and secondary interventionism creating unemployment, checking economic growth, and even resulting in degeneration of living standards. Interventionism in general and the fiscal policy in particular were preventing recovery. It is even possible that the public was not prepared to part with its money, still desiring more financial security. At most, only the government was spending, sustaining in a socialistic manner some kind of economic activity, since the government and not the consumers was at the helm deciding what got produced. There was still hoarding by the general public, whose risk preferences were high. In response, the Federal Reserve kept inflating, hoping to reverse that trend. In the end, it inflated too much and got society to expect more inflation, raising interest rates. (a) fought with (b) and lost. Prices rose, too, as a consequence of old inflationary policies, but there was no recovery: high inflation coincided with stagnation. Mises’ conception of the “harvest of interventionism” had to do with taxation. It would arrive when soaking the rich will no longer be possible, and all tax increases will be borne by the middle class. The “reserve fund” of society will be exhausted. It is quite possible that in the 1970, the interventionists were reaping what they sowed. It is true that other explanations have been offered for the stagflation of the 1970s, but the problem common to all of them is that they postulate a coincidence of two unrelated causes, one of which produced inflation, and the other, stagnation. If it were not for the second cause which entirely by accident coincided with high money supply inflation, there would have been a recovery. The virtue of my explanation is that it shows how government attempts to “revive” the economy can backfire. Price inflation results, because the Fed’s printing money outstrips voluntary hoarding; and stagnation results from the transfer of sovereignty from the consumers to the government in many various ways. Finally, fiscal stimuli are exercises in futility, if government spending is not multiplied, i.e., so long as consumers remain fearful. At this point, a Keynesian might ask with innocent unbelief:

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“Would it be better, if the government gave money to those people who would just hoard it?” The answer is not exactly, since such an implausible policy would duplicate the utility of hoarding for individuals while failing to trigger its concomitant social purpose, namely, to reboot private investing into a far more prudent and judicious mode. Hoarding imparts responsibility to entrepreneurs, responsibility that gets lost in a boom. The “Third Way” ideology and fiscal policy (and not high interest rates) are paradigmatic causes of weak economy; and monetary policy (and not low confidence rates) is responsible for business cycles. Once again, hoarding during a depression has a social purpose. The business cycle is not a flaw inherent in the market economy; it is created as a result of (1) fiat currency, (2) fractional-reserve and therefore, fraudulent banking (for which more fault must be attributed to the government for not enforcing honest banking business practices), (3) the Central Bank’s underhanded monetary policies, i.e., credit expansion, and (4) the government’s destructive fiscal policies. The reasons why relative price adjustments cannot be simulated by inflation are outlined in (I, 58-59). The point is that the demand for money as a store of value must be satisfied, as any other individual market preference: the more is hoarded, the deeper the depression will be, yet the faster it will pass. But the latter is far more important than the former: we want the economy to start working sustainably and use as many resources as possible as soon as possible. Wages and prices must come down fast and low so as to dispel all the delusions of the boom and bring the fresh air of clear vision of what every resource is truly worth and finally recovery. 13. THAT STAGFLATION MAY BE OUR INTERVENTIONIST BEST AND THAT THE PRESENT STATE OF THE BANKING INDUSTRY IS HARDLY FREE MARKET Hyman Minsky (1982), a noted Post Keynesian, focuses upon deficits, because he claims that they, along with an aggressive monetary policy, have so far prevented the repetition of the Great Depression. They have done so by sustaining high profits for businesses, even though “the government deficits do not result from spending that leads to useful output.” Presumably, the point of deficits is, as I explained above, to counteract private hoarding. However, Minsky says, though deficits and inflation can prevent a depression, they have unpleasant side effects. Especially important is that they are cumulative, such that sufficiently

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large deficits lead to stagnation, and sufficiently activist monetary policy leads to inflation. Put together, they inaugurate a noxious environment of stagflation. Stagflation, in Minsky’s opinion, “is the price we pay for the success we have had in avoiding a great or serious depression.” (14-57) This explanation has similarities to the one I offer in the previous chapter, though I would say that stagflation is the price we pay for the fatal conceit of dreaming that we can manage the economy “scientifically.” I would also subsume deficit spending into the interventionist octopus as a whole. Economists have been drunk with power for almost a century, but they are not the great wizards controlling cosmic energies they imagine themselves to be; at most, they are wizards of Oz. Stated differently, Minsky argues that we are caught between a rock and a hard place. The rock is the fact that “financial traumas… occur as a normal functioning result of a capitalist economy. …there are inherent and inescapable flaws in capitalism,” namely, the capitalism’s tendency toward deep depressions. (111-2) The hard place is the toxicity of the alleged remedies for those flaws. Minsky got it half right. As Mises discovered, and as I point out in (I, 65), it is often the case that government interventions are unstable: they generate a case for further interventions. Thus, the laissez-faire that Minsky condemns as unstable is not laissez-faire at all; it is hamstrung by (1) legal privileges to the banking industry, legal tender laws, deposit insurance on the government side, (2) lending of not-so-last resort on the central banking side, (3) ideology of inflationism (namely, the false belief that credit expansion by commercial banks can generate wonderful prosperity for all) on the side of the masses, and all the rest. It is these factors that are responsible for business cycles, and since the public demands that something be done about them, the government is faced with a dilemma: should it go “back to the future” to hard money, competitive minting, and 100%-reserve standard for deposit banking, or should it “manage” the already crippled economy so as to attempt to prevent another Great Depression? It is not really a dilemma, because the state is unlikely to relinquish control over money creation without intense public pressure, which is why we indeed regress into stagflation as a substitute illness for depression. Minsky’s own theory of the business cycle is somewhat similar to the one set out in this book. For example, he realizes that a high level of business activity (which he divides into hedge, speculative, and Ponzi, each in this series riskier than the previous one) makes the economy “increasingly sensitive to interest rate variations.” (1982: 106) If only he had realized why so many would-be entrepreneurs appear out of

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nowhere during a boom: it is because credit expansion makes a great number of new investments including into longer (and more speculative and risky all the way to Ponzi) projects falsely appear to be profitable. As it is, he holds a paradoxical view that “stability – or tranquility – in a world with a cyclical past and capitalist financial institutions is destabilizing.” (1982: 101) So far as I can tell, it is human nature, Minsky thinks, to rebel against stability as such and take greater and greater risks until men’s projects crash and burn, at which point people, having learned their lesson, will want stability again. This sort of dubious psychological analysis, however, does not satisfy the mind. Minsky’s (1982) first premise for interventionism is, again, that laissez-faire is fundamentally unstable and tends on its own toward nasty business cycles. Eliminating the cycles is the job of that arch-rational supercomputer that sees all and knows all, even what Minsky himself acknowledges as our “very sophisticated and convoluted financial system,” (199) the Federal Reserve. In the process of operation, however, the Fed creates inflation, because this is the only way of smoothing out the business cycle. Thus, our supercomputer must be wise and strike a correct balance between the amount of inflation and the depth of the recession that it allows. The Fed’s goal is noninflationary growth. Minsky’s second premise is that the Fed ought to provide money (or rather present goods) through the mediation of banks to various enterprises as a lender of last resort. Here the Fed’s goal is financial stability, such that companies deemed “too big to fail” do not experience collapse. Both premises are false. First, the growth that the Fed promotes is not at all the slightly-deflationary secular growth described in (I, 52) but rather the boom part of the business cycle. But though the economy is booming at t1, it will sooner or later (at some t2) experience a bust. At this point, the Fed is in a dilemma: it can try to reflate, continuing the boom for a little longer which will make the bust worse and accelerate the rate of inflation, or it can raise interest rates, triggering a recession. The dilemma is entirely self-caused. But let us forget for the sake of argument that the Fed started the boom: remember that for Keynes, booms or “quasi-booms” have no disadvantages inherent in them. Can it successfully steer the economy toward a soft landing? It is possible but unlikely. For the Fed centrally, though indirectly and with a time lag, plans a key variable, namely, the interest rate, whose value, sans the ideology of inflationism, would be set by the market.8 But central planning does not work. Hence, the best 8

Gordon (2009) identifies 5 types of lags, some of which apply to

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thing that the Fed could do is allow the interest rate to become equal to the natural EIR. Unfortunately, in the present situation the Fed neither knows the value of the natural EIR nor could force it (along with the correct quantity loaned / invested), even if it did know it, because any amount of credit expansion relative to the previous state of affairs lowers the interest rate below the natural level, and credit contraction can raise it above this level. This means that the Fed would have to freeze all its money-creating activities, and 100%-reserve banking would have to be enforced. But these are political issues not economic ones. The Fed then is stuck trying to minimize the combined misery from a recession / unemployment and inflation. Even if the socialist calculation problem for the Fed could be surmounted in theory, the purely practical problems would still trouble it. It could work by trial-and-error, changing the money supply fairly rapidly and seeing what would happen. But the position of the Fed is vastly different from the position of a shopkeeper who can vary his prices every day in order to unload his inventories. The Central Bank cannot change the variables it controls often, as a store owner can change the price of a box of raspberries. Moreover, it must predict the state of the entire economy in all its complexity precisely at the time, after the numerous lags have elapsed, when its policy will finally be having an effect. And this it can hardly do. As any quasi-socialist institution, the Fed is irrational in more ways than one. The second premise, as I understand it, is based upon the following picture. Let X owe money to Y, Y owe money to Z, Z owe money to W, etc. If X were to default on its debt and declare bankruptcy, then Y would have no income with which to pay Z; so, Y would collapse as well; and Z would collapse soon after for a similar reason. The downfall of one company results in a cascade of losses and an economic disaster for a nation or the world. What truth there is to such a possibility stems fiscal policy alone; some, to monetary policy alone; and others, to both. These are 1. the data lag or the time it takes for the policymakers to find out what’s going on; 2. the recognition lag or the time it takes for a change in data to prove significant; 3. the legislative lag or the delay that the Congress or the Fed create while making a decision; 4. the transmission lag or “the time interval between the policy decision and the subsequent change in policy instruments”; and 5. the effectiveness lag or how soon the target variables respond to changes in policy instruments. (458)

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from the fragility of the banking industry due, again, to its unsafe fractional-reserve intercourse with (or rape of?) the people and the incentives that generate moral hazards to banks as described in (I, 65). Banks are not free-market institutions, which means that laissez-faire can once again be absolved of the guilt for depressions. At any rate, a cascade of losses cannot normally occur, because numerous simultaneous losses are needed to trigger such a chain reaction. Most people and institutions will survive, even if some of their debtors refuse to pay. It is only when there are true mass losses, a phenomenon fully accounted for by the Austrian business cycle theories (see (I, 61-65; 69)), when general insolvency of even financial powerhouses becomes possible. However, those powerhouses bring their doom entirely upon themselves: they prayed to the state for fractionalreserve banking (for selfishly anti-social reasons, as the masses wanted it for ideological reasons), and they are getting exactly what they asked for. Remember that there is no honor among thieves, and the state regularly betrays those who it thinks have outlived their usefulness. It is interesting to uncover the metaphysical presuppositions of various economists. Anyone who desires to analyze some system must determine (1) whether the system is natural or artificial and (2) whether it is self-sufficient or dependent on something outside of it. “Natural” here means having originated in the past without a direct intervention of an intelligent agent; “self-sufficient” means that it depends on nothing for its present operation. For example, a car is both artificial, being a man-made object, and dependent on a driver to operate properly. A cell as a species is artificial, having apparently been in some part intelligently designed, but self-sufficient, able to survive and function on its own. However, a subsystem within a cell responsible for that cell’s resistance to antibiotics is both natural and self-sufficient. Again, a human being has grown from a single cell into an adult naturally, but he is dependent upon God for the mysteries of grace. Most nature is self-sufficient in the sense that God does not occupy His eternity protecting the creation from an inevitable collapse. God does not push particles of matter around nor drags things through the vacuum nor keeps the earth from falling into the sun nor brings the economy into equilibrium. Nature knows how to take care of itself. God does no violence to nature, such as when nature wants to do X, but God intervenes and forces it to do Y instead, other than, perhaps, through explicit miracles. Where nature is not sufficient, grace abounds; but the difference between grace and miracles is that the latter are coercive, while the former is not. Intelligent design for complex and specified physical objects “creates information” such that, wherein nature would

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“choose” randomly, the designer chooses, that is, constrains vague possibilities into something definite, intelligently in order to reach a goal. With respect to the economy, then, one can first deny that it is a natural system at all, as Marx did. For Marx, the free society is in fact profoundly perverse, with the state protecting the capitalists’ property rights in the means of production to the detriment of the vast majority of people. Laissez-faire, instead of being a natural system of liberty, is an artificial and self-“negating” clunker that is bound to fall apart because of its inner contradictions. Of course, a capitalist economy is an outcome of numerous purposive and intelligent human actions. But the economy as a whole is not designed by any overarching intellect, though its manner of operation can be understood by the human intellect, and the economy can be freed from government control by an explicit society-designing ideology such as libertarianism (or, on the contrary, entangled into such control by a statist ideology). As I hinted in (Introduction, 2), social evolution and social intelligent design complement each other. Economists are fundamentally lawgivers. Alternatively, one can accept that free market is consistent with nature (i.e., that it was not imposed on people by force or guile but arose by serving the self-interest of the immense majority and continues to do so) but deny that it is self-sufficient, as Keynes has done, asserting that it needs constant government intervention in order to hobble along somehow. Finally, one can think of the free economy, as the Austrian school economists have thought of it, as both natural and self-sufficient, not “so defective that reiterated… intervention is needed to prevent its failure.” (Mises 1996: 147) It almost seems that Minsky has despaired of the possibility of social cooperation under the system of natural liberty. Now St. Thomas’ opinion was that human nature was wounded by the possibility and ease of sin. However, a man can, with constant struggle both to maintain innocence and to grow wise, master himself, and achieve imperfect happiness in this life. I submit that our political life, too, is wounded deeply (1) by the pitifully weak federal state that – instead of doing the only task it can in actual fact perform, namely, enforce free trade – mad with destructive power, constantly shoots the economy in the foot; (2) by the corrupt pressure groups seeking private advantage at the cost of general welfare; and (3) by ideological nonsense like inflationism and tax-and-spendism. But I hold that if we struggle manfully, then we can create a peaceful and incredibly prosperous commonwealth that would span the entire globe and then maybe even beyond! The sky for us is the limit.

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Mises argues that “the tremendous progress of technological methods of production and the resulting increase in wealth and welfare were feasible only through the pursuit of those liberal policies which were the practical application of the teachings of economics.” (1996: 8) As the joke goes that humans use only 10% of their brains, so perhaps only 10% of what is firmly established in economics is used in policymaking. My own strategy for the liberation of society from state oppression can be summarized as “morals for the masses; economics for the elites.” If only we were schooled in economics and committed to the common good, half the job would be done, and we would be ready to fill the earth and subdue it, as befits creatures as great and fearfully and wonderfully made as us men. Whenever I visit Yahoo!, say, I am most interested in reading the technology section. This is because fascinating and wondrous new things keep being invented, and it is sheer fun to observe the latest tools and gadgets that make life interesting. Human ingenuity really knows no bounds. Click on the “Politics” link, on the other hand, and prepare to be depressed. Is there any good news there? Is our system of government getting better? Are more efficient policies being implemented? Perish the thought! It is the same old boring “business as usual.” Is it not a pleasure to observe things improve? Adam Smith argues as follows: “It is in the progressive state, while society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the laboring poor, of the great body of people, seems to be happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is really the cheerful and hearty state of all the different orders of society. The stationary is dull; the declining melancholy.” (Wealth of Nations, I, 8; quoted in Hayek 1960: 42) Consider that below the poverty line, people actually suffer and feel pain from material deprivation. Above, their “uneasiness” takes the form of boredom. Both feel temporary joy when their desires are satisfied. Hence, a rich person is not necessarily happier than a less rich person, because in the absence of pain, both experience a finite set of desires that occupy their energies; yet as soon as one desire is quenched, another takes its place. The pleasure of an old want fulfilled is soon forgotten. Hence, the condition for a steady supply of happy feelings is constant struggle for new heights, regardless of one’s income level. The most offensive part of politics to me is hearing the “conservatives” gush over how “our” government is better than the government of every other nation. To illustrate the absurdity, consider the standard positive

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externalities argument in favor of public schooling. Apparently, children who are educated will be ready for self-government. They will make wise decisions regarding public affairs, thereby benefiting everyone around them. For example, having been inculcated with the value of democracy, they will tend to support democratic governments. Suppose that this is true. Suppose, moreover, for the sake of argument that democracy is actually superior to, say, monarchy. Are these sufficient to approve of at least this aspect of public schooling? Well, you see, the most obvious reality of human life is improvement. Throughout their entire lives, people seek to improve their well-being and themselves. New things are invented and built all the time. These include political theories and systems. How do we know that there is nothing superior to democracy? We have not seen the “end of history” (our descendants will mock us and Francis Fukuyama in particular for this presumption). Life goes on and with it, growth in understanding. If the children are told that democracy is “good” without learning the skills to think for themselves, then they will never invent or discover an improvement to democracy, if such exists. We are supposed to transmit to the new generation those abilities that will allow them to build a world that is better than the world we are living in. There is very little general authoritative knowledge that needs to be imparted. The three “R”s encapsulate those, and it takes only about 100 hours of formal schooling for children to pick up on them adequately. Surely, private and home schools are able to do those things. Whether democracy is the best of the best or an improvement is possible is for children to figure out for themselves. It is good to expose the pupils in the United States to the Constitution. It would be even better to enable them to judge for themselves which aspects of the Constitution are sensible and which may need to be tweaked or reformed, radically, if necessary. In short, the key property of a successful society is the ability of its members to think critically. And public schools impart only mindless automatisms. If schooling is provided by the state, then we will never know which wonderful things those geniuses, whose spirits were crushed in state schools but who would have flourished in private schools, would have made for all of us to enjoy. For instance, some people complain that government schools fail to teach people useful skills. This is quite so but beside the point. For it is not at all a purpose of public schools to instruct children but to “socialize” them which is a euphemism for teaching them obedience to the regime in power, never to rock the boat. The goal of schools is to substitute for prisons. Thus, both are compulsory, and not because it is

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either true or generally accepted that parents will neglect their children, if not coerced into outsourcing their own function. Schools are state correctional facilities for the young. The children are “corrected” not after making genuine mistakes but for having the temerity to exhibit uniquely gifted personalities. Instruction in reading and arithmetic and so forth is an entertainment activity, like watching TV or working out for prison inmates, resorted to in order not to drive the brighter children totally nuts. I am not saying that this ideology is always explicitly held. There is a tension between the sober understanding of public schools as a dumbing-down institution and the parents’ occasional interest in growing and developing their children. The point is that these two visions conflict. Hence, the schizophrenic thinking, in which we accuse public schools of failing while at the same time sanctioning their intended purpose of imparting conditioned reflexes into students that are useful to the state. Proponents of compulsory government schooling do not deny any of this. They essentially postulate a 3-tier educational system: universities train scholars, trade schools teach practical skills, and K-12 education prepares students for “citizenship.” However, if it is the duty of every citizen to strive for the betterment of his community, country, and the world, then primary and secondary government education, consisting mostly of indoctrination of politically correct fallacies, fails at this task, as well. We realize that private and home schools are superior to public schools in teasing out moral and intellectual development in children. But at the same time, we grasp that public schools are better at brainwashing the kids and at rooting out creativity in them in order to make them tractable and submissive to the ruling elite. We cannot really have both and need to choose which end we should strive for. At the very least, then, I sincerely hope that the next generation will not grow up to be conservatives who have never seen a new idea they liked. Minsky concludes that few people understand American capitalism. He would have done well to realize that the American banking industry was not capitalist at all, and that his own understanding of capitalism was weak. 14. THAT NAÏVE UNDERCONSUMPTIONISM IS NONSENSE

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All underconsumptionist theories of the business cycle claim in one way or another that the goods being produced cannot all be sold at a profit. Different reasons are given for this unfortunate situation. These theories try to build on the facts that goods are often sold below cost during a bust, and that consumption declines with hoarding. Underconsumption Theory #1. Take a look again at Figure I.49.1 which represents an evenly rotating economy. It is claimed that the workers in stage 6 “cannot buy back their own product.” Well, of course, they cannot, because only $170 of the total expenses of $1,000 of the entrepreneurs operating in stage 7 is spent on the original factors of production, of which labor itself comprises only some percentage. The rest goes toward interest payments and the supplies of materials and machines obtained from the capitalists producing in the previous stage, as well as entrepreneurial profit, if any. However, since all capital is reducible to the original factors, namely, labor, space, time, nature, and natural resources, the amount of money spent by all the factors in the ERE eventually necessarily equals the total consumer expenditures. All the factor owners combined can buy back everything they have helped to produce. Underconsumption Theory #2. This theory has to do with reserves and sinking funds. I refute it in (I, 23). Underconsumption Theory #3. It is observed that payments to factors in Figure I.49.1 precede the creation of consumer goods. Therefore, the factor owners spend their income on whatever goods are available at the time, and when the new goods finally become available some time later, they have no money with which to buy them. The first thing I will point out is that money does not disappear from the economy, unless it is hoarded or destroyed (e.g., by banks, when the loans they advance are repaid). Somebody will end up with the cash with which to buy the newly made goods. In addition, production goes on day in and day out. After the very first goods made within the entire industry mature, every stage exists simultaneously with all the others, such that when the goods in stage N are ready to be sold to the next capitalists or to the consumers, so are the goods in stage N + 1. If we call the entire 7-layer structure of production in Figure I.49.1 a “round,” then it is hardly ever the case that an industry exists for a single round and then disappears. The factors, therefore, receive income continuously, and this enables them to buy goods at all times. Even with respect to the very first round of production of a particular firm, it is precisely the case that present consumption is sacrificed for the sake of investment and greater future prosperity. The whole point

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is that the capitalists do not consume that money which they invest, while the investments are being developed. Therefore, (1) capitalists, at least, choose not to consume; hence, they do not need to have any money for that purpose. And (2) the result is that both the supply of and demand for consumer goods that lie in inventories or being manufactured to replace them are lower, making it possible for all goods to be sold. More important, however, is the fact that investments are not random; they are made in anticipation of consumer demand for future goods. Entrepreneurs thus expect that the consumers will save some of their money in order to pay for the new goods when they arrive on the market. For example, if Crusoe asks Friday to fabricate him a fishing net and pays him a daily wage in gold dust, then Friday will have nothing to spend it on, until the greater amount of fish that Crusoe will be able to catch with the aid of the net will provide him with something to buy. Similarly, when factors of production are advanced present money from entrepreneur Smith’s savings, it is expected that these factors in their capacity as consumers will engage in their own saving in order to have the funds necessary to purchase Smith’s goods when they are ready. Capitalist saving by Smith, especially if Smith is a good entrepreneur and ends up profiting, will be matched by consumer saving by the people. Even in the most favorable to underconsumptionism scenario, namely, when the people are utterly surprised by the new article, nothing stops them from breaking their even rotation by shifting consumption from the old things to the Smith’s items, e.g., with the help of borrowing. It is surely not as if the people have spent their money and “don’t have any left”; even if Smith is the only entrepreneur, production continues in an ERE round the clock, and factors continue to receive income thereby. Underconsumption Theory #4. Called the “A + B theorem,” this idea describes the payments made by a firm as consisting of two groups, namely: A payments, which are all payments made to individuals, such as wages, salaries, or dividends; and B payments, which are payments made to other organizations for machinery, raw materials, interest on bank loans, and so forth. (Estey 1946: 266) Unlike A payments, B payments do not add to the income used by the consumers to buy the final goods. And yet both A and B payments enter into the price of the final goods. Hence, underconsumption.

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This argument simply fails to take note that all payments to capitalists, as we go back in time, are split up into profits (if not in the ERE) and income to the original factors. Underconsumption Theory #5. A comparatively lower social rate time preference means that people are willing to sacrifice present pleasures for a smaller increase in identical future ones. Suppose that, spurred by a high supply of savings (present goods), entrepreneurs have invested into more roundabout and more physically productive processes. At long last, a time comes when the public is able to enjoy the fruits of postponing their consumption. To everyone’s surprise, however, by the time the consumer goods have matured and are about to hit the market, time preferences fall once again, and the demand for the very consumer goods, for the sake of which past sacrifices were made, falls, as well, and the savers make it clear that still more roundabout processes ought to be started. The present goods cannot be sold but at a loss. As a result, firms reduce production or go out of business, triggering a recession. Now if the time preferences change is not foreseen, then it is true that the marginal companies, whose production processes are in operation, will suffer losses. But why assume that? J.A. Hobson argued that the “rich” tend to save a high proportion of their income than the “poor.” He was right about that, as argued in (I, 21). However, he takes this fact to mean something quite peculiar. During expansions, he claims, the rich get richer faster than the poor get richer. As a result, the overall time preference rate falls. The companies which have labored to produce the future (and now present) goods are deceived. The consumers tell them that they want to devote still more resources to investment and to increasing productivity. Again, there are mass losses and a recession. The first problem with this “theory” is that entrepreneurs need not be making such mistakes, if they are aware of the trend in time preferences and interest rates. If the reason for diminishing time preferences is known (especially if the Hobson’s theory both is true and has been popularized), then why would the entrepreneurs not take it into account in their calculations? We should generally be able to trust them to anticipate the new interest rates and the demand for their products and to produce just enough goods to satisfy the present desires of the consumers at precisely the time when the goods are ready to be sold and no more. A decisive objection, however, is the following. Being rich means reveling in lots of consumer goods. But while longer projects are being rolled out, no one is getting richer. In order for the still lower time

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preferences to arise among the wealthy, these folks must enjoy a higher amount of present goods. Some consumer goods, in fact, a greater amount than before, will be sold. So, this theory fails, as well. If the underconsumption theories have any grain of truth to them, it is that entrepreneurs make errors. They produce goods which they had hoped to sell at a profit, but now find their old plans dashed. But their losses “are not caused by a general abstention from buying on the part of the public; they are due to the fact that the public prefers to buy other goods.” (Mises 1996: 301) The existence of a normal or nonanomalous rate of entrepreneurial attrition is not a reason to find naïve underconsumption theories of the business cycle any more plausible. On the other hand, in a business cycle, there is not so much underconsumption as malinvestment. Too many things are attempted to be produced, signifying overinvestment; yet too few things actually are produced, signifying not that people are not consuming but insufficiency of real capital: factors of production are too scarce to enable any significant number of projects to be completed and the goods to be sold at a profit. 15. THAT THOMAS HALL’S “KEYNESIAN BUSINESS CYCLE THEORY” DOES NOT EXPLAIN BUSINESS CYCLES

I want to give a brief account of Hall’s (1990) model in order to underscore the abysmally weak level of analytical thinking among the Keynesians. Hall certainly writes in admiring terms about the master: “any list of great economists must include John Maynard Keynes.” (48) But he is content with so little theory that I am embarrassed to evaluate his work. Apparently, we start in an evenly rotating economy. For reasons unknown, a slew of entrepreneurs suddenly perceive numerous profit opportunities, especially by investing into durable goods that take a long time to build. At this point, the “animal spirits” are high. The multiplier is doing its allegedly holy work, spreading prosperity around, “increasing aggregate demand and output.” Unfortunately, the time to build characteristic of capital goods is why the expansion eventually ends. As the expansion progresses, great quantities of new capital goods come on line that were planned some time in the past. The marginal efficiency of capital declines as a result of this abundance. Office buildings are “overbuilt” in the sense that developers have difficulty renting

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Summa Against the Keynesians the available space. Subdivisions of houses and apartments lack buyers and renters. Because these investment projects are now less profitable, firms’ demand for investment goods declines and the multiplier and accelerator work in reverse. Consumer and business expectations about the future become more pessimistic, putting downward pressure on consumer durables and investment demand. This overall decline in aggregate demand drives business inventories above their desired levels and causes firms cut production. (1990: 60)

Some observations are in order. (1) Hall clearly postulates that of all the projects thereby started, many turn out to be unprofitable. We are not told why. Entrepreneurial errors occur all the time; why is there a cyclical pattern to them? In other words, why are losses suffered en masse by folks at the same time? (2) That an investment “takes time” to be transformed into output is such a primordial phenomenon as to be directly imputable to the axiom of human action; how can such an arch-general fact be the cause of highly particular events like business cycles? “2 + 2 = 4 → business cycles occur” is a true conditional; but few would insist on its usefulness. Hall seems to believe that “investment projects are now less profitable” simply because there are so many of them, resulting in a natural deflation. A lot of entrepreneurs and their products compete with each other for consumers’ money. Hence, before the deflation reared its head, their costs were high, yet now revenues lower than anticipated. First, gold mining will act as an antidote to the deflation. Second, in the next production round, everyone’s costs of doing business, too, decline. Third, every entrepreneur faces the deflation, so no particular entrepreneur is disadvantaged relative to everyone else. Scarcity of the factors of production is duly accounted for; hence, no vicious malinvestment and resource misallocation occur. In other words, given that saving takes place through time by putting away a part of income, enough time is normally apportioned for the creation of novel capital goods. Fourth, it is quite possible that Smith’s contemplated product would be superior to what exists now, but it may well be inferior to what will exist one year later when his product is finally out. In such a case, his losses are well deserved. Fifth, suppose that there are 5 consumer goods being produced in an economy, each costing $100. Folks decide to save and invest

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money and in the end, 100 consumer goods are outputted. In order for all of them to be sold, their prices must hover around $5, the velocity of circulation of money and the money supply being equal. With this price deflation, can all our entrepreneurs at least break even? The answer is yes. In saving, one unemploys factors working in those firms that experience weakened demand. If those factors want to work at all, then they will have to be content with much lower nominal wages per product. This ensures that the entrepreneurs spend in costs no more than what they will get in revenues. Sixth, excessive disequilibration may, indeed, produce some losses. But the number of entrepreneurs squabbling with each other is usually nowhere near that number that is generated by the unsustainable boom. If, in addition, real savings are adequate, then there is no problem. Finally, it is true that some potential entrepreneurs might be better off keeping their money in the bank and waiting for it to appreciate in value with economic growth. Insofar as some actually do that, the competitive pressures on those entrepreneurs who still dare to risk their capital are lessened. (3) Whether losses cause pessimism or pessimism causes losses is unspecified, as well. On the other hand, the Austrian theory postulates an interplay of objective and subjective factors together, perhaps, with what I in (II, 10) call the “catalyst” in causing both a contraction and recovery from it. (4) We do not, of course, start in the state of equilibrium; the law of averages would seem to imply that in the real economy, new entrepreneurs constantly appear and seek to test their mettle on the market; the sudden waxing of the animal spirits and an investment binge must be explained as part of explaining the business cycle itself, not assumed from the beginning. (5) There is no reason why so many entrepreneurs must fail if there are sufficient savings to supply all of them with present goods which will constitute their capital. It is true that the established businesses, those that are evenly rotating, may experience losses, if the newcomers do a better job than they, but that is just creative destruction in action. Why must it proceed in cycles? A theorist cannot be content with saying that what goes up must come down and vice versa. The problem is, first, to understand why the process of economic improvement, for which capitalism is so justly famous, should be stopped in its tracks and reversed; and second, why the disruptions are so monumental in scope. (6) Finally, of which capital does the marginal utility decline? Presumably, society is more productive because of the influx of the capital goods. That means that the consumers’ less urgent wants can now

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contend for satisfaction. The diminishing marginal yields of capital and other factors of production in terms of the consumer happiness obtained by employing these factors are surely notable; though, again, there is a certain parity between a poor society, whose members by acting satisfy few “very important” desires, and a rich society, where lots of “less important” goals are achieved on the margin. But people choose only between those goods that are presented to them by the entrepreneurs. If all firms become more productive by an equal amount, then this will provide a boon to the consumers and raise real wages, but it need not necessarily endanger the relative position of any one entrepreneur with respect to any other. The average MEC need not decline for that reason; indeed, the means of monetary profits to various market agents are a different thing altogether from the end of real psychic profits. Hall’s entry on the Keynesian business cycle is not a theory at all; it is as if he is afraid that an undergraduate reading his work will be confused unless he makes his presentation exceedingly simple. But simplicity is not to be found in economics. Hall is peddling nonsense. 16. THAT THE RATIONAL EXPECTATIONS SCHOOL’S THEORY OF BUSINESS CYCLES IS BASED UPON IRRATIONAL EXPECTATIONS AND FALSELY SO

Thomas Hall presents the idea of rational expectations in terms of the difference in the quality of knowledge of economic agents of certain kinds of events on the market. A company knows “a lot” about its own product, and workers know “a lot” about the demand for their skills and about the supply of other workers with similar skills. “In other words, the worker-producer has very accurate, up-to-date information about the price of his or her own product but is not as certain about the aggregate price level.” Even if a Misesian housewife (see (I, 3)) may know quite a bit about the market prices of commonly bought articles, nevertheless, “there are many goods and services that are purchased only occasionally, such as houses, autos, and appliances by households, and structures and equipment by firms.” People do not, the rational expectation theorists argue, keep up with the market data on these rarely bought items. Our author continues with a bizarre sentence. “Suppose that these individuals and firms suddenly observe an increase in the price of the product they produce.” (1990: 97) Observe an increase in the price? I thought they set the price! This can be interpreted in three ways. First, that the individuals and firms observe a shortage or surplus of their

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product and alter prices in order to bring the supply and demand into equilibrium. Second, that firms observe their competitors producing the same or similar things raise or – more plausibly – lower their prices. Third, that firms see their costs of production change and wonder if they need to and can adjust the supply of their products, as well. In any case, Hall argues that this change (suppose it is an increase) could be due either to an increase in “aggregate demand” or to an increase in the particular demand for the individuals’ or firms’ product. In the first case, we seem to be moving instantly from one ERE to another, and all nominal wages and prices will rise or fall in unison without any consequences for the output. In the second case, both price and quantity supplied can increase, as well as, after a while, the real wages of the workers involved in making the product.9 Here is the key point: if the changes in the aggregate demand are anticipated, then companies will not try to increase output, correctly perceiving the change to be “global,” affecting the price level but not production. If they are not anticipated, then they will mistakenly seem to be “local,” representing a change in the demand for the firms’ particular product, and the firms will try to raise output. The business cycle can now be understood as a cluster of errors arising from foolish misapprehension of global changes as local. Output and therefore, economic activity are increased, generating a boom. After a period of time, errors are revealed and corrected, and malinvestments, liquidated. The cycle thus depends for its existence on human irrationality. Now the Austrian business cycle theory defended in this book postulates a deception perpetrated on entrepreneurs (actual and potential before the onset of credit expansion) by the monetary authority. It argues that credit expansion distorts economic calculation, and that the expectations of abnormally high profits by all cannot be sustained. Moreover, it points out that businessmen cannot avoid competing in this poisonous environment. If they do expand, along with everyone else, then they run a high risk of losing money and going bankrupt. If they fail to expand, then they have lost already. As Cassidy points out, “in the frenzied atmosphere of a bubble, companies that stick to the old ways of doing 9

Notice an inconsistency, namely, that in Keynesism inflationary increases in aggregate demand fail to affect output only in the long run. The rational expectations theory of business cycles is false from the Keynesian point of view.

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things lose market share, their stock prices suffer, and their top managers get criticized.” (2009: 246) Here, however, there is no fundamental reason why a company must fall prey to an illusion. The decision whether a change in the demand is only nominal or both nominal and real is made by each company every day. If becoming a Fed watcher, keeping an eye on those rarely bought goods, and learning to spot bubbles are good for business, then nothing prevents companies from hiring the right experts. Surely, corporate economists are a dime a dozen, and with the modern computers and data warehouses and the Internet, one can upgrade, if ever so slightly, our housewife’s capabilities. Moreover, since rationality garners profits, and irrationality makes for losses, irrationality is self-penalizing and would tend to go extinct in the economy. Hall gives an example of the Fed’s behaving predictably and economic agents’ taking its actions into account and interpreting them as “global” events, which means that “output would not deviate from the natural rate.” That, in turn, means that “systematic monetary policy” is futile, because it will be foreseen and countered. Our author makes an error precisely opposite to the one which he thinks are made during the boom part of the business cycle. For inflation does not raise all prices equally at the same time. As I argue in (I, 19), money is not neutral at all in the short-run, and neutral only with respect to the economy’s general laws of operation and not in its actual production structure in the long run. Given the interminable interventionism, the long run is never even reached, anyway. Thus, the Fed may generate inflation which will result in a local increase in the demand for a particular company’s product. Now is the time for the company to take advantage of the opportunity that may not last long. If it interprets the change in the demand as global, then it will miss its chance to profit. The profit will be shortlived, but then all profits are. People learn by watching other market agents succeed or fail; they then avoid those actions that seem to fail; and engage in those that seem to succeed. In general, the market abhors profits and will imitate them away, whatever their source. There are few, if any, changes in the economy that do not privilege one company against some other. A general rise in the price level may be a long-term consequence of an old inflationary policy. But even it will come about as a result of numerous local and uneven price changes, predicting which is the point of entrepreneurial art. To strengthen my critique, any company or worker will be well advised to be biased toward considering any change as local. Even if a company has not been blessed by the inflation and receives the new money last, such that the price increases of its products are the last step in the process

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of the rise of the entire overall price level, it may have been forced to contract production under pressure from those firms that received the new money first, and having weathered the storm, it now, finally, has an opportunity to expand again. This is a perfectly reasonable course of action which has no connection with business cycles. It is undoubtedly wise for the Keynesians to keep in mind that expected inflation can take the bite out of actual inflation. But there is no reason for irrational expectations to persist, and moreover, most of such expectations will not even be irrational in the first place. It follows that the rational expectations theory must be understood differently. I have argued that it is most sensible for individual firms to consider spikes in demand as local. This is because all such spikes are local, even if months or years later all prices will eventually catch up. But perhaps, what Hall means is that each firm’s expansion helps itself but harms everyone else. All entrepreneurs consider global changes as local, expand, and then are forced to contract due to each other’s interference. Against this, I will make two observations. First, prices rise one after another in sequence, as new money finds its way into the hands of an increasingly greater number of people. Therefore, expansions are not attempted at the same time, which means that increases in demand for X and Y trigger increases in costs of Z and W. Each expansion by one business necessitates a contraction somewhere else, thus avoiding the dog-eat-dog competition for factors.10 10

Garrison (2001) describes a “monetary disequilibrium” business cycle theory proposed by Leland Yeager. In it, deflation triggers a depression. But this conclusion is belied by the reverse analysis. A decrease in the demand for X ipso facto decreases the costs of production of Z. The production structure is reconfigured, but there is no malinvestment. Nowadays, deflation through lower supply of money would take the form of credit destruction, which is a consequence of an Austrian-style bust. Lower supply of money due to voluntary hoarding is part of the recovery from the bust. Deflation can also be accomplished via higher demand for money. Yeager sees trouble here: “excess demand [for money] is… pervasively disruptive.” But this demand is an aggregate of individual demands for goods. That money “lacks a price and market of its own” means that the demand for money is an abstraction which, however, can be concretized by taking note of everyone’s demand for goods and services. A rise in the demand for money then is not some identifiable grand shock but a composite of billions of private market decisions about buying and abstaining from buying everything other than money. It is not the case then that “all prices and wages have to adjust downward” (234); simply in some nebulous sense, more prices go down than go up.

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The Austrian theory points out that numerous longer projects are started, as money is injected via credit markets, while factors prices are still low. In the beginning, the established late-stage companies lose some workers and capital, reflecting natural scarcity of resources, exactly as in the rational expectations theory. However, at the very time when goods are being carried down the production structure, inflation is also spreading in the economy. Consumption and derived demand for factors in the late stages of production pick up. The escalating bidding war causes costs of doing business for early-stage companies to rise relentlessly, though unpredictably and differently for every entrepreneur. At some point, the factors needed to complete the longer projects come to be priced so high that profits cannot be obtained. In the simplest of terms, first, early stages expand, and late stages contract; as time goes on, late stages expand, and early stages contract. But the two contractions could not differ more. The former contraction is in between production rounds. A latestage businessman simply realizes that he cannot evenly rotate and prunes his operations. No losses are suffered. The latter contraction is inside a round, while goods are still being manufactured. It reveals that the costs will outweigh the revenues, yet there is no way to avoid losses. The capital restructuring that accompanied the boom has been futile and must be undone. In the process, capital evaporates, and society is impoverished. In the model being considered here, however, there is no misallocation of resources. Second, the rational expectations story might sound plausible, if inflation was initiated by the government’s printing fiat money and mailing “stimulus” checks to every citizen. If our imp secretly doubled the size of everyone’s cash balance overnight, then this act, indeed, would result in a consumer feeding frenzy and attempts to expand production that are doomed to failure. Immediately after the impish stimulus, any given expansion due to higher local demand may seem doable, but as expansions are attempted by more and more companies, the prices of both original and produced factors rise ever faster. This upsets profit expectations and leads the economy to a bust. However, it is a fact that inflation is not introduced into the economy in this way but rather through increases in credit money by the Central Bank and commercial banks. Let me suggest, therefore, that there is a rational expectations theory of business cycles, but it is inapplicable to the actual cycles that we have experience with.

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17. THAT THE MONETARIST ACCOUNT OF THE BUSINESS CYCLE IS BASTARDIZED AUSTRIANISM Thomas Hall (1990) makes monetarism look uncomplicated. An increase in the money supply standardly done causes interest rates to fall and some local spending to get a shot in the arm. Not realizing that the increase in “aggregate demand” is due to purely monetary factors, those companies that receive the new money first expand production, and the factors employed by those companies after a while enjoy higher incomes. Hall writes that “there is a peculiar asymmetry in this model. Firms know what the inflation rate is and base their hiring decisions on the actual real wage, while workers base their labor supply decisions on the expected real wage which is based in part on adaptive expectations of the inflation rate.” Of course, there is an asymmetry: the demand for consumer goods is original and direct; the demand for factors of production is derived and indirect. The whole point of entrepreneurship is to take advantage of any temporary spread between the prices of the factors, corresponding to their lower derived demand, and the expected price of the consumer goods, corresponding to their higher original demand. It, thus, depends on the ignorance of the factor owners of profit opportunities noticed and acted upon by the entrepreneurs. These opportunities include inflation-generated profits. Eventually, however, the injections of new money into specific points of the economy percolate into the rest of the system and raise the overall price level. The interest rate goes back up concomitantly to its natural height. But at this point, price and wage inflation can be observed. Not only that, but people take into consideration the acceleration and even higher derivatives like jerk (which, measured in m/s³, a body experiences, if during a period of time its acceleration changes at a constant rate), etc. of inflation, if any. This causes output to shrink to its previous dimensions. If the Fed wants the boom to continue, then it must create more money at an ever increasing rate; otherwise, the nominal interest rates will go up, because people now expect the inflation to continue the way it has so far (according to their “adaptive” expectations). Sooner or later, however, the public will demand that inflation be curbed. The Fed obliges, and the results are higher interest rates and lower money supply, i.e., deflation, such that those who lose the old money last benefit. This creates an additional disincentive to consumer spending. The economy is steered toward a recession, such that the contraction is argued to be due to the conjunction of the increase of the general price level and the Fed’s attempt to combat this increase (which it itself, of course, brought about) by raising interest rates.

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Notice that there is no trace in the monetarist account of the Austrian understanding of the Fed’s subversive role. For the monetarists, then, the Fed’s tightening the money supply merely aggravates the contraction that begins with general price inflation. But the interest rate will remain high only for a spell; in due course, the system is normalized, and this rate returns again to the level set by the market. The Fed must destroy money at an accelerating rate in order to keep the interest rates high. But then unemployment rears its ugly head, and the Fed is forced to loosen its monetary policy. And round the merry goes. The cause of business cycles, then, is “erratic nominal aggregate demand growth caused by unstable monetary growth.” The money supply growth is unstable, because the Fed’s target has often been low interest rates (stimulated no doubt by inflationist ideology) rather than the money supply simpliciter, and manipulating those can call for a mercurial monetary policy. (Chapter 5, “The Monetarist Model”) The idea is that, given its interest rate target, the Central Bank engages in what may be called “market confusion,” in which its only chance of being “effective” is to be unpredictable. The point is to prevent people from surmising a trend in the Fed’s actions and countering it by raising or lowering the nominal interest rate so as to protect themselves from inflation. For example, if the Fed pumps in money in a predictable fashion, then real interests rates will head down, but the nominal rates will compensate for that, as lenders seek to nullify the deleterious effects of inflation on their interest returns. As I have emphasized in (I, 61), inflation alone is a necessary condition for a business cycle. Monetarism claims that inflation paired with market confusion are sufficient to create a business cycle. I disagree and will provide reasons against this proposal. Only inflationary credit expansion (or rather credit’s being expanded at any moment in time in accordance with banks’ fractional reserves) will tend to produce a neverending sine wave of booms and busts and do so even in the absence of the Fed’s using the full array of its tricks. The business cycle theory flowing from the foregoing is unlike the Austrian theory expounded on in this book. The latter focuses on the travails of interest rates and derived demand and their effects on the intertemporal structure of production. The monetarists admit that manipulation of interest rates has the power to stimulate or cool off the economy. But their theory of how this process works invokes solely the inflation caused by the Central Bank. Credit expansion in monetarism is merely a particular way in which inflation and its consequences are unleashed. For all the monetarists care, people could instead be bombarded with newly created paper dollars from outer space in a

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random and unpredictable fashion in order, as per their system, to confuse the market. The boom arises, because inflation creates profit opportunities for business firms. It is true that the monetarist “confusion” damages the function of money as a unit of account. The market is supposed to be rational, as in permitting correct economic calculation, and the Central Bank scuffs up the lightsomeness of this rationality. But not enough to cause a business cycle, and this for three reasons. First, monetarism makes it seem that new output stimulated by the higher short-term aggregate demand appears immediately, while in reality it takes time to increase production. Now (money supply) inflation does not manifest its symptoms (i.e., price inflation) fully for a while; so, (a) higher nominal demand is not reflected in higher (overall) price level. At first, companies whose products have enjoyed higher demand must raise prices (of their specific goods) to ration existing inventories. So long as there is unused capacity within the fortunate firms and their suppliers, it can be utilized, resulting indeed in (b) an increase in output, exactly as monetarism proposes. A bit later the same firms may attempt to (b’) expand capacity and increase supply still more, this time lowering prices. However, as soon as unused capacity is exhausted, the higher demand will result only in (c) shortages of capital goods, including labor in possession of the requisite human capital. Soon enough factors prices will catch up, and profits due to inflation will disappear in exactly the same way as all profits disappear due to equilibrating entrepreneurship, except that nominal incomes will rise. Therefore, the expansion due to (i) local increases in nominal demand does not take the economy beyond its production possibility frontier. Whoever gets the newly created money first benefits at the expense of those who get it last. The steps that one group of entrepreneurs take to expand their production, such as slurping up the factors of production working in other firms, signal to other entrepreneurs, as per (c), to shrink production, insofar as the latter receive their revenues in money of diminished purchasing power, signifying higher costs of doing business. The economic processes going on are morphed and restructured, but there is no systematic deception being executed. In other words, a local spike in demand for X normally comes at the expense of demand for some Y. X’s quantity supplied increases; Y’s, decreases. Under inflation, a boost in the demand for X comes at the expense of higher costs of producing Y. This time, Y’s supply curve shifts leftward, and quantity supplied again decreases. In either case,

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there is no boost in output or employment whatsoever. It is true that the Austrian theory, too, is subject to a similar query: Will not the factors of production being demanded by both longer and shorter processes be in short supply? The Austrian theory depends on the prices of these factors rising with some speed and annihilating the expectations of profits by virtue both of itself and of the subsequent tightening of credit money creation. It does not need, like the monetarist theory, a period of expansion, during which actual profits are had, and inflation is unseen by most. For the Austrians, entrepreneurs find themselves in the money through investments which are later proven vain and profitless; for the monetarists, money goes to them through consumption which does generate profits. The technology stocks boom in the 1990s is sufficient evidence to refute monetarism. There were no profits at all being enjoyed by most dot-coms at any time during their brief existence. For if there are profits, then the expansions have been successful, unlike the efforts of the hapless entrepreneurs in the Austrian scenario. Moreover, the contraction due to (ii) a global price level increase does not take the economy below the production possibility frontier but again, keeps it on the frontier. The reason is that as the expansion peters out and is then reversed within the initially lucky firms, it picks up with the initially unlucky firms which at long last enjoy higher demand. Hence, we should not see boom and bust, happiness and misery, or mania and crash; and therefore, there is no cycle to speak of. Recall that in the Austrian theory, credit expansion stimulates production, in particular, the lengthening of the production structure, while inflation stimulates consumption and the demand for factors in the later production stages. This sets the stage for a clash between a much higher than usual number of entrepreneurs and projects in which those entrepreneurs are engaged. No time has been supplied for new capital goods to be created, and there are not enough existing goods and factors to make every entrepreneur’s project profitable. Mass losses ensue. Monetarists argue that higher demand and therefore, consumption stimulate production. Business cycle arises because this new production gives way to a contraction, when inflation is curbed. What they do not seem to understand is that the stimulation is sequential. Demand for X increases; then quantity supplied of X increases; this raises costs of production for other businesses; which then contract production. There is no wild competition for resources at the same time. A similar process occurs in the alleged contraction. Certain companies experience a diminution of demand for their products. They restrict production and fire their workers. These workers are picked up

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cheaply by other firms, which, in addition, receive revenues in the form of the money of higher purchasing power. These luckier firms, on the contrary, step up production. Whence, then, the business cycle? Second, the price level in a large economy rises slowly regardless of the details of the monetary policy, which means that firms have ample time to detect and adapt to it. They need not be taken by surprise by the spread of the money that is fresh and still unspoiled and should be able, contrary to monetarist predictions, to adjust production to the new realities well before they are harmed. Third, firms should take advantage of injections of new money, if they are the ones who are going to receive it first (via a higher demand for their products, according to the monetarists), before the price level has risen. Once again, profits do not live long, and this kind of opportunity is no more disreputable than any other. The first recipients of new money are not responsible either for the inflation or for inflationism. They should maximize their profits and care not a whit for politics or ideology. At the same time, there is no malinvestment going on. There is, indeed, an arbitrary redistribution of wealth; but that is an inescapable feature of all inflation. In the Austrian theory, an individual firm’s decision to use credit expansion for its own benefit is sensible, but when everybody does it, there is trouble. People’s individual rationalities conflict with the group rationality of the whole society. But the expansion and contraction postulated by the monetarist theory both (1) are rational and correct as responses to an inflationary policy for the market agents, and are such that (2) the first recipients of the newly printed cash do not interfere with one another when they expand production. Spurred by this naïve inflationist theory of the business cycle, the monetarists recommend bidding the Fed to “maintain a fixed rate of monetary growth. Proposals include requiring the Board of Governors to tender their resignations to Congress each year they do not meet a specified monetary growth target, or replacing the Federal Reserve with a computer that simply buys enough bonds on the open market to maintain a certain percentage growth rate for the monetary base.” (84-5) The difference between the monetarist and rational expectations theories of the business cycle that works in favor of the former is that the monetarists recognize the unpredictable nature of the initial inflationary stimulus’ fanning out throughout the economy. However, they err in thinking that it is the inconstancy of inflation that is at the root of the business cycle mischief and not (1) the extent of the inflation and (2) the means by which inflation is carried out, namely, credit expansion. For example, Milton Friedman’s famous prescription was to have the Fed increase the money supply by 2-3% per year. The amount

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may or may not be justified by the (wrong-headed) desire for price level stability. But there is nothing in the monetarist theory of business cycles that compels a low inflation. The inflation needs only to be predictable but can presumably be 20-30% or 200-300%. And the fact that inflation is actuated by the concerted action of the Central Bank and the commercial banks will ensure that the business cycle will not be appeased by such a paltry sacrifice of the Bank’s authority. The final comment on Hall’s account of monetarism I will make concerns the “price expectations effect.” Remember that interest rates showcase people’s preference for present goods vs. future goods vs. liquidity, present and future. Inflation makes money less useful as a store of value, stimulating spending and investing. As a result, real interest rates head down, because liquidity is less in demand, and nominal interest rates head up, as people are eager to borrow hoping to repay the loans in less valuable money, and lenders in their turn desire to be delivered from the lower purchasing power of money in the future. Consequently, there is another and potentially more sinister aspect to the monetarist remedy. Normally, expected steady money supply inflation does not lead people to expect steady price inflation, because of constant changes in market data. I point out in (I, 3) how difficult it is to measure changes in a money’s purchasing power. But suppose for illustration purposes that the inflation rate is a predictable 200% per year. High price inflation is inevitable. But since certain people will no longer consider money to be a good store of value, they will seek to get rid of it. This will lower the overall demand for money. And raise prices still more. And increase the margin of people who no longer want to keep the quickly deteriorating cash balances. Demand for money will decrease for these new individuals, and as they spend or invest, the price level will rise again. Which will bring in still more marginal folks who will refuse to suffer the price inflation. The steady price inflation will accelerate into a hyperinflation and crack-up boom. Predictability has its drawbacks. Even if there is no creation of fiat money by the Central Bank, the creation of credit money alone by commercial banks is sufficient to produce business cycles. For the latter still depresses the interest rate below its market level with all that that implies. In short, the monetarist policy fails on its own terms, even if we consider the theory on which it is based to be correct; but of course, it is not correct. At best, the monetarists have brought to our attention a technical point, upon which the Central Bank’s machinations are based. The monetarist business cycle theory must, hence, be judged wanting.

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18. THAT THE “REAL BUSINESS CYCLE THEORY” IS NOT EVEN WRONG Business cycle theorists proceed as if by discovering the obvious. What the Austrian school from its inception has considered to be fundamental facts, directly derivable from the axioms of human action, other schools periodically figure out as profound breakthroughs and build theoretical edifices on them. Case in point: according to Thomas Hall (1990), “modern demand-side models also postulate that real wages are countercyclical over the business cycle…, because of incorrect price expectations by labor suppliers (monetarist and rational expectations) or rigid nominal wages (new-Keynesian).” Of course, they postulate that, because in the real economy, unlike in an ERE, factor incomes lag behind profits and therefore, behind prices. If they did not, then there could be no such thing as profits. Profits are earned in the boom part of the cycle, according to the theories mentioned, and disappear in the bust part of the cycle. Therefore, wages are comparatively low during a boom and catch up during the bust. Hence, wages are countercyclical. Now plainly, this result flies in the face of common sense. We all know that some wages go sky high in the upward reaches of the business cycle and must dramatically come down during a depression. Therefore, “wages” in aggregate are neither pro- nor countercyclical; rather, during a boom some workers enjoy high derived demand for their services, while others languish at the bottom. In other words, there is a redistribution of wage incomes from the old “dinosaurs,” shall we say, toward those workers who are employed in the industries and firms awash in new money. Moreover, according to the ABCT, profits are never received by the majority of the firms started during a boom in the first place. There is lots of investment, to be sure, but most of it is worthless or “toxic” in the current parlance. So, it is certain fortunate factor owners who gain the most during a boom, because they receive high present wages; entrepreneurs who pay these workers their wages lose, because their projected future profits never materialize; and less agile and quick-thinking workers end up holding the short end of the stick, when price inflation hits the goods they buy. The Austrian theory explains all that; no other theory herein presented does so. Hall ignores Austrianism entirely; hence, he is puzzled over the “inability to explain actual real wage behavior” by “modern theories.” (121) The real business cycle theory makes another “discovery.” The real economy, it breathlessly tells us, is subject to “supply shocks.” “These shocks can be caused by a wide array of factors including demographic changes, technology shocks, changes in relative input prices such as the oil price shocks of the 1970s, and changes in consumer

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preferences.” (122) Other examples include “major shocks like a plague or a war, but more likely they are a series of smaller shocks to labor, capital, and technology that have a positive trend value plus a random component” (123), even new government regulations and bad weather. The business cycle occurs when several shocks in a row all tend in the same direction, resulting either in an increase of output or in its decrease. Well, shiver me timbers. Again we are informed that the real economy does not evenly rotate. The external environment in which human beings live changes, and people act purposively in hopes of improving their lot in life. These acts of God and acts of men constitute the “shocks.” But since we are being macroeconomists, we are not concerned with such trifles. We soar high above and enjoy a bird-eye view. Therefore, we conclude, if we are lucky, then we will randomly experience a streak of positive shocks which will increase productivity and wealth. If the fates are against us, however, then we might suffer a streak of blackjack losses… I mean, a series of negative shocks, throwing us back into primeval poverty. And since it is inevitable that sooner or later a situation of a sequence of positive shocks that is followed by a sequence of negative shocks will arise, we observe cycles. Another crucial “finding” is that shocks tend to persist. Well, if the “real” theory purports to explain business cycles, then it must surely presuppose that business cycles occur. And if they occur, then they persist for some time. Why do shocks persist then? Hall explains it as a consequence of two “assumptions”: first, that production of new capital or consumer goods takes time, and second, that following a personal “shock” of a change in income or wealth, people adjust their consumption patterns slowly. The first assumption is nothing of the sort but is yet another corollary of the human action axiom. I could say that the formulation of a plan of action can take a short amount of time; but putting that plan into action can take years. Therefore, the initial “shock” of an entrepreneur’s committing himself to the realization of his plan may take a while to manifest its full consequences. But that these 100% generic events, namely, people’s forming ideas on how to profit, have the power in and of themselves to cause business cycles, is nothing less than incredible. Moreover, the production of a good is not a blob of a shock; it involves variable multiple transformations of raw materials by means of machines and human capital. The second assumption is also a perfectly general observation: if anything changes within the market process, it is people’s “income” and “wealth.” Is every single such change a Hall’s “shock”? It does not matter whether people react to these shocks slowly or quickly; a

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phenomenon that contends to explain everything (i.e., is, like, say, “2 + 2 = 4,” consistent with any set of data) actually explains nothing. A final feature of the real business cycle theory is its view of money. It claims that higher demand for money (a standard feature of a growing economy) necessitates a higher money supply “to meet the higher demand.” This is quite absurd. If demand for widgets increases, then the company producing the widgets must find that point on the new demand curve at which its profits, consisting of ((price times quantity) minus costs), are maximized. When all such points are connected, a supply curve, indeed, results. But money supply need never increase, because, to reiterate the point made earlier, a lower supply will work and satisfy the needs of society just as well as a higher supply (only changes in the money supply have effects). Therefore, it is naïve to argue that the supply of money ought to “increase only in step with the growing needs or a growing economy.” (quoted in Kaldor 1982: 8) No economy, whether growing or shrinking, has any need for a money supply different from that money supply that it already has. It is true that a growing economy may have a need for a (private) gold mining industry in order to palliate any ill-effects of mild deflation due to economic progress. Now actual price deflation with economic growth is completely innocuous, even beneficial, except in the odd psychological effect of workers’ receiving cuts in wages rather than raises, as their careers pick up. However, expected price deflation discourages buying and may in principle slow growth in the following way. Smith’s waiting to buy when the prices get lower or quality, higher may be a smart decision for him, but if everybody adopts the same strategy, then production may be dazed and losses, suffered. Of course, things will normalize in future rounds of production; moreover, people’s total money savings (in the wide sense) are unchanged, even as prices drop, enticing folks to unload their cash. There is little to no danger that in a free society, deflation will snowball out of control, but as a check against even that minute possibility, mining of precious metals serves as a venerable institution of laissez-faire. Other than that, only in hyperinflation might the monetary authority have a “reason” to inflate at an increasingly higher rate in order to “meet the demand,” but only because prices rise faster and faster, precisely because people expect more inflation. During a hyperinflation, indeed, the moment the government prints “enough,” inflationary expectations cause the demand for money to fall and prices to rise so much that the amounts of money in people’s hands are too low to buy anything on the market, and the Central Bank is forced to print still more paper. Here is how it works. Believing their savings to be losing value, people seek to spend

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their money, reducing the money’s purchasing power and raising prices. On the other hand, durable goods are withheld from the market, as merchants hold out, thinking that it is not worth to sell the goods at “low” prices. Demand for money D, being proportional to T / V, goes down with continuous decreases in T and increases in V. Insofar as goods are not being sold, they are not being produced, either. Price level P, proportional to M / D, rises also as M rises. The market falls apart, as social cooperation is sabotaged. Goods end up costing much more than what people have on hands; there is a shortage of cash. Since money has no substitutes and is the only thing that vendors will accept in exchange for their products, people petition than they be given more money. If the Central Bank accommodates, then the present inflation helps to kick-start exchanges for a short while but also confirms the previous expectations of inflation and strengthens new similar expectations to a still greater extent, lowering the demand for money yet again. Think about it this way: the prices are affected by three factors which reinforce each other: increasing money supply, increasing velocity of circulation of money, and spiraling down production; while the money supply is affected by only one factor: the willingness of the Central Bank to print money. Therefore, in hyperinflation, the rise in the price level will generally exceed the capacity of the Central Bank to keep up with it, with the result that the money supply and prices will chase each other into a crack-up boom. In a hyperinflation, money loses its utility as a store of value completely and its utility as a unit of account partially. These events undermine money’s primary function of medium of exchange. Otherwise, money supply ought to be fairly stable, as gold and silver have proved to be. Hall also points out that for the realists money is neutral even in the short run, certainly an outrageous notion and sufficient in and of itself to reject the theory. This “luck hypothesis,” namely, that a business cycle will occur, when a totally random composite event of lots of good shocks that are followed by lots of bad shocks occurs, may be a sign that economists are finally giving up on finding any genuine explanation for this phenomenon.11 Perhaps, in time, the despair will give way to joy as the Austrian account of business cycles is rediscovered by the mainstream.

11

Surely, we are not dealing with the “infinite monkey” theorem or anything like that. It would take a lot of monkeys banging on the threads of fate in order to generate business cycles that way.

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19. THAT THE “KEYNESIAN CROSS” COMBINES KEYNES’ PSYCHOLOGICAL LAW, THE CIRCULAR FLOW CHART, AND THE MULTIPLIER The Keynesian cross is a graph that links “planned expenditure” Ep on the y-axis with real income Y on the x-axis. “Planned” can mean a couple of things. Say, I am in line at a convenience store and all of a sudden fancy a piece of candy. I pick it up, and it happens to be the last candy bar of this sort in the store. Behind me, next in line, is a fellow who came to the store specifically to get this bar of candy. He is pretty upset, but what do I care? We see that my “unplanned” impulse buy was successful, while his planned expenditure was unsuccessful. However, from the point of view of the candy’s producer, it does not matter who got the thing. All he cares about is the sale. By “planned” expenditure, then, it is rather meant “expenditure (a) foreseen and (b) provided for by entrepreneurs.” Conversely, unplanned expenditures, such as net savings channeled into investments, in the process disturbing an evenly rotating economy, are those that have not been foreseen. Thus, for planned expenditures, quantity supplied equals quantity demanded, and not so for unplanned expenditures. If Qs < Qd, then the entrepreneur foresaw that he would sell the entire stock but failed to provide enough to satisfy the demand. If Qs > Qd, then, on the contrary, the entrepreneur produced a sufficient but unnecessary amount, such that every buyer went home happy, but a part of the inventory was unsold. “Autonomous” spending is that which is independent of income; it can be financed by savings, be selling assets, or by borrowing. Presumably, it is at least that amount of money needed to sustain life and satisfy basic needs. The Keynes’ dubious psychological law is expressed in the line with the equation Ep = Ap + cY,

(EQ. II.19.1)

where Ap is autonomous planned spending, c is the propensity to consume, and Y is income. The property of the circular flow diagram that the factor owners consume all of their income is depicted as a straight line from the origin at 45° angle: Ep = Y.

(EQ. II.19.2)

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The intersection of (Eq. II.19.1) and (Eq. II.19.2) is the equilibrium point (Ap / (1 – c), Ap / (1 – c)), in which the economy is primed to evenly rotate. Finally, the multiplier comes into effect when Ap changes: if c = 0.75, then for every point of increase in Ap, both equilibrium income and planned expenditure increase by 1 / (1 – 0.75) = 4 points which is the multiplier. (See (I, 55) for an algebraic derivation of the multiplier.) Let Ep = 1,000 + 0.75Y (in billions of dollars). If the economy is not in equilibrium (which is attained at (4,000, 4,000)), for example, at point (6,000, 5,500), then $6,000 billion “worth of goods” have been produced, but only $5,500 has been spent in one production period. That $500 billion would be saved was not anticipated by the entrepreneurs. Here is where the textbook account of what is going on and my own will diverge. The textbook claims that the unsold goods will accumulate in inventories, and businesses will cut production. (Gordon 2009: 68) Unfortunately, the Keynesian cross has nothing to say about the fate of the saved $500 billion. Logically, there are three things that can be done with it. Consider that production in the aggregate will be decreased, only if it is projected that in the next time period consumption will remain at $5,500. But it need not necessarily do so: it may even be expected to exceed the old amount and grow to, say, $6,200. In that case, production will contrariwise be shifted into high gear. In other words, if more money is spent during the next period of production, then companies who failed to anticipate that will lose, while companies that invested into building expensive goods to be delivered precisely during that next period will win out. For example, firms that stand ready to build or sell a house to Smith on notice will benefit, if he has been saving $200K to be spent in a single dose on the house (perhaps, Smith dislikes being in debt). That they foresaw his demand, say, a year ago, when his savings were far from complete, is a tribute to their entrepreneurial skill. Second, if the $500 billion is invested, then we are faced with a familiar morphing of the production structure. I have nothing more to add to what has already been said about it. Third, if this money is hoarded, then income is redistributed from the entrepreneurs who failed to foresee the lower demand for their products to those who will be forecasting an even higher profit than in the previous period due to monetary deflation. The duller entrepreneurs will, indeed, lower their prices in order to get rid of the inventories, take losses, and possibly curtail some of their production. Income to their factors will decrease alongside with their revenues. But these occurrences will enable other entrepreneurs to obtain (1) the losing firm’s

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products for less, and (2) the resources previously held by these losing firms and now released for less. Their costs of production will fall. In other words, a single dose of deflation will permit even some losers to evenly rotate in the future. Since hoarded money is in a sense not part of the money supply, the resulting deflation will ensure that entrepreneurs are paid with more valuable money; hence, only the least successful entrepreneurs will be hurt, while deflation will let the more alert and opportunistic folks enjoy higher profits (and their factors, enjoy higher incomes), even if their nominal sales receipts are the same. The Keynesian cross may be useful for college freshmen who are looking to understand some of the most basic claims of Keynesism, but it barely scratches the surface of the complexities of macroeconomics. 20. THAT IN THE IS-LM MODEL, THE IS CURVE ILLUSTRATES THE WORKINGS OF THE MONETARY POLICY, AND THE LM CURVE, OF THE FISCAL POLICY, BUT NOT MUCH MORE The IS curve builds upon the Keynesian cross. It takes as a given the fact that aggregate income depends upon autonomous spending. As shown in the previous chapter, the value of real income Y in the equilibrium point, at which curves (Eq. II.19.1) and (Eq. II.19.2) intersect, is Ap / (1 – c); where Ap is autonomous planned spending, and c is the propensity to consume. In addition to that relationship, there is also the fact that Ap is a sum of several components which include autonomous consumption and “planned” investment: Ap = X + Ca + Ip. But both Ca and Ip depend negatively on the interest rate. Call this the CE (for “credit expansion”) hypothesis. Now a person familiar with the basics of Austrian economics will immediately point out that in the short run, consumption and investment run in opposite directions relative to each other: the more is consumed, the less is invested, and vice versa. Therefore, CE is to be interpreted in very modern terms: when the Central Bank increases the supply of fiat money, and the commercial banks pyramid credit money on top of their new reserves, the interest rate declines, and both consumption and investment skyrocket. Hence, Ap itself depends negatively on the interest rate, and so does income, e.g., Ap = 2,500 – 100i = f(i), with i expressed as a percentage, such as 5%; and

(EQ. II.20.1)

678 Y = f(i) / (1 – c).

Summa Against the Keynesians (EQ. II.20.2)

Curve (Eq. II.20.2) can be plotted on a graph with the interest rate on the y-axis and real income on the x-axis. It is downward sloping. For every i, Y is such that (Y, Y) is the equilibrium point of the Keynesian cross corresponding to (Eq. II.20.1), and the economy can evenly rotate another round. The LM curve is drawn within the same system of coordinates as the IS curve. Its derivation is a little trickier. It is proposed that the total demand to hold real cash balances or (M/P)d is equal to a function of income Y and interest rate i. It is fairly obvious that the greater the Y, the greater the aggregate demand for money. The higher the i, on the contrary, the more money the suppliers of present money (who are at the same time demanders of future money) want to get rid of (by lending it), and the more strongly the demanders of present money (who are at the same time suppliers of future money) are reluctant to borrow, lowering the total demand to keep cash on hands. Therefore, (M/P)d is positively dependent on Y and negatively dependent on i, e.g., (M/P)d = 0.5Y – 200i. There are three unknowns and one equation. In principle, this requires a 3-dimensional graph. We can dispense with such an inconvenience, however, since for a given Y, there is a 2D graph linking real cash balances with the interest rate. Draw a number of such parallel lines for different Ys. Now instead of keeping Y fixed, keep the money supply Ms/P a predefined constant, draw it as a vertical line, and see what happens when the total demand to hold cash balances equals the total supply of cash balances to be held: (M/P)d = Ms/P. Again Y becomes a function of i; for example, if Ms/P = 2,000, then Y = 4,000 + 400i.

(EQ. II.20.3)

(Eq. II.20.3) is an upward sloping LM curve, showing us all the combinations of (Y, i) at which the “money market” is in equilibrium. If income increases, then there is a shortage of money at the old i (meaning that quantity demanded is greater than quantity supplied), and only a higher interest rate can equilibrate the (variable) demand for and the (fixed) supply of money. If income decreases, then there is a surplus of money at the old i (meaning that quantity supplied is greater than quantity demanded), and the interest rate ought to go down in order to raise the total quantity demanded to hold money to such an extent that it is equal to the quantity supplied of money which, again, is a constant. This happens, because at lower i savers will want to lend less and keep more

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for themselves, such as in order to spend, while borrowers will want to obtain more in the form of loans; the result being that keeping more cash balances is more attractive to both groups. The economic meaning of the IS curve is that when the monetary authority alters the interest rate, the economy can experience a boom either in consumption or in investment, raising real income, or so it claims. It is inflationism in pictures. Of course, I did not derive this meaning from the equation of the curve; rather, the equation was constructed under the assumption that monetary policy works as expected. Moreover, since it is a superstructure of the Keynesian cross, it suffers from all the failings of that model. Monetary policy is manifested in the movement along the IS curve or, equivalently, in the shift of the LM curve downward and to the right (monetary expansion) or upward and to the left (monetary contraction). The motion of the LM curve is initiated by a change in money supply: remember that our equations require that (M/P)d be equal to that money supply, and a change in (M/P)d results in the shift of the curve: Y = (a ± Δ(M/P)d) + bi. The economic meaning of the LM curve is this: first, higher income to Smith makes him want to hold more cash, all things being equal. At the same time, higher interest rates increase Smith’s opportunity cost of holding more cash; in other words, they increase the payoff of lending his money out. Hence, they provide an incentive to him to get rid of his cash balance under his mattress or in the bank. Those combinations of Y and i at which every dollar finds a single willing holder (either in Smith’s own hands or in his borrowers’) make up the LM curve. Time preferences and the consumption-investment decisions are covered by the IS curve; liquidity preferences and the spendinghoarding decisions are depicted with the help of the LM curve. For example, motion along the LM curve is accomplished by the government’s fiscal policy, whose very aim is to scoop out and spend hoards. Since any spending by any Smith is automatically income to some Jones, an increase in spending will increase aggregate income and therefore, the demand to hold cash. Given also a constant money supply, this must needs entail that the interest rate go up in order to offset the increase in this demand for money, so that the total demand to hold again equals the total supply that can in principle be held. But spending can be by the people or by the government. If the latter, e.g., due to a borrow and spend fiscal policy, then both income and interest rate will rise. That is, the motion of the IS curve upward and to the right, representing government spending, or downward and to the left, representing “austerity,” in conjunction with the motion of the equilibrium point along LM, will have a limited effect of changing both the interest rate and income.

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When autonomous spending increases, if the LM curve is horizontal, then income will be increased, and the interest rate will stay the same; this means that there will be no “crowding out” of private investment. If the LM curve is vertical, then income will stay the same, and the interest rate will rise by the greatest possible amount which means complete crowding out. Finally, if the LM curve is normal, then crowding out will be partial; moreover, private spending may even increase, since income increases along with the interest rate. For instance, let an equation of the IS curve be, as per (Eq. II.20.2), Y = 10,000 – 400i, given c = 0.75. The equilibrium between this curve and (Eq. II.20.3) lies at (7,000, 7.5). Increasing Ap by 500 will move Y to the right by 2,000. Then 12,000 – 400i = 4,000 + 400i,

(EQ. II.20.4)

which means that the new equilibrium is achieved at i = 10%, an increase by 2.5%, and Y = 8,000, an increase by $1,000 relative to the old curves. Note that the purpose of monetary policy is to lower interest rates; to the extent that income increases due to inflation, it is an unpleasant side effect; conversely, the purpose of fiscal policy is to increase spending and income, and the higher interest rates act as a check on this goal. A reasonable question at this point is: So what? Well, we care about this model, because it provides a justification for the Central Bank / government activism: by manipulating government spending and inflation, we (and by “we” I mean a central planner endowed with all the power in the world) can apparently achieve any GDP and EIR we want. For example, Gordon (2009) claims that Japan could escape its economic woes by pursuing both monetary and fiscal policy together in such a way as to get the government to spend by borrowing from the Bank of Japan. Now the Japanese interest rates are already extremely low, and Japan’s government debt is huge. It would seem that all is lost. Not so, says Gordon. By moving both the IS curve and the LM curve to the right, income will rise but the interest rates, with proper calculation, need neither increase nor decrease. Moreover, by borrowing from its own Central Bank, Japan will not be increasing public debt but instead generate inflation. But inflation would be the least of possible evils. (118) Thus, by cleverly varying policy alternatives, such as from whom to borrow, economic progress can proceed at a more or less steady pace. Just as the combined forces of the Central Bank and government can keep the interest rate stable while changing the GDP, so they can

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target the GDP and manipulate the interest rate. The way toward the exercise of that power lies, e.g., in shifting LM to the left and IS to the right. Before the shifts, at the lower interest rate, there is more (private) investment and less (government) consumption; after the shifts, at the higher interest rate, there is less investment and more consumption. If the government, instead of consuming its share at the higher interest rate, “invested” it into “infrastructure” and the like, then the choice would instead consist in comparing private with government investment. Where have I been led by this reasoning? I have arrived at the startling idea that both the interest rate and the GDP are arbitrarily set by the authorities. The market ultimately has no say in assigning values to these variables. But if my reader takes nothing else from this book, then he should understand, über alles, that both the interest rate and the GDP have real market values. They are not undetermined until the Central Bank and the government mercifully set them to whatever they choose. [I] In the presence of only commodity money (without either fiat or credit money), the interest rate would be set in accordance with individual time and risk preferences, perceptions of entrepreneurs, and the loan and futures markets’ dynamics. It would have a perfectly definite value or values, seen by all market agents. Defying the market rate of interest leads to business cycles and impoverishment, as described in Book I. [II] In the absence of taxes, the GDP would be set according to consumer preferences in buying and selling. A fiscal policy requires a partial surrender of consumer sovereignty. Gordon writes about Japanese “roads that lead to nowhere and a report that 60% of Japanese coastline is encased in concrete,” (76) meaning that they are economic bads. But presumably, we do not want the government to be socialistic. We want consumers to continue deciding what gets produced, of what quality, how much of it, and so on. The GDP in the free market is representative of the level of consumer happiness and is also not arbitrary. Neglecting the market GDP leads to socialism and again to impoverishment. The IS-LM model fails utterly to take cognizance of these points. Consider lastly that fiscal policy operates by force, taxing the consumers; and monetary policy operates by fraud, deceiving the entrepreneurs. It is a staple of some of the most respected political philosophies that the main or even only task of government is to protect the citizens from force and fraud. It is clear, however, that the government itself, in pursuing its “policies,” is perpetuating one of the grandest uses of violence and deception ever conceived by man. Without making any

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value judgments, it is a fact that there cannot be a “limited” government, so long as the policies are considered by the academics, the opinionmolders, and the public to be, far from destructive, in fact essential to the commonweal. A combination of the fiscal and monetary policies, when taken to their logical conclusion – and why not increase the GDP to infinity and decrease the interest rate to 0? – ensures than nobody will know either what to produce or how to produce it. Precisely because it is not taken to such a conclusion, Keynesism is Marxism lite. For that reason, the most valuable contributions of the Austrian school of economics are its theory of (the impossibility of) socialism and its theory of business cycles. To imitate Seneca, Keynesism is regarded by the common people as true, by the wise as false, and by the rulers as useful. To imitate Marx, the socialism of the 20th century was a tragedy, with so much idealism invested in ignorance; the Keynesian interventionism of the 21st is a farce. Our economy is a barrel of laughs to anyone conversant with economics; and Keynes, usually garbled but sometimes also in a more pristine form, gives ample opportunities to second-hand dealers in ideas to make fools of themselves, in print or on national TV. As we saw in earlier chapters, Keynes had deified the state. He was Marx’s non-violent brother in faith, seeking “somewhat comprehensive socialization” that “can be introduced gradually and without a break in the general traditions of society.” (2008: 378) This book deals with positive and value-free economic science. But if it also helps to promote the libertarian political philosophy, then its contribution will lie in my refutation of the specifically Keynesian rationales for government taxation and counterfeiting. The state is very inventive, especially when it comes to its survival, and I am sure that there will be plenty of new pretexts for tyrannizing over and despoiling the populace in the future. But at least this coldest of all cold monsters will have a harder job at its destructive tasks. 21. THAT PRICE INFLATION AND LIQUIDITY TRAP OBSTRUCT MONETARY POLICY, AND CONSUMER PAIN AND THE CROWDING OUT EFFECT OBSTRUCT FISCAL POLICY The IS-LM model can show the limits of both the monetary and the fiscal policies. It does not exhaust those limits – in fact, I have made it clear that both kinds of policies are economically ruinous – but gives a framework in which common economic maladies from the point of view of the “policymakers” can be expressed.

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The most favorable for the authorities case may be conveyed by means of a vertical IS curve along with a normal LM curve. In this situation, the Central Bank can achieve any desired decrease in the interest rate, represented by a shift of the LM curve to the right, without price inflation. This happens because the people’s money slated for consumption is channeled into lending and investing. Overall spending stays the same, yet the supply of present money swells, leading to a decline in the EIR. In other words, a decrease in the demand for present money is coupled with an increase in its supply. Interest rates head down, but no price inflation is observed, meaning that factors prices do not rise, apparently leading to a sustainable boost in business activity. The fiscal policy, too, will be unusually potent, insofar as a minimum of borrowing and spending by the government is needed in order to achieve a given boost in consumption. Only hoards are lent out, as people buy government bonds, and converted to government consumption. Thus, when the government borrows from the people and spends, the interest rate rises, and quantity of present money lent increases, but not at the expense of consumption but rather of hoards. There is as little crowding out as possible under these conditions, because the dishoarding elicited by the higher EIR feeds the supply of present goods. Keynes’ plans to “promote” both investment and consumption can succeed only when this unique state of affairs exists. By employing monetary policy together with fiscal policy, the authorities can achieve a decrease in the EIR without inflation and increase in Y without crowding out private spending with least amount of effort. Of course, this is precisely what happens under natural growth. The building of a civilization is accompanied by decreasing time preferences, i.e., greater providence for ever more remote future, and by increasing confidence that this civilization as a whole and with it, individuals, will endure. As a result, gross investment perpetually rises, and the percentage of cash hoarded diminishes. Attempts artificially to speed up this process either fail or backfire. Again, a free economy does not underperform. A liquidity trap occurs, when the LM curve is (almost) horizontal, while the IS curve is assumed to have a normal shape. In this case, a large change in the money supply (again, actuated by moving the LM curve downward and to the right) leads to only a very small change in both the interest rate and output. For example, the banks may be sitting on a pile of money, refusing to start lending it, because they are insolvent and expect even more losses. Liquidity is trapped inside bank vaults. New money is not spent but accumulates in hoards; people go as far as borrow and hoard. Monetary policy is impotent: the Central Bank has lost all “control” over the situation. The psychology is that investment

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opportunities that would normally seem profitable to investors are discounted by the high rate of fear (due to low confidence) and are not taken, even if the interest rate is low. For the same reason, fiscal policy in these circumstances is at its most “effective,” because government deficit spending will not affect the interest rate and will cause no crowding out of private investment. The people use their hoards to lend to the government, considering the government bonds to be a safe investment. Supply of present money increases along with the demand. Real income still rises, as a consequence of voluntary dishoarding, but now the interest rate stays the same. The way out of the Japanese predicament mentioned in the previous chapter, then, simulates fiscal policy during a liquidity trap. (That does not mean that Japan actually is in a liquidity trap.) If the IS curve is horizontal or nearly so, then both policies are now problematic. Even a high level of government spending (illustrated by a move of the IS curve upward and to the right along a regular-shaped LM curve) can raise the GDP only by a little bit. Normally, an increased demand for present goods on the part of the government, in the case of a borrow and spend policy, will elicit more savings to be brought to the market. These savings will come partially from the money that would otherwise be spent and partially from the money that would otherwise be hoarded. The stimulus will “work” because of the latter. The economic meaning of horizontal IS then is that this increased demand for present money goes together with an increase in the supply of private savings, such that the interest rate is unchanged. Unfortunately, the people are in such pain that this supply increases at the expense of consumption. The money that the people would have spent is instead spent by the government. The same thing happens if the preferred policy is taxing and spending: what is taxed away is money that would otherwise be consumed. The downward pressure on prices is let up on only by a little bit. In short, people refuse to part with their hoards, and the government “crowds out private consumption.” The same goes for business purchases: even somewhat lower prices may not spur entrepreneurs to invest; the prices have to come down still further in order for business activity to begin to grow once more. Monetary policy here has no effect either, being highly priceinflationary. It raises Y without affecting the EIR at all. Both the demand for and supply of present money rise, soon causing prices to rise and stimulating no new business deals; moreover, interest rates go nowhere. Finally, a vertical LM curve coupled with a normal IS curve indicates that government spending occurs entirely at the expense of private investing. If there is a budget deficit, then this presupposes that the

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government is borrowing from the general public (as opposed to from the domestic or foreign Central Banks). Interest rates rise as a result of the issuing of government debt without any change in real income. Fiscal policy is impotent: the government’s poking and prodding the economy produces nothing that the legislature might consider interesting. The economic meaning of vertical LM is that changes in interest rates do not affect the total demand to hold money; in other words, this demand is unresponsive to changes in the rate of interest. When the government enters the loan market and bids on present money, in the process of competing with private business firms and consumers, it raises interest rates. But no new savings are forthcoming, and the government always wins, because it does not care about profits and can in principle offer any return. (If allowance is made for risk, then the government can usually borrow at lower interest rates than private entities, its debt being considered safer.) Therefore, all the money that would have been invested in the private sector goes to the state instead. The state fully crowds out private investment. Just as in the previous case, this happens when people’s risk preferences are unusually high, and they cling to their hoards, except that now they are unwilling or even unable to lower their consumption. In reality, the LM curve is usually neither vertical nor horizontal, so crowding out occurs but is only partial. Monetary policy will be highly pronounced under vertical LM, because the Central Bank will be able to achieve a given decrease in the interest rate with minimum (money supply) inflation. Credit expansion increases the money supply and lowers the interest rates, but the people do not want to hold any more cash balances than they did in the past. In other words, they hoard no more and no less than before. All of the new money is consumed or invested, resulting in a higher GDP and lower interest rates, as the purchasing power of hoards diminishes. Note that it is not strictly speaking necessary for these boundary conditions – the IS or LM curve at its extreme – to hold true; a monetary policy and fiscal policy at odds with each other will generate similar effects. For example, a fiscal stimulus (in which IS moves to the right) accompanied by a monetary tightening (in which LM moves to the left) will simulate the consequences of fiscal policy under a vertical LM curve. It might be fun to let the government and Central Bank fight, if the “policymaking” spectacle as such were not so revolting. This is yet another reason, in addition to the fact that the masses crave credit expansion, why the Central Bank cannot be independent of political goings-on. Mutually incompatible and antagonistic to each other fiscal and monetary policies will cancel out or even harm the economy beyond the harm done to it by these policies when they are

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coordinated. 22. THAT THE TERM “NATURAL REAL GDP” IS BEST DEFINED AS THE GDP PREVAILING UNDER UNHAMPERED FREE MARKET Gordon (2009) calls natural GDP that level of actual GDP “in which there is no tendency for the rate of inflation to rise or fall.” (6) Think of the absurdity of this definition, when the rate of inflation is under partial control of the monetary authority. People do not follow “tendencies”; they act; and the Central Bank acts, as well. It can at will change the rate of inflation; it can raise it, lower it, or turn it into deflation according to its own designs. I am sure that what Gordon means is that in a consumption or investment boom generated by easy money, there is lots of production (much of it in vain) complemented by price inflation in whatever the object of the boom is, such as houses or the technology sector of the stock market. The actual GDP, if too high, he writes, “puts upward pressure on the inflation rate.” Of course, it is money supply inflation that causes the boom not vice versa. Only then do prices start climbing upward, as the market responds to boatloads of cheap credit, generating price inflation. At natural GDP, Gordon writes, the price inflation rate does not change. For how long must this rate be the same in order for the GDP to approach its “natural” level? Is the natural level of GDP simply an average over a single boom-bust business cycle? We are not told. What our author has in mind is that the economy is not being “stimulated” by low interest rates and inflationary monetary easing; nor, on the contrary, is it being steered toward a recession by means of monetary tightening. But notice that for natural GDP to prevail, all that must be true of the inflation rate is that it be constant. Its actual value can apparently be anything at all. Even hyperinflation, if kept at a steady 100% / month growth rate, would yield a natural GDP. What is so natural about that? Some of this might appear to be semantic quibbling. Who cares how the word “natural” is defined? Yet an economy that experiences a constant rate of inflation is not being “left alone” by the Central Bank. It is not laissez-faire with commodity money and 100%-reserve deposit banking requirements. It might make sense to designate the GDP produced in such a free economy, “natural”; and consider the GDPs that would result in various interventionist schemes, “actual.” The reason is that even a

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steady rate of inflation depresses the interest rate below the level desired by the people in their capacity as consumers and savers. Far from being natural, the inflation rate is artificially imposed on an economy by a quasi-government agency of interventionist “planning,” the Central Bank. Now targeting a low steady inflation rate might be a good idea if we are stuck with the modern banking system. Gordon, however, judges this policy to be “hard to control; [it] requires extinguishing reaction to supply shocks, creating highly variable unemployment rate.” (2009: 472) This is false, if by inflation we mean an increase in the money supply which is unbacked by an increase in the amount of precious metals on hands, rather than, as Gordon means by it, any increase in the price level. Obviously, demand for money plays a role along with the supply in setting the price level. The demand cannot be manipulated; hence, the alleged need of the Central Bank to react to “supply shocks”: supply shocks on the goods side correspond to “demand shocks” on the money side. The real reason why this policy is implausible is twofold. First, monetary policy is used together with fiscal policy to achieve results consistent with the desires of the state. A simple monetary policy like the one just described will not serve the statist conspiracies. Similarly, and second, a steady and low inflation, seemingly a boon, is more-or-less equivalent in consequences to zero inflation. Nothing stops the Fed in the US from freezing all its open market operations, fixing the reserve requirements and the amount of high-powered money to their present values, and letting the money supply fluctuate only via actions of commercial banks creating and destroying credit money. Of course, this still would not be sufficient to tame the business cycles; moreover, it is not entirely clear whether the Fed can leave the banks alone and abandon monetary policy altogether. Perhaps, left to themselves, the entire banking industry, compromised by its fractional reserves, would sooner or later collapse. The additional reasons why the Fed will not do this are (a) political, because, again, the state cherishes its ability to borrow copious amounts of money from the Fed, and (b) ideological, because the public loves its booms. In short, then, Gordon’s definition fails at capturing the essence of naturalness of GDP or, for that matter, unemployment rate. 23. THAT THE STATE IS NOT AN UNCERTAINTY-REDUCING INSTITUTION

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Steven Pressman argues, in a perfectly Keynesian way, that when people’s demand for money increases at the expense of the demand for goods, “because no one is hired to produce money, workers get laid off, businesses cannot sell goods, and everyone is more fearful about the future.” In other words, increased demand for money does not result in increased quantity supplied of money. Money thus “helps create unemployment.” (King 2003: 198) Pressman does not realize that the fact that workers and capital do not get reallocated from producing goods to producing money is a godsend. The fact that any money supply is as good as any other money supply in fulfilling the money’s function as medium of exchange is wonderful. It is a blessed property of money that it does not need to be produced. The workers who become temporarily unemployed during an economic slowdown have an incentive to find other more productive occupations. Their labor is not wasted in producing money. In fact, this is an argument – the only good one – in favor of fiat money: if the Central Bank is fully committed to zero inflation, then society can save the cost of digging gold and silver out of the ground. The problem is that when we calculate all the real-world benefits and costs of commodity money vs. fiat money, e.g., taking politics into account, then the former wins straight out. The only way to eliminate cyclical unemployment is to eliminate the busts which can only be done by eliminating the entire business cycle. However, it is very difficult to compel the Central Bank to maintain a stable money supply and the government to enforce honest banking practices. Higher demand for money does not mean that people do not want to consume; it means only that they want to consume at lower prices. As this demand is proportional to T / V, V is almost random or, as Mises would say, governed by “subjective and arbitrary” forces of individual preferences. The dominating factor is increasing T, as the economy progresses. I have already pointed out that this process is entirely virtuous. Pressman considers the state to be a provider or “certainty.” For example, he writes that “people may not spend if fearful of the personal consequences of becoming unemployed. A viable social safety net alleviates this concern.” (2003: 199) Again our author fails to grasp that the fear of becoming unemployed is a holy fear; it is fear of becoming useless to society. It keeps all humans alert and eager to participate in social cooperation. It strengthens the will to health and the will to life. It increases worker and entrepreneur efficiency with obvious gains to society. To continue the discussion started in (Introduction, 2), libertarians are perpetually slandered by claims that they deny the utility of a

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social safety net. That a safety net is useful is not in question. The question again is not one of ends but of means. How do we design the most effective safety net? This institution must not interfere or conflict with the society’s productive forces. It must not put a damper on social cooperation and impoverish the general population. Some folks assume quite without thinking that this net must be maintained (1) by the government, (2) in the US by the federal government, (3) coercively by means of taxation; and they assume (4) that it must be handed out impersonally by bureaucrats. All of these assumptions are questionable. For example, in reality, a safety net can only be usefully maintained within personal institutions like the family or church, in which the helping actions are joined with charity in the heart, and charity in the heart is joined with keen discernment in the intellect. Impersonal bureaucracies responsible for handing out dole have no way of distinguishing when help is truly needed from when it is superfluous and even destructive. On the side of the recipients, personal safety nets offer reproach for being supported by the gifts of others, a dose of shame if you will, thereby instilling a desire in the poor person to become self-sufficient. Many government welfare recipients think that their benefits are richly deserved, and that the taxpayers are suckers for authorizing them. Financing the safety net by taxes constitutes naked unvarnished theft, in which some members of society are forced to relinquish their money for causes for which they themselves do not care. Capitalism is a system of consumer sovereignty. Items of consumption include charitable donations. It is the people individually not the state or political majorities that decide, under capitalism, whom to bless with works of mercy. The local government is praxeologically necessary, and taxation for the sake of supporting it may be justified, if no better way gets invented. But not charity. Again, either we have laissez-faire in its entirety, or we lose the ability to argue against out-and-out socialism. The one-size-fits-all social security system, even assuming that it operates not as pay-as-you-go but as a forced savings scheme with a personal account for every citizen, presupposes falsely that people are unable to save for themselves; that they are imprudent, while the state is there to save the masses from themselves. This, I want to suggest, is the exact opposite of truth: the state is profligate beyond belief, having in the US, for example, amassed an enormous debt. Further, what it does is prevents people from customizing their retirement plans for themselves. The reason why Social Security in the United States is the third

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rail of politics is also related to money and banking. For business cycles undermine people’s attempts to save for retirement “quickly” and spectacularly; inflation undermines the same “slowly” but surely. As a result, crypto-socialists of all parties obtain recourse to the argument that the community should be charged with providing for everyone’s old age. Make banking honest and money private, and Social Security will fast come to be seen for what it is: intergenerational theft. There is no principle of justice that takes the fact that young Smith was robbed by old Jones to permit Smith, when he himself gets old, to rob young Robinson. Is it at all conceivable to people these days that a society is possible in which there are no looted who become looters simply by turning 65, that one can be neither a victim nor a perpetrator but a free person? The way of the state is not to help the poor and disabled; it is (1) to brutalize and coerce the people with taxes and show them who is boss, (2) to twist and debase the characters of the welfare bums and vicious little old ladies who are little more than willing recipients of stolen goods, and (3) to glorify this system of plunder as the outcome of “social justice” itself. The state is a robber, deceiver, accuser, and tempter extraordinaire. And if the reader thinks that (2) is hard to believe, then let him contemplate the fact that Stalin confessed to desiring that every person had something evil about them or in their past, of which they are ashamed, so that his own deeds would not seem as awful by comparison. It is true that “deposit insurance, in conjunction with central banks operating as a lender of last resort, reduces the likelihood of bank runs and financial collapse.” (2003: 199) But these policies treat symptoms only and not the root cause of the disease. They are interventionist measures piled up on top of previous interventions that were revealed as contradictory and destructive. The results are a system subject to irrational business cycles, an ever-present possibility of hyperinflation, and a government empowered by the printing press to run a worldwide empire. Certainty? I will take less of that, please. Market stabilization is an oxymoron. The market is a process in perpetual flux. The system of prices, the structure of production, and the resources involved in productive activities are each day rearranged and reconfigured by novel human action. The market continuously tends toward equilibrium yet is again and again interrupted by entrepreneurial creative advance. Conversely, what is stable are laws undergirding the market which secure property rights and rights to exchange and contract. Grotesquely, it is these laws that the government is constantly changing, thereby exposing the market to extra political uncertainty. The government stabilizes what ought not to be stabilized (the market) and upsets

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what ought not to be frequently upset (the legal system, unless it is a once in a blue moon improvement to it). Consider again the understanding of the state proposed in (Introduction, 2). It is plain that the “stability” or “certainty” the government brings is not the stability of the natural law and praxeological law and “permanent things” like human virtues and efficient common law, but of the law of the jungle: what is stable (or more-or-less so) are the amount of money the state extorts from the populace and the certain limitations on the arbitrary power of the state to harm the subjects that the latter have wrested from the state after, perhaps, centuries of difficult struggle. The government indeed hates competition, because maintaining a monopoly of force over a territory is the government’s way of limiting exploitation of the public by rival gangs of thieves (exploitation which is subject to tragedy of the commons) and taking everything it can lay its hands on without ruining the economy for itself. Some “certainty” that is. In an unbelievable passage, Pressman lauds the state for “giving economic actors confidence that the future will be like that past.” Is he familiar with the word “progress”? The word “entrepreneurship”? The word “innovation”? The future ought not to be like the past; given that people struggle to increase their well-being, their future must be better than the past! That is what the axiom of human action means. The fiscal and monetary policies, Pressman avers, “give business firms the confidence to invest, knowing the chances are good that production from any new plants will be sold at a profit. They also give consumers confidence in the future, and keep them from hoarding money in fear of bad economic times.” (2003: 200) It does not occur to him that if all “business firms” are guaranteed a profit, then we are no longer dealing with a capitalist system. A system in which profit is private, while losses are socialized is self-contradictory and impossible not merely praxeologically, as socialism is, but logically (because it makes entrepreneurship – and human action – impossible). Even if Pressman means that only during a depression must the government rescue failing companies, this does not alter the nature of my argument. On the contrary, the mass losses during the bust part of the business cycle must be allowed to occur; subsidizing bankrupt firms at taxpayer expense is worse at that time than at the time of the illusory prosperity of the boom. The “bad economic times” are due entirely to the policies of the government, and I have demonstrated that hoarding is not socially vicious. In other words, human confidence in the stability of their surroundings increases naturally with economic growth. People in primitive societies are forever at the mercy of their environment. Anything,

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from drought to illness, can happen that would doom them personally or their entire tribe or community to privation or death. But an advanced society has numerous layers of redundancy. A disaster in one part of the social body will cause a variety of fail-safe mechanisms to kick in that would protect the larger society and offer aid to the victims. Lower confidence in a bust is entirely an outcome of a poorly constructed system of social cooperation. There are imbalances in the yin and yang economic forces. They may not be life-threatening, but they certainly check economic growth and induce social unrest. Hoarding is the economy’s healthy reaction to those imbalances and its way of promoting self-healing, as suggested in (II, 10). Normally, the amount of money in people’s bank accounts that is earmarked as hoards is fairly stable. A young person entering the workforce may decide to accumulate a certain amount of cash to be kept just in case. Having hoarded enough, he begins to spend or invest his entire paycheck. An old person may on the contrary dishoard and spend, because his “rainy day” has already come. (I do not mean that the old guy must decide to die broke; or spend millions to prolong his life by another week; but for example, he may give some money to his grandchildren before he dies in order to finance their dreams.) On average, the total amount hoarded will not oscillate too much. However, an important long-run tendency with regard to the confidence rate which governs hoarding decisions is for this rate to increase with economic progress, greater market connectedness, the strengthening of the human power over nature, and efficiency of mutual aid organizations. As hoards slowly diminish, consumption is gently stimulated (insofar as there is inflation without lower interest rates; see (I, 46)). At any rate, the “policies” keep consumers from hoarding money not because they become convinced that spending or investing is now beneficial to them, but because the government taxes and spends the very money that would otherwise be hoarded. The people’s risk preferences are overridden, causing them and society harm. If the economy is being undermined, then confidence in the future is an illusion, which, we can be rest assured, will be speedily dispelled as poverty and social and economic decline roll in. One cannot just paper over real discoordination and impoverishment and economic chaos with fiat $100 bills. Pressman’s naïveté is staggering. The reason we need certainty is that both businesses and consumers “would spend more.” That is it! Spend more. That is the essence of Keynesism: prosperity is attained by “spending more.” Pressman has no leg to stand on.

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24. THAT THERE IS NO SUCH THING AS “WAR PROSPERITY” If there is any flaw in Mises’ writings, it is his somewhat cavalier attitude toward war. On the one hand, he insists in numerous places that war and market economy are ultimately incompatible with each other. “Capitalism is essentially a scheme for peaceful nations,” he points out. (1996: 828) His personal feelings are well expressed in a poignant “How far we are today from the rules of international law developed in the age of limited warfare! Modern war is merciless, it does not spare pregnant women or infants; it is indiscriminate killing and destroying. It does not respect the rights of neutrals. Millions are killed, enslaved, or expelled from the dwelling places in which their ancestors lived for centuries. Nobody can foretell what will happen in the next chapter of this endless struggle.” (1996: 832) Yet he never considered the possibility that the interests of the state and the interests of the people may be in conflict with each other. To be sure, he condemns warlike mentality and argues for “supplanting of the militaristic ideal, which esteems only the warrior and despises honest labor. There are nations,” Mises explains, “in which transient atavistic impulses toward plunder and violence, which one would have presumed to have long since been mastered, still break out and once more gain ascendancy. But by and large, one can say of the nations of the white race that today inhabit central and western Europe and America that the mentality that Herbert Spencer called ‘militaristic’ has been displaced by that to which he gave the name ‘industrial.’” (2002: 151) Moreover, Mises denounces war as such, arguing that “not war, but peace, is the father of all things.” (1996: 24) He has nothing but scorn for those who argue to the effect that “civilization, in creating unnatural humanitarian laxity which alienates man from his animal origin, has tried to quell these impulses and appetites [to fight, to kill, and to destroy]. It has made civilized man a decadent weakling who is ashamed of his animality and proudly calls his depravity true humaneness.” (1996: 170) One of the arguments Mises uses in this connection is an ad hominem, but he employs a particularly potent version of it: a charge of a performative contradiction: “It is noteworthy that the men who were foremost in extolling the eminence of the savage impulses of our barbarian forefathers were so frail that their bodies would not have come up to the requirements of ‘living dangerously.’ … The apostles of violence wrote their books under the sheltering roof of ‘bourgeois security’ which they derided and disparaged. They were

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free to publish their incendiary sermons because the liberalism which they scorned safeguarded freedom of the press. They would have been desperate if they had had to forego the blessings of the civilization scorned by their philosophy.” (1996: 172) This is beautiful argumentation, to be sure. Mises’ understanding of war has two other strong points. First is his contention that war need not eliminate free markets. For example, there is no need for price controls or inflation during a war. The best way to secure advantage on the battlefield is precisely to utilize the productive power of private enterprise. He suggests merely that the government raise taxes in order to redirect production via the market mechanism of consumer sovereignty, and therefore, “naturally,” in a manner of speaking, into making weapons of destruction. The government becomes the preeminent consumer on the market during a war; only consumption of the people and not production by them needs to be sacrificed. “Unfair” or not, armies are best supplied with the weapons of war under capitalism, Mises maintains. He warns again that “what makes war and capitalism incompatible with one another is precisely the unparalleled efficiency of the capitalist mode of production.” (1996: 8278) Second is his insistence that the war be paid entirely by the people involved in it. It is almost a moral imperative for Mises that the costs of war not be shifted to the next generation, e.g., by government borrowing. Perhaps, he thought that such a policy provided an incentive against wars. At the same time, Mises is clear that if there is a war, then it is to involve, one way or another, all citizens. Again and again, he speaks in terms of nations at war. And there is another side to having government finance the war by taxing the people, which is that the citizen who works for the war effort becomes a state employee. The line between citizens and soldiers is blurred. But if the public is financing the war, could they be justifiably targeted by the nation’s government’s enemy? Then there is his infamous and scandalous tirade on conscription: “But as conditions are in our age, a free nation is continually threatened by the aggressive schemes of totalitarian autocracies. If it wants to preserve its freedom, it must be prepared to defend its independence. If the government of a free country forces every citizen to cooperate fully in its designs to repel the aggressors and every able-bodied man to join the armed forces, it does not impose upon the individual a duty that would step beyond the tasks the praxeological law dictates. … He who in our age opposes armaments and conscription is, perhaps unbeknown to himself, an abettor of those aiming at the enslavement of all.” (1996:

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282) Perhaps, the atrocities of the wars that Mises had witnessed had hardened his heart. He himself never escaped the view that total war was an inevitable and permanent fixture of human existence. The only other speck in Mises’ eye I have noticed is the lack of his usual outspokenness about government-run or nationalized enterprises (GREs). Thus, Mises describes a certain interventionist argument as follows: “To ask that such public utilities should be self-supporting, is, say the interventionists, a relic of the old-fashioned ideas of orthodox finance. One might as well aim at making the roads and the public schools self-supporting.” (1996: 856) It is as if the idea that schools and roads must be socialized is self-evident. Bureaucratic management, Mises opines, “is the case in the conduct of an institution on a non-profit basis, e.g., a school, a hospital, or a postal system.” (1996: 310) He includes into the list of public enterprises subway systems and water works. (1946: 62) The problem is that Mises never draws a clear line separating public from private enterprises. If schools ought to be run by the state, then why not also farms and shoe factories? Mises does say that “grave arguments could be advanced in favor of restricting public spending and lowering the burden of taxation.” (1996: 857) But such arguments are sparse in his works. I believe that he would nonetheless attack GREs on three grounds. First, their inefficiency: “nationalized and municipalized enterprises… very often result in financial failure; their accounts regularly show losses burdening the state or the city treasury… due to the notorious inefficiency of the public conduct of business enterprises.” (1996: 856) Second, lack of innovation and stagnation in them: “Under a bureaucratic system it is necessary to convince those at the top, as a rule old men accustomed to do things in prescribed ways, and no longer open to new ideas. No progress and no reforms can be expected in a state of affairs where the first step is to obtain the consent of the old men. The pioneers of new methods are considered rebels and are treated as such. For a bureaucratic mind law abidance, i.e., clinging to the customary and antiquated, is the first of all virtues. … Nobody can be at the same time a correct bureaucrat and an innovator.” (1946: 67) Third, their consequences for economic calculation: given a sufficient number of GREs, there will arise islands of calculational chaos which will eventually join together and eliminate all rationality from the economy, as nationalization goes on, and the economic system slouches toward socialism. Every new GRE contributes its share to harming society. Be that as it may, Mises could have been more explicit. Hans-Hermann Hoppe (2002) has theorized that democracy has

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made fuzzy the line between rulers and subjects. Since entrance to the ruling class is alleged to be open to all (insofar as “any boy can grow up to be President”), the masses of common people have acquired the illusion that they are “ruling themselves.” One of the results is that wars, which were once the province of kings who had to finance them from their own assets and which scarcely touched the populace, have now expanded to include everyone. Democracy, in Hoppe understanding, has been in part responsible for bringing back total war.12 In a brilliant article, Gene Callahan alerts us to a distinction between a civil association and an enterprise association. The latter is “a group formed around a common purpose to achieve specific ends, and in which one must either work to achieve the stated ends or cease to be a part of the group. … Further, in so far as an individual is acting under direction of the enterprise as a whole, whether that direction is arrived at by a vote or by command from the top, the entire enterprise is responsible for the action taken. … However, an entire society… is not an enterprise association, but a civil association, united not by a single 12

My own view is that democracy is less to blame than the geographical size of the state and the number of states competing with each other for citizens and businesses. Hoppe goes so far as to deny that democracy can work even within cities, in which it produces the urban grotesquerie that we observe today. I do not agree: correctly limited, such as to property owners, requiring a fee for the privilege to vote, and so forth, a democratic government can function reasonably well in small- to medium-size towns. Federal “welfare” programs that ruin cities, like the doings of the US Department of Housing and Urban Development, must be immediately abolished. It is true, however, that the phrase “democratic self-government” is meaningless when applied to jurisdictions broader in territory than an average city which is the largest “natural” human association there can be. Finally, excellent solutions, such as fully private courts, for limiting the powers of city governments even beyond their present limits can be devised. Hayek predicts that in a successful federation, “not only will [the economic powers of states] be decreased by the functions taken over by the federation, and by those which cannot be exercised by either federation or states but must be left free from legislative control, but there will probably also be a great deal of devolution of powers from the states to smaller units. … The competition between them, together with the impossibility of erecting barriers, would at the same time form a salutary check on their activities and, while leaving the door open for desirable experimentation, would keep it roughly within the appropriate limits.” (1948: 268) My recommendation for a system of political organization, e.g., for the United States or Europe, is an extremely weak confederation uniting thousands of city-states into a web of free trade.

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common purpose but by adherence to a lex, a system of law. It is an error to ascribe to the entire society blame for some particular activity undertaken by a group within that society.” Writing about the Japanese government’s attack on Pearl Harbor, Callahan continues, “even if support for Japan’s military conquests was widespread in Japan, it certainly was not universal. Retaliation against those not in the military, such as the bombing of civilian targets, ignores this important distinction.” (6/29/2002) Martin van Creveld describes “how states, having discovered the forces of nationalism…, transformed themselves from instruments for imposing law and order into secular gods; and how, having increased their strength out of all proportion by invading their citizens’ minds and systematically picking their pockets, they used that strength to fight each other (1914-45) on such a scale, and with such murderous intensity, as almost to put an end to themselves.” (1999: viii) As Murray Rothbard has put trenchantly, Especially has the State been successful in recent centuries in instilling fear of other State rulers. Since the land area of the globe has been parceled out among particular States, one of the basic doctrines of the State was to identify itself with the territory it governed. Since most men tend to love their homeland, the identification of that land and its people with the State was a means of making natural patriotism work to the State’s advantage. If “Ruritania” was being attacked by “Waldavia,” the first task of the State and its intellectuals was to convince the people of Ruritania that the attack was really upon them and not simply upon the ruling caste. In this way, a war between rulers was converted into a war between peoples, with each people coming to the defense of its rulers in the erroneous belief that the rulers were defending them. (2000) Given this, let me suggest how Mises may be acquitted. He correctly considered the state to be an organization that is chartered by the entire community for the sole purposes of providing security (indirectly), administering commonly owned properties, if any, and managing a few local external economies and diseconomies. How can an enterprise that is so fundamentally limited and answerable to the entire people turn against society and ruin the economy through war, nationalization, regulation, and all the rest? Where does the assumption that the state can play with the economy at all come from, anyway?

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The state’s only function is to protect the citizens from individual gangsters. That is it. To be sure, the executive branch of the state itself must be monitored for any skulduggery, but that is the job of the private courts and the city council. It is the socialist and interventionist ideologies that have imbued the state – this strange institution of securing social peace – with absolute power to do anything it pleases. It is like this: Smith likes the new speakers he has bought for his computer. All of a sudden, this interest in speakers completely takes over his life. His every thought and action are centered around the speakers. He looks at them adoringly; he sniffs them; he never stops talking about them; he cleans them 20 times per day, etc. Is that not insane? Then how is giving the state the power to manage the economy not insane? The state is simply the largest and most powerful “public” gang, to which the people have reluctantly submitted so that violence from smaller “private” gangs could be suppressed and deterred. The state is a tool of survival, not cultural and economic progress and enjoyment; of security, not production and pleasure. It makes social cooperation possible, but it is not social cooperation. How could anyone mix these up? Yet this is precisely what has happened. Mises thought this was deeply and fundamentally nuts. To normal people, the state cannot be anything but a salubrious though practically invisible to an average person organization. In addition, wars nowadays have a strong ideological component; they are imagined by their supporters to be holy and good, the carnage and destruction often justified as promoting precisely democracy.13 Formerly one of the four Horsemen of the Apocalypse, wars are now considered to be a way of making the world a better place. (To be fair to modernity, I will ask when, in truth, have they not been seen as such? The holiest defenses have always been reserved for the vilest uses of violence.). This is commonly understood. The interesting 13

Aristotle considered democracy to be a corruption of “commonwealth” which is presumably a society imbued with brotherly feelings and eschewing parasitism and exploitation of minorities by majorities as a way of governing. (1241b30) Otherwise, without goodwill, democracy is, indeed, two wolves and a sheep deciding what to have for dinner. He also lists tyranny as a corruption of royal rule. Could it be that the American crusade for democracy through violent overthrowing of more-or-less tyrannical foreign governments merely substituted one perversion for another? We can arrange the systems in the following pattern: the legislature should represent the entire commonwealth; the executive branch is royal; and judges, though they may be private professionals, i.e., not on the payroll of the government, rule as an aristocracy. In such a case, restoring lawmaking to the people is a worthy goal, though war is the wrong means to it.

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for our purposes piece of ideological garb in which wars are clothed is the notion that war can bring prosperity to a nation. Let me consider some possibilities. First, there is the opportunity to plunder the defeated enemy. This, however, falls prey to the inevitable outcome of a Hobbesian war of all against all: in such a world war is perpetual, and life is “solitary, poor, nasty, brutish, and short,” though it is the lives not of individuals but of nations. Moreover, (total) war dissolves the international division of labor (and the threat of a war prevents the world markets from uniting in the first place). In fighting the enemy, a nation wipes out its own trading partners. Any desire for plunder must take into account the possibilities (1) that after bombs have reduced cities to rubble, there will be nothing left to take and (2) that killing the other side’s people even without destroying property will cut future production short. Therefore, a libertarian can impart a certain worldly wisdom even to a “mighty potentate” a la Mises: “He is convinced that victorious war is an evil even for the victor, that peace is always better than war. He demands no sacrifice from the stronger, but only that he should come to realize where his true interests lie and should learn to understand that peace is for him, the stronger, just as advantageous as it is for the weaker.” (2002: 24) There prevails, in Mises’ view, the “futility of victory” (1996: 832).14 The idea, to which some warlike “conservatives” contemptuously refer to as “economism,” namely, the claim that strong economic ties and foreign trade serve to discourage wars between the nations so connected, is entirely true. Can anyone imagine the citizens of Akron, Ohio ganging up on the citizens of Kent, Ohio? If it were not for the state government repressing violence between cities, would the Kent residents be “speaking Akronese by now”? Second, a nation may profit from selling weapons to all parties involved in a conflict. In so doing, it is like a skeleton dancing on the ruins of the world. In the end, it is likely itself to be drawn into the war. At any rate, under peace, the weapon-supplying nation would specialize 14 Mises would only affirm the pointlessness of victory and the harmony of national interests in the long run. In the short run, there may always be an attack that will benefit the aggressor, just as a robbery might benefit the robber. But an ideology that countenances war as a rule will lead everyone into the Hobbesian jungle. Hence, such morals and institutions and limitations on government power must be devised that would aim at preventing war as such, even if in practice isolated acts of war may still from time to time occur by “rogue states.”

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in producing articles beloved by the consumers not the governments. What is seen is the profit from the sales of weapons. What is not seen is the profit that would also occur by selling desks and cell phones and so on, if only there were peace. Unless a nation were unusually skilled at making weapons (and why should it be?), it would not care what to produce. Indeed, I am assuming such cynicism and agreeing with Mises’ thesis that the market will manufacture whatever is being demanded, whether atomic bombs or mere physics books for students describing how atomic bombs operate. Third, in a severe depression, the government may conscript the unemployed to fight as soldiers in a war. It will thereby deal with a “political problem”: perhaps, the unemployed are a fertile ground for revolutionary ideas. Now under unhampered free market, there is no such thing as permanent unemployment. Such a phenomenon is always and at all times government’s own creation. To allow the government to kill the very people that it has put out of work is to put a premium on creating severe depressions. It is to remove any incentive the government might have not to wreck the economy. This is not a path to prosperity, either. Finally, I come to the Keynesian view that a war can help by “stimulating” the economy with government spending. E.g., Paul Davidson (2009) is explicit about this: “[Franklin Roosevelt’s] spending on winning the war financed by huge government deficits proved… that the government could always play an active role in guaranteeing full-employment prosperity for its entire civilian labor force.” (144) Remember that Keynesians do not care if their “public works” are useful or not. The only things that matter are the amount spent and the multiplier. But it is hardly a long step from the indifference between useful and useless to the indifference between useless and destructive. The idea of fiscal policy began with imagining that government spending (whose usefulness is merely a secondary consideration) can generate private spending that would cause an increase in happiness, were it not for perverse hoarding. In the first place, it advocates a Keynesian cure for a sickness induced by previous Keynes-inspired policies. In the second place, it is coercive over individual preferences and socialistic, overthrowing consumer sovereignty; it fosters a business cycle due to distortions in the futures markets; and it fails to consider (1) the curative properties of hoarding, (2) the phenomenon of crowding out of private consumption and investment, (3) the key point that in order to permit spending, there must be products and services on which money can be spent. A higher velocity of circulation of money does not make a poor society richer. Having extolled war, Davidson continues that Eisenhower’s “building the interstate highway system… created profits and jobs in

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construction and related industries.” (145) First of all, the highway system could have developed privately in obedience to consumer rather than government preferences. Second, must I refer to what is seen and what is unseen? Because resources were forcibly tied up in highways, which industries were never created, which suffered losses, and which lost jobs? Higher savings invested coupled with technological progress will, indeed, increase productivity of labor and create a greater amount of goods and services per capita, provided that the entrepreneurs will make no errors. (Of course, it is up to individuals to form their own time preferences and balance present consumption with investments into future goods.) But with nothing produced, even a high amount of money changing hands will yield little consumer surplus. Beating plowshares into swords may keep people busy, but to what end? And now the fiscal policy is openly admitted to destroy things that make people happy, both in its capacity as having an opportunity cost of unmade consumer goods, and when the government’s bombs blast public and private properties. The “multiplied” private spending is supposed to rebuild the shattered societies and to add insult to injury, be a pleasant activity. An obvious rejoinder is to ask: “What is to guarantee that the multiplied spending will not be destructive, either?” Full employment can be generated just as well when people are busy purposively grinding goods into dust. This madness must stop. One cannot save a village by destroying it; similarly, one cannot make the villagers richer by acts of destroying goods, both by blowing them up and by consuming them ever faster, that the government calls an “economic stimulus.” 25. THAT THE SIZE OF THE GOVERNMENT AND GOVERNMENT DEFICITS FEED ON EACH OTHER

Gordon considers both the size of the government as measured in its spending as compared with the GDP and the government’s budget deficits to be separate “policy instruments.” “A given government deficit can be achieved with high spending and high tax rates or with low spending and low tax rates.” (2009: 453) That surely is not right. A small government whose tax revenues are $1 billion cannot possibly run, say, a $1 trillion deficit. It is impossible both politically, in that such a comparatively enormous borrowing will never be permitted by the voters; economically, insofar as such borrowing will severely disrupt the

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markets; and financially, because no one will lend the government so much money. Only a “big government” can afford large budget deficits and accumulate a large public debt. That was the point of Minsky’s observation first examined in (II, 13) that a big government can prevent depressions but at the cost of stagnation and inflation. It is interesting that Keynes has few kind words to say about “the rentier.” In fact, he is partial to “euthanizing” him. Yet he never mentions the fact that the interest on government debt goes from the productive individuals and companies to “idle” bondholders. This burden can slow down investment and business activity. First of all, “history does not provide any example of capital accumulation brought about by a government. … What individuals had saved was dissipated by the government.” (Mises 1996: 851) Steven Landsburg suggests that deficits do not matter. (1997: Chap. 15, “The Arithmetic of Government Debt”) He is correct in the sense that if a person does not care about future generations, then he can live it up and leave them with nothing even in the absence of government deficits; on the other hand, if he does care about those generations, then he can provide for them just as well even if the various governments are running deficits. For he can leave a bequest which will collect interest and help his grandchildren pay the higher taxes due to interest on government debt. I fully agree that the man who arranges a bequest will essentially tax himself in order to neutralize the effect of government borrowing, “converting” for himself debt into taxes. Whatever else we might say about Rickardian equivalence (such as that tax policy is more predictable than “deficit policy”15 or that different ways of financing deficits have different short-term effects), deficits matter for the same reasons why taxes matter. Both are inimical to prosperity. Second, this is not a mere transfer payment which may seem economically innocuous in the sense that Smith loses, and Jones gains. 15

The entire point of deficit finance is to evade the will of the voters regarding tax policy. Deficits are fundamentally discretionary, resorted to whenever the state finds doing so to be expedient. Thus, the voters may elect congressman Smith who promises not to raise taxes. The same congressman may also proclaim his desire to balance the budget. We see the difference right away: Smith preserves taxation but abolishes deficits as an institution. It is unlikely that Smith would run promising to substitute, say, borrowing from the public to monetizing debt through the Federal Reserve, as if the former has been proven destructive, whereas the latter will lead us to a new golden age. In other words, the voters’ power to influence taxation, however ineffectual it may be in actual practice, is far greater than their ability to authorize a particular deficit or a particular way of financing it.

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The economic effects of taxes are insidious. Thus, some (1) entrepreneurs and (2) factors are (a) taxed, and others are (b) subsidized. Regarding (1a), if taxes are raised to pay the interest, then the marginal investment projects (which would be profitable without the taxes but are unprofitable with them) will not be undertaken. Taxes discourage creative human actions by reducing the rewards from such actions yet preserving the risk. The cost of this is slower growth, because consumption is stimulated at the expense of investment, yet another government intrusion into what is normally an outcome of numerous private decisions. The government essentially commandeers consumer and investor authority. For example, taxes on profits converted to income are problematic, because before a businessman has earned it, there was a chance, in part quantifiable and in part not, that he would earn less, nothing, or lose his money altogether. The prospect of high gains was for him necessary in order to decide to undergo the risk at all, to enter the competition which produces both winners and losers and in fact, must by necessity produce both. If their income is taxed away, then marginal entrepreneurs will choose not to start new businesses or expand existing ones, because the reward will be made by taxes too small to bother with the risk.16 John Maurice Clark writes about a businessman reasoning about a potential investment as follows: “If we lose, we lose. And if we win, the government will get most of it. I guess we won’t go into it.” (Haberler 1951: 303) Here I mean that well advised, i.e., non-Fed-initiated, risk-taking will fail to take place. Society will become rigid, boring, and ossified. For (2b), people will be paid not to work. We are inured to the welfare state and may need to stand back a bit to realize the repugnancy to reason and justice of producing nothing but still getting paid. It is not so much that one who does not work does not “deserve” to eat; or even that whoever does not work does not eat; but rather, one eats what he produces. Take away division of labor and specialization for the sake of clarity, and people who fail to grow their own food naturally starve. Being on welfare is deeply unnatural and perverse and is an attempt to cheat at life. As Rothbard points out, a parasite “violates… also the nature of the aggressor himself, who abandons the natural way of production – of using his mind to transform nature and exchange with other producers – for the way of parasitic expropriation of the work and product of others. In the deepest sense, the aggressor injures himself as well as his unfortunate victim.” (1998: 50) To use our understanding of the three kinds 16

The risk may be lowered eventually, as other entrepreneurs drop out of competition, but then the risk to reward ratio was unacceptable to them.

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of good, in doing physical evil to his victim, the parasite brings moral evil upon his own self. Again, with respect to (1b), entrepreneurs who are subsidized end up producing the wrong things from the consumers’ point of view. They may satisfy the state, but society will be poorer when such privileged enterprises slurp up scarce resources for no good reason. Case (2a) is a little more involved. How will a factor, such as a worker, respond to income taxes? Will he work more of less? And if he works more, will that not be socially virtuous? Suppose that under freedom, Smith chooses to work 8 hours per day, 5 days a week, 52 weeks a year for $20 / hour. He thus receives $41,600 per year. As far as he is concerned, the disutility of working a 9th hour every day (and forgoing R & R) outweighs the happiness he would enjoy from the extra $5,200 per year. On the other hand, the irksomeness of, say, the 7th hour is not sufficient to get Smith to choose to spend it on leisure. As hours per day at work are accumulated, and income grows, the disutility of a marginal hour (most likely) rises, while the utility of the marginal yield obtained by working declines, since the newly acquired income will be allocated toward increasingly less urgent wants. Suppose now that taxes have reduced Smith’s income from $41,600 to $31,200. Smith still works 8 hours per day but only 6 of those for himself, toiling 2 hours every day for the state. Faced with the new reality, will Smith attempt to recoup some of his losses by working more than 8 hours per day? That depends on the amount of tax, because Smith has to estimate his pleasures only with after-tax income. In our case, on the one hand, Smith’s income has fallen, making any extra money he can earn more valuable. On the other hand, by working an extra hour, Smith will be bringing home only $5,200 * 0.75 = $3,900. When the tax is low, Smith will probably work more. If we start at 0% and keep raising taxes, the variable “hours worked” will start at 8, peak (e.g., at 11 hours reached at 21%) and starts to decline, at some point falling back to 8 hours (e.g., at 38%), declining further at still higher tax percentages, and ending at 0 hours at 100%. If Smith works less, then society will suffer in an obvious sense. If he works more, then the situation is less clear, but I will say that a master who squeezes from his slaves every ounce of performance may be happy, but the slaves – who are also members of society – are surely miserable. By working longer hours, Smith chooses the lesser of the two evils. Surely, humans are not bees, doomed to spend every waking hour working for the sake of others or the hive. That Smith fails to consume leisure condemns taxes as counterproductive. In all four cases, taxes will harm society.

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The US government has seen fit to deal with its enormous debt in several ways. First is inflation which whittles down the real burden of the debt. Second is government growth as a proportion of the GDP which makes old debt appear trivial. Third is engineering a ploy to make the dollar a world reserve currency, such that foreigners would be steered into financing the US government deficits. It is plain that these ways of diminishing the threat of the debt to the federal government’s solvency correspond to the ways of financing the deficits which make the debt bigger. The government can borrow from its own Central Bank, from the citizens, and from foreign Central Banks. The US government has made deficit spending into an art form. Of course, the bigger the deficits, the higher the debt, the greater the size of the state and its spending, the smaller the deficits of previous years seem in comparison with the deficit of the succeeding year, and the higher the next year deficit can be. A trillion dollars is an unimaginable number; I venture to guess that most people do not grasp just how vast and powerful the US empire had become by 2010. Inflation and the power to inflate are particularly interesting. Both the banks and the federal government benefit from inflation, but in different ways. For the former there are, at the first glance, two apparent such benefits. First, banks can now treat checking and saving accounts as CDs and loan them out, even though these are redeemable on demand. Second, they can loan out a lot more cash than they have in reserve. The banks’ assets can cover only a fraction of their liabilities in case of a bank run. These may look impressive, but they are, in fact, trivial advantages, and in the long run they do not even matter, because the temporarily higher profits will attract other banks in the industry (if there are no barriers to entry) and lower the profits to their market rates. Even with a 100% reserve requirement, banks could compete with each other, innovate, provide better service, and thereby attain higher profits than the duller of their competitors. The privilege to defraud, in the long run, is useless to the banks. The only genuine benefit they enjoy is a much reduced possibility of business failure or bankruptcy. The Federal Reserve stands ready to loan the banks any amount of cash to help them with any difficulty. This protection from entrepreneurial errors courtesy of the paternal Central Bank makes banks somewhat like government enterprises; it causes listlessness and lassitude, discourages innovation, creates a moral hazard to lend sloppily, and makes banks less interested in serving consumers. In the US, unlike, say, in Argentina or Zimbabwe, as of 2010,

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the expansion of the money supply does not directly benefit the federal government. That is, the Treasury cannot order the Fed to buy its newly issued securities; it has to compete for capital on par with everyone else. But it nevertheless enjoys the following three advantages. First, it benefits from inflation in the same way any other borrower does: it gets to borrow money at lower interest rates. Second, it pays no interest at all on securities held by the Central Bank. As the Fed itself states, “Federal Reserve Banks are not… operated for a profit, and each year they return to the U.S. Treasury all earnings in excess of Federal Reserve operating and other expenses.”17 Third, unlike private debtors, the government never has to pay back the principal. The debt is not expected to be retired. Everybody knows and is resigned to this. When the bonds mature, the Treasury issues new bonds of an even greater total value to pay off the old ones. This is a Ponzi scheme made more attractive by the fact that the Fed’s never-ending money creation puts more cash in the hands of the public and lowers the interest rates the government has to pay, if it borrows from the public. In this way, the debt is never paid but is continuously “monetized.” The government enjoys interest-free money, which it never expects to pay back, which causes the debt to grow every year. An organization could not have gone into $14.7 trillion (as of 2011) debt without the ability to inflate. Not even the power to tax would have been of help here. At some point, the lenders would have realized that any attempt actually to repay the debt would ruin the economy; interest rates would have skyrocketed; and the government would have had to break its contracts and default. Americans keep buying government bonds, because these bonds are backed “by the full faith and credit of the US Government.” Citizens of other nations do, because the world is on a dollar standard, and for now, there is nothing better. And the US Fed prefers to buy government debt in its open market operations; and moreover, it may be instructed (it depends whether secretly or not) to do so by the government in order to facilitate the latter’s fiscal policy (remember that the monetary and fiscal policies must be in sync in order not to produce a complete catastrophe). That is why, for example, from 1995 to 2005, the value of the Fed’s portfolio increased almost two-fold – it is the means by which the operation continues. And it will keep increasing, until a real reform takes place. To rephrase the point made in (I, 54), the threat of massive 17

http://www.federalreserve.gov/pubs/frseries/frseri3.htm

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inflation is precisely what has kept borrowers willing to buy so much US government debt. They know that the state will never default. But this threat is like mutually assured destruction: if the feds actually go through with it, then it will be a disaster. The borrowers realize that in the case of an economic collapse, they will be paid back in money of lower purchasing power. This, however, is not enough to deter them: in the opinion of most people, the power of the US state is eternal. Thus, people worry about actual hyperinflation while enjoying the benefits of possible one. Perhaps, they do not even worry about it, for two reasons. First, folks think that their profits as creditors are “private,” whereas if the US does go down in flames, then they “collectively” will have more to worry about that some lost interest income. They will not suffer the opprobrium of being bad entrepreneurs, because everyone will be in trouble. Stated differently, in a normal Ponzi scheme, if a person thinks that a possible investment opportunity is a scam, then he may be wary of committing money to it, because he may turn out to be one of the last investors, after whom the scheme will quickly unravel. He will be left holding the bag, while the early investors may already have received high profits. But in a Ponzi scheme in which the tricksters have the power to print money, any investor realizes that if push comes to shove, then everyone will suffer from hyperinflation and not just the newest lenders. Every holder of US dollars, except the government, potentially billions of people will be unpleasantly surprised. He will not be proven to be a sucker. Second, the actual event of the destruction of the dollar, a kind of mini-end of the world, feels so improbable to them that they figure that it can safely be treated as impossible for all practical purposes. Most people do not believe that it needs to be hedged or insured against. Now I do not, of course, think that inflationary monetary regimes benefit the world or even Americans. It is true that certain advantages to the people ruled by the Central Bank in control of the world reserve currency and to the state owning this Bank do exist, ephemeral and zero-sum though they are in the long run. But sound money has the power not only to propel economic progress forward much faster but also to foster good will in our world. It is a genuine means to both prosperity and peace. The size and power of the state are perpetually enhanced by the state’s going into ever higher debt by means of ever higher deficits. Conversely, the always growing, year after year, deficits are possible only because of ever bigger government. These two feed on each other and make any kind of “limited government” an impossible ideal to reach.

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Summa Against the Keynesians 26. THAT THE KEYNESIAN OBJECTIONS TO FREE TRADE FAIL

The law of comparative advantage introduced in (Introduction, 2) illustrates the benefits of division of labor. Paul Davidson attacks it on three grounds. First, he argues that for a number of industries, production can proceed in different areas of the planet with equal efficiency. Therefore, “mass production industries… are likely to locate factories in those nations where the economic system values human life the lowest.” (2009: 112) Now the reason why Chinese workers are poor is because of low amount and quality of capital, both human and physical, that is invested into them. In the free market, one’s wage tends to approximate one’s DMVP, and one’s DMVP is increased when powerful equipment and tools are used in the workplace. But for as long as the poor nations remain poor, the law of comparative advantage takes a particularly strong form, because rich nations can specialize in capital-intensive projects, and poor nations can specialize in labor-intensive projects. Global efficiency is thereby increased: in economics, diversity is strength. Davidson writes: “Under current conditions, free trade with low-wage nations is not free competitive trade at all since the U.S. law prohibits American entrepreneurs from matching Chinese labor hiring and working conditions.” (2009: 113) Is he serious? American entrepreneurs cannot pay their workers as little as Chinese entrepreneurs do, law or no law, because of these workers’ high productivity. The butler paradox shows how even a laborer who uses no capital in his work, such as a butler, benefits from capital accumulation in his community and enjoys ever higher wages. This is because his employer is always in danger of losing him to capital-intensive projects where he will be ever more productive and so must offer increasingly higher (real) wage to prevent that from happening. While China remains poor, Americans retain a competitive advantage in capital-intensive industries. It is, therefore, absurd to hold that free trade will “reduce the wages of American workers to less than a dollar per hour and simultaneously permit American children to work in factories, as Chinese children do, so that the family can earn enough to avoid starvation.” (2009: 112) That is assuredly not going to happen. On the other hand, if “the East ultimately will attract enough foreign capital… to meet global demand,” (2009: 118) and China becomes as wealthy as the US, then American workers will again be in no danger of becoming poor, precisely because division of labor will be beneficial even if China is better than the US at producing everything. Our author, in addition, has a faulty view of competition. His

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reasoning is that competition, if it is to be legitimate, must be somehow fair. Everyone must start out in the same conditions. Davidson does not grasp that the purpose of market competition is to improve consumer welfare, and this purpose is served even if entrepreneurs have varying amounts of starting capital, and even if the prices of the nearby factors of production differ for them. Second, real-world competition is marked by the rivals’ attempts not only to win under “fair” conditions but precisely to position themselves better relative to others even at the onset of any productive endeavor. That, too, serves consumers. Moreover, American entrepreneurs have no duty to pay high wages to American workers. Escaping overseas into China and collecting the benefits of cheap labor are not a violation of any plausible moral law. The notion of fairness of catallactic competition is nonsensical. Second, Davidson argues that it is not obvious that the superadded fruits of division of labor will all find buyers. Well, to be sure, an individual producing for himself will have an easier time not making entrepreneurial errors than an individual producing for other people, the consumers. I argue a similar point in (I, 15). But what of it? All people have by their actions demonstrated a preference for a greater abundance of goods brought about by division of labor. No one wants to go back to autarkic conditions, especially for such a silly reason as that when he, in some dystopian future, grows his own food, he might be able to produce tomatoes that suit his taste more precisely than the tomatoes grown by farmer-entrepreneurs in a sophisticated economy. Third, Davidson points out that the law of comparative advantage holds only under the assumption that neither capital nor labor is mobile across national boundaries. This is entirely true. But Davidson is mistaken if he thinks that the experience of today’s world, in which the mobility of both capital and labor is higher than it has ever been before, refutes free trade. On the contrary, given such mobility, there is no longer any essential difference between national and international trade. Both stand or fall together. Capital travels to labor and vice versa, and the same wage eventually is earned for the same work everywhere in industries not tied to a particular parcel of land, as agriculture and mining are in some cases tied. If Davidson considers free trade between the states composing the United States to be fine and good, then he must, on pain of contradicting himself, find free trade between the United States and Canada fine and good, as well; and with that, between US and China. The law of comparative advantage illustrates that even under the worst possible conditions, in which only consumer goods cross national borders, though not capital goods or labor – that even then international

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trade benefits all parties. For example, in considering Smith and Jones in the example in (Introduction, 2), I assume that the human capital of Smith cannot easily or immediately penetrate into Jones, and therefore, their productivities differ. The anti-economist Taleb (2010) condemns globalization for a different reason. He thinks that it is efficient “naively”: if there is an unexpected change, then a specialized nation will suffer gravely, having invested too much into achieving competence in a field that is, perhaps, no longer valuable. Now before there is specialization between nations (which is useful to acknowledge, because each nation is governed by a state with its own legal system which influences the areas of specialization), there is specialization between individuals. It is true that if Smith is a computer programmer, then if the demand for programming were to slacken, then Smith would have to contend with lower wages or become unemployed and “forced” to learn new skills. That danger does not entail that specialization is foolish, nor that people should be exempt from the market responsibility to forecast which occupations will be more stable than others. One may even face a choice between a more “dense” occupation (i.e., one that yields more income per unit of time) and a more “durable” one (i.e., one that yields income for a longer period) and have to calculate which suits him more. There is never a chance to escape the duty to commit to something (a project, a spouse, a personality), just because making the choice is potentially fraught with error. On the contrary, the mutual dependence of people in a global web of trade creates useful “redundancies” (Taleb’s term). A small isolated community can starve if a single harvest is ruined by a fluke in the weather. On the other hand, if tomorrow the entire Latin America vanished into thin air, then there would still be coffee available to the folks in the US. The existential plight of entrepreneurs – risk and surprises, requiring constant exercises of prudence and courage – serves the consumers adequately. Now to be sure, that there is so much capital accumulated in the US, and so little elsewhere, is a settled historical fact. For example, the US has enjoyed a strong tradition of liberty and respect for private property rights which contributed to its affluence. A company that wants to outsource its labor force to a poor country will, at first, be immune to the butler paradox, because of intense worker competition there. As long as there is little capital accumulation overall in society, a firm can import even the most sophisticated tools and still save a bundle on labor costs. A worker will be very productive in that firm’s line of business but receive low wages, since his community will still be poor, until the amount

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of capital invested per worker reaches some critical mass. Immigration presents its own complications. If both capital and labor are mobile, then, abstracting from the political problems of mass immigration, and even assuming that only labor is mobile, i.e., unemployed people cannot move easily (contrary to all reason, because it is precisely the unemployed who are most in need of relocation services), it is the case that the capital presently concentrated in the US will become “spread” over the entire world. Hundreds of millions of people will want to move to the US, and firms will want to move out of the US. This would improve the standard of living of the poor in the “developing” countries but indeed, lower the standard of living of the US workers. Imagine half of Africa suddenly moving to the United States. It is unlikely that the wretches will arrive with any capital goods in tow: tools, equipment, machinery. Before, the American Smith was a construction worker and was comfortably matched in his work with various complementary produced factors. Now, there are five more people competing with him for use of those capital goods. The average productivity of labor within America falls dramatically. Smith is poorer to that extent, even if the immigrants are somewhat richer. It is this and not the possibility that immigrants may take advantage of the welfare state that has people worried about opening up borders. However, as economists, we must not take the parochial view of “America first” but be mindful of the interests of the entire world. Marshall argues that “custom in a primitive society… prescribes an attitude of hostility to strangers. In a modern society… neighbors are put more nearly on the same footing with strangers. In ordinary dealings with both of them the standard of fairness and honesty is lower than in some of the dealings of a primitive people with their neighbors: but it is much higher than in their dealings with strangers. …sympathy with those who are strangers to us is a growing source of a kind of deliberate unselfishness, that never existed before the modern age.” (1964: 5) That was, of course, written before the mass slaughter of World War I. But the devil’s century has finally left us, and we should struggle to live up to Marshall’s observations of the state of affairs in the 19th and early 20th centuries. Even in the unique situation in which we find ourselves, there is everything economically right about freedom of movement of capital and labor both within and between national borders. This is the fastest “path to global economic prosperity” in the long run. Do the Mexicans, say, take American jobs? Assuredly, they do.

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However, in order for the situation to be ameliorated, it would be sufficient that for any 50 Mexicans who become workers here, 1 becomes an entrepreneur and creates jobs both for his fellow Mexicans and for Americans, as well. The whole reason why this rarely happens is that the Mexican illegal immigrants have no standing under the US law. How could they become entrepreneurs with all the settled responsibility (such as, at least, a permanent address) that this implies, if they cannot even get driver’s licenses legally? We need to retain and even reinforce the privileges of citizenship: immigrants should not be able to vote or be elected to public office; but the status of “illegal immigrant” ought to be abolished. What Mexicans do take is the use of capital that is clustered in the US. But that, too, is scarcely relevant, because if Americans enjoyed sustainable economic growth with sound money and banking, no taxes beyond the local, and the rest of my pleasant visions, then they would be happy to “share the wealth” with the Mexicans. In all probability, there would be an immense sense of pride that America is such a magnet for immigrants. Moreover, a great political system would attract capital back into the US, as opposed to the current incentive to companies to go overseas. The American system of government needs to stay competitive and improve, not deteriorate. Banish the cynical thought that good government (and in many cases, no government) is a pie in the sky. It is a laudable goal, worth fighting for, and never a lost cause. An evil empire can last for a century, look impregnable, and disappear in a day. There is even more to it. An increase in wealth brought about by capital accumulation will strengthen the incentive for people to have more children. Now people purposively limit the number of the children they have precisely to enjoy the fruits of their labor. Children are expensive in two senses. First, as helpless infants to their parents. Second, even when they grow up to society as large; that is, to each other as workers competing for jobs and bidding down wages. Regarding the first sense, in times of peace and prosperity, people’s happiness may overflow into their kids. I fully endorse the wisdom of St. Thomas that the “generation of offspring for the multiplication of the human race” is a “great blessing.” (ST, I, 98, 1) The “optimal” population size can only be discovered and reached under unhampered free market with the aid of the individual and family responsibility promoted by it. Regarding the second cost, let us consider an extreme case of there being so many machines out there that there are not enough people to work them. Then accumulation of novel capital must slow down, and complementary to capital labor must be found, either by means of capital

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goods physically moving to workers or vice versa. It is far more efficient to do so than to abandon whole projects and industries due to something so easily remedied as dearth of workers. The latter process can relieve the scarcity of workers and reignite economic growth. (Machines, such as some sort of super-intelligent robots, can perhaps be designed and built that “on their own” produce other machines, but in practice it is much cheaper to import some folks from abroad. At any rate, we have dealt with the differences between men and machines and thereby also between labor and capital already.) It may be readily objected that we are far from the happy surfeit of capital under consideration. That is true, but that is our fault. And in second place, the poverty of other nations will under freedom of immigration cause a tremendous influx of people into the more prosperous countries. True, as well, but that is now their fault. What both faults have in common, however, is that they stem from similar anti-laissez-faire ideologies and from Keynesism in particular. If Keynes were decisively refuted, and if nations quit ruining their own economies, then immigration policy would become a non-issue, and freedom of movement (restricted only by private property rights) would in not-so-distant future reign throughout the world. The reason is, again, that free nations, like happy families according to Leo Tolstoy, are all alike in the most important ways. “The funniest thing about Europe,” says Vincent in the movie Pulp Fiction (Miramax Films, 1994), “is… the little differences.” In other words, cultural differences. Laissez-faire capitalism in country A will make it less likely for a person to feel the need to emigrate to country B. The pressure on countries with a high standard of living now treated crudely with coercive immigration controls will subside. Insofar as people do move around, there will be no easily identifiable pattern to the migrations, just as it is hard to track how Americans move throughout the very porous states, cities, and communities within the United States. Recall the discussion of ideology in (Introduction, 1). A pertinent query is how one can measure general happiness. A useful measure is precisely immigration. If more people move from country A to country B than the reverse, voting, as it were, with their feet, then country B must be doing something right. The economist David Friedman understood well the civilizing effects of the ability to emigrate: “Consider our world as it would be if the cost of moving from one country to another were zero. Everyone lives in a housetrailer and speaks the same language. One day, the president of France announces that because of troubles with neighboring countries, new military taxes are being levied and conscription will begin shortly. The next morning the president of

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France finds himself ruling a peaceful but empty landscape, the population having been reduced to himself, three generals, and twenty-seven war correspondents.” (1995: 123) By cutting off immigration, we lose the ability to gauge our own relative national success. Speaking of taxes, Americans seem to think that paying them is a badge of honor rather than a sign of servility. The Mexican sub-economy in the US is far freer than every other economy, precisely because the illegals operate below the government radar. But if Americans wanted immigrants to pay taxes, then the best way to achieve that would be to legalize all movement of people through national and state borders. Having dealt with Davidson at this point fairly thoroughly, I am no longer certain whether he can claim for himself the mantle of economist. Keynes deserves a worthier champion. 27. THAT “MARK-UP” PRICING IS ABSURD Frederic S. Lee has a Post Keynesian idea. The idea consists essentially in denying that consumer demand has anything to do with determination of prices. Whereas one of the central messages of Austrian economics is that capitalism is mass production for the masses of the consumers and is guided by those consumers, this understanding is entirely lost on our author. One would normally have it that consumers, by choosing to spend their money on some particular baskets of goods and in so doing, refusing to spend it on all the other possible baskets, influence the prices of the consumer goods. A firm, thus, projects the demand curve for its product and chooses that point on the curve that appears to maximize its profits, if that firm is an innovator. If the firm is an imitator and is trying to seize arbitrage gains, then it is more limited in its price-setting process, but in both cases there must be a demand curve in the minds of all suppliers.18 18

Contra Elizabeth Webster, arbitrage is not a “zero-sum activity.” (King 2003: 294) From the point of view of the money flows, all entrepreneurship is eventually zero-sum. From the point of view of human happiness, no entrepreneurship, even arbitrage, is zero-sum. Under arbitrage, prices fall, and incomes to factor owners rise, benefiting the great majority of the consumers. An obvious example is a disaster area, in which the prices of necessities have shot up greatly. These high prices encourage entrepreneurs to bring in fresh supplies as soon as possible in order to be the first to benefit from the arbitrage opportunities. The results are that goods go to where they are most urgently needed, and that the prices come down to pre-disaster levels within

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Lee believes that firms set the prices of their products in an entirely different way. What they do, he claims, is calculate their costs of production and add a mark-up to those costs which constitutes their profits. Now Lee is right in saying that “the price of a good is set before the good is produced and exchange takes place.” (King 2003: 285) That, however, is merely the projected price, one that the entrepreneur thinks he can get for the product. Moreover, the price may, indeed, be such as to let the entrepreneur profit, at least in his dreams. But this price is determined not by costs of production but by expected consumer demand. What costs of production do determine is whether any given good, whose sale is estimated to return some amount of revenue, will be selected to be produced at all. But a businessman does not pick a random good out of thin air, say, shovels or mushrooms or kittens, slap a markup on it, and get busy producing it. How would he decide, out of millions possible production processes, which one to undertake on the “mark-up” pricing strategy? Any good can be marked up. And how would he determine the value of the mark-up? The sky seems to be the limit. Further, the demand curve suggests not only the price but quantity supplied, as well. Without it, what determines how much output a firm engaged in mark-up pricing will produce? Finally, the entrepreneur can add a mark-up on the price, such that the revenues will exceed the costs, only if his prediction of the state of the market was correct. If he had made a mistake, it is entirely possible that he will have to sell at a loss. Again, the consumer is king and is telling his subject the entrepreneur to serve him better. Lee may have succumbed to the childish error that Mises describes as follows: The orders given by businessmen in the conduct of their affairs can be heard and seen. Nobody can fail to become aware of them. Even messenger boys know that the boss runs things around the shop. But it requires a little more brains to notice the entrepreneur’s dependence on the market. The orders given by the consumers are not tangible, days, if not earlier, far from zero-sum events. Cf. Marshall (1964): “It is sometimes said that traders do not produce: that while the cabinet-maker produces furniture, the furniture-dealer merely sells what is already produced. But there is no scientific foundation for this distinction. They both produce utilities, and neither of them can do more: the furniture-dealer moves and rearranges matter so as to make it more serviceable than it was before, and the carpenter does nothing more.” (53)

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Summa Against the Keynesians they cannot be perceived by the senses. Many people lack the discernment to take cognizance of them. They fall victim to the delusion that entrepreneurs and capitalists are irresponsible autocrats whom nobody calls to account for their actions. (1996: 272)

An entrepreneur is, indeed, a novelty bringer. He creates new products, new marketing campaigns, new methods of production, and new types of business organization, because the only way to profit in the state of an ERE is to introduce something not yet experienced into the world. But an entrepreneur does not reach into an urn, pick a technology at random, and go on to implement it. He builds his business upon only those ideas that he hopes will yield profit to him. Answering the question “What factors cause the price of X to be such-and-such?” an economist can reply “Supply and demand.” This is curt but true. Lee has it on the contrary that prices are set “without reference to an inverse price-sales relationship and are not set to achieve a specific amount of sales.” (1996: 288) Again the influence of consumer demand is ignored; the very law of demand is nowhere mentioned, or at least, its relevance is denied. It is true that no businessman cares simply about the number of sales, i.e., quantity supplied; one could sell practically everything that is not an economic bad by lowering the price of his good down to a penny. That is not at issue. What the businessman really wants to do is maximize his profits, but the only way of doing so is to take into account the demand for his product. Another point is that costs of production do not determine the prices of output; it is, on the contrary, the demand for output, such as for consumer goods, that determines the prices of the factors of production. The prices of the factors are imputed from the prices of the goods made with their help. It is true that a particular firm is faced with a definite array of factors prices. But the way these prices are altered is by means of entrepreneurial action that considers them to be “false” and reflecting a state of consumer satisfaction that is illusory due to global ignorance and that can, in the entrepreneur’s estimation, be improved. Once the good is out there and is being sold at a profit (and therefore, at new prices), forces arise that lead the economy into equilibrium and toward disappearance of profits. The changes in the prices of the factors of production (and therefore, costs) play a crucial role in this process. Thus, changes in costs react to changes in prices, and neither the businessman nor the economist can utter anything so silly as “prices are determined by the costs of production,” unless he is describing the market process as I do in (I, 10-11). Even then, prices do not go down to costs but both

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converge to yet a third value. The socialist slogan “production ought to be for use not for profit” seems to have exactly this situation in mind. Socialists consider the mark-up to be robbery. Why should not the consumer surplus be as high as possible, and why should not the entrepreneur sell his goods “at cost”? The reason, of course, is that consumer demand determines prices and output of consumer goods, and these prices help to determine costs (again, via the mediation or actions and projections of entrepreneurs, as per (II, 8)), not the other way around. The entrepreneur does not sell “at cost”; rather, factors of production eventually cost “at prices.” More complex yin and yang phenomena may be considered. Take “luxuries becoming necessities.” Say, one company has invented a Violet-ray DVD player and has embarked on producing it for public consumption. At first, the device is crude, costs a lot to make, but the richer folks show interest by buying even at high prices. The technological process of building these VR DVD players slowly gets perfected. As a result, at present prices, there are high profits. Other companies notice that and want a piece of the action. Their entering the industry has both disequilibrating and equilibrating effects. Insofar as there is yang-competition or attempts to influence physical productivity, marginal costs, value productivity, and marginal revenue, i.e., creative advance, as new people are focusing on the device, costs of production decline further and quality improves. Insofar as there is yincompetition, marginal revenues fall to match the marginal costs. Marginal revenue is simply the price of one VR player. Given the same demand, over time, as supply grows, prices chase costs of production downward. But at lower prices, quantity supplied increases, as more people are prepared to spend their money on the machines. A former luxury is now being mass-produced and has become a staple of human existence. Eventually, the drop in costs is arrested and reversed, as technology is pushed to its physical limits and as per the law of increasing marginal costs. As the never-never land of perfect competition approaches, and profit margins are being squeezed, someone else invents an Ultraviolet-ray DVD player, re-energizing the market process. As the yin and yang morph and twist yet seek balance, prices come to be influenced by both demand and costs. Mark-up pricing can be a viable strategy for setting the prices of the output of a government bureau. The bureau is tasked with providing a particular function. It is not important whether profits can be garnered but simply that the function is performed. A peculiarity of bureaucratic management is that expenses are arbitrary and are, indeed,

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unconnected with the demand for the bureau’s product. The question “How much should the government spend on this enterprise?” is extremely hard to answer, because the bureau’s function can always be improved if more money is given to it. What is the proper combination of budget / service quality? This is to be understood as an application of marginalism. How much money per month should be spent on a such-and-such Post Office (PO) branch? If we spend $10,000, then the branch will have bad pens and long lines. If we spend $100,000, then the branch will be encased in marble, and most things in it will be rather pretty. But in that case, the taxpayers will be very unhappy. Mises argues: “It is precisely the efficient and honest manager who will try to make the services of his outfit as good as possible. But as he is not restrained by any considerations of financial success, the costs involved would place a heavy burden on the public funds. He would become a sort of irresponsible spender of the taxpayers’ money.” In other words, for a private business, if we start with the minimum of $10,000, then we should keep increasing the expenditures (say, by $1,000 each iteration) as long as the marginal costs are lower than the marginal revenues that would result if the costs are borne. However, the PO is a monopoly. It is illegal to compete with the “people’s postal service.” Even with the Internet and all, it is unlikely to become completely irrelevant soon. Therefore, the demand for PO’s services is inelastic or for simplicity’s sake, vertical. The government then can extort any amount of money from the consumers, e.g., by setting the price of a stamp to $5. It can then use this money to build pyramids like Las Vegas’ Luxor for every branch office. Would that be a good way of spending taxpayer money? One might say, obviously not! That would be a mistake, for in fact, we have no idea. In a competitive market, it may well be that the customers of a private first class mail carrier (FC, Inc.) would be willing to pay for the “Luxors.” It is unlikely but possible. Only the market can determine that. The FC’s owner then would start with our $10,000 and the services he can profitably provide with that amount of money and then consider the profitability of each marginal service. Should there be working pens? Well, that would cost $20 / month (say). But it would also attract enough customers to supply $75 worth of revenues. Out with the old, in with the new pens, then. Should there be 3 clerks on duty at any time or 4 or 5? A business calculation will provide a tentative answer. The present monopoly PO cannot take recourse to the procedure of calculation. “Luxors + $5 / stamp vs. no-Luxors + ¢50 / stamp” is a bureaucratic or at best political decision by whoever is in charge of this

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government-run enterprise or by the Congress. It is a legitimate complaint against GREs that failure does not cause the enterprises to “go out of business” but on the contrary, to receive more funding. Bureaucracies are ultimately irrational. They receive almost no feedback on whether what they are doing is right or wrong, sensible or insensible, helpful or harmful. If the people are by law required to use the bureau’s service, such as to renew vehicle license plates, and must pay for it, then user fees can be set in such a way as just to cover the expenses. If the service is funded by general taxation and is free, then the bureau’s output must be fixed by legislation or rules from a parent bureau, and a particular budget must be accorded to it. Both fees and taxes might be apportioned in such a way as not to generate public unrest and cause the present officials to lose in the next election (a weak feedback, to be sure, but possibly the only one available). Here, the revenues depend on costs. But such a pricing scheme is insane for a profit-making company. It is no wonder that Lee admits that “the profit mark-up remains theoretically underexplained in Post Keynesian theory.” (2003: 287) 28. CONCLUSION: THE KEYNESIANS The state of Keynesian thought today is subpar. From methodology to business cycle theory to monetary theory to policy, Keynesians have failed to produce either truth or happiness, doing which I outline in (Introduction, 2) as the mission of the economist. The Austrian school stands alone as a unified body of economic theory and practice, ready to deliver explanations of the past and suggestions of future reforms. For example, in regard to the recent financial crises, there is another choice, different from both the straitjacket of socialism and the faux-capitalist interventionist chaos with laws on the one hand so complex that no one understands them, yet on the other apparently not complex enough to prevent anti-social behavior by the financial elite. The reform I, and countless others before me, are proposing, is so simple, so pro-freedom; and it will abolish the business cycle for good. It will harmonize the interests of the 1% and the 99%, countering the state’s ubiquitous divide and conquer strategy. (Capitalism, the social system that harnesses the talents of the best 1% and drives them to act in the interest of the other 99%, must be purified not destroyed.) It will limit the government’s imperial ambitions: unable to monetize its debt, it will have more trouble starting wars. All that it takes is a bit of thought about the fundamental nature of money and banking. The conclusion is inevitable:

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put the choice of money into hands of the people, and check credit expansion at the source by crushing the ability of banks to deceive their own customers by loaning out the cash entrusted to them for safekeeping. Once the logic is understood, how can anyone fail to agree?

Appendix Some Interesting Problems 1. SOLVING THE GETTIER PROBLEM As I indicated in (I, 26), “in philosophy of science, knowledge is any proposition that is well-justified, so far as we can tell; in epistemology, knowledge is simply true belief.” Thus, in science, “we” know something, so long as it is reasonable to believe it; but it need not be true, and a scientist need not actually believe it. With respect to (1) truth, one is reminded of Robert Nozick’s desire to be “non-coercive” in philosophical argumentation. He has a point, even if he took it too far in his own work. A scientist does not put forward true propositions that ought by all rational people to be believed. Rather, he suggests ideas that might be interesting to entertain, if one is inclined to spend his time doing this sort of thing. On very little there are such things as final words and final authorities. With respect to (2) beliefs, one would need to assent to a proposition, if something practical depended on it. If an architect is designing a bridge, then he is ipso facto believing a great deal of things about math and physics. But a purely speculative endeavor like much of science and philosophy can easily be started by saying, “Let us provisionally assume such and such to be true and see where this leads us.” Though one would want to assume things that appear to be well justified, so as not to waste his time building edifices on false foundations, the things assumed but not believed may be vast in number and actually seemingly fundamental to modern technology. Recall that the will is fully immaterial; the body is fully material; and the intellect is half of each. The will is free; the body is not. As can be expected, the mind is in between. It is free to assume X or to assume ¬X. But it is not free to escape the consequences of extending belief to either X or ¬X and acting on that commitment. This understanding also neatly dissolves the Gettier problem in epistemology. Here is a typical such problem. Smith believes that “someone in the room owns a Ford” (call this proposition X). He has good evidence that Jones owns the Ford. In fact, however, Jones has just sold his car to

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Robinson who is also in the room. Thus, Smith has a justified true belief (JTB) that X. Yet we are reluctant to concede that Smith knows that X. The reason why the problem arises is that we say that Smith believes X which happens to be true, because he is well-justified in it. His mind is moved toward the belief by the force of the evidence which is decent but imperfect. If he had better evidence, then he might cease to believe X. Yet X remains true! Smith would go from one error, namely, basing belief in X on unsound (if passable) evidence, to another, false belief that ¬X (or at least, lack of belief that X). Smith’s JTB is fragile and does not rise to the level of knowledge. Smith has been led into a trap; he is deluded and stuck in a kind of catch-22. Under knowledge as JTB, improvement in justification for X causes a shrinkage of Smith’s set of true beliefs. In reverse, dumbing oneself down can lead Smith to truth. In other words, the justification is shown to be insufficient, because better evidence causes a change in the belief. But the change is vicious, stripping Smith of knowledge altogether. In such a paradoxical situation, Smith cannot be said to have “knowledge simply” of X either before or after. However, when we split knowledge into scientific (Ks – Smith knows X, if X sounds reasonable) and philosophic (Kp – Smith knows X, if he believes X, and X true), we do not suffer from this problem. Ks of X does not require that X be true or that Smith believe in X. At most, Smith may need to assume X for the sake of argument. Similarly, Kp does not depend on justification. Now in our Gettier case, Smith has both Ks and Kp of X. But he does not proceed to Kp upon acquiring Ks. The two kinds of knowledge are isolated from and do not influence each other. Improvement in Ks (e.g., amassing evidence for various propositions) cannot lead to deterioration of Kp; and improvement in Kp cannot be had by forgetting some Ks. For this philosophical problem, then, we ignore the fact that in real life, people form beliefs on the basis of evidence. Again, when something practical is involved, some human action aimed at securing success, then Ks and Kp, indeed, coalesce into a JTB which may not be sufficient for K simply. Evidence causes belief which had better be true, or we fail at our task. (Truth is normally defined as correspondence of thought to reality. But such correspondence also occurs in human action. A plan of action stands between an immaterial desire and physical labor. And plans work almost always only when one’s knowledge and understanding of reality are correct. We justify our belief that X is true whenever an action that depends on X’s being true succeeds; though not the reverse, because an action can fail not just because the plan was faulty

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but also because of poor execution.) For example, Smith would be in for an unpleasant surprise, if he asked Jones to drive him to the airport. But in that case, we are no longer doing philosophy. This solution does not require perfect or super-strong justification (which is good, because there are no such things for most empirical propositions). Any agreed upon rules of evidence will do. I look outside and see a silver SUV. I conclude that there is a silver SUV on the parking lot. In fact, the vehicle I am looking at is a remarkable hologram, giving a very convincing impression of the real thing. However, in the corner of the lot that I do not see, there is an actual silver SUV. I have a JTB that “there is a silver SUV on the parking lot.” Yet it is not really knowledge. The problem, again, is that better evidence (the car blinking in and out of sight or my being shown the holographic projector) can cause one to believe a falsehood (that there is no silver SUV nearby). Another example: “Henry drives through a rural area in which what appear to be barns are, with the exception of just one, mere barn facades. From the road Henry is driving on, these facades look exactly like real barns. Henry happens to be looking at the one and only real barn in the area and believes that there’s a barn over there.” If Henry knew that there were so many fake barns out there (better evidence), then he would lose his true belief that right now he is looking at a real barn. His justification can be revealed to be (relatively) worthless from his own point of view, being so easily overridden; and his true belief vanishes, if that justification improves but remains imperfect. When we “stress-test” the proposed JTB, the belief turns out to be either unjustified or false. Hence, no knowledge. Again, my grandmother gave me a pack of sliced cheese at t1. Then at t2, she called me saying that looked in the fridge and realized that she gave me the wrong box which was already open. In a couple of hours, at t3, she called again and said that she looked again more carefully and no, the thing she gave me was exactly right. At t1, did she JTBknow that she was right? We must admit that no, she did not, despite holding a JTB. To take stock, the Gettier problem notices that a JTB is in some cases not sufficient for knowledge, and that is true, as the foregoing examples prove. How then is knowledge to be defined? I have suggested that there are two types of knowledge, scientific and philosophic. J is sufficient for the former; and TB is sufficient for the latter. Disconnecting Ks from Kp allows a person to Ks X and Kp ¬X. At first, Henry has both Ks and Kp that he is looking at a real barn. He then learns that most of the barns are mere facades. He thereby Kss that

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he is not looking at a real barn. But he still Kps that he is. He considers the idea that this barn is real to be implausible. But he continues to believe it. Perhaps, to him, it is a Sorelian “myth” to be clung to (which, oddly enough, happens to be true). Henry improves his J while preserving his TB, though the two pertain to contrary propositions. Practically, it is nonsense. Philosophically, this is OK and not double-think, given the “non-overlapping magisteria” of Ks and Kp. In short, in regard to JTB, in active life, B is not an independent variable but is a function of J. This is what causes the perversions noted. We need to root out the dependence, and I have proposed a way of doing so. The utility of this understanding is first, that the Gettier problem does not apply to it. Thus, in our first example, at first, Smith had Kp that X; later, when told that Jones had sold his car, he lost that Kp; and finally, when apprised of the fact that the person who bought the car is Robinson, he regained it; each time, however, improving in Ks of X and the world. When we put the matter this way, Smith’s epistemological exploits might make for interesting reading but have no trace of a contradiction or paradox. Second, that it allows us to reconcile the notion of knowledge with progress in science. With knowledge as JTB, in both science and our daily lives, we often go from believing X at t1 to believing ¬X at t2 back to believing X now, while being relatively well-justified in all. But X and ¬X cannot both be true at the same time. Hence, if ¬X is true, then it cannot be said that we ever JTB-knew X (at t1) or know it now. But scientists do say “we know that P” all the time, by which they actually mean that they have pretty good evidence that P. Yet they also realize in matter of fact that new evidence can overturn P. If knowledge is JTB, then “we know that P” is an outrageous statement; not only is it arrogant, but its truth or falsehood can never be determined. But if it is Ks, then scientists speak sensibly. And we would do well to assume that most scientists are not nuts. Third, that it frees the pure philosophical Kp from any dependence on the down-and-dirty dealings with justification. It follows that now when saying “Smith knows X,” we must specify whether Smith’s knowledge is scientific of philosophic. Some statements like “2 + 2 = 4” are genuinely “self-evident” and may be said to be justified perfectly. For such propositions, the Gettier problem does not arise, and one may, if he wants to, retain the definition of knowledge as JTB for them. There are other benefits of cleaving philosophy of science from epistemology. For example, this understanding sheds light on the

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problem of a “thing-in-itself.” When I say, (a) “This desk is brown,” is it not the case that “brownness” is not “really” “in” the desk? It is just a perception, conditioned by our sensory organs and spiritual machinery. Brownness is a subjective experience. What has it to do with the actual desk? In epistemology, we would have a truth-bearer (that thing which has a truth value), i.e., an (ideal) proposition; and a truth-maker (that thing which makes the truth-bearer true), such as the (real) state of affairs of the desk’s being brown, to which the proposition corresponds. If (a) is to be true (and since in epistemology we do not indulge in justifications, I will certainly not lower myself to prove that to my reader), then there had better be a real brown desk out there. The brown desk is the thing-in-itself, and that is the end of it. In philosophy of empirical science, on the other hand, all we have are perceptions. All we see and hear and so on are signs – of something, perhaps, but who knows and who cares of what? We use these signs in our lives to pursue happiness. We manipulate them in order to cause them to conform to our desires. Simply put, we entertain ourselves. Mises would seem to agree: “We may define the external world as the totality of all those things and events that determine the feasibility or unfeasibility, the success of failure, of human action.” (1962 [2]: 6) There are no longer truth-bearer and makers, only usefulnessbearers and makers. Notice how the situation is reversed: the usefulnessbearer (that item which is useful) is (really) “out there,” as represented by signs. The usefulness-maker is our (ideal) notions on how exactly the usefulness-bearer is useful. Whether there is anything “behind” the perceptions is now irrelevant. The material world can be cut off with Occam’s razor. “Solid reality,” according to science, is a useful illusion. To that (and only to that) extent could George Berkeley’s idealism be justified. Again, scientific induction gives us only probability. Regarding speculative life, there is a genuine difference in kind between 99% certainty and 100% certainty, but only a difference in degree between 99% and 1% certainty. The latter difference is practical only. In short, the exact numerical probability, unless it is 100%, is of little value, unless it figures somehow in human decision-making and influences human actions. (100% probability can also be interpreted praxeologically: in the state of perfect confidence, one may be justified in betting his immortal soul for a mere fiddle made of gold.) We may split actions into two kinds: (1) narrow or concerned with progress in science; and (2) wide or pursuit of happiness.

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For (1), the value of the probability of a given inductive generalization is a reason to accept or reject the corresponding hypothesis and continue one’s research based on that. For (2), this value may assist in deciding whether to undergo some promising but risky new treatment for a difficult illness. Or let us say you believe that the probability of finding a white raven somewhere in the world is around 5%. However, a wealthy eccentric has offered you $10 million if you find a genuine white raven and bring it to him. Despite your chances, you may still decide to hack through jungles with your machete, all in order to locate the elusive white raven. 2. THAT THE WILL REMAINS FREE EVEN WHEN SURVIVAL IS AT STAKE The following two quotes from above seem to contradict each other. 1. “A causes B by necessity in the case when if A failed to cause B, then it would instantly corrupt; its nature would be destroyed; it would be annihilated as an instance of its nature. It cannot afford not to cause B, if it cares to save its own skin.” (I, 28) 2. “Let Allison be coerced under threat of death. In that case, she prefers living and stealing the car to dying and not stealing the car, a perfect example of free will, i.e., the process of ranking goals which results in a values scale in Allison’s mind and heart, in uninhibited operation.” (I, 33) But if Allison fails to steal the car, then her nature, too, will corrupt. She will be killed. Is she, therefore, in the position of A? Is she no longer human, because her will has been taken hostage? Well, if A fails to cause B, then it will corrupt necessarily, as part of how the world works. But if Allison fails to steal the car, then her death is accidental, because of her captors’ whims. It’s a contingent event. For example, perhaps, Allison’s kidnapper is bluffing. He threatens to kill her but does not plan to go through with the murder if she disobeys him. The world does not work in such a way that if B abducts A and orders A to do P or die, then A must die if it refuses. I can predict with 100% certainty that A will be destroyed; but whether Allison will be killed is not as obvious. But here is another example. Allison is trapped in a cell, in

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which the ceiling is a hydraulic press which is slowly descending. Allison can push a button to stop it; if she fails to do so, then she will soon be crushed. Is her will unfree? Before the will starts going about its business of seeking happiness, it must survive. If a human being dies, then there is no longer any action and any pleasure. In this sense, there is only one option available to Allison in pursuit of survival, and that is to push the button. Since we assume that Allison wants to be happy, we must ipso facto assume that she wants to live. She is free vacuously, insofar as there is only one thing presented to her intellect for consideration and to her will for weighing. Then Allison becomes determined to behave in a single way and thereby does become like a merely material object. She “has no choice.” Allison’s will remains free but this freedom is not exercised until she escapes. That survival is a precondition of pursuing happiness does not entail that the human will is ever unfree; only that it is silent or “idling” until its owner is safe and secure. Therefore, a better example would be “Let Allison be forced to choose between stealing the car or getting kicked in the butt.” This way we can skirt the “survival prior to action” problem. The proposed merger of AT&T and T-Mobile provides another illustration. The government is invoking antitrust laws in an attempt to halt the merger. There is a general argument that we should all heed in discussing this government intervention. In the free market, one’s search for private profits conduces to social good. The merger of these two companies, initiated by the shareholders and executives, is aimed at making the resulting concern more profitable than either AT&T and TMobile would be in isolation. Hence, it is also socially virtuous. Those people who claim that this merger will be bad for the consumers must, therefore, argue that the merger is an entrepreneurial error. The new company will actually lose money. In so doing, they present themselves as better entrepreneurs than the owners of AT&T and T-Mobile. That is just presumptuous. If one thinks that the merger will be a failure, then he is welcome to sell his AT&T and T-Mobile stocks. But perhaps, it will be charged that the new company will be a “monopoly.” There are at least two senses of monopoly. First, monopoly price. This is actually an indispensable accompaniment of disequilibrating entrepreneurial human actions. Temporary monopoly prices are part of the market process itself. There is absolutely nothing wrong with them. Supporters of antitrust laws argue that in some circumstances, these monopoly prices are permanent. For some reason, the equilibrating forces are checked, and imitation never commences. I

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find it implausible, however, that any private company, when not assisted by legal barriers to entry or other government privileges, can, in a worldwide free market, rest on its laurels and contemptuously resist the currents of yin and yang in the economy. Hence, this sense of monopoly is illusory. Second, ownership of some crucial resource. For example, in a desert, there is a single oasis for 100 miles in every direction. The owner of the oasis can be said to be a monopolist, insofar as he can extort money from travelers who are dying of thirst. Surely, neither AT&T nor T-Mobile has this sort of market power.1 This sense of monopoly is real, because the oasis owner sells not pleasure but life. We may think of the problem thusly. Voluntary seems to mean at least “freely chosen.” Most voluntary actions do not involve pure pleasure but rather pleasure tinged with sorrow, since choosing entails picking one thing and setting aside everything else. It is just that the distance between the benefits and opportunity costs is positive. Hence, voluntary has the sense of “something done purposively for the sake of psychic profit.” There are two exceptions here: first, when one does something freely without choosing it; second, when one chooses something but not freely. An example of the first case might be stroking one’s beard absentmindedly. A pleasure is had, and obtained without compulsion, but there was no deliberation. If there are opportunity costs of this action, then they are not considered. The second case arises when one’s very survival is at stake. Then the will has only one option before it, namely, to live, and efforts to make it so are voluntary despite the fact that the choosing is not done freely. There may be deliberation whether to live or die but no pleasure either way. If one wishes to object that some people sacrifice their lives for a cause, then take “survival” to pertain to immortal soul, in which case, there truly is no freedom whatsoever. At the same time, choosing the lesser of the two evils is still voluntary. If choice A yields –5 “utils,” and choice B, –8 utils, then the profit of selecting A, –5 – (–8) = 3, is positive.

1

Some people may have a vague feeling that the merger will narrow down consumer choices. This feeling must be resisted. There is actually no telling what will happen. The market process evolves in mysterious ways.

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3. HOW TAXES ARE SOCIALLY UNPROFITABLE Warren E. Buffett suggests (8/14/2011) that taxes be raised on the “mega-rich.” Why? Well, I assume that it is because that is where the money is. It does not make sense to rob the poor, does it? But why stop there? Who else have lots of money? How about banks? And investment funds, like, say, Vanguard S&P 500? The government could raid all of those to raise money. And why should the government even condescend to pay for its purchases with money? It should be able to conscript anyone, including the mega-rich, and put them to work, e.g., as cannon fodder or peasants in collective farms. But here is the real reason why Buffett seems so eager to open his wallet. It is that the super-rich are rich because of their net worth, on which all taxes have already been paid! He does not disappoint: “I would raise rates immediately on taxable income in excess of $1 million.” Wealth is not the same as income. A tax like this will make it harder for the poor to rise to the rank of the rich, i.e., to acquire the wealth they do not yet have. It will make it harder for poor yet eager and determined entrepreneurs to challenge and possibly dethrone Buffett. Again, Buffett is set for life. He does not have to lift a finger anymore to provide for himself. Other people who have ingenious ideas and want to become entrepreneurs, on the other hand, have yet to prove themselves. If taxes prevent them from rising into the upper class, then they will remain poor and fail at the same time to create wealth for the rest of us. Under laissez-faire, Mises remarks, “great fortunes are shrinking and finally melting away completely, while other people, born in poverty, ascend to eminent positions and considerable incomes.” (1994: 80) Buffett aims to halt that process. He may be likened to a political party that won elections and announced an end to democracy: “We have the power and we’ll have it forever.” It came to power by legitimate means but decided to abolish elections from then on. Even if Buffett became rich honestly, he now wants, by using the government, to prevent other people from getting rich. Such people would in the market process enrich not only themselves but society, as well. We may even postulate a class struggle between high-wealth individuals and high-income individuals who are still building up their fortunes. Ideally, the membership in any elite is open to all who qualify, and it is precisely this openness that has made true the adage, “three generations from overalls to overalls” (as noted by Schumpeter (2010: 156)). Sometimes, however, existing members seek artificially to bar

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newcomers from entering the club. Economists must ensure, through teaching, that this does not happen to the elite of the industrial magnates. The confusion between wealth and income may be the basis of a fallacious argument for progressive taxation from utility analysis. It is argued that a rich man benefits less from a marginal dollar than a poor man. To rob the former of $1,000 would be harming him less than so to rob to latter. Now the argument is unscientific for two reasons: first, it depends on interpersonal comparisons of utility; second, it neglects the utility to people of money. We might argue that a rich person is rich precisely because he attaches higher utility to money and has devoted more effort to obtaining it. Even if we let these slide, however, the argument works for wealth, i.e., if we expropriate and distribute existing fortunes. It leads to the opposite conclusion, namely, regressive taxation, in the case of income. For a rich man presumably benefits “little” from an extra $1,000 of money income added to his net worth, and a poor man benefits “a lot.” Surely, a panhandler on the street will glow with joy upon receiving one grand; the same amount will leave a modern-day Croesus unperturbed. In order to equalize these marginal utilities, we would need to take away most of the poor man’s wage and leave most of the rich man’s in his hands. Progressive income taxation does not equalize total utilities, because “net worth” and “rate of increase of net worth via an income stream” are completely different variables; and it does not equalize marginal utilities for the reasons just stated. Hence, the argument fails. It is of note, however, how the policy of confiscation and expropriation of wealth has the same even near-term consequences as the policy of punitive income taxation. The latter causes businessmen to be dissuaded from investing because the reward is made to appear to them to be too small compared with the risk. The former deters them, because they enjoy no security of property rights and are afraid of future paroxysms of theft by government decree. Either way, no creative advance occurs. In mathematical terms, just as speed is first derivative of position, so income is not net worth but instead a first derivative of it. For example, Smith’s net worth might be described by the function w(t) = 10K + 5K * t, where t is time measured in years. At first, Smith’s parents give their son $10K to get started at adult life. Smith gets a job where he makes $30K / year. For several years, he spends $25K and saves $5K. His relevant income is w’(t) = 5K, meaning that his net worth increases at a constant rate. If a person receives raises at his job every year, then these raises constitute “acceleration” and are as though the second derivative.

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Confusing net worth (w) with income (w’) is like confusing income (w’) with periodic raises (w’’). Taxing income in order to squeeze the rich is as absurd and counterproductive as forbidding raises in order to equalize incomes. High-income people would love that: a no-raises policy would keep low-income workers in their place and unable to increase their wages. Similarly, the rich love high income taxes: even if they fail to get richer, they are more than compensated for this disadvantage with the fact that the poor fail to get richer, as well. Further, a worker (perhaps, an inventor or actor) who lives off his savings for 9 years, at last succeeds marvelously, and obtains $1 million in year 10 is taxed far more heavily than a person who receives $100,000 every year for ten years (ignoring interest). This seems unjust. Buffett is a good entrepreneur but bad economist. He fails to understand that any incentive has an effect on the margin. Not everyone will be deterred from investing. But some people will be. Buffett argues that “I have yet to see anyone… shy away from a sensible investment because of the tax rate on the potential gain.” But this is only because opportunities uninvested into and unpursued are not part of the sample. The investments realized are, indeed, seen; but those that are passed over are not seen. And Buffett does not consider what is not seen. If one makes $1 million, then he pays a tax, so that his total income is, say, $500K. If one loses $1M, then the government does not pay him a “negative tax” or subsidy to soften the blow. Thus, with taxes, the reward is made smaller, but the risk is preserved. How can this possibly not have a marginal effect? People do not shy away from sensible investments, indeed, but taxes affect which investments are going to seem sensible. In other words, taxes convert sensible investments into foolish ones. Here is a simple example. Smith can invest $1M into a business venture. He will either lose this money or make another million. He estimates that the probability of success, taking all things into account, is 0.7. With the tax equal to 50%, he invests; if the tax is raised to 60%, he does not. If he does not, then nobody but Smith will ever know about this decision. If precise probabilities are objectionable, an alternative example would invoke an investor with a diversified portfolio. Taxes on income or capital gains can make it so that the gains in the portfolio are so negligible that the investor finds it in his interest to consume the funds in the first place. The net result is that the investor pulls his entire savings out of the stock market to society’s detriment. Thus, either Buffett is evil for wanting to take away people’s

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opportunities; or he is too stupid to grasp how society gains from successful entrepreneurial endeavors. I might suspect the latter, if he voiced support for harsh inheritance taxes, as well, so that his own children after his death would be left with nothing. But I would not be holding my breath. If I may speculate, some of these “patriotic millionaires,” who petition the Congress to raise taxes on high-income individuals, are ashamed of the fact that they made their money during the business cycle roulette. They are bothered that their own success had, at the same time, a weakened effect on the welfare of the consumers, because the boom set in motion the process of general impoverishment. But their self-flagellation is both unjust to them (a sin that St. Thomas called “irony” “which consists in belittling oneself by forsaking the truth” (ST, II-II, 113)), because they are not responsible for the ideology of inflationism, and futile. “Loot the looters” is hardly a coherent ideology, and socialism for the rich cannot be cured with socialism for the poor. 4. THAT PRESENTISM IS FALSE I have already mentioned the distinction between trivial presentism (which is true) and non-trivial presentism which I will try to show is false. The trivial presentism simply notes that Socrates, say, is dead and obviously does not exist right now. Hence, indeed, only present things exist. Markosian (2004) calls this the “temporal location” sense of “exist.” The latter asks whether, “if we were to make an accurate list of all the things that exist – i.e., a list of all the things that our most unrestricted quantifiers range over,” there would be any non-present things in it. When we propose, “All men are mortal,” are we required to make sure that Socrates is mortal, as well? This is called the “ontological” sense of “exist.” Markosian then claims that presentism is the “common sense” view. In so doing, he forgets his own distinction! For the man on the street would acquiesce in the temporal location sense of presentism but would have no opinion about its ontological sense. Hence, common sense is not on the side of the non-trivial presentism. Consider the proposition (1) Socrates was a philosopher.

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One of the problems Markosian needs to solve is the following: how can one refer to past things? He unfolds (1) as (2) ∃(x) [x is the referent of ‘Socrates’ and InThePast(x is a philosopher)]

He says, in effect: Socrates is not present; therefore, he does not exist; therefore, “Socrates” in “Socrates was a philosopher” does not refer; therefore, (1) is a confusing (in itself) and false (when converted into (2)) proposition, somewhat like “The present king of France is bald.” Markosian’s reason for thinking that “Socrates” cannot refer to past persons is that he likens the past world to possible worlds. Regarding existence, Socrates has the same relation to me as my possible brother. Neither exists. In order to rightly understand this problem, it is necessary to recall our big picture, such as described in part in (I, 32).

Has Essence Does Not Have Essence

Exists past present

Does Not Exist timelessness future

TABLE APP.4.1. TIME PERIODS CLASSIFIED

If “meaning” is understood as an objective description of essence, and “reference,” as a real thing out there, then we obtain another correspondence:

Meaning No Meaning

Reference old objects events generated

No Reference event handling new objects formed

TABLE APP.4.2. MEANING AND REFERENCE

Thus, for example, we can say with Trevor Goodchild that “events contain no meaning in themselves; only that which the mind imposes on them.” I doubt that we could even identify the “present” without a mind; the “present” is in fact the events being observed (or experienced) by an intelligent agent. Time periods must be distinguished by someone who, though perhaps living in the present, is nonetheless able to comprehend all time, such as to engage in perception (present), imagination (timeless), recollection (past), and anticipation (future). Event handling is performed according to laws of nature; they are definite and quite precise but lack a referent. One cannot walk down

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the street and stumble upon a law of nature. Such laws are not matter but form, information. The future does not exist in the most primal sense, future objects having right now neither essence nor existence. We can see then how Markosian confuses the past with timeless abstract objects, such as possible worlds. The source of his error is that Socrates existed in the past but does so no longer. However, the relevant difference is that abstracta do not exist essentially, according to their very nature; while Socrates does not exist merely accidentally, such as because he lived long ago. The question is whether we are willing to dignify Socrates by including him into the set over which our quantifiers range. Similar a bit to how Achilles in The Odyssey says that he would rather be the lowliest slave in the world of the living than king of the dead, it may be better not to exist (in the temporal location sense) as a real thing that to “exist” ideally. It is better to be a dead man than a “live” abstraction. It is better to be even a real rock than the thing than which no greater can be thought in the understanding. In short, it is better to have really lived and died than to be a proposition, no matter how timeless. In other words, that Socrates can (and did) die and “2 + 2 = 4” cannot does not mean that Socrates is less real than the proposition. Ideas do not die, but their power lies in influencing people. Ideal things have no references but can have meanings. These meanings can in their turn be more or less full. Thus, “Pegasus” represents a mere idea about a winged horse, and we can picture it in the imagination. “Sherlock Holmes” is likewise a shadow, though neither is a complete nothing. A possible fat man in the doorway is defined in part as an abstract object, as opposed to how a real flesh and blood fat man in the doorway would be a full-featured individual. A genus, such as “mammal,” is another abstractum, whereas my cat has a completed essence by virtue of really existing. Both, however, have meanings and essences. Therefore, when we say “Socrates was a philosopher,” we refer not to the essence of Socrates in the imagination or to the meaning of the term “Socrates” as we interpret it but to the real man. When I say, “I admire Socrates,” I am not saying, (3) “I would admire the person who is described by the meaning of ‘Socrates,’ if he were suddenly instantiated right now.” I am saying, “I admire the concrete and real man Socrates who actually existed and, ontologically, still does.” We have seen in (I, 27) that real things are public; ideal thoughts are merely semi-public; and ideal feelings are altogether private. As a

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result, we can point Socrates out: there he is: look at him, you can or could tug at his beard and everything! “I admire Sherlock Holmes,” on the other hand, does mean something like (3). One cannot really admire an idea, because Sherlock Holmes never did any of those things he did in the stories, being a fictional character. Sherlock is far more ghostly than Socrates. An interesting way to draw attention to the radical distinction between the real and ideal worlds is to ask whether there is such thing as the universal set. If we define this set as U: ∀(x) [x ∈ U], then a natural question is, does U contain itself? If U contains only real objects; that is, if the universal quantifier ranges only over real things, then, since a set is an ideal entity, the quantifier does not pick it up, and consequently U does not contain itself. If x can range over ideal objects, then the fact that U must then contain itself is unintelligible which indicates that there is no such thing as a set of all ideals. There is no largest infinity, any more than the largest integer. Ideal infinities multiply without end. At the same time, there can only be a finite number of real things. In short, there is sufficient reason so to honor past real things – as opposed to abstracta – as to consider them to be ontologically existing. As a result, (1) both is true and expresses a proposition. Another aspect of this is human personal identity. It is arguable that humans are 4-dimensional; our past and future exist as part of our identities. Not merely in memory of the past or anticipation of the future; not even merely reflected in present character or personality; but actually existing, since men are spread out in time. For example, St. Thomas writes about wrongful actions that “the act of sin passes, but the guilt remains.” (ST, II-I, 113, 2, reply 3) But if humans (though not inanimate objects) are 4D, then presentism is false. Finally, consider this. There are well-developed and highly useful modal logics, encompassing possible worlds; but not really “tense” logics dealing with the past and future (though I have seen attempts to construct them in some books mostly as didactic examples of “other” logics). Does this not suggest that people consider past events to be pretty real and on par with the present reality so much that they think that standard logic is fit to deal with the past, as well? 5. SOLVING THE RESWITCHING PROBLEM The reswitching conundrum seems to suggest that it is not the case that as interest rate falls, more capital-intensive production techniques will necessarily be chosen. The classic example is Paul

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Samuelson’s. Let it be that both techniques A and B take 3 years to make output P. Each utilizes some labor input L, as in Table App.5.1. We can take zero units of labor employed in a year to mean that P is growing or ripening or maturing on its own during this year. Regardless, the entrepreneur starts making P at the beginning of year –3 for both techniques. Year –3 –2 –1 0

Input / Output

A

L P

B 0 7 0 1

2 0 6 1

TABLE APP.5.1. TWO PRODUCTION TECHNIQUES

Samuelson’s idea is that at a high interest rate (IR), technique A will be more profitable; at moderate rates, technique B will; yet surprisingly, at a very low IR, the entrepreneur will switch back to technique A. Here is the intuition behind this. Let the wage be $100 / unit of labor. Suppose that initially Smith has $800. In year –3, at IR = 150%, when using A, he can loan out the money and receive $1,200 interest. When using B, however, he only gets $900 interest. These will be compounded, such that A will end up as slightly superior. At a very low IR, including 0%, A will be preferable again, because A’s 7 units of labor will dominate B’s 8 units. But at intermediate IRs, B will be selected. A simple calculation seals the argument. Call the wage w, and IR i. Then Cost = (1 + i)wL–1 + (1 + i)2wL–2 + (1 + i)3wL–3.

(EQ. APP.5.1)

For example, for Ai where i = 75%, we borrow $700 in year –2 and wait 2 years to pay back the loan; hence, we invest 700 * 1.752 = $2,144. Table App.5.2 is obtained. Samuelson takes this to mean that it is not the case that as interest rate falls, more roundabout or longer and more productive processes will always be chosen to replace less roundabout ones. Sometimes, a lower IR will cause an entrepreneur to reswitch to a shorter process. In our example, there occurs a mysterious shift from a more roundabout process to the less roundabout one, i.e., either from A to B or vice versa. Recall that time is a factor of production, because the work of human labor, machines, and land takes place over time. The more time we allot to a task, the more can be produced, and not just as

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proportionately more of other inputs are fed into the same production function. Moreover, we can pack more or less labor or land (such as power of nature to mature goods) into the same time period. Some technologies that would produce novel goods that do not yet exist at all take quite a bit longer, but without them, we cannot have such goods. For the time being, these techniques may be ignored due to the cost of the time factor, whatever the cost of the other factors involved in them may be. i 150% 75% 5%

A

B $4,375 $2,144 $772

$4,625 $2,122 $862

TABLE APP.5.2. RESWITCHING BETWEEN A AND B. SHADED AND ITALICIZED CELLS ARE THE LESS COSTLY OR MORE PROFITABLE METHODS OF PRODUCTION

Time, then, is a placeholder into which we can insert labor and land. Time itself, on its own, has no productive power. When there is suffering, it is a pure cost with no constructive component. Hence, it is not a complementary factor to labor and land but an “enabling” one. Some technologies allow one to use less of everything, including time. In (I, 51), I call the use of such happy inventions “disinvestment.” But these are rare. If no way to disinvest can be found, then perhaps, more time-intensive techniques must be used. Such techniques “had better” be more productive in terms of consumer happiness: the revenues from using them have to increase by more than the costs (which include interest on the money borrowed or the opportunity cost of interest not collected on the money invested). Moreover, in actual fact, as matters stand in the real world, such technologies do exist and are invented all the time. For example, let factors 7A + 2B + 3C tied up for 1 month yield: (1) 1P every day; or (2) 50P one month from now; or (3) 1Q one month from now. Technique (2) results in a disproportionately more goods, but one has to wait a month to obtain them, as opposed to technique (1) which produces only 30P per month but 1P every day. Technique (3) outputs good Q which was impossible to make in less time at all. The people’s time

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preferences and the equilibrium interest rate will influence which goods will be produced. The Austrian claim is that if the time input costs less – for example, if people do not suffer as much from sacrificing present goods (i.e., are willing to be content with fewer future goods at the same cost of present happiness foregone), and if interest rates go down – then according to the law of demand, more (or at least, no less) of the input will be utilized or bought. But here comes Samuelson claiming that sometimes a reswitching to a less time-intensive project will occur, even as i continues to fall. Note that, first, process B is not more physically productive than A, with both outputting 1P, though their unit costs differ. Second, the disutility of waiting is also the same, equal to the discomfort from longing for P lasting for 3 years. This means that the “roundaboutness” of both processes, defined simply as their length, is exactly the same! There is no need to compare the physical structures of production in A and B with respect to their “objective” complexity or circuitousness. X is more roundabout that Y, if and only if it takes more time for X to finish from the moment the desire for P is formed in the entrepreneur’s heart than similarly for Y to finish. But in the puzzle, A and B have the same length. The most important lesson that we can learn from Table App.5.2 is that as the IR falls, the opportunity cost of investing into P in terms of interest income not acquired goes down for both A and B. Hence, other techniques C, D, etc. longer than both A and B may become profitable, given a drop in the price of the time factor from 150% to 75% and then to 5%. What happens when there are only these two techniques? When i falls from 150% to 75%, it is possible to employ more labor over the same time period and yet enjoy higher profits. When i reaches 5%, the entrepreneur can, on the contrary, disinvest by cutting down the number of labor-years back from 8 to 7 yet again obtain higher profits. Here is the problem. First, “labor-years” is an illegal mixture. If the labor units are expended at the same time, then 4 workers tied up for 2 years each is a situation distinct from 8 workers tied up for 1 year each. The investment and disinvestment are in an extra worker who spends a year working in either year –3, –2, or –1 and does not add any time to the period of production. It is explicitly stipulated that both A and B are equally roundabout and therefore, cannot serve as examples of reswitching into more and less time-intensive methods of production. Second, we have shown that as the interest rate drops, sometimes more labor will be hired, and sometimes, less. This is a far cry

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from saying that as interest rate drops, sometimes longer processes will be selected, and sometimes, shorter ones. We do not care about pure labor; this is not what the reswitching puzzle is supposed to be all about. In other words, since A and B are equally roundabout, the reswitching occurs for reasons other than different lengths of production periods. What if we made B 1 minute longer than A? The calculations would persist practically unchanged, yet B would be more roundabout. Well, a part of the Austrian claim is an a priori application of the law of demand to time, i.e., that all things being equal, less sadness from not enjoying something right away results in higher supply of present money on the loan market. If all things are not equal, then lower cost of time does not necessarily entail that more time-intensive projects will be undertaken, because other considerations (such as cost of labor) may prove decisive. Samuelson imagines that Table App.5.2 represents a dynamic process, in which we perceive reswitching as interest rate falls. It is as if we are watching the IR thermometer and trying to predict what will happen to the structure of production as the mercury in the thermometer goes down. The Austrian notion that increasingly longer techniques will come to the fore as this is happening seems falsified. However, to reuse a Keynes’ remark, “lengthy processes are not physically efficient because they are long.” (2008: 214) They have a chance to be more efficient, because (1) more time lets an entrepreneur get more done, and (2) most of the less time-intensive projects have already been taken up. The law of demand does not say that more time must of necessity be used, as the interest rate declines. The reason is that time is not purchased alone but only as part of a method of production into which it is embedded as one factor among many. Time always comes bundled with other goods and services. Hence, decreasing interest rates may cause projects to be started that require more time, since (3) their costs drop more than proportionately as compared with shorter techniques, which makes them relatively more attractive (though not necessarily enough to be picked). They do not have to be started, as the reswitching examples indicate. For example, 1 minute is so trivial an amount of time compared with 3 years that the extra savings from the lower i for technique B are dwarfed by the higher costs of labor in B. Roundaboutness refers to the original factor, time; not to the produced factors, capital goods. Given an array of more roundabout technologies, then, we have a conjunction of three claims. The first logical claim is that a lower interest rate may benefit some of them considerably, because their interest expenses are so predominant. The second empirical claim is that a lower interest rate will

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benefit many of them considerably. What we do not argue is that every longer process will end up being more efficient than a given shorter process upon a decrease in interest rates. It may well happen that out of A1, …, A20, A5 and A16 will not become superior to A with a drop of i from 75% to 5%, thought the rest of the As will. B is another such unlucky technology. The empirical proposition is that there are numerous situations in human affairs when both greater entrepreneurial profits and greater consumer happiness can be realized only by using techniques that take more resources – that include time – as inputs than all existing processes and despite the costs of those resources. Normally, numerous highly productive technologies that take a very long time already exist and sit on the shelves somewhere waiting for their chance to be used. When interest rates fall, in a real-world economy, some of these technologies are going to be brought into use. Moreover, time can never be fully employed. In short, when i drops from 75% to 5%, B reaps extra benefits, because it is 1 minute longer than A. But this is not enough to outweigh the now central costs of labor. The empirical claim is not illustrated by the reswitching puzzle. My disagreement with Samuelson then regards whether reswitching has any relevance to a real economy. For example, it is reasonable to argue that human beings will cooperate with each other, creating an economy and civil society. We do not falsify this statement by considering the mere possibility that Friday, chancing upon Crusoe, may choose to kill and devour him. Again, Crusoe and Friday will benefit from association, if their island features moderate scarcity, which is most likely to be the case. That a world of super-abundance or extreme dearth will not serve up the right incentives for social cooperation does not give the lie to this fact. The third claim is this. Changes in interest rates cause reswitching. But these rates themselves are altered by fluctuations in the public’s time preferences, e.g., when people agree to lessen more immediate consumption for the sake of smaller rewards in the future. Thus, a drop in time preferences (a) causes a drop in IRs which in turn (b) causes folks to switch to more roundabout methods of production. The reswitching puzzle challenges (b), and I have responded to this challenge. It says nothing about (a). Therefore, Samuelson’s strange comment that “It is no longer literally true to say, ‘Society moves from high interest rates to low by sacrificing current consumption goods in return for more consumption later…’” (1966: 577) is uncalled for. As we can see, none of these claims are affected by the reswitching problem.

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6. SOLVING THE NEWCOMB PARADOX This scenario involves a human being, call him Smith, and an (almost) infallible predictor, call him Zeus, who is able to prognosticate the future without fail. Smith is presented with two boxes, one of which, box 1, is opaque, and the other, box 2, is transparent. Box 2 contains $1,000, and Smith sees the money in it. Smith is offered a chance to choose either box 1 or both boxes. Zeus predicts which choice Smith will make and makes the following arrangements. If Zeus predicts that Smith will take one box, then he puts $1,000,000 into box 1. If he predicts that Smith will take both boxes, then he leaves box 1 empty. If Smith likes money and wants to make the best decision, then which course of action should he undertake? There are two ways to grasp how this is a paradox. [I] On the one hand, utility maximization counsels the “obvious” decision to take one box. Then Zeus would have predicted it and placed the $1M in it. On the other hand, when Smith is choosing, the money in the first box is already either there or not. Whatever is in box 1, Smith can do better by taking the extra $1K. The two-box strategy dominates the one-box strategy, as laid out in Table App.6.1. Choice One box Both boxes

Box 1 Full $1,000,000 $1,001,000

Box 1 Empty $0 $1,000

TABLE APP.6.1. PAYOFFS FROM DIFFERENT NEWCOMB STRATEGIES

If looks as if two venerable decision-making principles recommend different things. What should Smith do? [II] Here is another and more fruitful way of looking at this issue. How will Smith deliberate in order to make a decision? He might proceed as follows. “Surely, the best thing is to pick one box, because Zeus would have seen that and placed the money in there. But wait a minute: if Zeus did place the $1M in there, then I would be better off getting both boxes and raking in $1M + 1K. Of course, if I did that, then Zeus would have seen me reasoning like this, too, and abstained from putting the money in the first box. That cannot be the best decision then. So, I should be clever enough to pick box 1, in which case the money is definitely there, and the best decision is to pick both boxes.” And so on, ad infinitum. The Newcomb problem is a paradox, because a seemingly innocuous situation makes it impossible to reach a happy decision.

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It is a little like preferring C to A, B to C, and A to B, in which case one spins in his mind, unable to stop and come to a decision. (We might say that consistency in thought is praxeologically necessary.) We have a chess game, where one player is omniscient and knows all of Smith’s plans. Smith’s every move is known and countered; Zeus is reasoning one level higher than Smith. Every move results in some loss, though some losses are greater than others. In this case, the loss is the inability to obtain $1,001,000. Zeus forces Smith to pick between $1M and $1K. Zeus plays his hand in such a way that only one choice is possible. Smith cannot outfox him. The endless deliberation must be nipped in the bud. Smith needs to terminate the game, if only in order to be able to go have dinner. But now it makes sense in surrendering, to minimize the losses. This happens when the one-box strategy is pursued, since $1M is better than $1K. Given this understanding, even I can now predict that Smith will take one box. It is evident that one cannot escape “being seen” making the decision, or having his reasoning scrutinized by Zeus who will base his prediction on whatever point one will break free of the vicious circle in order actually to act and make some money. Related to this is the puzzle whether prayer can in any way affect the past. If a person hears that Titanic has sunk but does not know the details, is it useful for him to pray that his friend who was on the ship be alive, when it is already a settled fact whether the friend has survived or not? I think that our initial inclination is to pray, such as “Please be alive,” just as it is to pick one box in the Newcomb puzzle. And it is the right one. For if the prayer is costly (for example, if Zeus owes Smith a favor, and praying entails cashing it in), the thinking is very similar: “If I pray, then my friend would have been saved by Zeus. But my friend is either alive or dead. Nothing can change that fact. I may as well not bother praying. But Zeus would have foreseen that, too, and let my friend die. I can’t have that, so I’d better pray.” Again, ad infinitum. When Zeus makes his prediction, he is asserting a proposition that Smith will make a particular choice. Zeus says: (1) ∃(t > now) [Smith will choose X at t]. When Smith, indeed, does X at t, then he is supplying the truth-conditions for (1). Smith produces the t at which (1) is true. In both scenarios, the values scale is given: in Newcomb’s, I prefer more money to less; in the prayer puzzle, I prefer saving my friend to retaining my wish granting credit with Zeus. The chosen strategy is assumed to be executed flawlessly. So, out of the

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trinity, only the plan and its construction are of note. Interestingly, if Smith can see into box 1, then it is now Zeus who is in trouble and cannot predict. Smith can always choose other than the choice he sees Zeus has predicted. In other words, Zeus sees Smith choose on the basis of a set of data S and makes his prediction. But in fact, the data Smith uses to make his choice are not S but S + Zeus’ prediction. Thus, Zeus would be thinking: “I can put money in box 1, but seeing that, Smith would want to prove me wrong and choose both boxes. Which means that I should put no money in box 1. But then Smith can overturn my prediction by choosing one box.” This also continues forever. Now it is Smith who is playing one level higher than Zeus. Though less interesting than the Newcomb’s scenario, this does explain why divine prophesies in the Bible and elsewhere are usually so hard to interpret. If it were obvious what a prophesy meant, then people might want to ensure that the prophesy did not come to pass. This means that the prophet would end up lying which is bad publicity for God. The moral is that as far as the predictor is concerned, the future is like the past, determinate and predictable. Zeus does not care whether he is looking into the past to see what Smith was doing or into the future to see what Smith will be doing. He knows both with equally perfect certitude. Smith, on the other hand, does distinguish between whether an event has occurred or is yet to occur. Let Smith again be praying for his friend’s safety. If he knew that the friend did or did not survive, then he would not need to waste his prayer. Same thing if he knew that the friend would or would not be alive more-or-less reliably (for example, if he was sent on a suicide mission or was undergoing surgery whose rate of success is 1%). The difference is that Smith lacks the knowledge of how the future will turn out per se due to uncertainty, whereas in the Newcomb’s and prayer’s scenarios, he does not know the past per accidens. The future cannot be known; the past can be but actually is not. These similarities and distinctions are what imbue our cases with an air of paradox. 7. THAT GÖDEL’S AND TARSKI’S THEOREMS SUGGEST A WAY IN WHICH HUMAN AND MACHINE INTELLIGENCES DIFFER

Given a formal system S, ideally, we want three things out of it. We want it to be (1) decidable, (2) consistent, and (3) complete. Some of following is adapted from Hunter (1996). S is decidable, if and only if for all formulas of S, there is an effective method for telling whether or not this formula is a theorem of

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S. (An effective method is a procedure for computing the answer that, if followed faithfully, would necessarily yield the right answer (and, in the meantime, no wrong answers) in a finite number of steps.) S is consistent, whenever it is not the case that for some formula A of S, both A and ¬A are provable from the axioms. “S is complete” means that there is no true theorem expressed in S that cannot be proved from the axioms. What Gödel and Tarski showed was that any sufficiently interesting system is going to have only two out of these three properties. For example, we may be able to get (2) and (3). A formula A is decidable in S, iff either A or ¬A is a theorem of S. Hunter points out that a decidable system may have undecidable formulas. Thus, the formula ¬p in the system of propositional logic S is not decidable (because neither ¬p nor ¬¬p = p are tautologies); but S itself is decidable (for example, we can prove by constructing truth tables for every formula, including ¬p and p, whether it is a theorem of S). Further, “every formula in an undecidable system may be decidable.” We can construct a system S’ which is both consistent and complete, but such that “nothing… need guarantee that there is an effective method for telling, for each formula A, which of the two formulas A and the negation of A, is a theorem of S’.” (119) A system TA called “true arithmetic,” whose axioms consist of all true statements about natural numbers and no false statements, is both consistent and complete but not decidable. Now a formula is a theorem, if it is provable from the axioms. The axioms are the “reality,” to which the theorem “corresponds” or “conforms” and because of that is counted as true. There is no mechanical algorithm that could be programmed into a computer to verify or falsify every formula of true arithmetic. However, there is a way to get all three properties, but only if we resort to a meta-language to describe the object language of S. The non-mechanical way of deciding S is precisely to construct a meta-language S’ to speak about the object language of S. For true arithmetic, TA’ might be second-order arithmetic. Now we come to the main claim. Machines are limited to the object language whose axioms they have been programmed with. Any ability of a computer to create a meta-language for object language S1 must itself be part of S1. Computers cannot generate meta-languages to infinity. But humans can. Unlike machines which are (a) finite, then, humans are (b) potentially infinite: the (c) actually infinite totality of all truth will forever escape them, but there is no limit to how much knowledge they can aspire to. This constitutes the key difference between human and artificial

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intelligences. If we had a canvas, on which anything whatsoever written would be evaluated as either true or false, then how would it evaluate the Liar Paradox (L): “This sentence is false.”? Let me suggest a solution. L is neither true nor false, because there is no truth-bearer; there is no thing that might be considered true or false. “This sentence is false.” What is false? This sentence. But the sentence affirms nothing other than that it is false. A contentless no-proposition may very well be neither true nor false. We can even call it meaningless. It is meaningless not as “abracadabra” or “square circle” is meaningless, but as silence or an empty string “” is meaningless: nothing whatever is asserted by “This sentence is false.” That something is asserted is an illusion foisted on us by the fact that the sentence is grammatical like “This sentence is in English.” Ask, when you read L, do you learn anything about the world? Not at all; you learn nothing. Suppose that you already knew reliably that L was false, though not what exactly was false. When you actually read the sentence, do you find that out? Of course not. A proposition is a real state of affairs or slice of the real world being proposed, and proposing something is thinking about it as holding or failing to hold. But L does nor deserve to be called a proposition. One may try to re-introduce the paradox by rephrasing it as (L’) “2 + 2 = 4 & This entire sentence is false.” Now the sentence seems to convey some possibly useful information. This is no help. What is the value of L’? Since the first conjunct is true, the answer depends solely on the second one. Let Le = “This entire sentence is false.” Again, what is false? This entire sentence. But “2 + 2 = 4” is obviously not false. So, Le must be false. Le says: “Le is false.” Or: “I am false.” Or, equivalently: “This sentence is false.” We have already seen that Le is content-free. It does not propose anything to believe or disbelieve. Hence, L’ may be rewritten as “2 + 2 = 4 & .” Silence may be golden, but it has no truth value. L’ is now ungrammatical and does not have the form of a valid proposition. “p &” is not a well-formed formula. L’ is still meaningless, and there is nothing to evaluate. One could try to avoid self-reference by asking for the truth value of each of the following propositions in a system S: (1): 2 + 2 = 4 & (2) is true (2): 3 + 3 = 6 & (1) is false In order to solve S, we will substitute the symbol “(1)” with the sentence (1), as follows: (2): 3 + 3 = 6 & ¬(2 + 2 = 4 & (2) is true), which again

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is either silent or ungrammatical. But if something meaningless follows logically from S, then surely, we are justified in calling S itself meaningless. Then there is the Strengthened Liar Paradox: (Ls) “This sentence is not true.” If Ls is meaningless, then it seems that it is, indeed, not true, and the difficulties are again upon us. The solution is simple. If Ls has no meaning and is similar to not saying anything, then we do not care what it falsely appears to be saying. If Ls = “”, then the paradox vanishes. 8. SOME EXAMPLES OF THE MORAL / METAPHYSICAL GOODS DISTINCTION

In the movie Aladdin (Disney, 1994), Jafar sings about the hero that “His personality flaws Give me adequate cause” to kill him. Is not Jafar one to talk? He is an evil villain. Is not being evil a personality flaw? The solution is that Jafar is virtuous in himself but not loving; Aladdin loves the princess (and presumably, his fellow men in general) but has vices within his character (as a “diamond in the rough”). Another Disney movie, Hercules (1997), has a very Christian motif. Hercules, who was born a god, is now mortal, though he retains his tremendous strength. His girlfriend Megara dies through the machinations of Hades, ruler of the underworld. The underworld is pictured as a river or lake in which the spirits of the dead drift or swirl about. Hercules offers Hades a deal: he will try to swim inside the lake to retrieve his beloved, and for that, he agrees himself to die. Hades accepts. Hercules dives in and, as he is nearing Megara, he is visibly growing older. As Atropos the goddess of fate is preparing to cut the thread of Hercules’ life, the hero reaches Megara, and the thread turns golden and indestructible. The fate’s scissors will not cut it. Hercules becomes deiform and immortal. This sort of noble self-sacrifice for the sake of another is far above the petty dictates of morality. There is no moral rule bidding anyone to die in anyone’s place. We would not call Hercules a “just man” for his deed which is metaphysical in nature. And the reward for such an achievement is an upgrade in one’s very nature: the hero becomes like a god. St. Thomas believed that certain saints receive special rewards

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called aureoles. There are three kinds of aureoles, due to doctors (as in: PhDs), virgins, and martyrs. Remember the three causes of rejoicing identified by Aristotle: sensual pleasures, the active life, and the contemplative life. Each aureole is apparently given for victory in each kind of life. Virgins beat the flesh; martyrs, the world; and doctors, the devil. St. Thomas suggests that “the martyr’s aureole is simply the greatest of all.” (ST, Supplement, 96, 12) Perhaps, the flesh represents 1st-grade matter, over which man must be master (not despising matter but being in control of it); the world represents 2nd-grade human beings, for whose sake one has chosen to sacrifice himself; and the devil represents 3rd-grade God, whom one must judge to be good and the source of happiness. All three are the adversarial yin that urge one to do battle with them. Glory or the crown is given for charity, but extra decorations like aureoles are given for the deeds. But the latter already entail the former: there are no aureoles without the “main” charity-aura. That is why Catholics are not urged to pray for martyrs. Genuine martyrdom is generally a sure sign that one has earned his reward. Hannibal Lecter, the carnivorous psychologist from the movie The Silence of the Lambs (Orion Pictures, 1991), despises people. Lecter holds others in contempt, because, in his view, they do not see themselves in the true light, having prostituted their best selves in exchange for a few illusions and petty vices. In being killed and eaten, they receive the fate they so richly deserve. Lecter, on the contrary, having the power to see men’s souls, knows who he is and is bothered by no inner turmoil. Unfortunately, Lecter fails to grasp that those with power save those without it. He is morally good but metaphysically evil. Professor Moriarti, the arch-nemesis of Sherlock Holmes, is described as the “Napoleon of crime, the organizer of half that is evil and nearly all that is undetected in this great city.” He is again a powerful and excellent being marked, however, with utter malevolence. At the same time, the compatibility of moral goodness with diabolical character needs to be qualified. We have already seen that when two people love each other, their wills and values scales unite, merge. But what does it mean to love God? God is omnipotent and therefore, perfectly happy and needs no one’s assistance in reaching that pleasant state. It seems that one cannot “do good” to God.

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We might enunciate the first sense of loving God as follows: it means blessing all of His providential works in the world, even if it seems (at first glance) that they come at one’s personal expense. “Shall one accept good from God, and not trouble?” (Job 2:10) However, this is still just loving the created universe as a whole, putting its welfare above one’s own, though of course, (1) every individual is a very important part of the universe, and (2) the best way to promote overall goodness is most often to pursue one’s own self-interest. The problem remains. One’s love for God must be different then from love for humans, because they are fundamentally different “things.” Recall the “levels” in previous chapters. I cannot really say what sort of feeling one needs to cultivate, but one clear difference between creatures and God is that worship is due to God only. A human being can certainly be revered (dulia), but no man deserves even a scintilla of worship (latria). As a result, God is due dulia for His 2nd-level perfection and latria for His 3rdlevel goodness. Second, then, worship expressed in ACTS gets us a bit closer: adoration, contrition, thanksgiving, and supplication in dealing with God are certainly appropriate. However, God derives no benefit from any external worship, however just and pious. We need to do better. Third, let me suggest that a person who persists in sin is dishonoring goodness which created, redeemed, and sanctified him. He is making it regret creating the world. In a real sense, the world exists for the sake of the saints. This lesson is taught with spectacular clarity in Gen 18: Abraham approached him and said: “Will you sweep away the righteous with the wicked? What if there are fifty righteous people in the city? Will you really sweep it away and not spare the place for the sake of the fifty righteous people in it? Far be it from you to do such a thing – to kill the righteous with the wicked, treating the righteous and the wicked alike. Far be it from you! Will not the Judge of all the earth do right?” The Lord said, “If I find fifty righteous people in the city of Sodom, I will spare the whole place for their sake.” (2326) Abraham then reduces the count of the righteous to ten. Ten compared to a whole city! That is very few. But some are required. So, one ought to not free ride and rather do his part to let the world be spared God’s “wrath” by being the very person for whose sake that world is

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preserved. We see that becoming lovable is the essence of loving God. A great God deserves and is honored by great creatures. To become great, one needs wisdom and virtue. (Of course, wisdom is also a virtue, but here we may think of “virtue” as moral only and of wisdom as the highest and most precious intellectual virtue.) In short, one should make oneself into something that goodness would be proud to call its creature and child. Remember that our Lord says: “And do not begin to say to yourselves, ‘We have Abraham as our father.’ For I tell you that out of these stones God can raise up children for Abraham.” (Lk 3:8) We must admit that natural ungodly humans are a dime a dozen; there are plenty more where they come from. They are not valuable to God. But saints are valuable, because becoming holy is extremely taxing and a huge feat and achievement, something that very few people succeed at. As a saint, one is truly set apart as a gem of high quality. To keep with the terms used in Table I.27.3, in pursuing nature, man loves neighbor; in pursuing virtue, he loves God; in pursuing happiness, he loves himself. Soul-making, then, as both a theodicy and ideology, when rightly understood, fulfills all the major commandments bequeathed to us by the best – both divine and human – minds. Here is another way to think of this hierarchy. We observe that man cannot survive on his own. Taking autarky to its logical conclusion entails the extinction of the human race. Man needs the assistance of his fellows, starting from parental care and ending with protection offered by the state and division of labor in the market. A man who hates his neighbors and does evil to them is an outlaw. He is cancer on the body politic. He puts himself outside social bonds. Even if he is not immediately hunted down and killed like a mad dog, he is alone. Again, doing a reductio on his demonstrated preference yields his quick demise. Now the large amount of interdependence between humans certainly does not deprive the phrase “human nature” from meaning. We simply point out that without relation-virtues, man dies. Having secured his bodily survival, one can then attend to his soul. The chief perfections of the soul consist in intellectual virtues, control over sensuality, and holding onto the correct political ideology. Unless man makes himself into a saint, he is of no value to God. Without pure virtues, man has no eternal life in him. Upon reaching the blessed state of virtue and wisdom, one becomes worthy of happiness and can seek it with full abandon. In order to effect this, man needs act-virtues, i.e., arts, skills, techniques. With

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those, he can, having mastered his environment, enjoy every moment of his life and live without care. He is ready for paradise. The equivalence of love of self and of God can be illustrated as follows. The Buddhist injunction to “be a light unto oneself,” though entirely true, neglects to mention that in order to be a light, one must first be lit. And it is God who does the lighting. A person starts with his natural light of reason, power, and will, i.e., the trinity within. When he exhausts himself in struggle, and this light can do no more, God may give him grace which is generally speaking an increase in his potential, whatever it may be. The person then restarts his work of actualizing this now greater potential. When the new limit is reached, more grace will likely be forthcoming. Now grace enhances personality and becomes personality. If Smith has 10 gold coins, and God gives him 2 more, then it is impossible to distinguish between Smith’s and God’s shares. All we can say is that Smith now has 12 coins. In giving the light of grace, God loves man; in cooperating with God by doing his utmost to realize his grace-upped – and now fully his own – potential, man loves God back. Without grace, a person would be a rather little light; unless man redoubles his efforts to attain the new heights, grace giving is pointless. The Eastern focus on virtue is well complemented by the Western dynamic of interaction between man and God. 9. THAT PUBLIC CORPORATIONS ARE NOT GREEDY ENOUGH Many big corporations are owned by numerous people, perhaps millions, especially through mutual funds. As a result, it is not a single individual but a “community” of people that owns a public company. But is not communal ownership, well, communism? The only difference between the corporate system and socialism is the stock market that allows the trading of shares. If so, then who has the incentives to strive for corporate profits? Take corporation X. An investor may have a diversified portfolio; so, he is hedged against the failure of X. He does not care that much. Moreover, even if the company makes a good profit, he receives only a tiny portion of the total dividends that are distributed, again, to millions of people. Again, there is little incentive to a shareholder to worry about X. Of course, if one invests into too many losers, he will end up broke. So, it pays to invest prudently. But no shareholder exercises prudent concern over any X. A person acts most efficiently when he bears both the costs and

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benefits of his actions entirely by himself, i.e., when the consequences of his actions, whether good or bad, are internalized to him. Split ownership is dilution of responsibility culminating in complete separation of ownership from control as in the modern public corporation. Let us then take the X’s CEO. There is the familiar principalagent problem right there. Suppose the CEO is paid in stock. He runs a huge company, thus having huge responsibility but again benefits very little comparatively if the stock price goes up. He will tend to be too conservative. Alternatively, the CEO may be receiving a large salary. A regular worker is kept productive with fear of being fired. But the CEO is chief. He can only be fired by the board of directors which is supposed to represent the shareholders. But who elects the board? And who cares to do that well? This causes the CEO to be, on the contrary, irresponsible. These two contrary influences do not neutralize but on the contrary magnify each other. The two wrongs do not make a right. What follows from this insight is that investing as it is done today is irrational. Recall the idea of “fear, uncertainty, and doubt” or FUD introduced in (I, 47). It means lack of tactical mastery that can ruin a potentially profitable undertaking. But the very fact that an entrepreneur is seeking investors indicates FUD in his heart, a reason in and of itself not to invest into him! He does not consider his own business plan good enough to risk his own money or go into debt; so, he wants to play with other people’s money instead. I would not invest into any business that would have me as an investor, (1) because the leader feels FUD; (2) because I am not that good at picking investment opportunities. I would be, if given any chance to influence business decisions, a liability to the company. When a company goes public then, it ceases to be truly entrepreneurial. It freezes; it is neglected; it is not greedy enough. If not for challenges from privately owned new firms, we would be living under quasi-socialism. Some “ownership society” this is. Of course, the claim of irrationality of modern-type investing needs to be justified. And here is the argument: the culture of mass investing is a grotesque reaction of the people to business cycles and inflation. Millions of people who should be mere workers get accounts at online brokerages and buy stocks in hopes of (1) taking advantage of booms and (2) protecting their savings from inflation. Remove both, and investing will come very properly to be the domain of the tiny percentage of the population who have some entrepreneurial skills. As Jörg

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Guido Hülsmann points out, saving by putting gold coins in a personal vault was extremely suitable for ordinary people. Carpenters, masons, tailors, and farmers are usually not very astute observers of the international capital markets. Putting some gold coins under their pillow or into a safe deposit box saved them lots of sleepless nights, and it made them independent of financial intermediaries. (2004) For example, mutual funds are mostly designed for the risk averse types, which are the vast majority. But if the vast majority are so risk-averse, then in a society not plagued by business cycles and inflation, they would not be in the stock market at all! Business is the domain of lone heroic entrepreneurs, not dull masses whose only interest is in protecting their cash savings. Imagine that our Pure Gold standard, described in (II, 11), suddenly arrived. There would be little reason to own stocks for the great majority of regular folks. This would trigger a massive sell-off of stocks which in the process would dramatically lower their prices. The few entrepreneurial types around would slurp up these stocks at these ultracheap rates and end up owing most “public” companies. This is perfectly salutary! As Mises argues, “ownership of the means of production is not a privilege, but a social liability.” Let them lose their sleep. Take the evil forces of credit expansion and inflation away, and stock market will, on the truly free market, be reduced to a non-entity. There is also the matter of limited liability (LL) which seems tailor-made for mass investing. Clicking a few buttons on a web page and buying a stock does not expose one’s house or car or all other stocks to danger. Limited liability then encourages stock market speculation. LL converts lenders (who are owed the principal and interest by the borrowers according to justice but also are not entitled to profits) into investors (who both suffer losses and enjoy profits). This type of uncertainty is unhealthy and unworkable for most “good hard-working” people. If even big companies were sole proprietorships or partnerships at the most, then this practice would, in my view, simply wither away “naturally.” The fundamental difference between capitalist and entrepreneur is that the capitalist saves and lends; the entrepreneur invests both his own and borrowed money. Notice how full liability would make lending more attractive: it would allow lenders to plunder the failed entrepreneur’s personal assets. This diminishes (in practice) the risk to lenders,

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increases the supply of present money, and lowers interest rates. The business cycle begins with the Central Bank’s pumping in reserves on which commercial banks pyramid credit money. This also lowers interest rates but with contrary results. Bank lending with new money crowds out individual lending, such that personal investing during a stock market boom is stimulated as the expense of personal lending. As a result, many millions of people who have no idea how to run a business open online brokerage accounts and buy stocks. This is, in a word, nuts. There is, of course, a simple and superior way of limiting one’s liability even in the absence of LL laws, as ancient as the market itself: one lends rather than invests. In the case of lending, then, there is perfect separation of ownership and control with zero liability of the lender toward anybody. Alternatively, in the case of investing, there ought to be no such separation with full liability of the investor toward whoever the company enters into contracts with including its creditors. An intermediate limited liability is, let us put it this way, an abomination unto the Lord. It is an illegitimate “third way.” Now full liability is invoked precisely when the entrepreneur has borrowed money and lost it all. For a person who has piqued the interest of investors and owes nothing to no one, the type of liability he has is irrelevant; he cannot end up with nothing and in addition to that, in debt. One useful reform of the present system then would be to forbid (1) any publicly traded company to borrow money and (2) any IPO to have debts. I stress again, lest I be misunderstood, that LL is only a symptom of the larger agency problem inherent in mass ownership of private companies which fail to seek their self-interest – and through that, the interest of society via the invisible hand and all that – with sufficient vigor. It is this situation that is anti-social. But a laissez-faire reform toward sound money and honest banking will quietly do away with LL, as well. There is another argument in favor of credit expansion, namely, that it allows even poor entrepreneurs to obtain credit which may benefit society by allowing their talents to be utilized. However, a NINJA person (one with No INcome, Job, or Assets) has more things to worry about than unpursued business opportunities. Such an investor does not deserve capital. Why should a completely untested person be entrusted with other people’s money? If he is so badly positioned in the social order, then why would anyone lend him money? Or invest into him, for

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that matter? In sum, communal ownership of the means of production and the system of mass stock market speculation so prevalent nowadays are individually irrational and socially vicious, sustained only by the perverse incentives generated by our ugly money and banking regime. 10. THAT IDEOLOGICAL ACTIONS AND MASS MOVEMENTS ARE DISTINCT PHENOMENA

In (Introduction, 1), I compare and contrast science and ideology. Another way to advance the discussion is to take a page from Eric Hoffer (1951), and argue that interest in ideology and public affairs detracts one from one’s own personal pursuits. Hoffer invokes the axiom that people have ideas about how to improve their own welfare. “Nothing so bolsters our self-confidence and reconciles us with ourselves as the continuous ability to create; to see things grow and develop under our hand, day in and day out.” (§30) This is normal and healthy. Caring for one’s family members and friends is perhaps less hard-boiled but still OK. But people with ideologies have gone to some lengths to figure out how society as a whole, of which they themselves are a very small part, functions best. Even if they succeed at influencing public opinion, their personal lives will not improve. Is it not crazy to neglect one’s own projects for the sake of “society”? Isn’t it only the “pettiness, meaninglessness and shabbiness of his individual existence” (§31), the “barrenness and futility of his life” (§108), and a desire to “slough off his blemished, ineffectual self” (§78) that would cause a man to act on an ideology? Further, I might add, ideologues no longer care about any identifiable individual but about an abstraction: “total happiness,” or “general welfare,” or similar things. Finally, this sort of concern may be detrimental to one’s own personal well-being, e.g., if one is struggling against an oppressive government. For these and suchlike things the ideologue obtains from Hoffer the epithet “fanatical.” The essence of Hoffer’s haughty critique is that people who have no individuality in the first place, such as those within the “sheltering and soothing anonymity of a communal existence,” are not eager to join mass movements. It is only people who were given a chance to develop their personalities and to achieve something, tried, yet failed at it who want to slink back into a commune. They find a mass movement to be a substitute. “The ideal of self-advancement… brings with it the plague of individual frustration.” A frustrated person leads an “ineffectual, purposeless existence.” (§33) Yet under the movement’s

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anonymity, “no one can then point them out, measure them against others, and expose their inferiority.” (§28) People who have no hope of satisfaction by personal effort (including, according to Hoffer, those who definitively failed at a creative life, the especially ambitious, the impotent, even those who perceive unlimited opportunities before them but realize to their regret they cannot seize them all) tend to be attracted to mass movements which can help them to place their hopes in something seemingly “greater” than themselves. To be sure, this analysis parallels Mises’ Anticapitalistic Mentality. The chief difference seems to be that Mises ascribes to the “frustrated” a very self-interested desire to benefit from the coming of socialism. As Mises sees it, one begins to support socialism by hoping that on the day after the revolution he will enjoy the wealth, prestige, or favor of which he was shamelessly cheated under capitalism. Mises thinks that capitalism becomes a scapegoat for people’s life’s failures “in order to render inaudible the inner voice that tells them that their failure is entirely their own fault.” (1994: 12) There is a tension here in Mises’ thought: by joining the anticapitalistic crusade one contributes very little to the “revolution,” as one “comrade” among millions. It seems illogical from the point of view of narrow self-interest to care. Perhaps, his own purely psychological explanation has more merit to it. Hoffer, on the other hand, first, does not single out totalitarian political movements; in fact, he argues that all mass movements are interchangeable: a “fanatical” communist might easily, change a few minor circumstances, become a fanatical Nazi or Christian. Second, Mises does not address mass movements but rather ideas and ideologies held by individuals. Third, Hoffer locates the attraction of mass movements in people’s spiritual sickness. Hoffer’s fanatic wants to dissolve in the crowd. Having been given a precious individuality and uniqueness, he wants to be saved from himself by letting go of those things. The differences are subtle, but they are there. Yet Hoffer’s position is not entirely tenable. What would he say about a “mass movement” of people who insist that 2 + 2 = 4 and who do not tolerate the opinion of those who think that 2 + 2 = 5? Such a movement exhibits all the features he so vigorously condemns. It spews rigid “propaganda,” aimed especially at young children, in schools and universities. Engineers who believe that 2 + 2 = 5 and whose bridges for that reason collapse are fired, sued, and otherwise persecuted. 2 + 2 = 5’ers are regarded as quite insane and coercively shipped to mental hospitals. Intellectuals (such as mathematicians) are unanimous in seeking to undermine the belief that 2 + 2 = 5. It demands blind faith as a selfevident proposition. Is it really the case that this mass movement is a

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haven for the “frustrated,” the misfits, the criminals, the bored, the selfhating? As a matter of fact, a “movement” is required just to keep things as they are, for all things deteriorate when left to themselves. Unless each generation is taught without any doubts expressed by its parents that 2 + 2 = 4, civilization will come to a swift end. Capital is used up in production; unless it is maintained, a drift toward increasing poverty will immediately be kicked off. Simply preserving the old achievements entails a genuine “revolution in permanence.” For evil to triumph it is sufficient that good men do nothing, etc. “To our real, naked selves there is not a thing on earth or in heaven worth dying for,” writes Hoffer. “We are ready to sacrifice our true, transitory self for the imaginary eternal self we are building up, by our heroic deeds, in the opinion and imagination of others.” (§47) A reformed thief regrets his actions and sacrifices his old corrupt personality to live a righteous life. Is that, too, disreputable for Hoffer? If Hoffer wants to be “true, if transitory,” then I remind him that ultimately and forever, he is a stinking corpse. Is that, a dead body, his real true self? Death comes to us all; if there is a purpose to it, then so much the better. I want to emphasize that acting on an ideology is very different from joining a mass movement. First of all, one’s ideology may well be self-generated; it may be arrived at by means of serious engagement with economics, philosophy, and suchlike. If, as I suggest, ideology is simply applied science, then it loses all connotations of irrationality. Second, one can spot a mass movement where in fact there is none. Smith is a fan of Madonna (Ciccone), and so is Jones. Their interests are the same, yet there is no self-conscious pro-Madonna movement of any sort. Lots of people may have a libertarian ideology, yet it is usually unexpressed even in such a familiar and quintessentially mass action as attempting to elect a libertarian politician. “A has the same ideas as B” is very different from “A is acting in concert with B to achieve a common goal.” Acting on an ideology can be done of one’s own accord. Third, for the vast majority, acting on an ideology requires exceedingly little involvement or effort, coming down as it does to casting a vote once every couple of years. Fourth, ideological errors held by the multitude have real consequences; though always disastrous, different errors have different consequences; so, ideologies are not all interchangeable. Fifth, developing one’s ideology is an express civic duty. It is, indeed, the nature of any duty to call for a self-sacrifice. But this selfsacrifice is the polar opposite of that asked of a member of a brainwashed cult, such as to go to war and kill and die for the cult or country

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or dogma. On the contrary, it enjoins serious reflection and study and self-searching. It is a sacrifice only of human indifference to anyone other than oneself, indolence, and ignorance. Finally, the duty I am talking about flows from love for others. For in saying that “there ought to be no protectionism,” one comes to be committed to denying the benefits of protectionism even to himself and even when he is in a position to take advantage of it. One chooses to will the greatest happiness to the greatest number (thereby showing his love for humanity) even at the possible cost (in narrow happiness if not in virtue) of harm to himself. Perhaps, Hoffer might consider such a thing, too, to be unintelligible. But I think that most sane people will get the point. When evaluating a movement toward reform of the status quo, then, we should first ask whether the proposed measures will attain the ends their supporters back. What is important is whether the social or political change will make society as a whole – and through it, society’s members – more successful and happy. One must find out whether the means offered in assistance of the human search for happiness work or are true. If so, and if the only real way of implementing the reforms is to change the opinion of the masses, then a mass movement may well be in order. Hoffer writes that a “radical” considers the present to be irredeemably spoiled yet propounds visions of (unrealizable) future utopias. He ascribes to the “liberal” the view that “the present is the legitimate offspring of the past and as constantly growing and developing toward an improved future: to damage the present is to main the future.” (§52) His liberal is wise. We enjoy or play in the present, but we also want to enjoy in the future, that is, we seek future expected utility, and to have that, we must also work in the present. Hence, Hoffer is entirely right that the perfect should not be an enemy of the good; the present is both an end, where all happiness is found, and also a means, via which a better tomorrow is built. However, progress does not come relentlessly by itself but a result precisely of human efforts. Whether there is divine providence guiding either each individual or humanity as a whole or both to something no eye has seen nor ear heard is a matter of faith not unaided reason. To such reason, “nothing suggests the belief that progress toward more satisfactory conditions is inevitable or a relapse into very unsatisfactory conditions impossible.” (Mises 1996: 861) But the latter can only be prevented with a great ideology held by the common men. Hoffer’s own ideological stance is unclear. But should he object that a free society contains in itself the seeds of its own destruction,

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simply because some people in it will fail and resent their failure, my reply is that libertarianism has never promised “mental health for all.” It promises increasing human control over the material world; ever greater collective power of mind over matter; an initially wild world, (to quote from Gladiator) “brutal and cruel and dark,” subdued and bent to serve human welfare better with each generation. To long for a static society in which there is no progress, indeed, no movements, mass or otherwise, is, to me, the greatest inhumanity of all. Because what is the universe for if not a process of its eternal self-improvement?

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