Home > Macro/Monetary Theory, Philosophy, Politics > Why Austrian Economics is Devastating to Libertarians

Why Austrian Economics is Devastating to Libertarians

Since it’s the weekend, I’m going to take a break from my attempts to reinvent (essentially) the existing macroeconomic paradigm from the ground up using debt (and collateral) as the backing for money and do something much easier–bash Austrians.  This is from a recent post on The Money Illusion.

I constantly hear conservatives complain that elderly savers can’t earn positive interest rates because of the Fed’s “easy money” policy.  Is there any time limit on how long you will make this argument, before throwing in the towel and admitting rates are low because of the slowest NGDP growth since Herbert Hoover was President?  Or is your model of the economy one where decades of excessively easy money leads to very low inflation and NGDP growth?

In other words, is there some sort of model of monetary policy and nominal interest rates that you have in your mind, or do you see easy money everywhere and tight money nowhere?  What would tight money look like?  What sort of nominal interest rates would it produce?

If you have spent any time at all reading econ blogs you should know exactly what answer you will get to this without bothering to check the comments section.  But in this case, you don’t have to wade too deep into the 266 (and counting) responses before you get it.  On the second comment Old Reliable, Major_Freedom, supplies it for us.  (I bet when people see “Free Radical” they expect me to be like that guy but it’s partly tongue-in-cheek!)

1. No scientific predictions are possible for the economy, because humans learn in a priori unpredictable ways and hence act in unpredictable ways.  Thus, asking Austrians when their alleged predictions will come true, is asking a question about something not derived from Austrian theory.

This is where all Austrian roads lead.  But of course they do make predictions.  They are constantly talking about “hyperinflation.”  But conversations with them always follow the same pattern.  They talk about hyperinflation and destroying the wealth of savers etc.  Then you point out that inflation is low.  Then they say it isn’t low because when they go to the supermarket, the price of X is higher than it was a year ago.  You try to point out that this is not a reliable measure of inflation and then they tell you how many dollars you could get for an ounce of gold a hundred years ago.  You point out that this is the result of exactly the “moderate” inflation that the Fed has been telling us that they were trying to produce all along and that economic growth and standards of living have done pretty well over that timeframe.  Then they tell you just wait, it will fall apart any minute now.  Then you point out that they have been saying that for the last hundred years and they say “well I don’t know who was saying that but we don’t really make ‘scientific’ predictions.”

But it would be too easy to just go and dig up a hundred examples of Austrians predicting hyperinflation and call them hypocrites.  Instead, let’s take them at their word and ask: If Austrians don’t make “scientific” predictions, what is the point of what they do?

Here is an excerpt from my introductory micro text from pages 4-5.  In other words, this is the starting point for economics from a “mainstream” perspective.

Economics, above all, is a science.  It is scientific in that it seeks explanations of events which take place in the real world.  An important aspect of science is the ability to predict that when certain situations arise, certain other events will occur.  A theory that can predict events successfully is a powerful tool for understanding the world.  Prediction is probably the truest test of a theory’s explanatory powers.  Economics uses a set of principles, or propositions to analyze human behavior.

So if Austrian economics does not make scientific predictions, it is certainly not a science.  But what is it?  Here is Daniel’s (another commenter) answer.

who cares what the austrians think ? They’re basically a cult devoted to Mises – who, quite plainly, was a charlatan.

I mean, he openly says that his theories are not subject to verification or falsification on the ground of experience and facts.

If that isn’t pseudo-science, I don’t know what is.

According Wikipedia:

Pseudoscience is a claim, belief or practice which is presented as scientific, but does not adhere to a valid scientific method, lacks supporting evidence or plausibility, cannot be reliably tested, or otherwise lacks scientific status.[1] Pseudoscience is often characterized by the use of vague, contradictory, exaggerated or unprovable claims, an over-reliance on confirmation rather than rigorous attempts at refutation, a lack of openness to evaluation by other experts, and a general absence of systematic processes to rationally develop theories.

Every part of that gets a “check” by their own admission except arguably the first one: “is presented as scientific.”  So I wonder what they would call it if not a science.  A philosophy maybe?  If they called it “Austrian moral philosophy” it wouldn’t bother me.  Here is the next paragraph from my textbook.

Economists believe that it is important to separate one’s own beliefs about what is desirable from what we believe to be true or false.  We say that economic science should consist of positive statements, not normative statements.  Positive statements are statements that can be lassified as either true or false.  They are statements about what is.  as opposed to what an observer feels ought to be.  Statements about the desirability of some policy are value judgements, and no matter how widely shared, they are not a part of science.

Scientists start with a set of positive propositions that they think are true (or at least approximately true) and they try to use reason to determine what those propositions imply  logically abut other positive phenomena.  Then they test those implications and if they fail to observe what they predicted, they go back and examine their initial propositions and try to alter them to get a better (more predictive) theory.

Austrians start with moral propositions.  Free markets are better (more moral) than command-and-control economies.  Nobody has a right to initiate force against another person.  People should own the produce of their own labor/property (and not of others).  The government has no right to weigh benefits to one person against those of another and try to manage these.  Then they try to construct arguments to support these moral assertions.  But these “theories” cannot be disproven because, at the root of them they are value judgments.

Because Austrian “economic” is built on value judgments which are not refutable, they must not only construct vague arguments to support these claims, but they must essentially wall it off from science as we know it.  It cannot be reconciled with the rest of economics because it shares none of the characteristics of a science.  It is not based on positive statements and therefore it is not refutable/verifiable.  They want to argue with the claims that other economists make but they are operating in an alternate universe.  So instead of trying to figure out what “mainstream” economists are doing and point out some flaw in their assumptions or reasoning, they construct independent arguments that just claim you can’t do science in economics.  This allows them to avoid understanding what economists are doing but still argue with it.

This puts them in a position where they are constantly making positive claims which can be refuted but they are not arriving at them through any kind of scientific reasoning.  So they keep making claims that seem to be scientific except that when somebody tries to refute them, they claim that doesn’t matter, it’s not scientific.

Similarly, when other people do try to develop a scientific theory they go on their blogs and tell them that everything they are saying is wrong.  Of course the “scientists” tend to treat this like a scientific claim.  We think it is a statement about what is true and not true.  Then we try to get them to explain what they think is wrong with our reasoning.  But they don’t know because they aren’t trying to understand our reasoning at all, it is the fact that we are reasoning that they object to!  That and the fact that we somehow came to a different conclusion than they did (which always seems to be the same conclusion Von Mises came to…).

So instead of making a logical (scientific) argument against what the scientist is claiming, they just say it is wrong and launch into the argument they have constructed to support their ultimately non-refutable, non-scientific claim which they think is somehow incompatible with the refutable scientific claim made by the scientist.  So it should be no surprise that no amount of evidence ever changes their minds, or that they haven’t come up with a new idea in the last fifty years.  Their philosophy is not designed to evolve or change to get better at predicting real-world events.  They purposely relieve themselves of this responsibility by not calling it science.  It’s just a set of beliefs.

So here’s the kicker.  I agree completely with essentially all of those moral beliefs!  But that is why Austrians drive me so crazy.  Because everyone else who also agrees with them gets sucked into it thinking it is some kind of science.  How many college kids who lean libertarian are transferring to schools that teach Austrian economics because they are under the mistaken belief that Austrians have something to say about real-world economic outcomes other than “no scientific predictions about the economy are possible.”

It is only when they run into hard evidence which seems to contradict one of the predictions they thought they were making that they realize that, actually nothing real can be explained.  Unfortunately by this time their notions of intellectual integrity and discipline will already be twisted into such a horrible knot of inconsistency and false logic that the chances of them realizing it and going through the trouble of untangling it will be slim.

Unfortunately people who are conservative/libertarian tend to gravitate toward the moral claims which they agree with.  But this is a huge problem for us because we are left with a movement centered around a ridiculous quasi-economic belief system that causes us to make incorrect economic arguments about the real world!  I believe this is actually the biggest hurdle preventing libertarians from becoming a major political force.  What will happen to this movement if we go through another deflationary recession?  Austrians will say “see we told you markets were going to collapse!  All that other stuff we said about hyperinflation and loose money doesn’t matter because we don’t make scientific predictions and no human behavior can be explained…”  God help us if conservatives actually manage to do something like pass a balanced budget amendment without first figuring out how the economy works.

By the way, here is Bob Murphy  sort of answering (preemptively) Sumner’s complaint, talking about Japan where they have been “printing money” for a while and have had basically zero inflation for decades.  It is worth noting that he is not as evasive when it comes to his predictions as some Austrians.

Many critics, including me, have worried that this [QE] will disrupt the proper
functioning of credit markets, and threatens to severely debase the US dollar.
(Obviously our warnings on the latter point are either totally wrong, or have
yet to be fulfilled.)

However, he then goes on to essentially argue that the BOJ has been expanding their balance sheet for a long time without causing any inflation to speak of but that their economy hasn’t been that great over that time period and basically all they (the Austrians) were arguing was that QE is bad and it was bad so they were right.  Nevermind that the other side (everyone else) is arguing that the Japanese economy has been bad because of the low inflation rate and that they need to create more so the data is perfectly consistent with the theory he has been arguing with.

So now Murphy seems to have come around to agree entirely with the mainstream’s predictions about actual scientific, real-world, events but he still clings to the moral assertion that QE is bad which was really all he was ever saying.  He just had to dress that moral claim up in claims about the real world to make it seem like it was more than that.  But when those claims turn out to be wrong and the exact opposite–which is exactly what the other side was predicting all along–happens, his moral belief simply changes clothes.

 

 

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  1. John S
    March 9, 2014 at 11:27 pm

    I agree overall, but I think it’s better to replace “Austrian” here with “Rothbardian.” There is a definite Austrian split btw Auburn University (Mises Institute) and GMU (coordinationproblem.org, freebanking.org). The former really should be labelled “Rothbardian”–fanatic opposition to fractional reserve banking, misguided views on the causes/effects of inflation, and insistence on praxeology over empiricism (the last could be levelled against Mises as well).

    It is truly unfortunate that Rothbardians have hijacked the term “Austrian” and heavily outgun the GMU side in terms of popular appeal. But I still think the Menger-Mises-Hayek-Kirzner tradition is an highly honorable one, and I refuse to cede the name Austrian to the MI crowd. Better, I think, to promote the reasonable Austrian economists (White, Selgin, Boettke, Horwitz, Rizzo, O’Driscoll, Garrison, Leeson, and the blogosphere’s own Jon Catalan, as well Murphy on good days) rather than trash “Austrian economics” as a whole when it’s really Rothbardianism you’re attacking.

  2. John S
    March 9, 2014 at 11:30 pm

    Post from freebanking dot org’s Kurt Schuler on the contributions of GMU Austrians:
    http://www.freebanking.org/2013/07/13/what-we-have-done-for-you-lately/

    • Free Radical
      March 10, 2014 at 9:28 pm

      After perusing that list, I feel I should mention that I am grateful particularly for the historical accounts of the banking system by these guys (especially the “free banking” period in the U.S.) which have contributed significantly to my understanding of the subject.

  3. Free Radical
    March 10, 2014 at 1:57 am

    Good comments John. I am not deep enough in Austrianism to fully appreciate these distinctions. I just know that most of what is penetrating into the surface political/economic debates of our day is horribly misguided. I do agree that the guys over at freebanking.org are mostly doing good work and I have no gripes with them. I also agree that the whole Rothbard anti-fractional-reserve banking thing is the most visible part of the problem but I think praxeology which (as you say) falls at the feet of Mises, is at the heart of it all. I admit I have read only bits of Mises so it is possible that his actual intent is being abused to some extent by these guys.

    I do think the works of Hayek that I have read were pretty good and probably somewhat underappreciated, but I think he falls a bit outside of the hardcore Austrian tradition. Also, a lot of the stuff Austrians like is basically just mainstream economics except that they claim when mainstream economists do the same thing that it is somehow different and crazy. (When they talk about “utility” and “subjective value” it makes blood shoot out of my eyes.)

    http://realfreeradical.com/2013/02/24/diminishing-marginal-utility-again/

    For what it’s worth, when I took “history of economics” and they explained the whole German school/Austrian school debate, they framed it as basically a debate about theory versus empiricism and I was totally on the Austrian side. But that doesn’t seem to be where these modern “pop Austrians” or whatever you want to call them differ from the mainstream. They don’t seem to believe in models or observation. So basically they don’t believe in anything scientific. They just make a bunch of arbitrary unsupported claims.

    So I’m in support of salvaging Austrian economics if that means taking the good parts and incorporating them into an actual scientific theory along with the good parts of “mainstream” theory. But that means we need to have refutable implications and the ability to disagree with Mises to some extent.

  4. Free Radical
    March 10, 2014 at 2:06 am

    Oh also, on Bob Murphy. I agree he is not the worst offender (as I mentioned he did at least admit that it is possible that they could be proven wrong about hyperinflation). I’m not intimately familiar with his work but I did read his “politically incorrect” book on the great depression and I really liked it. That was years ago when I was sort of an Austrian Sympathizer so maybe if I read it again, it would drive me nuts, I don’t know.

  5. John S
    March 10, 2014 at 1:52 pm

    Yours is a very dense post, and you bring up many good points which can and should be discussed at length. (Here’s a thoughtful defense of modern Austrianism by JFCatalan: http://www.economicthought.net/blog/?p=5653). My own (layman’s) take is that the “good” Austrians are neoclassical, mainstream economists with particular emphases on:

    1. Spontaneous order: in my view, this is the economic equivalent of biological natural selection (taking into account humans’ unique ability to harness reciprocal altruism for mutual gain) with the profit/loss mechanism and firm survival/growth taking the place of genetic propagation. The theory of subjective value implies that the vast majority of transactions that take place will benefit all parties (since they would have no incentive to participate otherwise), so legal restrictions against voluntary trades should be minimized (e.g. drug laws, occupational licensing, various forms of red tape–basically standard libertarian lines).

    2. Real-world economies that are in perpetual disequilibrium, with entrepreneurs as re-equilibrating forces (Kirzner). In fact, this disequilibrium itself is the source of profit opportunities for entrepreneurs to exploit via intertemporal arbitrage (i.e. combining currently undervalued inputs in such a way to gain future profits). This story is far more dynamic than the Econ 101 textbook talk of equilibrium, which focuses on deadweight losses and surpluses/scarcities (stories about monopolies, grain policy, and rent control)–essentially a static picture which, as Arnold Kling (non-Austrian) puts it, “how trading opportunities play out among a given array of goods.” Instead, Austrians focus on the “learning economy” (a view Kling attributes to Hayek) in which “market competition rewards productive innovations, while forcing misguided innovations and obsolete methods to be discarded” (this of course ties back in with #1).

    [Is this entrepreneurial stuff just good storytelling by Austrians? Who knows–but it’s a damn good story. Other Austrian emphases include distributed knowledge and capital theory, the latter of which I’m least familiar with.]

    I’m certainly not saying that non-Austrian mainstream economists don’t appreciate these points; I’m sure many do and even focus on these issues. But I do believe that if you took a survey of what most Econ 101 students remember a week after finals, I doubt you’d hear much about the above from anybody (aside from the students who already had an interest in Austrian econ!) I really do think the world would be a much better place if intro econ textbooks were organized more along the lines of Gene Callahan’s “Economics for Real People” rather than Mankiw. http://www.amazon.com/Economics-Real-People-Introduction-Austrian-ebook/dp/B005O178VO/ref=sr_1_1_bnp_1_kin?ie=UTF8&qid=1394459468&sr=8-1&keywords=economics+for+real+people

    • Free Radical
      March 10, 2014 at 10:10 pm

      I agree with both points. I will say this however. There is actually a great deal of “mainstream” literature about “disequilibrium.” This is actually essentially what Keynes was trying to do with his General Theory. The problem is that it is very difficult to make a simple (or otherwise for that matter) model of disequilibrium. So when we are teaching 101 we (at least in my experience) basically describe what would be an equilibrium in the model and then sort of talk about the forces that we think would drive the market (or economy) toward that equilibrium if it were in some other state. To my knowledge Austrians don’t have a better way of modeling this, they just put more emphasis on talking about those forces and less on the model of equilibrium but the two are not really separable.

      I think I used Mankiw once and didn’t like it very much (though I could be forgetting who it was). For what it’s worth, I think the text used at U of Washington (Silberberg/Ellis), which is what I have mostly used does a good job of dealing with these issues in a way consistent with the points you make. (Silberberg was a genius by the way, and very much anchored in “classical” economics.) This text is not widely used though. Sadly, I suspect most people after a principles class, understand very little about what was actually presented to them but that’s sort of the nature of academics in general. I certainly didn’t understand the intellectual foundations of this stuff until I had been studying it for years, much of it is very subtle.

      Part of the problem is that people who don’t like math (aren’t very good at it) enjoy theories that have more vague suppositions, especially if they throw in some flimsy arguments for why doing math is bad in general and should be avoided. Unfortunately, the math imposes a degree of discipline on the subject which this attitude largely annihilates.

    • Free Radical
      March 10, 2014 at 10:42 pm

      That Catalan piece is excellent. There were so many lines I was inclined to quote that I won’t bother with any of them but basically, he describes the problem in essentially the way I see it. It is praxeology which purposely isolates “Austrians” from the rest of economics and the scientific process in general. If Austrians can get over these methodological objections to “mainstream” economics, they will be a lot better off. I think there needs to be more self-policing by Austrians like Catalan to overcome these problems and salvage the school so that when I go on freedomworks university and places like that, I don’t see so many ridiculous criticisms of the mainstream.

      The “means/ends” framework is at the heart of a lot of the issues in Austrian economics. I am adding it to my list of things to write about but will have to wait until I do a bit more on money and debt. Essentially, the mainstream just found a better way of doing it that is pretty much equivalent but more general and more rigorous and the Austrians (at least some of them) never realized it and have been railing against it all this time.

  6. John S
    March 10, 2014 at 2:05 pm

    “we need to have refutable implications and the ability to disagree with Mises to some extent.”

    Oh, absolutely. Far too much effort has been wasted on debates of “what Mises meant” as if Human Action were some sort of sacred text.

    (However, since the debaters willingly expended that effort and subjectively viewed it as enjoyable, I shouldn’t rag on them too much).

    • Free Radical
      March 10, 2014 at 9:09 pm

      Haha, you’re one of the good ones John S. I have no problem with people debating what Mises meant either, I just kind of agree with the “cult of Mises” remark. They seem to start with the assumption that whatever Mises meant must have been right (and is everything that is worth knowing). I really like Adam Smith and I am happy to engage in debates about what he did or did not mean but I’m well aware that there was a lot of stuff he didn’t understand. Keynesians agree that Keynes didn’t know everything, monetarists agree that Friedman didn’t know everything.

      In contrast, if you are a Christian, you start with the assumption that Jesus was right about everything and then you argue about what he meant. Similarly, you construct practical arguments to try to explain why what you think he said makes sense on some practical level. (Don’t have premarital sex because of babies, or STDs or it destroys the incentive to get married and that indirectly undermines the foundation of society etc.). This is totally appropriate for Christians (or Muslims or Buddhists or what have you because they are dealing with ethical (normative) questions. But this is an inherently anti-scientific approach to positive questions. This is essentially the approach that this “cult of Mises” takes and that is why they have to weasel out of any real positive predictions that they make.

  7. John S
    March 12, 2014 at 3:47 am

    I think this discussion on methodology, the role of math in econ, and the place of Austrian econ within the mainstream (of which it is a sub-school, imo) is great, and I hope you do more posts on this topic. But for now I’d like to touch on a more pragmatic issue.

    For better or worse, I think we both agree that the term “Austrian economics” is slowly winning the branding battle in the general public’s mind for the role of standard-bearer of “free market economics.” And in terms of its conclusions, this isn’t really unjustified. If the first fundamental theorem of welfare economics implies that “competitive markets tend toward an efficient allocation of resources,” then why does nearly every non-Austrian mainstream economist a prioristically assume the necessity of a central bank and treat the theory of privately produced money as unworthy of any mention in macro/monetary textbooks? This is a huge black eye for the entire non-Austrian mainstream.

    Furthermore, nearly every non-Austrian economist tacitly accepts the overwhelmingly dominant role of the state in the provision of healthcare, education, and variety of other services. I realize there are exceptions, but nearly every other “school” seems to focus inordinately on externalities and “market failure” rather than on the coordinating power of the market; only the Austrian school seems to take the (entirely reasonable) default position that, until proven otherwise, the free market does it better. As a recent blog post title puts it, “Markets where possible, states where necessary.”

  8. John S
    March 12, 2014 at 4:12 am

    So my question is: what is a better catchphrase or shorthand expression than “Austrian” for an economic POV that consistently maintains the default position that the free market approach is best? I submit that 1) such shorthand *is* necessary to distinguish such economists from those who seem to assume some degree of market failure from the outset; and 2) the term “Austrian” has a long history of consistency and contributions on this point that makes it the most suitable choice.

    Austrians seem to be the only ones who consistently ask the theoretically “right ” question re: policy (Why not try the market solution first?) and well as draw the conclusion that most economists hold on most issues (competitive markets are optimal). As you have pointed out, there is a big methodological problem in getting from Point A to Point B (praxeology), but this isn’t an insurmountable issue, and in fact GMU Austrians have already made a lot of progress on this front. So why not build on this intellectual foundation instead of try to create a new “brand” from scratch?

    (By the way, in terms of publication in mainstream journals and positions in prominent econ departments, GMU actually outguns Auburn/Mises Institute by a wide margin. So why do critics of Austrian econ, mostly coming from an academic background such as yourself, focus only on the popular version rather than the mainstream academic body of work? In other words, what qualifies Joe Salerno and Hans Herman-Hoppe, let alone Major_Freedom, to speak for the entire “Austrian school” over Larry White and Peter Boettke?)

    [Apologies if this tone of this comment seems shrill; that’s not my intention. You are certainly a much more thoughtful critic of Austrian econ than most.]

    • Free Radical
      March 13, 2014 at 7:15 am

      No apology necessary, I actually think that is a pretty good point. I think the simple answer, frankly, is that most mainstream economists don’t read the stuff that those GMU guys are writing. On the other hand people like Major_Freedom and friends are constantly insinuating themselves into discussions by mainstream economists on blogs etc., claiming to be “Austrian” and making crazy arguments.

      I didn’t put it in this post but I have several others critical of Austrian economics and most of them include some kind of disclaimer to this affect: “This criticism is directed at the Austrians I see on popular blogs, TV, etc. I allow for the possibility that there are other more serious Austrians out there to which this criticism does not apply.”

      It goes beyond trolls on blogs though. It’s the guys like Peter Schiff that are popular in libertarian (not necessarily academic) circles. It’s the fact that I keep seeing supposed “Austrians” popping up on the Blaze or on Stossel or places like that and saying things that I think are pretty misguided. So I think your characterization of the practical situation is pretty spot on. I’m not opposed to the word “Austrian.” If it really is a sub-school of the mainstream that just tends to favor free markets to centralized control, then consider me an Austrian. But I feel like we have to somehow get control of the popular movement and make it less insane.

      As far as your complaints about mainstream economists and their willingness to abandon free markets, I agree with you and I tend to find that frustrating too but it’s sort of frustrating in a different way. There are legitimate economic reasons for the opinions of these people. But the reasons have different natures. Sometimes it comes down to economic reasoning, in which case I can try to understand their reasoning and try to argue with it if I want. Other times, there is a difference in normative judgments underneath it. In these cases, I can try to understand their reasoning and identify the difference in value judgments.

      The thing that I don’t think most of these pop-Austrians understand is that you can agree about economic analysis and still disagree about what is desirable. For instance, I can agree with someone like Sumner about how monetary policy works and still think it is a bad idea to give that kind of power over the economy to a few people in that way. A lot of people seem to agree that this is a bad idea but then they feel compelled to argue with mainstream assessments of how monetary policy works because they feel the need to somehow prove that that system can’t possibly work. Because they are committed to the value judgment, they become committed to a particular economic analysis. They feel like admitting that QE doesn’t necessarily have to lead to hyperinflation is akin to admitting that QE is good.

      What they need to do is separate the two things. The economics needs to be free from normative constraints. But this doesn’t mean you can’t make value judgments. You just have to identify the line between values and analysis. The big risk is that they end up building the case against whatever they are against, not on the appropriate moral foundation but on a flawed economic foundation. They may think that their analysis is impervious to empirical refutation but others will not see it this way. So when their predictions end up not being accurate, the whole case will crumble.

      I don’t know if you were witness to the great Cantillon effects debate but it is a perfect example of this.

      Incidentally, I think there are quite a few mainstream economists who are pretty pro-free market but I think publishing papers about how the free market works fine doesn’t get a lot of attention these days. That’s so 1890.

      • J Thomas
        March 13, 2014 at 11:51 am

        To the extent that it’s true that free markets work fine and need no attention from anyone, economists can ignore free markets. There is no *market* for a detailed explanation why nobody needs to understand how free markets work because they will always do the right thing even when nobody understands them.

        So economists need to argue about the proper role of government, because that’s what there is for economists to do.

        Plus of course they can teach people how to run businesses, if that doesn’t get split off into a separate academic discipline of business management.

        How would we argue that free markets run perfectly without requiring anybody to understand them? One approach is to argue it as a sort of religious doctrine. Free markets work because it just has to be that way. But this will only convince fellow believers.

        A second method would be to collect a lot of data and demonstrate that particular free markets work. But nobody can ever collect that much data. Markets fluctuate, and to tell how well the markets work we would need to somehow measure how well they work for each participant. What do market participants need and what do they get? Nobody has ever done this and probably nobody ever will.

        A third method is to argue from evolution. The winners in a free market must be the ones who compete best. They must be the most efficient at supplying whatever it is the market needs. And since nobody participates in a market unless they think they benefit, the winners must be the best at benefitting everybody. If somebody figures out a better way to compete this must inevitably have the result that everybody benefits. Therefore free markets will always evolve into better free markets, while any other arrangement may be frozen into a bad pattern.

        However, biologists have found that evolutionary processes don’t necessarily benefit anybody in particular. Here is one example, “segregation distortion”. I will give an example of the example — imagine that a gene carried on the Y chromosome results in males that produce sperm that carry Y chromosomes but no sperms that carry X chromosomes. (This has been observed in rats.) They will father twice as many male offspring and no female offspring. So on average this gene will be selected and will just about double every generation, until the time comes that there are no females left. The surviving males must leave the area, hoping to be accepted in other rat colonies that have females.

        We can argue from first principles. If everybody in the market knows everything that’s going on, and they each do the right thing, then they will get the best result. (People used to make an argument like this for God. They said he knew everything, and he could do anything, and he was good. The new argument for free markets doesn’t require people to be good, so it’s an improvement.) This fails utterly because people in markets are mostly ignorant and they don’t even consistently do what they think is best. For example, there is a long tradition of bribing people in purchasing with booze and prostitutes and kickbacks to make bad decisions for their companies. Companies could, if they chose, combat this by giving their purchasing people all the booze and prostitutes they wanted before they made purchasing decisions, but I don’t know how to handle the kickbacks….

        I think one reasonable conclusion from this is that if people generally make OK choices but sometimes make very bad ones, we should try to avoid having a few people make choices that are very very important for the economy. The chance they will do bad is too big to justify they chance they might do extra well. So we should try to avoid having important government people make big decisions about the economy, and we should also try to avoid having important people in big companies make big decisions. As it is, we pay big bucks to important CEOs in the belief that they will make such good decisions they will justify the expense. But maybe the safer approach is to find ways to avoid big decisions that are so important….

      • John S
        March 14, 2014 at 1:35 am

        I feel like we have to somehow get control of the popular movement and make it less insane.

        Yes, I think this is the key battle.

        Here’s how most blog readers and blog critics of Austrian econ seem to view/frame the issue:

        1. Austrians (really they mean Rothbardians/Mises cultists/pop-Austrians) use really bad methodology (praxeology). [I agree.]

        2. Austrians (really some Austrians and Peter Schiff, a non-economist) have made a bad prediction about imminent hyperinflation. [Again, I agree.]

        3. Thus, pure free markets are bad.

        Ok, I’m kidding slightly on the jump to #3. But I think a lot of blog readers/bloggers roughly view econ schools on the following (politically) left/right continuum:

        Socialism/Marxism –> Post-Keynesian/MMT –> Saltwater –> Freshwater –> Austrian

        So discrediting the methodology and predictive record of “Austrian econ” equates to discrediting the “extreme right” fringe of economic debate and the idea that a strong commitment to free markets (even in sacrosanct areas of govt control such as money, health, and education) is wrong. (Krugman, Noah Smith, and Cullen Roche have done this to varying degrees).

        The problem of course is that there is a school of thought (GMU Austrian/Free Banking) which doesn’t adhere to pure praxeology (I’d say some measure of deductive reasoning/thought experiments are part of any process of generating hypotheses/theories) and didn’t predict that QE1 and QE2 would lead to imminent hyperinflation (more on this below), yet still maintains a strong commitment to free markets. So the only conclusion that can be drawn from points 1 and 2 is that pop-Austrianism is a bad basis for economic analysis. But most bloggers/readers seem to think that 1 and 2 are enough to dismiss Austrian ideas such as free banking (“End the Fed”), any form of commodity money (“goldbugs”), privatized healthcare/education, etc.

      • Free Radical
        March 15, 2014 at 5:16 pm

        Well I think we are basically on the same page here. I didn’t consider the Free bankers “Austrians” because I have seen Selgin rail against the Rothbardians (he seems to eschew labels). But if the line between the real Austrians you are talking about and the ones I am talking about is as stark as you say, then I am probably being too hard on the former. This also means there is another way of approaching the problem (as you have been saying) which is to not attack “Austrians” in general but point out that the particular brand of “Austrianism” which is getting all the popular attention is not even consistent with “real” Austrian economics. This might be able to penetrate some of the anti-mainstream defense mechanisms built into their ideology.

        At any rate, assuming that most actual academic Austrians see things much like you do, the problem in my mind becomes less about economics and more about politics. You characterized the view of others basically the way I see it but that is, at least partly, the fault of the people making the wrong predictions (hyperinflation). And that is my point. The libertarian movement is infected with bad economics which threaten to discredit the movement in general. (I’m not saying they are all bad but much of it, especially macro, is pretty bad.) So get some legitimate Austrian to call up Glenn Beck and John Stossel and Rand Paul and Matt Kibbe and clue them in to the problem. I assume you have the requisite connections to make that happen haha.

      • John S
        March 14, 2014 at 2:10 am

        Here’s why this matters, in my view. As we both agree, pop-Austrianism is gaining converts among libertarians, Tea Party-types, and the American right in general. This process isn’t going to stop anytime soon, and it may accelerate (e.g. if Rand Paul gets the nomination–a definite possibility). So like it or not, we’re stuck with the situation where the term “Austrian econ” increasing equals “radical commitment to free markets.”

        If you want to reach these people (which I assume you do), you’re going to have to convince them that you’re not “the enemy.” The most effective way to do this, I feel, is not to say, “Austrian econ is bad/illogical/crap.” This creates hostility from the outset, and pop-Austrians will likely stop reading right there. A better approach would be to say, “Austrian economics makes a lot of good points, and here’s how it can be improved.” An even more effective move would be to pin the label of “Rothbardianism” on Auburn/Mises Institute and contrast it with the wider Austrian tradition (including Hayek, GMU, Free Bankers). This is actually a more historically accurate classification, and it also allows pop-Austrians to “save face” somewhat and approach your points with a more open mind.

        I *don’t* think that all mainstream economists with strong free-market leanings need to self-identify as “GMU Austrians.” But I do think they need to be careful to make sure that their attacks on Rothbardianism/pop-Austrianism don’t provide fuel for free market critics. Caplan, in his “Why I’m Not an Austrian” essay probably had the same motivations you did in writing your posts. Nevertheless, I’ve seen it invoked countless times in forums/blog comments as “evidence” that Austrian proposals are bad (e.g. “See, even a crazy libertarian like Caplan says Austrian ideas are too radical).

        Most readers rely on mental shortcuts. “Oh Austrian econ is unscientific; ok, I don’t need to consider any of their ideas.” If free market ideas are to be salvaged/revived, the image of Austrian economics, with which these ideas are now somewhat inextricably tied, is going to have to be rehabilitated to some degree.

      • Free Radical
        March 15, 2014 at 5:45 pm

        These are good points which I will try to take to heart. Incidentally, I am familiar with that Caplan essay (and the Boettke debate on youtube) and I think he is pretty much right. My thinking is sort of that people end up throwing out free-market principles because they think Austrians are the only ones who really believe in them and that’s why, if you discredit Austrian econ, people find another school which is inevitably much less focused on the effectiveness of free markets. So your argument is that we shouldn’t criticize Austrians (I know I’m simplifying/overstating it) but my thinking is basically that there needs to be a more mainstream free-market movement/school for them to go to. You say that GMU is that school already which may be true (I will have to get better acquainted with them) and if it is true, then it is just a question of branding which is not really my specialty. Obviously, I don’t expect to solve this problem with a blog post, I just think one way or another we have an “Austrian” problem that we need to work on.

      • John S
        March 14, 2014 at 2:25 am

        J Thomas, you wrote: “biologists have found that evolutionary processes don’t necessarily benefit anybody in particular.”

        In no expert on evolution, but I do think a clear distinction has to be made between biological evolution and spontaneous order in human societies w.r.t. economic/institutional arrangements and outcomes. Only humans are 1) capable of creating widespread networks of exchange among non-related members of the same species (examples of reciprocal altruism among animals are rare, extremely limited, and hard to distinguish from kin selection); and 2) consciously aware of the current and future gains from such exchanges (i.e. the iterated Prisoner’s dilemma). So one can indeed maintain that evolutionary outcomes in human interactions can be mutually beneficial while acknowledging that biological evolution doesn’t “benefit” anyone in particular.

        Books like Robert Wright’s “The Moral Animal” and “Nonzero,” as well as Matt Ridley’s “The Rational Optimist,” make this point a lot better than I can.

  9. J Thomas
    March 12, 2014 at 11:24 am

    John S :
    If the first fundamental theorem of welfare economics implies that “competitive markets tend toward an efficient allocation of resources,” then why does nearly every non-Austrian mainstream economist a prioristically assume the necessity of a central bank and treat the theory of privately produced money as unworthy of any mention in macro/monetary textbooks?

    Because banking and insurance are problematic for free markets.

    When it’s a question of trading what you have for what you want, free markets work well. You make the best exchange you can manage, and then if what the other guy trades you is not what he promised, you work it out with him or sue for damages.

    But when what one side is trading is *promises*, then the traders on that side are competing in the short run to see who can provide the best promises. This is — problematic.

    Private free-enterprise banks traditionally found that they needed to keep at least 5% reserves. They could get by with 3% for awhile, but 5% was safer. Bigger banks could manage with somewhat smaller reserves because the statistical fluctuations tended to even out more. So bigger banks were more inherently profitable than smaller banks.

    Banks could accept other bank’s checks and banknotes, or they could refuse them. If your bank refuses, you can go to the other bank and collect cash and then spend it or deposit it in your bank. Typically banks would accept each other’s checks and then exchange them. If one bank has $12,000 in the other’s checks and the other has only $10,000 to exchange, then it pays $2,000 cash. These exchanges are far more important for the smaller bank. If bank A is 9 times bigger than bank B, then when a customer of bank A writes a check, 90% of the time it will be to a customer of bank A, and only 10% to bank B. But when a bank B customer writes a check, 90% of the time it will be cashed at bank A.

    Bank A can plan war against bank B. Hold back on clearing bank B’s checks. Bank B thinks that its customers are doing well and it’s attracting new customers, its reserves are up, so it lends more money. Then suddenly present bank B with claims of more than bank B’s reserves. Tell the world that bank B has no reserves and start a panic. 5% of bank B’s total liabilities is only 0.5% for bank A.

    Smaller banks must be more conservative, they must hold much higher reserves and be less profitable. Larger banks can temporarily lower rates to attract business and starve smaller banks of debtors.

    Basicly, banks depend on stability. Their business is inherently risky. And larger banks can create extra instability for smaller banks. Only the largest survive.

    Similarly for insurance. When what you sell is promises, and people rarely find out whether the promises will be kept, it’s hard to detect fraud and also the biggest are better able to weather the rare events that test them. Free markets do not work well in that case.

    When free markets fail, government steps in. The result is not necessarily better, but people are ready to give it a try when the alternative is clearly inadequate.

    For banking, the Fed tried to stop bank wars. Member banks must all keep reserves at the Fed, and it makes loans on those reserves like a bank. If one bank tries to break another, the Fed can simply lend reserves to the weaker bank until the attack is over. Etc. The Fed provides the stability that banks need. Also it lets them increase the money supply far beyond what they could manage by themselves. Today they need at least 0.5% reserves, and the Fed can easily lend reserves to the banks that fall short. I haven’t heard that anybody gets to look at the Fed’s books, but if banks kept 5% of their assets with the Fed, that would usually be enough to lend out 100%. And the Fed doesn’t need to lend 100%.

    It’s banking compounded. Inherently risky, but the serious risks should be very rare.

    Something like the Fed could be done privately, but what banks would participate? If enough of them did they could easily destroy all other banks, but they would each be at the mercy of the private central bank and whoever controlled that would control all of them. Banks more readily trust the government with that power than each other.

    • John S
      March 13, 2014 at 12:54 pm

      J Thomas, thanks for the detailed response, but I’m not sure that you’ve made a persuasive case against free banking (I don’t know anything about insurance).

      Private free-enterprise banks traditionally found that they needed to keep at least 5% reserves. They could get by with 3% for awhile, but 5% was safer.

      May I ask where you got these figures and which country/period you are referring to? According to Selgin and White, gold reserves in the mature Scottish free banking system fell to around 2% of inside money liabilities (mostly banknotes, not deposits). [See Selgin’s “Theory of Free Banking,” p. 26]

      Bank A can plan war against bank B. Hold back on clearing bank B’s checks.

      It seems to me you are describing “note-dueling” or “note-raiding” as practiced in the early days of Scottish free banking, with checks (claims to deposits) taking the place of private banknotes (claims to specie). As a matter of history, note-dueling in Scotland only lasted a few decades, with formal note exchange between the Bank of Scotland and the Royal B of S being established in 1751 (24 yrs after the RBoS had received its charter), followed by mutual par clearing among all major banks in 1771. (Canada and Australia experienced no note-dueling episodes during their free banking episodes, evidently having learned from the Scottish experience).

      http://www.terry.uga.edu/~selgin/econ4100/ReadingsPtI.pdf (p. 45)

      • J Thomas
        March 13, 2014 at 4:46 pm

        “May I ask where you got these figures and which country/period you are referring to?”

        I don’t remember now, it was from reading about banking. I vaguely remember it was from free banking in the USA. Still, 2%, 3%, both far lower than the 20% to 25% later required by US law. As my old undergraduate economics teacher used to say, “What’s $50 billion among friends?”

        “It seems to me you are describing “note-dueling” or “note-raiding” as practiced in the early days of Scottish free banking, with checks (claims to deposits) taking the place of private banknotes (claims to specie).”

        Your own source discusses this in the abstract around page 30. It points out that banks have an incentive to create anticompetitive agreements so they collectively make more money. Of course this isn’t true for just banks, most competitors in free markets find ways to do that, much of the time. Similarly, most nations are at peace with most other nations most of the time.

      • John S
        March 14, 2014 at 11:46 am

        banks have an incentive to create anticompetitive agreements so they collectively make more money.

        Sorry, you’ve lost me here. Are you referring to mutual clearing of notes at par as an anticompetitive agreement? What is anti-competitive about this? Any bank that overexpands (either with notes or loans) will suffer from adverse clearings and lose reserves.

        both far lower than the 20% to 25% later required by US law.

        The interesting thing to me is that although banks in free banking systems tended to hold a very small of amount of specie reserves compared to demand liabilities, they had very large capital cushions in the pre-FDIC days (out of necessity) apparently advertised that fact to attract depositors.

        http://www.freebanking.org/2011/06/11/capital-and-cash-reserves/

    • John S
      March 13, 2014 at 1:18 pm

      Even in your example, 90% of the checks that Bank B’s customers bring to be cashed will be from Bank A. So two can play at this game; Bank B, anticipating Bank A’s strategy, can hold off on clearing an equal amount of Bank A’s checks so that any time Bank A attempts a check-raid, Bank B can immediately offset these claims and prevent a drain of reserves. And if Banks C and D realize the futility of check-dueling, they can return the checks of both A and B for immediate clearing and gain commodity-reserves (which presumably would be used in a free banking system), which can be used to expand lending.

      When free markets fail, government steps in. The result is not necessarily better, but people are ready to give it a try when the alternative is clearly inadequate.

      May I ask how free banking has historically proven to be clearly inadequate?

      For banking, the Fed tried to stop bank wars.

      As far as I can tell, the Fed was established to rectify the crisis-prone nature of the post-National Banking Acts system, not to prevent bank wars. Mehrling gives a good account of the thinking leading up to the Fed.

      https://economics.barnard.edu/sites/default/files/inline/economists_and_the_fed_beginnings_revised.pdf

      However, the Fed wasn’t the only alternative. Canada’s free banking system of the same era, which lacked the faults of the US system (such as branch banking restrictions that led to an inverted pyramid banking structure resting on a reserve base concentrated in NY, Chi, and StL), was a viable option.

      • J Thomas
        March 13, 2014 at 5:00 pm

        “Even in your example, 90% of the checks that Bank B’s customers bring to be cashed will be from Bank A. So two can play at this game”

        Sure, but look at the ratios:

        A to A: 81%.
        A to B: 9%.
        B to A: 9%
        B to B: 1%

        Bank A has a giant advantage, and if bank B tries to retaliate it drasticly interferes with doing their normal business.

        “May I ask how free banking has historically proven to be clearly inadequate?”

        The big problem is occasional giant liquidity crises, where many people lose their property and some banks fail. The surviving bankers say that they lost a lot too, but somehow each time they come out owning a bigger fraction of the whole economy.

        Recent events might give the impression that this is not limited to free banking … but that doesn’t keep people from wanting some kind of regulation after each interval of havoc.

        For banking, the Fed tried to stop bank wars.

        “As far as I can tell, the Fed was established to rectify the crisis-prone nature of the post-National Banking Acts system, not to prevent bank wars.”

        But the Fed does work to prevent bank wars, whether that was an intended result or not.

      • John S
        March 14, 2014 at 12:33 pm

        If you want to argue that note/check-raiding guarantees victory for large banks, I believe the onus is on you to explain why this never actually happened in historical free banking systems. It didn’t work in Scotland, and it didn’t work in early 19th century New England when the Boston banks tried to put the country banks out of business.

        Here’s a list of note-issuing banks in Scotland in 1845, after many decades of free banking. No bank has more than 15% of a share of the total notes in circulation.

        http://www.iea.org.uk/sites/default/files/publications/files/upldbook115pdf.pdf (p. 33)

        As soon as a few banks in the system realize the advantages of a mutual par clearing, they will make such an agreement. Any bank that refuses to join (or does so in a haphazard way, engaging in the occasional raid) is going to be at a competitive disadvantage and shunned by its rivals, greatly lessening the attractiveness of holding its notes and deposits. Do you disagree? If so, what historical evidence can you cite?

        The big problem is occasional giant liquidity crises, where many people lose their property and some banks fail.

        Again, may I ask what specific historical episodes you are thinking of? There is one major instance, but I don’t think you can find a consistent pattern. If you can, I’d be glad to hear about it.

        But the Fed does work to prevent bank wars, whether that was an intended result or not.

        Well, I’m not aware of bank wars being a major problem in the pre-Fed US system, so I don’t really see this as a point in favor of central banking. As I mentioned, Scotland, Canada, and Australia all avoided note-dueling through mutual par clearing arrangements, so you could say free banking also prevents bank wars.

    • John S
      March 13, 2014 at 1:37 pm

      Something like the Fed could be done privately, but what banks would participate?

      I’m not sure what you mean by “something like the Fed”–a payment/clearing system, lender of last resort, a regulatory agency? But historically, a private institution performing these functions did arise: the clearinghouse. [See Selgin, “Theory,” p. 28-29]

      http://files.libertyfund.org/files/2307/Selgin_1544_Bk.pdf

      If enough of them did they could easily destroy all other banks, but they would each be at the mercy of the private central bank and whoever controlled that would control all of them.

      This seems to be Perry Mehrling’s conclusion–pure free banking leads to someone like JP Morgan having to save the entire system as in 1907 and being “at his mercy,” as you put it. But if the US didn’t have such a crummy system, it’s not clear that the US would have suffered from such recurrent panics. It’s notable that Canada has enjoyed much more financial stability than the US since the late 19th century; arguably, this stability can be traced (at least in part) to Canada’s free banking roots.

      http://eh.net/eha/wp-content/uploads/2013/11/Bordo.pdf

      • J Thomas
        March 14, 2014 at 12:11 am

        “But historically, a private institution performing these functions did arise: the clearinghouse. [See Selgin, “Theory,” p. 28-29]”

        Yes, and he pointed out the sequence that let it happen in steps where probably even the people who caused it to happen did not know ahead of time where it was going.

        “But if the US didn’t have such a crummy system, it’s not clear that the US would have suffered from such recurrent panics. It’s notable that Canada has enjoyed much more financial stability than the US since the late 19th century; arguably, this stability can be traced (at least in part) to Canada’s free banking roots.”

        My own conclusion from this is that it takes more to tell whether a system will work well than to know that it is free enterprise or government regulated. Either can start from some random beginning and evolve toward something better, or at least different. Where they end up depends partly on where they started. So “free” systems might on average randomly come out better than government-influenced systems, but it’s probably better to put a lot of thought into careful design when they’re being set up. If you start with a bad design it could take a long time for it to evolve into something reasonably good, and it may keep bad parts indefinitely.

        I don’t claim that government workers should be the ones who put a lot of thought into how to design things, maybe it’s better if it isn’t them. But somebody ought to.

      • Free Radical
        March 14, 2014 at 1:31 am

        I enjoy your comments Thomas because they help remind me how people think that have not noticed the fundamental beauty of free market systems in general. I don’t mean that to be snarky, I think this is representative of most people but let me see if I can steer you toward that realization. (For the record, this is the big plus on the Austrian side.)

        Decentralized systems do not evolve randomly. They arise because people think they will make them better off. Since, in a free market, they have to be mutually voluntary, they are forced to arise in a way that everyone (directly) involved in them agrees to. This means that everyone involved has an incentive to try to figure out how those systems will work and whether they are a good idea. So if someone proposes a banking establishment that is likely to be unstable and other people can figure that out, then people will refuse to participate in it. Obviously people are not perfect and they make mistakes in their judgment but it is difficult to explain why they would do so in a large systematic way over an extended period of time. If there is a mutually beneficial exchange possible which is difficult to execute for some reason, there is a profit available to anyone who can figure out a way to structure an institution through voluntary contracts that will make that exchange possible.

        When the government tries to design things, they do not have the same incentives (what their incentives are in any given case is debatable) and are able to force everyone to participate in them. This leads to a completely different process of “evolution” when control is substituted for free markets.

  10. Free Radical
    March 13, 2014 at 9:52 pm

    Wading into this free banking debate, I will just say I agree with John (I’m for free banking). I don’t know as much about the history of it as John, (though I’m adding that paper to my reading list), but I have spent some time imagining how such a thing would/could work and I can add one thing.

    Exchange in a free market is governed by contracts (which are “promises”) this is not unique to banking. The thing that is somewhat unique to banking is that they are in a constant state of being illiquid, even when solvent so in theory, a perfectly good bank could be taken down by a run on reserves. But the nature of the contract governing the relationships is important.

    So for instance, if the nature of the convertibility were such that if the level of reserves fell below a certain level, the bank closed its doors and went into a pre-structured default in which all of its assets were liquidated over a certain period of time and the proceeds from those assets distributed to note holders in proportion to the nominal value of their notes/accounts, then the incentive to engage in this sort of “note-dueling” would be largely eliminated. If you tried to present a quantity of notes sufficient to break the bank, you would end up damaging the value of the very notes you were holding. Plus you might weaken the position of your own bank since those notes would go from being highly liquid to highly illiquid over the term it took for the bankruptcy to play out.

    • J Thomas
      March 14, 2014 at 1:44 am

      “So for instance, if the nature of the convertibility were such that if the level of reserves fell below a certain level, the bank closed its doors and went into a pre-structured default in which all of its assets were liquidated over a certain period of time”

      Yes, something like that could probably be made to work. It requires that banks not be soveriegn. Somebody — somebody from government, or the public, or some incorruptible private institution must have the right to audit their books and announce the results. And the level of reserves is kind of arbitrary. Some banks some places might need 5% or even 10%, today US banks get by with somewhere between .5% and .1% in reserves that could be used to head off a run on the bank. If we wanted a level of reserves that was not arbitrary, it would be 100%. You put your money in your safety deposit box at the bank, and the bank doesn’t touch it.

      See, governments mostly started out as robber bands. They attacked people on footpaths and sometimes attacked homes. Then they gradually turned into protection rackets where they protected their clients from other robbers, and they wound up dispensing justice and coining money and all sorts of other things because when the jobs opened up they were in a good spot to claim them. Maybe we’d be better off with some other way to handle most of the functions of government.

      And banks mostly started as fraud. Goldsmiths or whoever noticed that they could defraud their customers and usually not get caught, they branched out to loansharking, one thing led to another and now they create most of the money for the whole economy — at a great big profit.

      In both cases, who needs it? Maybe we can design institutions that will meet our needs better.

      • Free Radical
        March 15, 2014 at 5:29 pm

        I think your definition of “sovereign” is not quite right. In the type of system I describe, all of that stuff would be part of the contract. It would be “arbitrary” in the sense that banks could choose what to put in the contract but they wouldn’t choose it randomly, they would do so to best satisfy the concerns of their customers.

    • John S
      March 14, 2014 at 12:48 pm

      Mike, you have very good intuition. But the actual solution against note-raiding–the option clause–was even better, since it didn’t require that banks close their doors.

      (Google “Experience of Free Banking” “option clause,” and it should come up on p. 25)

      Option clauses were actually banned in Britain and given a bad rep by Adam Smith. But that doesn’t rule them out as a good idea.

      http://monetaryfreedom-billwoolsey.blogspot.com/2013/03/why-ban-option-clause.html

  11. Free Radical
    March 13, 2014 at 9:59 pm

    Hey John, what do the GMU and Free Banking types think about hyperinflation?

    • John S
      March 14, 2014 at 11:02 am

      That’s a good question, and I don’t really know the answer. I don’t recall any GMU/FB predictions of it. The only thing I remember was Larry White, in one of his Congressional testimony videos, mentioning the possibility of future hyperinflation (I don’t remember the exact chain of events he based that possibility on).

      [In fairness, I believe Krugman also admitted the possibility of future hyperinflation, if govt debt wasn’t reigned in eventually, in his debate with MMTers–I may be wrong, but I don’t think this is an unreasonable view in any case. Also, in this link Sumner for some reason thinks helicopter drops, if done wrong, could lead to hyperinflation (which seems fairly paranoid, fwiw). So admitting some possibility of a hyperinflation scenario doesn’t seem like a sign of losing one’s marbles.

      http://www.themoneyillusion.com/?p=6119 ]

      My understanding is that most FBers agreed that QE1 and 2 were necessary, given our current system and the (possible) mismanagement of the money supply during the boom years as described by David Beckworth et al in “Boom and Bust Banking.” However, they all seem to be suspicious of the need for ongoing QE (i.e. QE3).

      I will say that I don’t see the GMU/FB guys as all-knowing sages, and there may very well be things they’re missing. In my spare time I’m trying to watch Mehrling’s Money and Banking lectures on Coursera, and I’ve started reading Gorton’s “Slapped by the Invisible Hand” to get a better handle on QE and shadow banking, respectively. But even if FBers partially misunderstand how the current system works, they certainly have a ton of knowledge on past free banking systems and can give insights into how a modern version of it might work.

      • Free Radical
        March 15, 2014 at 6:17 pm

        For the record, I’m not denying any possibility of hyperinflation. But it would take changes in the paradigm more significant that what is happening now. And it’s not just the Rothbardians’ fixation on hyperinflation but their dismissal of the threat of deflation (I agree it wouldn’t be a systemic threat in a free banking system but that’s not what we have). Anyway, my limited experience with FBs is also that they don’t spend many words on that stuff (to their credit). And of course we are all missing things.

  12. J Thomas
    March 14, 2014 at 3:06 am

    “Decentralized systems do not evolve randomly. They arise because people think they will make them better off. Since, in a free market, they have to be mutually voluntary, they are forced to arise in a way that everyone (directly) involved in them agrees to. This means that everyone involved has an incentive to try to figure out how those systems will work and whether they are a good idea.”

    Casinos. Pimp-run prostitution. Government. I understand that you want to think of it as a utopian sort of thing, but each institution arises in a mostly-mutually-voluntary way. Even when they victimize somebody, they must be mutually voluntary among the oppressors, who have to believe that the system works well for *them*.

    “So if someone proposes a banking establishment that is likely to be unstable and other people can figure that out, then people will refuse to participate in it.”

    Once as a grad student I listened to the lab techs talking about a chain letter they were thinking about buying into. It was called Circle of Gold. The chain letter explained that most chain letters failed because somebody broke the chain. But this one was foolproof. You found somebody who would join, and you watched them send a letter with $50 in it to the person at the top of the list. And he gave you $50. Do that twice and you get your $100 back. Then everybody who actually sends you money is sending you free money. You get your $100 back when you make sure the chain isn’t broken.

    They thought it looked foolproof. A beautiful lab tech that I had thought was smart was all enthusiastic about it because it meant everybody could be rich.

    Of course I refused to participate in it. I tried to explain it to them. Somebody would get hurt and would lose their money. The beautiful woman explained to me that if somebody didn’t have the gumption to go out and find two people to participate, then he didn’t deserve to be rich. Eventually I was able to get the point across by comparing to bacteria doing exponential growth. She’d seen that, so she finally realized that at some point in the chain we’d need everybody in the world to send all the money in the world, and the next step we’d need everybody in the world to do it twice….

    Most of the others still weren’t convinced. I tried a moral argument. “It doesn’t create any wealth, it just transfers money around from one person to another. So how can it make people richer? And what do you owe the people who started the chain? You could start your own chain. Put your mother’s name and address at the top of the list, and your uncle’s second, and so on. And don’t just do it twice, do it as many times as you can. Every time you do it, you get $50 and your mother gets $50. But if anybody can do that, what good is it?” The lab tech I had always thought was the smartest nodded and said he understood now.

    Three days later the newspapers reported on the Golden Circle. They said it was a scam and it was mail fraud. Everybody who read about it refused to play, and the whole thing fizzled. A lot of people lost $100. One of the lab techs was very upset about it. If only it had lasted a few more days he would have won. The smart one said he had no complaint. “I made $650, and so did my mother.”

    Mike, I don’t have a whole lot of faith in people’s ability to analyze complex systems and understand their long-term effects. I’d like to think we can do better with computer simulations. At least that way we can make our assumptions plainer, and observe the consequences of our beliefs — the consequences that were implicit in our assumptions that we didn’t think out.

    If you are right about banking, it means the smartest economists in the world have gone hundreds of years without understanding the fundamentals of how money works. Pathetic. But if you look at mainstream explanations of banking today, and look back at mainstream explanations for the last 300 years, are they right? Independent of whether you have it right, can you seriously argue that they got it right at any time in the past?

    “Obviously people are not perfect and they make mistakes in their judgment but it is difficult to explain why they would do so in a large systematic way over an extended period of time.”

    Observation says it is so, however hard it may be to explain.

    “If there is a mutually beneficial exchange possible which is difficult to execute for some reason, there is a profit available to anyone who can figure out a way to structure an institution through voluntary contracts that will make that exchange possible.”

    Perhaps a very *LARGE* profit. The more money you can make off of it, the more resources you have available to *stop* anybody who tries to set up a better approach….

    “When the government tries to design things, they do not have the same incentives (what their incentives are in any given case is debatable) and are able to force everyone to participate in them.”

    Agreed. Plus they have rich cronies trying both to bribe them and to coerce them to maintain systems which give those cronies a great big income. Without government would powerful people find it so easy to stop fledgling competitors? Maybe. Probably. But then maybe not.

    • Free Radical
      March 15, 2014 at 6:11 pm

      If you see a casino as “oppression” then there is no common ground between us.

      The free market is not anarchism, it requires a government that enforces contracts and property rights and that must be carefully conceived and controlled. You can’t equate institutions that arise naturally out of anarchism with those that arise out of a free market.

      “Mike, I don’t have a whole lot of faith in people’s ability to analyze complex systems and understand their long-term effects.”

      That’s exactly the argument in favor of free markets.

      “If you are right about banking, it means the smartest economists in the world have gone hundreds of years without understanding the fundamentals of how money works.”

      That is partly right and partly not. Most implications of what I am saying are not that different from what most economists believe. I am just looking at it a different (I think more accurate) way. But it’s true that we don’t have perfect understanding of these things, that shouldn’t be surprising and will be true when I’m long gone. Coase once said “everything I ever said was obvious.” I agree but it apparently wasn’t that obvious until he said it.

      For the record, I think the current paradigm in economics about money is surprisingly inadequate but the mistake is sort of understandable in that it is essentially a conflation of pure fiat money with the kind of “money” (hard currency) which mankind has used for pretty much the entire history of civilization (as opposed to credit). We’ve only really had pure fiat money (with no expectation of going back to a commodity standard) for about fifty years. In intellectual time that’s like the blink of an eye.

      • J Thomas
        March 16, 2014 at 12:27 am

        “The free market is not anarchism, it requires a government that enforces contracts and property rights and that must be carefully conceived and controlled. You can’t equate institutions that arise naturally out of anarchism with those that arise out of a free market.”

        I don’t see that I did equate those. Though I have no idea what institutions arise naturally out of anarchy, or for that matter whether any particular style of institution tends to arise out of free markets.

        One generality that I think might tend to hold true, is that institutions that people build in free market contexts tend to be particularly profitable for the particular people who build them. Rather than seeing a need and filling it, the tendency is to find a product that could be sold at a fine profit, and pushing that product. The two could of course go together, but there’s no need for them to go together.

        “I think the current paradigm in economics about money is surprisingly inadequate but the mistake is sort of understandable in that it is essentially a conflation of pure fiat money with the kind of “money” (hard currency) which mankind has used for pretty much the entire history of civilization (as opposed to credit). We’ve only really had pure fiat money (with no expectation of going back to a commodity standard) for about fifty years.”

        China had pure fiat money off and on, from around 220 BC on.

        Herodotus claimed that Sparta had fiat money in his time. I think. They used iron coins that nobody else thought were valuable. http://www.metrum.org/money/castiron.htm There’s room for disagreement about this one.

      • Free Radical
        March 16, 2014 at 1:29 am

        “One generality that I think might tend to hold true, is that institutions that people build in free market contexts tend to be particularly profitable for the particular people who build them. Rather than seeing a need and filling it, the tendency is to find a product that could be sold at a fine profit, and pushing that product. The two could of course go together, but there’s no need for them to go together.”

        There is a need for them to go together, people make profits through mutually beneficial exchange (or by filling a “need” though that term is not very “economic”). This is the fundamental principle that I don’t think you are seeing. Maybe you should read more Adam Smith haha.

      • J Thomas
        March 16, 2014 at 10:30 am

        “Mike, I don’t have a whole lot of faith in people’s ability to analyze complex systems and understand their long-term effects.”

        ‘That’s exactly the argument in favor of free markets.’

        I can see it very well as an argument not to force people to do things your way when it isn’t absolutely certain that their way is wrong.

        I don’t see it as much of an argument that all free markets must inevitably provide good results. I haven’t seen much evidence of that. I’ve seen evidence that various coercive systems have produced worse results, but that is not the same thing at all.

        I once read a book by somebody named Andrew Groves, about how to run production lines. I think the title was _High Output Production_ or something like that. He talked about how to sell cooked eggs. You can wait until somebody orders an egg and then cook it and serve it. Each customer must wait the time it takes to cook their egg. If you get a sudden surge of customers, more than your maximum production can handle, some of them must wait longer. If you consistently get a big enough volume of business, at some point you can cook eggs expecting that customers will arrive wanting them. This cuts customer waiting a lot, but you get some overhead from the eggs that did not get sold in time. There are various ways that a buildup in unsold inventory can hurt you even if it has a long shelf-life, and your accounting should be set up to reflect that.

        There are a lot of different ways to do things, and he described circumstances that made one better than another. It all made sense.

        I haven’t seen anything like that for free markets. There are lots of different ways to run a free market. Should there be one official market-maker or is it better to let the job rotate to whoever competes best? If you want to discourage having a market-maker at all, which methods work best and what are their trade-offs? What are the consequences of allowing short sales? Which rules for short sales give better performance, given whatever standard of “better performance” you happen to have? I’ve seen individual papers that address some of these issues, but I haven’t seen any overview of it, and the bloggers I notice all seem to completely ignore the whole thing.

        I’d expect that people who’re interested in how well free markets work, would be interested in which free markets work better for which purposes.

      • Free Radical
        March 16, 2014 at 7:07 pm

        “I don’t see it as much of an argument that all free markets must inevitably provide good results.”

        Is that the burden of proof that liberty must bear these days?

  13. J Thomas
    March 14, 2014 at 12:20 pm

    John S :
    J Thomas, you wrote: “biologists have found that evolutionary processes don’t necessarily benefit anybody in particular.”
    In no expert on evolution, but I do think a clear distinction has to be made between biological evolution and spontaneous order in human societies w.r.t. economic/institutional arrangements and outcomes. Only humans are 1) capable of creating widespread networks of exchange among non-related members of the same species (examples of reciprocal altruism among animals are rare, extremely limited, and hard to distinguish from kin selection); and 2) consciously aware of the current and future gains from such exchanges (i.e. the iterated Prisoner’s dilemma). So one can indeed maintain that evolutionary outcomes in human interactions can be mutually beneficial while acknowledging that biological evolution doesn’t “benefit” anyone in particular.

    I didn’t make my point clearly. Evolution can — and often does — lead a species into a dead end. They get selected to do a particular thing, they get selected to do it more and more, and then they are left in a box where the adaptations that used to be so useful leave them with nothing and natural selection does not give them anything better and they go extinct. A literal … dead … end.

    Evolution does not give any guarantees. And you can’t not do it. Find a way to fail to respond to natural selection and your species will be replaced by something which adapted. Respond to natural selection and your species is likely to go extinct anyway.

    Natural selection is much affected by initial conditions. Typically each species is selected to do better what it’s already doing. All the other species around it have left it with an ecological niche — a box it’s put in — and it is selected to fit into that box better. There could be new niches available and only a few species get rewarded for moving toward the new niche. One of those few will be in a better position to exploit the new niche, and it will get most of the benefits. Typically a lot of its advantage will be that it can better handle the new niche and the old one at the same time, before selection for speciation lets it specialize in the new stuff.

    There are no guarantees for a good outcome. On average things that impair reproduction — most changes — will be selected against. Changes that enhance reproduction right now — right now! — will be selected for. This sometimes results in amazing chains of improvements. How many wonderful adaptations that would help a species survive are never discovered? You don’t see those. In computer simulation, most adaptations remain undiscovered but there could be real genetic mechanisms that work better than the simulations do.

    Humans have the chance to do better than evolution. We can look ahead and see problems that haven’t shown up yet, and choose not to do something that looks good in the short run. At least we can do that in theory. In practice, not so much.

    Somebody sees a way he can make a billion dollars. You tell him it will cause big trouble in the future so don’t do it. Does he listen? Definitely not! He will claim you don’t know what you’re talking about, and he will keep claiming that until he has made his billion dollars and the problems have become undeniable.

    Consider the climate change issue. I don’t claim that the scientists are right. But suppose they were. How could they convince people to take drastic action to prevent a certain catastrophe? Most of the people who are unconvinced now would be unconvinced by anything except great big climate change. People simply do not trust big science to get the right answers, when it means personal inconvenience to them.

    On the other hand, consider bitcoins. A lot of people are so pleased at the idea of free, nongovernment money, that they’re ready to assume that bitcoins will work. Other people say that there are theoretical reasons that prove bitcoins cannot work. The people who want to believe in them ignore that. And then the failure of an utterly-unregulated bitcoin bank that started out as a trading card company persuades a lot of the public that they can’t work. An unregulated bank run by amateurs would be likely to fail if it used gold coins or paper dollars or whatever.That doesn’t say anything about whether bitcoins would work. Mostly people make their decisions for stupid reasons. And their hopes and fears for their personal profit make more difference than anything else.

    • J Thomas
      March 14, 2014 at 12:42 pm

      Consider John’s reasonable claim that the Canadian banking system works a lot better than the US system. Why didn’t the US system evolve to be more like the Canadian system?

      One possibility is that Canadian bankers felt and feel more sense of responsibility for their communities, so they try harder to do the right thing. Maybe their mothers taught them that, while American mothers encouraged their children to do whatever got the most money for personally. I dunno. It isn’t something you can change easily.

      You can always blame government. Government isn’t very predictable, so whenever things happen that don’t fit predictions it’s a reasonable hypothesis that government interfered and prevented your predictions from coming true. Even if government obviously did not intervene, still people could have *expected* government to intervene and that could change their behavior enough to distort the results.

      But then, why would you expect any particular result to have evolved? Evolution is slow. Maybe the US system will become more like the Canadian system, in another 30 years, or 300 years, or 3000 years. If it lasts that long.

      Evolution is also not predictable. Everybody must adapt to the reality around them, so the particular existing circumstances shape which new things can succeed. You might imagine a far better system, that everybody can see would be better, that works well in computer simulations, and works well in testing among small groups of people who’re looking for ways to break it, and works well in foreign nations. But there may not be any way to get there from here.

      And that could be a good thing. If everybody did things the same way, a proven good way, it would limit the evolution of newer improvements. The US banking system inflicts occasional catastrophes on us, but there might be valuable new advances which can only come from that flawed system and not from a better one. Our current suffering might someday lead to a glorious new future.

      Or maybe not.

  14. J Thomas
    March 14, 2014 at 1:27 pm

    Here’s how most blog readers and blog critics of Austrian econ seem to view/frame the issue:
    1. Austrians (really they mean Rothbardians/Mises cultists/pop-Austrians) use really bad methodology (praxeology). [I agree.]

    I think praxeology is not bad in itself. You make reasonable guesses about how people act and you look at the consequences of those actions. What more can you do? I guess you could run small-scale experiments to see whether people act that way during small-scale experiments. And you could to some extent test whether people in stock markets or whatever actually behave that way. But there’s nothing wrong with making up stories about how people might behave, and noticing which of your stories are built around evolutionarily stable strategies (ESS). This is what behavioral genetics and evolutionary psychology are about, and nobody says they’re unscientific, right? 😉

    Where pop-Austrians go wrong is that they want to claim that the results of praxeology must be correct. If they agreed that they are making up reasonable JustSo stories that might or might not have some connection to reality, a lot of the opposition would die down.

    2. Austrians (really some Austrians and Peter Schiff, a non-economist) have made a bad prediction about imminent hyperinflation. [Again, I agree.]

    Well, but lots of mainstream economists have made predictions that didn’t come out just right. Hardly anybody got 2008 right unless you look at vague predictions that don’t say much until you read stuff in, in hindsight. If an economist got discredited just from being wrong, tremendous job opportunities in economics would have opened up in 2008.

    3. Thus, pure free markets are bad.
    Ok, I’m kidding slightly on the jump to #3. But I think a lot of blog readers/bloggers roughly view econ schools on the following (politically) left/right continuum:
    Socialism/Marxism –> Post-Keynesian/MMT –> Saltwater –> Freshwater –> Austrian
    So discrediting the methodology and predictive record of “Austrian econ” equates to discrediting the “extreme right” fringe of economic debate

    Yes. It’s unfortunate that people let their politics influence their views on reality. Starting in WWII we threw out whole schools of economics — we decided it must be all wrong — just because they were Nazis. But their politics does not in itself determine how well their economic ideas fit objective reality.

    Similarly, lots of people reject things named “austrian economics” because they think it’s created by conservatives and therefore must be wrong. On the other hand lots of people accept it without a lot of thought because they think it must say what they want to hear or people they respect wouldn’t say it’s good.

    and the idea that a strong commitment to free markets (even in sacrosanct areas of govt control such as money, health, and education) is wrong. (Krugman, Noah Smith, and Cullen Roche have done this to varying degrees).

    I’d figure a pragmatic view is that free markets work well for the things they’re good at, and have some flaws in some contexts. We might look for ways to fix the flaws, or look for alternatives for the situations where they aren’t a good match. To decide ahead of time that they must be best for everything seems kind of — doctrinaire.

    Besides, free markets vary a whole lot in detail. Doesn’t it make sense to study which kinds of free markets are better for which circumstances? I think that gives more credibility.

    It’s like, if you simply say “In a race, horses always win over camels” people might accept it but the ones who know will realize that horses don’t do well on racetracks designed for camels. If instead you have opinions about which breed of horse is fastest on turf, which is fastest on dirt, which on mud, which on sand, which is fastest on a ten mile course with burning sand and hot air, which is fastest on a ten mile course with hot sand, hot air, running through thickets of thornbushes, they will think you know what you’re talking about.

    But most bloggers/readers seem to think that 1 and 2 are enough to dismiss Austrian ideas such as free banking (“End the Fed”), any form of commodity money (“goldbugs”), privatized healthcare/education, etc.

    Unfortunately, they dismiss the ideas first because they want to, and come up with a label to say why they’re dismissing them second.

    If you were to establish yourself as a liberal who believes in pop Keynesianism, and from there you gradually used logical reasoning to work yourself around to commodity money and free banking, I think they would dismiss you just as quick when they saw what you’d done.

    In general people dismiss what they have chosen not to believe. I have an evolutionary explanation for that, but I haven’t found any practical way to use it yet.

  15. J Thomas
    March 14, 2014 at 3:30 pm

    John S :
    banks have an incentive to create anticompetitive agreements so they collectively make more money.
    Sorry, you’ve lost me here. Are you referring to mutual clearing of notes at par as an anticompetitive agreement? What is anti-competitive about this?

    I don’t see a whole lot wrong with that cooperation. I was leading into an argument against some arguments in favor of free competition, arguments you may not hold anyway.

    Some people want to claim that competition inevitably keeps prices down, or otherwise avoids any problems we might get when businesses have no external regulation by anybody. But sometimes competing businesses have areas where they benefit by cooperating, as you exampled. And when they communicate and cooperate some, they may choose to cooperate more. Businesses may sometimes compete on price, sometimes on customer-perceived quality, sometimes on getting legislation that favors them, etc. They can choose what arenas to compete in. Sometimes one business that sees an advantage will break such an agreement and compete on price (or wherever he sees his advantage) — when he feels he benefits more than others that way. Sometimes they all think they benefit by not doing that.

    And the more they cooperate, the easier it is for a large majority (or one entity that gets some control) to coerce individual businesses that want to change agreements. They can threaten to stop cooperating with that one, who loses more than the rest when the cooperation fails for him and not for others.

    So even though we prefer to believe that competition will give us the results we prefer, in practice that is undependable in the worst way.

    If you depend on the idea that cartels always fail, a particular cartel may not fail fast enough to meet your needs. But if you depend on the idea that cartels sometimes last awhile, a particular cartel may not last long enough to fit your needs. When you depend on them to compete on quality they might compete on price, when you need them to compete on price they may instead compete on lobbying. Maybe in the long run over hundreds of years things are guaranteed to improve some. But arguments that they will become good in our own lifetimes might easily turn out wrong.

    There might be ways to improve on this without involving government. I see no guarantee that getting government involved will improve matters at all. But I say that the claim we can depend on competition to provide adequate results is bogus. It is not in general dependable. There may be ways we can make it dependable, and the matter deserves careful thought.

  16. J Thomas
    March 14, 2014 at 4:04 pm

    John S :
    If you want to argue that note/check-raiding guarantees victory for large banks, I believe the onus is on you to explain why this never actually happened in historical free banking systems. It didn’t work in Scotland, and it didn’t work in early 19th century New England when the Boston banks tried to put the country banks out of business.

    I don’t claim it guarantees victory. I claim that other things equal, if a war breaks out the bigger bank has an advantage, and the bigger it is the bigger the advantage it has.

    Here’s a list of note-issuing banks in Scotland in 1845, after many decades of free banking. No bank has more than 15% of a share of the total notes in circulation.
    http://www.iea.org.uk/sites/default/files/publications/files/upldbook115pdf.pdf (p. 33)

    You point out that a collection of banks survived, and say this argues there were no bank wars? I would prefer to look at the list of banks that failed, and ask why they failed.

    I haven’t had time to read your whole link, but I notice (page 40 on) that over one time very few banks failed in Scotland while many did in England. The reputation Scottish banks got for not failing helped keep them from being challenged, while people instinctively distrusted small English banks and withdrew their money at the first hint of trouble. When disruptions came the Scottish banks helped each other.

    Without seeing the whoe picture, I have the strong impression that Scottish banks did not have a culture where they competed in that arena. They didn’t try to destroy each other, and as a result few of them were destroyed. The example tends to show that banks don’t have to try to destroy each other. So we can’t depend on them to have regular bank wars.

    The big problem is occasional giant liquidity crises, where many people lose their property and some banks fail.
    Again, may I ask what specific historical episodes you are thinking of? There is one major instance, but I don’t think you can find a consistent pattern. If you can, I’d be glad to hear about it.

    Are you asking for examples for free banking that wouldn’t have happened with government involved? I don’t want to argue that. My claim is that this happens with *banking*, and free banking probably does not help much. Though it might help, or specific versions of it might help.

    • J Thomas
      March 16, 2014 at 11:04 am

      Free Radical :
      “One generality that I think might tend to hold true, is that institutions that people build in free market contexts tend to be particularly profitable for the particular people who build them. Rather than seeing a need and filling it, the tendency is to find a product that could be sold at a fine profit, and pushing that product. The two could of course go together, but there’s no need for them to go together.”
      There is a need for them to go together, people make profits through mutually beneficial exchange (or by filling a “need” though that term is not very “economic”).

      In an evolutionary system, random mutations followed by selection will tend to result in an local optimum. (You eventually approach a state where any small change is worse than what you have.) If a free economy is like an evolutionary system, you would eventually approach a pareto local optimum where any trade would make one of the two traders worse off. (But still a trader might find a way to make three trades that each individually make him worse off, but that together give him something of great value. And it’s much harder to notice the trifecta than the result of each individual trade.)

      But experiental studies with bacteria (which can be grown quickly in very large numbers) show that every so often a new mutant arises that grows and wipes out the rest of the population, and this happens repeatedly. There are multiple reasons for this. One is that some mutations are rare, and they can’t take over until they happen. Another is that when a mutant form takes over, it changes the environment that all the bacteria live in, which opens the way for new mutants that can handle the new environment. (In one case the medium used citrate as a pH buffer. The bacteria adapted to use citrate as an energy source. But with less citrate left, the bacterias’ own waste products made the environment more acid, so there was selection to thrive in acid.) (In another case, with air bubbling vigorously through the medium, the bacteria changed their mix of waste products. It’s cheaper to excrete waste products when the gradient is steeper, when there’s less waste product in the medium already. So they created and excreted more waste that easily evaporated, like ethanol, and less that tended to stay in the water, like butanol.)

      If the mutation process is somehow biased, that will slow the evolution and also bias it in some direction. The bias in the mutation process doesn’t tell you the bias in the evolution. (Like, if you have a bunch of bricks that each have a flaw in one corner, they might result in a wall that has some sort of flaw. But probably the wall won’t have a flaw in one corner….)

      Even with the bias you can expect to eventually approach a pareto optimum, unless innovations keep happening. But it’s likely to be a different pareto optimum they approach, and likely to be one where people are not as well off.

      I’m pointing out a bias in the “mutation”. I’m not clear whether anything can be done about it.

      This is the fundamental principle that I don’t think you are seeing. Maybe you should read more Adam Smith haha.

      Was that intended to be an insult? I wouldn’t tell you to read Darwin. Darwin had some good ideas but they were new, so they were buried in a whole lot of bloviation while he stumbled around with them, and he had hardly any concept of genetics. If you just want to blow me off, tell me to go away.

      • Free Radical
        March 16, 2014 at 7:09 pm

        No, it was a joke. I’m just pointing out the difference between you, who reads Darwin, and me, who reads Adam Smith.

  17. J Thomas
    March 16, 2014 at 11:51 am

    Free Radical :
    I think your definition of “sovereign” is not quite right. In the type of system I describe, all of that stuff would be part of the contract. It would be “arbitrary” in the sense that banks could choose what to put in the contract but they wouldn’t choose it randomly, they would do so to best satisfy the concerns of their customers.

    Yeah, right. The goal of allaying the public’s fears is different from the goal of setting up rules that businesses will actually follow.

    Your proposal basicly requires that banks should open their books to the public.

    There’s a cynical quote that says large businesses keep three sets of books, one for themselves, one for the auditors, and one for the IRS. The quote does not recognize that this is legitimate. The IRS has its own rules and needs books that make sense in terms of those rules. The auditors that announce the financial status of public corporations need accounting that fits GAAP, and accounting that fits GAAP is not very useful for business planning.

    Public corporations need trustworthy auditors to tell their stockholders they aren’t lying about how well the company is doing. They need the public to trust the auditors, and the auditors themselves need to be impeccably honest since their efforts are useless if the public stops trusting them.

    Every now and then a giant corporation fails after its auditors said it was OK. Each time there is a scandal. Editors say that it’s intolerable, if investors can’t trust the numbers they won’t invest. Then nothing changes and it all dies down until next time. Not so long ago this happened to all but one of the auditing companies the same year, and Arthur Andersen had to close down leaving four remaining that are still trusted for no good reason. The basic problem is that we depend on human beings to look after their long-term best interest, when in reality sometimes auditors let their short-run benefit take precedence. Investors now pay somewhat less information to financial statements knowing that they are crooked, but they still invest in US companies since they think that foreign accounting standards are even worse.

    This is the system you are proposing to use to regulate banks. Doing it for real would be tremendously invasive, banks would basicly be unable to keep secrets. But it could probably be faked well enough to satisfy customer concerns except after bank failures.

    • Free Radical
      March 16, 2014 at 7:11 pm

      Yes they should open their books to the public. That is not invasive, they would do it voluntarily because their customers would demand it (or another way of approaching it: because their competition would offer it).

      • J Thomas
        March 18, 2014 at 1:40 am

        “Yes they should open their books to the public.”

        If it’s clear to the public that they have, say, 5% reserves, will the public accept that?

        It’s one thing for the government to say they can do it because they’re a bank with a government license to do it. It’s something else for the public to actually notice what’s going on, that the banks are consistently doing something that you would go to jail for if you got caught.

        If banks revealed who they lent their money to, that would be tremendously invasive for their customers. Probably their customers would not want that at all. But maybe some way could be arranged for people to understand that the bank’s debtors were very good credit risks without actually revealing who they were.

  18. J Thomas
    March 18, 2014 at 1:36 am

    Free Radical :
    “I don’t see it as much of an argument that all free markets must inevitably provide good results.”
    Is that the burden of proof that liberty must bear these days?

    If that’s the claim you make, then that’s the claim you have the burden of proof to support.

    My own claim is that some free markets are better than other free markets, and we should try to arrange for better free markets rather than worse ones.

    Here’s a metaphor that might be interesting. Say you live in the US south and you have a pond, and you stock it with bass and bluegill. Usually, they will do pretty well without much attention on your part, and the pond will provide you with plenty of fish. You don’t need to micro-manage it, and if you try you’re as likely to mess things up as to make them better.

    But after awhile there’s a chance things will get out of balance and you might for example find yourself with a pond full of tiny bluegills that you have no use for. When that happens, you can drain the pond and restock it, and after that mostly leave it alone again.

  19. J Thomas
    March 18, 2014 at 1:50 am

    Free Radical :
    No, it was a joke. I’m just pointing out the difference between you, who reads Darwin, and me, who reads Adam Smith.

    I don’t read Darwin. Darwin is 150 years out of date.

    If economics was a science where people made a lot of progress, Adam Smith would be about 250 years out of date by now. But there are people who consider him an authority. There are people who consider Ricardo an authority. Hell, there are people who consider Mercant an authority after all these years! 😉

    (Mercantilism should have been discredited a long time ago, except that for some purposes it seems to work.)

  1. February 11, 2016 at 1:24 am
  2. April 2, 2016 at 3:26 am

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