12/27/07 The Commanding HeightsThe Commanding Heights

Purpose of viewing this material – discover threads of thought, their implementation, and their consequences – to avoid the mistakes of the past, as ‘old’ and ‘failed’ ideas and nostrums as sold to an unsuspecting new generation.

Nine hour PBS Special first aired in 2002. For full ‘Story Line, see: www.pbs.org/wgbn/ commandingheights/

-- Episode One: The Battle of Ideas

-- Episode Two: The Agony of Reform

-- Episode Three: The New Rules of the Game

Key points:

Free trade of the second half of the 19th Century [after abolition of the Corn Laws]

World War I -- the end of ‘free trade’Russian Revolution‘War communism’ – failureLenin – “Two steps forward, one step back” -- state control of the ‘Commanding

Heights’New Economic Policies (NEP)Economic DebateVictory of Stalin and the First Five Year Plan (FYP)

Keynes and Hayek – Profiles and predictions

Hyperinflation in Germany – war reparations, the destruction of the German middle class, and the rise of National Socialism and Hitler

Great DepressionHayek’s warningCentral Banks’ roleBretton Woods (Keynes)

Post War Britain/‘fair-shares’/defeat of Churchill/Labor nationalizes the ‘CommandingHeights’

Milton FriedmanDemocracy and free-markets

Germany Ludwig Ehrhardt’s dilemma: price controls vs. inflation – Price controls & shortages

The first ‘oil shock’ and ‘government failure’ – James M. Buchanan @

www.dallasfed.org/research/ei

Stagflation – if we had only had an Ehrhardt – the failure of the ‘New Economics’ aka Keynesianism; see: Henry Hazlitt, 2007/1957. The Failure of the ‘New Economics’: An Analysis of the Keynesian Fallacies.

Thatcher and Hayek

Thatcher and Reagan

Deregulation of sandwiches

Shock Theory

The Battle of Ideas

A critical point of Episode One is the a description of major political/economic trends from the ‘free trade’ era of the end of the 19th Century focusing around the ideas of two economists:

John Maynard Keynes and Frederick von Mises

Advocate of ‘central planning’ Advocate of prices & ‘free markets’ Fix ‘market failure’ Avoid ‘government failure’

Preserve individual ‘freedom’ Markets are self-correcting

The first era of globalization (or ‘free trade’) came to an end with an act of terrorism in August 1914 – the assassination of Archduke Ferdinand of Austria by a Serbian. This act launched the First World War. Hayek fought with the Austrian artillery in the Italian Alps, while Keynes advised the British government on the allocation of resources to win the war (‘government planning’). This war brought to an end the prosperity of the ‘first era of globalization’ associated with the British rule of the sea.

Free global markets → Specialization of task &

specialization of area → Lower prices for all

consumers.

The end of the war brought heavy ‘reparations’ [payments to the allies for war ‘damages’ by the losing parties] imposed on the losers at the Treaty of Versailles: Germany/Austro-Hungary and

Turkey. Keynes left the peace conference and wrote: The Economic Consequences of the Peace.

The war brought on a revolution in Russia, overthrowing Czar Nicholas II and the murder of the royal family. It also led to the rise of Communism in the Soviet Union under V.I. Lenin, and then J. Stalin, and a retreat to ‘regionalism’ (‘Communism in one country’).

Socialism was viewed as ‘more just’ than ‘free markets,’ this was a lure of socialism -- communism for a better, more just world. Hayek’s view was: Markets work, government doesn’t! Without a free-market, prices cannot be set by consumers’ choices – to buy at some price or to refrain from making purchases – the consumer is no longer free to tell producers: (i) what they want; (ii) in what color or style; (iii) in what quantities.

The Smithian (Adam Smith) admonition: “All production is for consumption” had been lost sight of by a self-anointed elite – an elite that presumes to know what consumers want or, at least, what they should want. Prices serve, as noted in the video, as ‘traffic signals’ and if they are messed with, it leads to chaos, or a ‘traffic jam’. It is not the free-market that is chaotic (as argued by Marx, Lenin and Stalin), but it is government intervention (the arbitrary setting of prices where the elite believe they should be set, for whatever reason) into the free-market that is the sources of the chaos. In the USSR, under the period known as ‘War Communism’ (1917-21), wages and prices were fixed, which led to disaster – shortages – as can be seen plainly in Boris Pasternak’s Dr. Zhivago. The shortages were especially severe in the towns and cities – since farmers couldn’t by anything with the money they received from selling their agricultural products – industrial production had collapses under ‘war communism.’ – and farmers refused to sell their products.

In Germany and Austria/Hungary the devastated economies were kept afloat and the ‘reparations’ were financed by printing more and more money (by inflation). These actions resulted in inflation and then more inflation and finally, hyperinflation. The hyperinflation destroyed the ‘middle classes’ by wiping out their savings and it helped bring the ‘ fascists’ and ‘Nazis’ to power in Germany. For the Austrian School of economics it is inflation that is the greatest evil. This is just the opposite of Keynes’ position on inflation –

The expectation of a fall in the value of money stimulates investment and hence employment generally, because it raises the schedule of the marginal efficiencyof capital, i.e., the investment demand-schedule; and the expectation of a rise inthe value of money is depressing, because it lowers the schedule of the marginalefficiency of capital. (1936. The General Theory of Employment, Interest and Money, 141-142)

To which, Henry Hazlitt has responded:

This is the equivalent of saying that inflation, and even more, the threat of further inflation, is good because it stimulates investment and employment. (1959/2007.The Failure of the ‘New Economics’: An Analysis of the Keynesian Fallacies, 160)

Disillusionment with the existing socio-economic systems (capitalism), bitterness over the distribution of ‘wealth’, demand for a ‘more just’ society and the desire and belief in a better

world stimulated the ‘socialist’ movements in Europe – whether National Socialism (Nazi) or Marxism/Leninism.

Hayek became a member of a discussion group led by Ludwig von Mises – a well known economic Libertarian who believed that individuals should be free as should markets, free from the intrusiveness of government. Both Mises and Hayek pointed out that ‘prices’ serve as ‘traffic signals’, that without them, economic chaos (‘distortions’), the inability of consumers to convey their NEEDS and WANTS to producers!! If the producers are government agencies, things become orderly, but consumers remain unsatisfied, as the needs and wants of the government, expressed in the Soviet Union by GOSPLAN (the Central Planning agency) are IMPOSED on consumers. [The ‘central planners’ know what’s best!] Mises argued: “Free markets do it best, why mess with anything less.”

Upon seizing power in Russia in 1917, Lenin abolished private property, ‘pooling’ productive assets and consumer goods – abolishing the ‘chaos’ of the free market. In the USSR [Soviet Union] in 1917-1921: Lenin encountered economic difficulty (‘War Communism’ – nationalized the land, did away with individual property rights, confiscated all industries, implemented ‘wage and price controls,’ and making ‘free market’ transactions ‘economic crimes’ punishable, even by death); thereby destroying individual INCENTIVES to provide ‘factors of production’ and to PRODUCE and MARKET goods and services. The economy was at the point of collapse and Lenin was forced to relax these strict economic laws, called the New Economic Policy (NEP) – he was attacked by the Left-wing of the Communist Party of the Soviet Union (CPSU) and he defended the NEP by reporting that the “Commanding Heights” (heavy industry, mining, electricity) would remain under the control and direction of the government. After Lenin’s death, Joseph Stalin gained control, ‘purged’ [murdered] all political opponents and ‘enemies of the state’. He collectivized agriculture, re-socialized ALL economic activities, and made it a crime to work for any employer, BUT the STATE, and implemented Central Planning.

In the United States, un-ravished by the ‘direct’ effects of WW I enjoyed an economic boom, as explained by L. von Mises:

It is customary to describe the boom as overinvestment. However, additional investment is only possible to the extent that there is an additional supply of capital goods available….The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. …The unavoidable end of the credit expansion makes the faults committed visible.

The erroneous belief that the essential feature of the boom is over investment and mal-investment is due to the habit of judging conditions merely according to what is perceptibleand tangible. (Human Action, 556; emphasis added)

Notice, ‘what is perceptible and tangible’, is reminiscent of Frederic Bastiat’s Things Seen and Things Unseen in the ‘Broken Window Fallacy.’

Interestingly, Mises continues his dissection of economic booms and ‘malinivestment’:

The increase of the quantity of fiduciary media certainly always has the potential effect of making prices rise. …Output per unit of input was increased and business filled the markets with increasing quantities of cheap goods. If the synchronous

increase in the supply of money (in the broader sense) had been less plentiful than it really was, a tendency toward a drop in the price of all commodities would havetaken effect.

The essential features of a credit expansion are not affected by such a particular constellation of the market data. What induces an entrepreneur to embark upon definite projects is neither high prices nor low prices as such, but a discrepancy between the costs of production, inclusive of interest on the capital required, and the anticipated price of the products. A lowering of the gross market rate of interest as brought about by credit expansion always has the effect of making some projectsappear profitable which did not appear so before. (Mises, 558, emphasis added)

… What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The boom is built on the sands of banknotes and deposits. It must collapse.

The breakdown appears as soon as the banks become frightened by the accelerated pace of the boom and begin to abstain from further expansion of credit. The boom could continue only as long as the banks were ready to grant freely all those credits which business needed for the execution of its excessive projects, utterly disagreeing with the real state of the supply of factors of production and the valuations of the consumers. These illusory plans, suggested by the falsification of business calculationas brought about by the cheap money policy, can be pushed forward only if new creditscan be obtained at gross market rates which are artificially lowered below the heightthey would reach at an unhampered loan market. It is this margin that gives them the deceptive appearance of profitability. The change in the banks’ conduct does not create the crisis. It merely makes visible the havoc spread by the faults which business has committed in the boom period. (Mises, 559, emphasis added)

An integral element of the boom in the 1920s in the U.S. was growth of ‘new industries’ based on the technological changes (electrification, refrigerators, radio, automobiles), the ‘internet’ companies of that period. The boom was expressed through ‘a stock market bubble’ as seen in the price of RCA’s stock which rose from $1.50 per share to $ 600 per share … much like ‘dot coms’ of the late ‘90s). Additionally, it might be acknowledged that the Great Depression corresponded with an extended drought in the mid-west, as chronicled in John Steinbeck’s classic: The Grapes of Wrath. [Since reading Steinbeck is no longer in vogue, watch the film, starring Jane Fonda’s humiliated father.]

The Great Depression was blamed on the ‘chaos’ of free markets, greedy businessmen and the like, absolving government of all responsibility for creating the favorable ‘environment’ for the boom! It’s important to question this conclusion and ask whether or not the Depression was the result of the failure of capitalism (‘free-markets’), or of government intervention in the market? The money supply was controlled by the Federal Reserve, which had been formed in 1913, and the Congress had passed the Smoot-Hawley Act (tariff) helped bring the ‘first era of globalization’ to an abrupt end. This is not an uncommon pattern. The government creates a problem, blames someone else, and intervenes even more intrusively to fix the problem that they have caused. A wonderful example may be found in Alan Greenspan’s brief paper, “Antitrust,’ (1962), reprinted in Ayn Rand. 1967. Capitalism: The Unknown Ideal, 63-71. Greenspan opens his essay with:

The world of antitrust is reminiscent of Alice’s Wonderland: everything seemingly

is , yet apparently isn’t, simultaneously. It is a world in which competition is laudedas the basic axiom and guiding principle, yet ‘too much’ competition is condemnedas ‘cutthroat.’ It is a world in which actions designed to limit competition are branded as criminal when taken by businessmen, yet praised as ‘enlightened’ when initiated by the government. (63)

As an example of his thesis, he considers the expansion of the U.S. railroad system, comparing its growth in the east (1830s-1860s), with its extension to the west coast (post-1965), first noting railroad growth east of the Mississippi River:

The railroads developed in the East, prior to the Civil War, in stiff competition with the older forms of transportation – barges, riverboats, and wagons. By the 1860s there arose a political clamor demanding that the railroads move west and tie California to the nation: national prestige was held to be at stake. But the traffic volume outside the populous East was insufficient to draw commercial transportation westward. The potential profit did not warrant the heavy cost of investment in transportation facilities. In the name of ‘public policy’ it was, therefore, decided to subsidize the railroads in their move to the West. (64)

Notice the points that Greenspan makes: (i) competition in the East; (ii) political pressure; (iii) insufficient demand outside the Northeast; (iv) lack of demand in the West meant expected profits, in a market context, could not cover the costs of railroad construction; (v) hence, a ‘political solution’ (government, i.e., taxpayer) was substituted for the ‘free market’ and the guiding currents of profits. He continues:

Between 1863 and 1867, close to one hundred million acres of public lands were granted to the railroads…. with the aid of the federal government, a segment of industry was able to ‘break free’ from the competitive bounds which had prevailed in the East. … (64)

…The western railroads were true monopolies in the textbook sense of the word. They could, and did, behave with an aura of arbitrary power. But that power was not derivedfrom a free market. It stemmed from governmental subsidies and governmental restrictions. (65)

When, ultimately, western traffic increased to levels which could support other profit-making transportation carriers, the railroads’ monopolistic power was soon undercut. In spite of their initial privileges, they were unable to withstand the pressure of free competition.

In the meantime, however, an ominous turning point had taken place in our economic history: the Interstate Commerce Act of 1887.

The Act was not necessitated by the ‘evils’ of the free market. Like subsequent legislation controlling business, the Act was an attempt to remedy the economic distortions which prior government interventions had created, but which were blamed on the free market.(65)

Clearly, it is necessary to keep Frédéric Bastiat’s comments on ‘things seen and things unseen’ in mind!

Back to The Battle of Ideas:

The global depression ensued and John Maynard Keynes formulated his General Theory, re-writing the rules of economics by splitting the discipline into two segments: (i) macroeconomics; and (ii) macroeconomics. He sought to layout the means for human beings to MANAGE economies – markets are incapable of operating smoothly without human guidance – markets are subject to ‘failure’…i.e., excesses. [See: A. C. Pigou. Economics of Welfare] Some argue (Keynesians), that Keynes’ policies would “save capitalism from itself.”

In the U.S, Franklin D. Roosevelt (FDR) fought the Depression by regulating the ‘recklessness of the unfettered market.’ The bold (Nazisesque) sculpture, at the ICC (Interstate Commerce Commis-sion), of a man bridling/reigning-in a horse is symbolic of the wild, ‘animal nature’ of the market and the social, ‘pacifying-nature’ of the government! There is a need to protect ‘the people’ from the excesses of ‘the market’ – regulate it to eliminate the boom/bust cycle [go back and read Mises comments on the ULTIMATE source of malinvestment and the ‘boom/bust’ cycle. Here once again, the view is that government is the solution, not the problem. The government has a responsibility to maintain ‘full-employment’, a la Keynes’ prescription of ‘contra-cyclical government, spending’ – in an economic downturn, practice deficit-spending to stimulate the economy, and during an economic expansion build-up surpluses to slow the economy. [Interestingly, the avowed Keynesians now disregard this prescription.] Note that John Kenneth Galbraith of Harvard University believed himself to have been the bearer of ‘Keynesianism’ to the U.S. He served in the FDR administration (Office of Price Administration – the usurpation of the basic functions of a free-market, based on the setting of mutually agreed upon prices) and argued that we had to endure “… a little inflation to assure low rates of unemployment.” Galbraith maintained that we “must put up with a little inflation in order to maintain high rates of employment”. This implies that a ‘trade-off’ exists between ‘inflation’ and ‘unemployment’, known fondly as the ‘Phillips Curve,’ after A.W. Phillips, an economist from New Zealand, who ‘postulated’ the trade-offs, based on historical data from Great Britain. [A.W. Phillips. 1958. “The Relation between Unemployment and the Rate of Change of Money Wage in the United Kingdom, 1862-1957,” Economica. His original argument:

…measured inflation by percentage change in wages, rather than by the percentage change in prices. Because wages and prices usually move together, this difference is not important to our discussion.” (Hubbard and O’Brien. 2006. Macroeconomics, 516, emphasis added).

On the following page, Hubbard and O’Brien report in a marginal note, “The Phillips Curve”:

A.W. Phillips was the first to show that there is usually an inverse relationship between unemployment and inflation. (517, emphasis added)

Notice the scientific precision of their argument – usually! Such terminology is NOT an attribute of a true science – the ‘law of gravity’ usually holds? ‘Ohm’s law of electricity’ usually works? ‘Boyle’s laws of gases’ usually predicts well?

Even more revealing are the comments on the ‘Phillips Curve” found on Wikipedia (I know, this is a suspect source, since it is ‘open-source’ and people can write or add whatever they like … it is not the truth as revealed by peer review and editorial ‘correction’ … Yet as an open source, Wikipedia is constantly updated and revised by its users):

… many economists in advanced industrial countries believed that Phillips’ resultsshowed that there was a permanently stable relationship between inflation and unemployment. One implication of this for government policy was that governmentcould control unemployment and inflation within a Keynesian policy. They could tolerate a reasonably high rate of inflation as this would lead to lower unemploy-ment. (Emphasis added)

During the late 1960s and early 1970s in the quest to ‘manage’ the economy, governments used ‘fiscal’ [government’s use of coercive taxes and preferential spending (redistribution of income) to achieve macroeconomic goals] and ‘monetary’ [use of money supply (printing press) and interest rates set by the Federal Reserve to attain macroeconomic objectives] policies to ‘tweak’ the economy. Such machinations to reduce unemployment resulted in ‘stagflation’ during the late 1970s – the simultaneous occurrence of slow economic growth, high rates of inflation and high levels of unemployment! Wikipedia, paralleling the narration of “The Commanding Heights,” report that:

Theories based on the Phillips Curve suggested that this [‘stagflation’] could not happen.

Nonetheless, it had happened! In a critique of the Keynesian economic management model, Milton Friedman argued that

… the demonstrable failure of the relationship [Phillips curve’s rates of and rates of unemployment] demanded a return to non-interventionist, free marketpolicies. The idea that there was a simple, predictable, and persistent relation-ship was abandoned by most if not all macroeconomists.

During World War II the FDR administration assumed DIRECT control over markets by ‘Wage and Price Controls’. [Ironically, the market distortions of THIS policy plague us today … to attract SCARCE workers, firms COULD NOT offer higher wages, so they offered FRINGE BENEFITS which were not controlled by John Kenneth Galbraith and his Price Administration. One of these fringe benefits was health care benefits provided by PRIVATE INSURANCE COMPANIES (a Third Party payer) … If an individual does not have to pay the ‘full’ market price for a good or service there is a propensity for her/him to over-use those goods/services, thereby stimulating higher prices… Look at a Supply and Demand curve relationship with an equilibrium price (Pe) reflecting free market conditions, compare this with a price set below equilibrium (Padmin), and compare the quantities supplied (Qs) and demanded (Qd). Note that the quantity demanded (Qd) exceeds the quantity supplied (Qs).]

At the London School of Economics, Frederick Hayek wrote The Road to Serfdom (1944) …

Too much central planning → Too much government

power in the market → Too little individual freedom.

It’s all about the acquisition and perpetuation of ‘political power’ by the ‘intellectual elite’ that has experienced the revelation of divine (with a small ‘d’) will … that human direction of the economy is far superior to the impersonal operation of the free market.

At the Bretton Woods Conference, which sought to design a framework to ‘organize the post-war economy’ [‘human direction’ as opposed to ‘the operation of free-markets’], the Keynesian worldview (discrediting of Capitalism and the need for external control) was adopted with the creation the World Bank and the International Monetary Fund (IMF).

In Great Britain, the desire to ‘build a new society’ based on ‘fairness’ or ‘equity’, in stark contrast to ‘efficiency’ of the free market, was labeled ‘fair share’ in reaction to the Great Depression. Churchill warned of the need for ‘economic police’ to assure that the full implementation of a ‘planned economy’, while the socialists ridiculed ‘that foreign chap’ (von Hayek)! The socialists won the election and turned-out Prime Minister Winston Churchill → using William Blake’s quest for the ‘New Jerusalem’ → which “Broke into the sacredness of private property . ” It might be observed that the Austrian economist, William Block (1998) wrote of the sanctity of private property and the individual’s property rights to the fruits of his/her labor:

Economic freedom also admits of a straight-forward definition. It is the idea Economic freedom also admits of a straight-forward definition. It is the idea that that people legitimately own themselves and the property they ‘capture’ from people legitimately own themselves and the property they ‘capture’ from naturenature … …

In 1947, in the fresh air of the Swiss Alps, Hayek brought together a group of similar minded economists and journalists, including Ludwig von Mises and Milton Friedman, to formulate the spread of ‘free market’ ideas. The group generally agreed that freedom was in danger from ‘central planning’, the group believed that free markets were an essential pre-requisite for individual liberty and political freedom!

While in Berlin, hyperinflation was running wild, with military imposed wage and price controls designed to curb inflation. Cigarettes and cognac (‘coniac’) served as the medium of exchange in the ‘illegal’ [notice: ‘illegality’ and Churchill’s warning of the need for ‘economic police’] black market. Ludwig Erhard abolished the ‘wage and price’ controls, and within days the economy began to recover, as prices stabilized and hoarding ceased. Hummm, now there is a ‘real’ economic experiment! Germany’s free-market, welfare state economy overtook the British socialist, welfare state.

In India, with political independence, Gandhi’s economic vision was for a village-based, small-scale production model, while Nehru sought to create a British-style parliamentary democracy with a Stalinist planned economy of large, state-owned industries. This became the ‘preferred’ model adopted by many of the world’s developing nations.

The Chicago School of Economics – “The Commanding Heights’ erroneously places a great deal of emphasis on the role of Milton Friedman – as important personages, if not more important, were Frank Knight and George Stigler [For both Friedman and Knight, see: www.dallasfed.org/research/ei]. The hallmark of the school is its emphasis on a minimal role for government in the economy, i.e., free markets. There are forces at work in the free market

economy – much like the “winds and the tides” (natural forces), they can be ignored or overridden (by humans) only at great risk. [Man over Nature…!].

By the 1970s, Hayek had been marginalized by ‘mainstream’ (i.e., Keynesian) economists, but the rise of stagflation signaled (were symptomatic of) that something was wrong → both high levels of ‘inflation’, slow growth, and high rates of ‘unemployment’… something that shouldn’t be happening, according to the Keynesian formulation (‘Theory’). If a model or theory fails to predict accurately, the Baconian Scientific Method requires that it be REJECTED, not just ‘tweaked’ to improve its level of predictive power! [See: Michael Crichton. “Aliens Cause Global Warming” and “Testimony before the United States Senate,” @ www.crichton-official.com]. Nonetheless, many economists sought to ‘salvage’ this bulwark of Keynesianism, adopting short-run and longer term models of ‘rational expectations’ and ‘natural rate of unemployment’ approaches (‘tweak’, ‘tweak’). [See: “Phillips Curve,’ Wikipedia.com] Some even changed ‘rates of inflation’ and ‘rates of unemployment’ found in the original formulation to ‘rates of change of inflation’ and ‘rates of change of unemployment.’ (‘tweak’, ‘tweak’) In some circles this might even be described as “Procrustian-bed economics” [i.e., make the data fit the model, even if we have to cut-off the subjects feet and legs, or stretch the body on the rack to fit the roll-away bed.]

President Richard Nixon, caught in the beginnings of ‘stagflation,’ declared himself a Keynesian, sought to ‘spend his way out of the problem’…exacerbating the situation! [Keep in mind Milton Friedman’s comment about the placement of blame] He was forced to resort to ‘wage and price controls,’ to appease the public – remember Ludwig Erhard and the ‘wage-price controls’ imposed by General Clay?

In regards to employment/unemployment, Ludwig von Mises has observed:

If a job-seeker cannot obtain the position he prefers, he must look for anotherkind of job. If he cannot find an employer ready to pay him as much as he would like to earn, he must abate his pretensions. If he refuses, he will not getany job. He remains unemployed.

What causes unemployment is the fact that … those eager to earn wages can and do wait. A job-seeker who does not want to wait will always get a job in theunhampered market economy in which there is always unused capacity of natural resources and very often also unused capacity of produced factors of production.It is necessary for him either to reduce the amount of pay he is asking for or toalter his occupation or his place of work. (1998. Human Action: A Treatise on Economics, 595; emphasis added)

…. Unemployment in the unhampered market is always voluntary….on the unhampered market, there is always for each type of labor a rate at which allthose eager to work can get a job. The final wage rate is that rate at which alljob seekers get jobs and all employers as many workers as they want to hire.(596-7, emphasis added)

Wage rate fluctuations are the device by means of which the sovereignty of consumers manifests itself on the labor market. (597, emphasis added)

Mises goes on to demonstrate that in an ‘unhampered market’ their will be the greatest amount of freedom for both worker and employer:

This amount of freedom is the maximum of freedom that an individual can enjoy in the framework of the social division of labor, and this amount of coercion is the minimum of coercion that is indispensable for the preservation of the system of social cooperation. There is only one alternative left to the catallactic pressure exercised by the wages system: the assignment of occupations and jobs to each individual by the preemptory decrees of an authority, a central board planning allproduction activity. This is tantamount to the suppression of all freedom. (597, emphasis added)

Little wonder that Von Mises found it so difficult to find an academic (teaching) position in the United States in 1940, in ‘intellectual tolerance’ of the Keynesian economic environment.

The virtues of the ‘free (unhampered) market’ begin with individual freedom and political liberty. The Commanding Heights reports that the economic consequences of government regulations are reduced production, leading to higher prices which fuel inflation, the suppression of competition, and reduced liberty. The French economist, Frédéric Bastiat, had written in the first half of the 19th Century, that: “Competition is merely the absence ofCompetition is merely the absence of oppression.”oppression.” The examplar of this process was the airlines industry. The program noted that the airlines in existence during the Depression were the same air lines providing service in the late 1970s … government regulations served as a ‘barrier-to-entry’, keeping new and innovative firms out of the market! Such governmental regulatory actions, the very opposite of ‘ the invisible hand’ of the free market (Adam Smith), became, for Milton Friedman, ‘the heavy foot’ of government.

In 1977 President Carter appointed Alfred E. Khan (Economics Professor at Cornell University) to head the Civil Aeronautics Board. Kahn noted that the largest branch of the CAB when he took office was the ‘Enforcement Branch’ [remember the comment made by Churchill about the need for ‘economic police’ whenever there is a ‘government economic planning agency]. He reported that 5% of the cases involved companies charging prices that exceeded the prices set by the government (‘too high’) and 95% involved companies charging prices that were below the prices set by the government (‘too low ’)! Now that’s ‘real’ consumer protection! Khan reported that the CAB even decided on the size of sandwiches that could be served on airlines. Clearly, air carriers enjoyed such government intervention on their behalf, at the expense of the consumer – higher prices, assigned routes, lower levels of service (times and destinations)! Under Khan’s leadership the Airlines Deregulation Act of 1978 was passed, abolishing the CAB and privatizing the U.S. airline industry, his evaluation of the results includes:

(i) lower fares;(ii) increased productivity;(iii) improved safety;(iv) improved services;(v) increased competition.

[See: Alfred E. Khan. “Airline Deregulation,” www.econlib.org/LIBRARY/Enc/AirlineDeregu- lation.html.]

In the discussion of the airline industry a woman is interviewed discussing the plight of her father, a jet-mechanic at Braniff Airlines when it failed from increased competition. He was hired back when Braniff emerged from bankruptcy, but at half his previous salary and “He played by the rules.” The rules of the game include inflated salaries in a government-protected industry, not subject to the disciplinary competition of a ‘free-market,’ all at the expense of consumers. Just a reminder, von Mises had written: “All production is for consumption.” That being the case, the United States has a current population of 305,593,462 and a total of 136,174,000 job-holders … 306 million consumers and 136 million workers! Hence, government is willing to intervene on behalf of 136 million workers at the expense of the rest of society!

In the United Kingdom, the Socialist, welfare-state, whose solution to stagflation was to ‘spend their way out of the problem,’ was wracked by STRIKES. Margaret Thatcher was elected Prime Minister and her solution was PRIVATIZATION of the state-owned industries. In the United States in 1979 President Carter was officiating over an economy beset by high rates of unemployment, high rates of inflation, slow economic growth – stagflation! Carter appointed Paul Volker as the Chairman of the Federal Reserve. He viewed INFLATION as a drag on the economy – his response was a tightening of the money supply (a monetary contraction) – with a decline in money supply, interest rates (i) would rise, slow private sector household spending (C), decrease production (GDP), cause an increase in unemployment and result in a decrease in the inflation rate. According to the video, unemployment rose to 10% [annual rate 1982 – 9.7% and 1983 – 9.6%] and interest rate to 20% [1981 -- average annual prime rate 18.8%]. Money supply data is available at the Federal Reserve website (www.federalreserve.gov). These data reveal that money-supply [M1 and M2] grew at excessive rates from 1969/70 onward through the late 1980s/early 1990s:

Money Supply Year-over-Year Change in Prime Rate Unemploy.Year CPI [M1 + M2] Rate of Change GDP (Ave. Mon.) Rate

1968 4.7 569.7 …. 3.61969 6.2 590.1 3.58 3.5

1970 5.6 627.8 6.39 4.91971 3.3 711.2 13.28 5.91972 3.4 803.1 12.92 5.61973 8.7 856.5 6.01 5.8 8.03 4.91974 12.3 903.5 5.49 - 0.5 10.81 5.61975 6.9 1,017.8 12.65 - 0.2 7.86 8.51976 4.9 1,153.5 13.33 5.3 6.84 7.71977 6.7 1,273.0 10.36 4.6 6.83 7.11978 9.0 1,370.8 7.68 5.6 9.06 6.11979 13.3 1,479.0 7.89 3.2 12.67 5.8

1980 12.5 1,604.8 8.51 - 0.2 15.26 7.11981 8.9 1,760.1 9.67 2.5 18.87 7.61982 3.8 1,918.2 8.98 - 1.9 14.85 9.41983 3.8 2,137.0 11.47 4.5 10.79 9.6

1984 3.9 2,322.0 8.66 7.2 12.04 7.5

1989 4.6 3,171.5 … 3.5 10.89 5.31990 6.1 3,292.0 3.80 1.9 10.01 5.6 1991 3.1 3,393.4 3.08 - 0.2 8.46 6.81992 2.9 3,449.3 1.65 3.3 6.25 7.51993 2.7 3,504.3 1.60 2.7 6.00 6.9

1998 1.6 4,406.3 … 4.2 8.35 4.51999 2.7 4,675.1 6.10 4.5 8.00 4.2

2000 3.4 4,962.7 6.15 3.7 9.23 4.02001 1.6 5,486.0 10.55 0.8 6.91 4.72002 2.4 5,832.3 6.31 1.6 4.67 5.82003 1.9 6,112.0 4.80 2.7 4.12 6.02004 3.3 6,456.7 5.64 4.2 4.34 5.52005 3.4 6,713.4 3.98 3.5 6.19 5.0

Sources: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; and the Federal Reserve Bank.

Review the ‘Unemployment rate’ available on the U.S. Department of Labor, Bureau of Labor Statistics website, from 1968 [3.6%] through 2006 [average is less than 5.0%] … Notice that the peak rate of unemployment occurred during the 1982-83 period, [so much for the ‘worst rate since the Great Depression’] resulting from the tightening of the money supply by Paul Volker during the Carter/Reagan Administration … the lagged-recessionary-effect as the COST OF BORROWING increased [the average annual prime interest rates rose from 6.84 percent (1977) to nearly 19 percent (1981)], the economy (GDP) slowed over the 1976 through 1983 period.

Notice the comments Gwartney, Stroup, and Lee [2005. What Everyone Should Know about Wealth and Prosperity] have made concerning ‘Inflation’ [Part II ‘Seven Major Sources of Economic Progress’: “Monetary Stability: Inflationary Monetary Policies Distort Price Signals and Undermine a Market Economy.”] Noting the three functions of money: (i) medium of exchange; (ii) a store of value or purchasing power; and (iii) a unit of account, they go on to demonstrate why monetary instability is so important – reduces exchange and retards specialization of task and area – permitting societies to be WORSE-OFF than the would otherwise have been! Notice their comment:

There is no mystery about the cause of monetary instability. Like other commodities,the value of money is determined by supply and demand. When the supply [of] moneyis constant or increases at a slow steady rate, the purchasing power of money will be relatively stable. In contrast, when the supply of money expands rapidly and unpredict-ably relative to the supply of goods and services, prices are inflated and the purchasing power of money declines. This often happens when governments print money (or borrow from a central bank) in order to pay their bills.

Politicians often blame inflation on greedy businesses, powerful labor unions, big oilcompanies, or foreigners, for example. But their efforts are a ruse – a diversionary

tactics. Both economic theory and historical experience indicate that persistent inflation arises from a single source: rapid growth in the supply of money….

Inflation undermines economic prosperity. It makes the planning and undertaking of capital investment projects extremely hazardous. …

When governments inflate, people will spend less time producing and more time trying to protect their wealth. … Speculative practices are encouraged as persons try to outwit each other with regard to the future direction of prices. Funds flow into speculativeinvestments like gold, silver, and art objects rather into productive investments like buildings, machines, and technological research. As resources move from productive to unproductive activities, economic progress is retarded.

But perhaps the most destructive impact of inflation is that it undermines the creditability and confidence of citizens in their government.

So, there you have it! Notice, gold prices have risen steadily over the past three years! It’s too late to buy gold NOW, despite all the advertisements! There is a historical chart of gold prices available at: www.kitco.com/scripts/hist_charts -- in 2001 -- lows @ $ 270/oz.; May 2006 $ 700/oz.; early October 2006 $ 590/oz.; and December 14, 2007 $ 793/oz.

Consider the material describing ‘fair-shares’ advocated by the Labor Party and the nationalization of the ‘Commanding Heights’ [heavy-industry, including coal mining, rail, steel smelting, utilities, communications, etc.]. Is this related to the condemnation of the income distribution in the United States today? [“Voters most often blamed the gap on ‘excessive salaries and bonuses’ and competition from companies overseas.”] “Highly paid CEOs!” No mention of the ‘incomes’ paid to Democrat Senators [Heinz-Kerry and Kennedy] from investments abroad (Caribbean and Pacific island nations), and untaxed or minimally taxed in the U.S.!

The argument is that there is a ‘wealth-gap’ that exists in America; that there is a certain amount of ‘unfairness’ in how wealth is distributed; that there are ‘two Americas’! In order to evaluate such hyperbole, several concepts have to be understood, and understood precisely. First, there is a distinction that must be drawn between ‘income’ and ‘wealth’: Income represents a return to a factor over some specified time period, e.g., what an electrician earns weekly, monthly or annually; while wealth is what an individual has acquired and owns at some point in time, e.g., assets that the electrician has acquired and possesses at the time she decides to retire. Income is a flow, and wealth is a stock. It is important to keep the two separate, but to understand the relationship between them: wealth of a household is functionally related to its levels of past incomes.

Wealth = f (∑ of past levels of income).

Sadly, the terms in the popular press are frequently used interchangeably. Wealth, since it is a function of time, is heavily influenced by the age of the head of the household. Young heads of households have not had as long to earn income and to acquire wealth. So the issue of ‘fairness’ of the distribution of wealth at some moment in time, without paying attention to age of householders is MEANINGLESS, but is frequently stated. For example, consider the data in the following presentation compiled from the U.S. Bureau of the Census:

Income and Earnings Summary Measures by Selected Characteristics: 2004, 2005 and 2006.

2004 2005 2006 Median Income Median Income Median Income

[dollars] [dollars] [dollars]

All households 45,817 46,326 48,201

Family households 57,179 57,278 59,894 Married couple 65,946 66,067 69,716Female householder, no husband present 30,823 30,650 31,818

Race of householder White 48,218 48,554 50,675Black 31,101 30,858 31,969Asian 59,427 61,094 64,238

Age of householder< 65 years 52,562 52,287 54,72615 to 24 years 28,497 28,770 30,93725 to 34 years 46,985 47,379 49,16435 to 44 years 58,578 58,084 60,40545 to 54 years 63,068 62,424 64,87455 to 64 years 52,077 52,260 54,592> 65 years 25,336 26,036 27,798

_________________________________________________Source: U.S. Census Bureau. Income, Poverty, and Health Insurance Coverage in the

United States: 2005 and 2006, 6.

Several significant points are apparent in this table … it substantiates the casual observation that household income is a function of age (education and experience), peaking-out in the 45 to 54 years age group. Notice that female head of households have less than half the income of that of a married couple (two- or three-workers); Black householders have 62.5 percent of the income of white householders (does female householder play a role in this?); and white householders have only 78.9% of the income of Asian householders!

Episode Two: ‘The Agony of Reform’Privatization of the Russian economy and the example of Norilsk

The limits of Central Planning were exposed by India and the corruption (loss of incentives for Investment and reduced rates of growth) … ‘Permit Raj’

The costs of protectionism become increasingly obvious

Dependency Theory became the guiding principle of economics in Latin America

It is unfortunate that an economy refuses to obey orders

Milton Friedman and the ‘Chicago Boys’ in Chile

Reform of the Chilean Social Security System = ‘privatization’

Gorbachev/Chubais/Gaidar – reform in Russia

Poland/Solidarity/Lech Walesa and Thatcher and Pope John Paul II

Bolivia/Jeffrey Sachs and ‘Shock Therapy’ (shades of post-war Germany)

Poland, the price of eggs and price controls

Soviet ‘free-fall’ failure of the privatization of agriculture

India escapes collapse

Lessons from the Soviet Union (USSR)

End of ‘Permit Raj’ (the Central Planners’ fall from grace)

Russia and ‘voucher capitalism’

Yetlsin and the Oligarchs

Episode Three: The New Rules of the Game

Global ideas – Bill Clinton/comments by Robert Rubin/the capitalist elite and the Democrat Party

NAFTA and the new rules of the game

Regional Economic Free Trade Areas

Clinton shifts his position/Gephardt on NAFTACrossing borders – ‘Free-trade’ vs. ‘Managed-trade’ (Mercantilism reborn)/Laura

Tyson

Winners and losers

Emergence of Global Markets

Invisible trade – markets are us!

Pensions go global (higher returns abroad)/CALPERS

The ‘emerging market hunters’

Capture of returns/Mark Mobius/Tyson/Rubin

Awaiting a melt-down

Capital gets nervous/George Soros and the run on currencies

The Global Vision

Communications explodes

Borderless world

Venture capitalism

China and the ‘Tiger economies’

Singapore’s miracle

The Japanese paradox

Global ‘contagion’/overheating of the Southeast Asian economies/’easy money’ andgambling/low interest rates (1997) – the ‘classic’ Austrian bubble, see: L. von Mises, Human Action, Chapter XX. “Interest, Credit Expansion, and the Trade Cycle,” 535-583.

Central Bank of Thailand – the baht was too high (tied to the dollar)/international investors (Soros) short the baht/devaluation of the baht/cost-of-living rises

Rubin and ‘open-markets’

Speculative ‘bubble’ and the IMF (International Monetary Fund) – bail-out loansconditional on ‘cutting Government spending’ and increase in interestrates (so much for ‘free-markets’) – Stanley Fischer

The bubble-burst/contagion engulfs the world/Tyson – US didn’t intervene/conditionsworsen/contagion spreads/money pulled-out of the region

Spreads to Malaysia (short the market)

Spreads to Indonesia

Investor/fund manager bail-out

Spreads to Korea (December 1997)/Rubin and Fischer/Central Bank/loan- roll-over

Largest bail-out in history, up to that time

Rubin and the Clinton administration might have averted the melt-down had theyacted earlier in Thailand

Russia defaults (February 1998), contagion contained – ruble falls in value/panic

The ‘crisis’ reaches America – Long Term Capital/direct and indirect costs