Chapter 1: The Marvel That Is Capitalism

0:00The Marvel that is Capitalism. This speech was given before the Adam Smith Club, Campbell University, Boys Creek, North Carolina, on April 4, 2002. Free market economics, of which the Austrian School is the preeminent exponent, asserts that every government intervention in the market generates consequences that are deleterious for prosperity and human liberty. However much such interventions may assist one group in the short one, everyone is made worst off in the long run. Government intervention destabilizes economic life in artificial ways and ultimately does not work to bring about the results that its proponents claim to desire. Carl Menger, the founder of the Austrian School of Economics, was a firm believer in the law of cause and effect. He believed that economic affairs could be analyzed in these terms as well. Menger's followers in this tradition of thought, including Ludwig von Mises and Murray and Rothbard, spelled out the implication of this idea for a huge range of issues that confront us on a daily basis in the world of economics

1:03and politics. They focused on universal principles that can be derived from the teaching of economics. The law of supply and demand, for example, cannot be repealed by any legislature or court. Government regulators can impose price ceilings, price floors, or limits to the size of firms It is important that we think of economic life as an intricate global system of exchange, one that works without any central direction and which generates prosperity in its own form of order within the framework of liberty. This is what is sometimes termed the magic of the marketplace, and we should never underestimate its power. By looking south to Argentina we can see how a failing economy, when thrown into shock by bad legislation and monetary policy, has destroyed the livelihoods of the entire population.

1:58We are not just talking about the earnings in people's stock portfolios. We're talking about whether mothers can afford to buy milk for their children and whether the businesses that deliver milk have the freedom to be entrepreneurial and find the least costly methods to make such deliveries possible. When we speak of economics, we're talking about the health of society, and whether medical equipment is working and affordable, and whether the labor market is sufficiently free to permit everyone a place within the division of labor. People who dismiss the teachings of economics forget that many of the world's wars and ethnic slaughters began with economic intervention. Before ethnic warfare broke out in Yugoslavia in the 1990s, the country was afflicted by by one of the most extreme hyperinflations in the history of the world. This literally destroyed the standard of living and helped turn a previously settled society into a killing field. If we look back at history, we can see that many wars began in trade disputes when governments attempted to reward some producers at the

2:58expense of others. This was the origin of the Civil War, for example. Even in our own times, the perception in the Muslim world that US-UN sanctions against Iraq have slaughtered The General Lesson we can draw is that economics is really just a fancy word for the quality of our lives, and that the quality of our lives has no greater enemy than the governments that attempt to restrict economic liberty. Looking at people's lifespans, we see the hidden history of the rise of economic development. Throughout the first huge period of human The Standard of Living for the average person throughout all but the smallest slice of human history can be aptly seen as the standard of living for the average person throughout all but the smallest slice of human history can be aptly seen as the standard of living At nature's mighty feast, there is no vacant cover for him. She tells him to be gone and will quickly execute her own orders.

4:18That was life as everyone but kings knew it after the fall and before the Industrial Revolution. But in the last tiny fragment of the history of the world, lifespans have more than doubled and the world's population has increased 1,000 times. by far the largest improvements in these vital statistics have occurred since 1800, at a time when the division of labor expanded dramatically around the world, when property rights were secure, when capital could be accumulated, invested, and a return paid and reinvested, when technological improvements permitted new forms of productivity. What made this possible was the free market. We take for granted such luxuries as refrigeration, the air conditioner, the internal combustion engine, and electricity to say nothing of email, the web and fiber optics, but we rarely reflect on the fact that all of these technologies so integral to our lives were absent when our great-great-grandfathers were alive, along with every previous generation in the history of the world.

5:18What set this revolution in motion was the world of ideas, when great thinkers began to understand the internal logic of the market economy and its potential for liberating mankind from poverty, dependency and despotic rule. Given this history meant one might think that everyone would sit and marvel at the products of capitalism. We might think that intellectuals would dedicate their lives to defending this system and explaining its merits. We might imagine that statesmen would dedicate themselves to protecting the system of economic progress from every attempt to curb or abolish it. Alas, that is not true. Quite the opposite. The intellectual world often appears to be a conspiracy against Market Economics, and the media routinely ridicule capitalism. Statesmen spend every waking minute trying to curb, regulate, hamper or otherwise loot the capitalist system. Those who attacked the World Trade Center were driven by revenge, but also by a belief that the towering products of the commercial society semi-represented evil that must be destroyed rather than a virtue that should be emulated. They were merely absorbing a view that is

6:24is pervasive in our culture today, where the anti-capitalist mentality runs rampant. In our own times we've seen the evil produced by this mentality, in the former Soviet Union and in many third world countries, where politicians do everything possible to keep the entrepreneurial spirit penned up, where property rights are not secure and where investment for the long term is not permitted. The result is always the same. Poverty, despotism, death. As founder and president of the Mises Institute, I have a special attachment to the ideas of Mises and to the courageous life he lived in defense of the idea of freedom. He began his career in Vienna, writing about the problems of the business cycle and the role of money and credit in fostering it.

7:10The core point he made in his great 1912 book, The Theory of Money and Credit, was that artificial increases in the money supply are not a substitute for real economic production. Indeed, such increases cause economic damage that can only be rectified through painful economic contractions. His point has continuing relevance. His next book from 1919 sought to defend the idea that governments ought to be small and geographically limited for the sake of social peace. Next, in 1920 and 1922, he proved that socialism could not work as an economic system because it abolished property rights and capital and thus destroyed the system of profit and loss that allows for economic calculation. His methodological and business cycle writings from the 1930s are some of the most profound in the history of the social sciences. Finally, in 1940 and 1949, he produced what is quite possibly the finest product of any economist in history, his monumental treatise called Human Action.

8:07Incidentally, he wrote most of his treatise while in Geneva in exile from his native Austria. The invading German armies deemed his work dangerous. They entered Mises's apartment and looted his files and papers. Mises, you see, was against socialism, whether Bolshevik or Nazi. Reflect on that and you begin to understand the absurdity of calling communism leftist and Naziism rightist as if they were polar opposites. They are both varieties of the very opposite of freedom itself. If I were to give all college students a reading assignment today, I would recommend Human and action above all else. Yet at nearly 1,000 pages it can be intimidating and you will probably need to read it with a dictionary nearby, but it will open up new vistas of thought for you and help you to rise above conventional wisdom. I continue to believe that this book points the way for us to bring about rising and sustainable prosperity and also to guard civilization against its enemies. The headlines of the business pages have been

9:06And trumpeting the arrival of recovery from March 2001 until the present. So far the entire length of the downturn. How do the experts decide when recession has turned to recovery? By looking at the data, which come in packages labeled in various ways. The GDP, the leading indicators, the unemployment rate, industrial production, housing starts, commercial borrowings, office vacancy rates and a host of other considerations. If these tend in the negative direction, we Let's grant first that the larger the data set, the more subject to manipulation it is. We can count housing starts, but measuring something like national productivity is very tricky business. The great scandal of the way the gross domestic product is collected is that it does not measure wealth destruction as caused by something like the attacks on September 11th or the 40% of private wealth consumed by government at every level all years.

10:05Neither does it make a distinction between private production and outright government spending. Because of this, looking at that data alone, without a proper theory of economics, can produce a highly misleading picture. For many months, the government has engaged in a serious effort to bring us out of recession through a variety of fiscal and monetary policies. If recovery is really here, can we say that these policies have worked? Not necessarily, because we must establish a firm relationship between cause and effect to draw such a conclusion. The economy might have recovered without such stimulus efforts. In fact, such stimulus efforts might make the recovery weaker than it otherwise might be. A more serious possibility is that the stimulus efforts have actually created an illusion.

10:51While everyone is celebrating the unexpected economic recovery, which is also unexpectedly robust, it serves us to look beneath the surface. There are aspects of this recovery that are highly unstable because they were brought about through artificial means. There are also certain policy trends which suggest that it might not last or that it will not be as robust as it might otherwise be. The Congressional Budget Office points out that new government spending has surpassed the amounts envisioned by the stimulus measures proposed in 2001 and 2002, exceeding what even the most spendthrift lawmakers dare demand. The spending surge, along with consumer debt, helps to explain why the recession seemed mild and why everyone is talking about recovery.

11:36A major increase in government spending, which has very quickly redirected $100 billion into to the Economy, began in October 2001. Outlays went up over 2001's increases by 13.1%. In terms of GDP, it accounts for fully 1%. As for consumer spending, it is financed almost entirely by new borrowing fueled by artificially low interest rates. Looking even deeper, we can see that Federal Reserve policy has been astonishingly loose since the beginning of 2001. Reaching as high as 20% per annum by some measures. Let's say I set out to stimulate economic production in a college classroom. We could all gather together to write some software that's valued by the market, or we could teach each other new skills and increase our labor productivity. But what if I stood there with a photocopying machine and made a thousand copies of a $20 bill, passed them around and then announced that we're all $20,000 richer than before. Everyone be rightly skeptical of this claim. When the Federal Reserve does the same thing with its money creation machine, we should be skeptical also. While

12:43recognizing that some of the rebound may consist of sustainable investment begun after the great shakeout of 2000, these factors just cited strongly suggest that the current economic recovery consists of more myth than reality. We need to ask ourselves whether and by what What means it can be sustained? The only means for doing so is for it to be supported through strong economic development and sound investment. Investment that is borne out in consumer purchases and long-term profits. It turns out, however, that the federal government is on everything possible to undermine the likelihood of a sustainable recovery. In 2002, the U.S. imposed a 30% tariff on steel. The idea here was to help one inefficient, bloated and pampered Industry at the expense of all U.S. consumers of steel, including U.S. businesses and all producers in Europe, Asia, Brazil and Australia. This is brazen protectionism, deeply harmful all around, not to mention morally repugnant. Did it help the steel industry? In the short run, yes, but we have to ask ourselves whether this kind of help is a good thing in the long

13:46run. The tariffs for an inefficient industry to continue to produce inefficiently and for for stall improvements in technology and cutbacks in wages that are necessary if the industry is to adjust to 21st century realities. There's no virtue to keeping dying and inefficient technology humming along so that workers who would be better employed elsewhere can continue to enjoy fat checks doing outmoded work. How long must these tariffs remain in place? The steel industry said they are only necessary in order to get it back on its feet. But that That belies the question of what precisely is going to inspire this sector to clean up its act. Protecting an industry from competition is a method that permits everything wrong with the industry to persist and not change.

14:32Either the tariff will have to be in place permanently or the industry will have to be shaken up. If you think about it, Soviet socialism survived for 74 years on precisely such policies. The Soviet state protected all its industries from market competition under the alleged need to build socialism. Factories were never closed, workers were never let go except for political reasons when their services were employed in the gulag. The system worked only if the standard was not efficiency, but merely the guarding of the status quo. Eventually the system collapsed, as status systems must, and the Soviets woke up to a world that was backward and decayed. The steel tariff imposed by the Bush administration is different from Soviet socialism only in degree, not in kind.

15:19It is an attempt to circumvent the market process through a centrally administered system of rewards and subsidies for industry to abide by political priorities rather than market dictates. In the meantime, all purchases of steel, whether consumers or other businesses, are harmed by being forced to pay a higher price for an inferior product. Also in 2002, the U.S. imposed massive punitive duties on softwood imports from Canada. Why? Because Canada refused to obey a U.S. demand that it place a new tax on its softwood. The new duties raised the price of softwood used for building nearly every home in America by 27%. This is going to distort the housing market among any other sectors that use wood. Higher prices for steel and wood put additional pressure on other businesses to use these products in production.

16:09In economic terms, tariffs are indistinguishable from sales taxes. They take people's property by force by requiring businesses and consumers to pay higher prices for goods than they would otherwise pay in a free market. To that extent, they harm the prospects for economic growth. If anyone says otherwise, he's ignoring hundreds of years of scholarship and the entire story history of government interference with international trade. The repercussions of these two actions are already being felt via damage relations in Latin America and Europe. The World Trade Organization will likely give the green light for retaliation. Protectionist lobbies all over the world are rushing to take advantage of the opportunity. The EU has imposed tariffs on U.S. steel, and Canada is considering retaliatory measures.

16:54This way lights trade war, which is the worst thing that can happen to an economy other than hot war. Another policy that endangers recovery is the war on terrorism. I'm not taking issue with the need for justice after September 11th, but it seems clear that the government used this tragedy as an excuse to vastly increase spending and regulation over the American and world economy. President Bush, who campaigned on a platform of cutting government, has asked for another $28 billion to pour into the military even as he is pushing for more regulations on banks and financial privacy in the name of rooting out terrorism. The total increases of 2002 and 2003 could be as high as 300 billion, depending on whom the U.S. plans to conquer next. Here again this spending can create the illusion of prosperity, but we must also remember that the first lesson of economic science is this.

17:45The world is a finite place where the use of any and all resources are constrained by scarcity. This is just another way of saying that you cannot always get what you want and when you do it must come from somewhere. from somewhere. When the government spends resources, it must drain them from the private economy through taxation, borrowing or inflating the money supply to pay for the new spending. Economics doesn't deny that redirecting resources from one sector where they are valued by consumers to another sector where they are valued by government can create pockets of expansion. What economics suggests is that this is not an efficient or sustainable use of such resources. Only the unhampered competitive market economy with a system of market prices, profits and losses can reveal to us with any certainty the most desirable destination of economic goods.

18:36But in the examples I have just given, you can see how government intervention is redirecting resources from consumers' most desired ends to purposes deemed desirable by political planners. The politicians believe that the military needs resources more than you and I, so they take them. They believe that the profits of the steel industry are more important than the international division of labor, so they protect that industry. They believe that the softwood industry deserves to obtain the highest possible prices for its products, so they intervene to hamper imports. As for the explosion of consumer spending that has taken place over the course of the downturn, this does indeed encourage businesses to expand. If low interest rates are encouraging consumers to dig deep to borrow for and buy new homes, This will encourage more investment in housing on the production side as well.

19:22This too will be encouraged by the interest rates being depressed by the Federal Reserve. Artificially low interest rates also tend to discourage savings and encourage people to put money back into the stock markets where they hope it can earn a higher rate of return. If credit expansion, protectionism and government spending were a path to prosperity, mankind would long ago have created heaven on earth. The politicians engaged in these activities have to contend with reality, and the reality is that economic forces in society must be mutually sustaining. To have production and borrowing there must be savings, which only occurs when people forgo consumption today to prepare for tomorrow, and when investment pans out in the forms of consumption. Absent such conditions, economic growth lacks a foundation in reality and turns to dust when economic conditions change. We have seen many examples of this in recent years. The Internet bubble was one such case. There was nothing unreal about technology or its potential to provide massive gains in efficiency as well as a vibrant new commercial marketplace and information

20:27delivery service. Nor was there anything ignoble about investors who put money into dot-coms on the promises of future profits. What distorted the picture was too much credit, courtesy When the Fed began to reduce the pace of monetary pumping, lenders pulled back, investors pulled out, and dot-coms and their support infrastructure found themselves overextended well beyond what the market would have borne if it had not been subsidized by a reckless Fed policy. The collapse of the Nasdaq was nothing more than reality reasserting itself. Some malinvestments were cleaned out, and the ground was prepared for new investment. .coms weren't the only ones affected by the bubble. Enron is another famed case in point.

21:12This company profited and dramatically expanded at a time when investors were encouraged to recklessly purchase stocks without regard to balance sheets. The auditors are catching the blame, but the truth is that Enron profited at a time when portfolio managers weren't paying very close attention either. The only way such a cluster of errors comes to predominate in a market economy is when the central bank unleashes new money and credit beyond anything the market can sustain for long. Prior to our own bubble we saw a similar situation in Asia and before that in Mexico. In each of these cases what we find is not market failure, but a failure of the system of money and credit provide reliable signals for investors and lenders. It is helpful to think of the interest rate as a price signal, so that Fed attempts to drive down rates simply misprice credit. In the same way that a government price ceiling would cause over consumption of any good, whether eggs, gas or electricity, distortions of the interest rate encourage over consumption of credit.

22:12It's not surprising then that we are seeing a spending boom take place today among consumers, even as producers are pulling back in many areas. Certain sectors have prospered since the reflation began after mid 2001. Housing in particular has boomed out of all proportion to what it would otherwise do in a free market. If any sector is being set up for a fall today, it is this one. Regardless of the fallout from day to day economic affairs, Mises believed that no power on earth is as strong as ideas. You live in a world of ideas, so take your responsibilities very seriously. The achievements of freedom should speak for themselves, but sadly they do not. Freedom needs courageous individuals who are willing to stand apart from the mob and state an unconventional truth.