Murray Rothbard on American History

I was listening to a lecture by Tom Woods (a fantastic historian I might add) and could not help but feel the need to repost these passages. They are from the introduction to Rothbard's four volume history on Colonial America entitled Conceived in Liberty. Just as Professor Woods was, I was struck by his unconventional yet honest statement that, essentially, "facts do not explain themselves." They do require some kind of theoretical apparatus - some kind of knowledge of cause and effect. Anyway, the purpose of this post is simply to repost!

What! Another American history book? The reader may be pardoned for wondering about the point of another addition to the seemingly inexhaustible flow of books and texts on American history. One problem, as pointed out in the bibliographical essay at the end of this volume, is that the survey studies of American history have squeezed out the actual stuff of history, the narrative facts of the important events of the past. With the true data of history squeezed out, what we have left are compressed summaries and the historian's interpretations and judgments of the data. There is nothing wrong with the historian's having such judgments; indeed, without them, history would be a meaningless and giant almanac listing dates and events with no causal links. But, without the narrative facts, the reader is deprived of the data from which he can himself judge the historian's interpretations and evolve interpretations of his own. A major point of this and succeeding volumes is to put back the historical narrative into American history.

Facts, of course, must be selected and ordered in accordance with judgments of importance, and such judgments are necessarily tied into the historian's basic world outlook. My own basic perspective on the history of man, and a fortiori on the history of the United States, is to place central importance on the great conflict which is eternally waged between Liberty and Power, a conflict, by the way, which was seen with crystal clarity by the American revolutionaries of the eighteenth century. I see the liberty of the individual not only as a great moral good in itself (or, with Lord Acton, as the highest political good), but also as the necessary condition for the flowering of all the other goods that mankind cherishes: moral virtue, civilization, the arts and sciences, economic prosperity. Out of liberty, then, stem the glories of civilized life. But liberty has always been threatened by the encroachments of power, power which seeks to suppress, control, cripple, tax, and exploit the fruits of liberty and production. Power, then, the enemy of liberty, is consequently the enemy of all the other goods and fruits of civilization that mankind holds dear. And power is almost always centered in and focused on that central repository of power and violence: the state. With Albert Jay Nock, the twentieth-century American political philosopher, I see history as centrally a race and conflict between "social power"—the productive consequence of voluntary interactions among men—and state power. In those eras of history when liberty—social power—has managed to race ahead of state power and control, the country and even mankind have flourished. In those eras when state power has managed to catch up with or surpass social power, mankind suffers and declines.

For decades, American historians have quarreled about "conflict" or "consensus" as the guiding leitmotif of the American past. Clearly, I belong in the "conflict" rather than the "consensus" camp, with the proviso that I see the central conflict as not between classes, (social or economic), or between ideologies, but between Power and Liberty, State and Society. The social or ideological conflicts have been ancillary to the central one, which concerns: Who will control the state, and what power will the state exercise over the citizenry? To take a common example from American history, there are in my view no inherent conflicts between merchants and farmers in the free market. On the contrary, in the market, the sphere of liberty, the interests of merchants and farmers are harmonious, with each buying and selling the products of the other. Conflicts arise only through the attempts of various groups of merchants or farmers to seize control over the machinery of government and to use it to privilege themselves at the expense of the others. It is only through and by state action that "class" conflicts can ever arise. 

A Bit on Bretton Woods, 1951 – 1971

The Bretton Woods System is an interesting creature. It is often stressed that the system looked very different than the way its founders originally intended in 1944. It ushered in a period of rapid economic growth on a scale never seen before or even after. While the system itself should be credited for some portion of the success, the larger context of a post-war boom must be kept in mind too.

The international monetary order as it existed prior to Bretton Woods, from 1914 to 1945, was such a disturbed period in human history that Winston Churchill referred to it as the “Next 30 Years War.” Calling it a kind of monetary “order” is probably an exaggeration. Prior to WWI, the monetary order referred to as the Classical Gold Standard was literally destroyed. Countries not only destroyed each other, but also their own economies and currencies in patriotic fervor.

The Bretton Woods System was a platform on which the unprecedented rise in the standard of living prior to WWI might resume. Who would have guessed that a system of fixed exchange rates and a world of immobile capital might yield such favorable results? (Since the late nineteenth-century, no period was characterized by such high degrees of capital immobility as that of Bretton Woods) Nonetheless, even this system was wrecked by political considerations. This time it was American fiscal exigencies.

The monetary order was, nominally, underpinned by gold. After a round of devaluations of around 30% in the late 1940s, the fixed exchange rate system was born. The Sterling was revalued in terms of the Dollar, from $4 to $2.80 to the pound. This was the opposite of what happened in 1925, when the British refused to devalue the Sterling. One of the effects was that an overvalued Pound reinforced existing structural unemployment by making exports less competitive.

However, the problem lay with the new hegemonic status commanded by the dollar. In the system, the dollar was pegged to gold at $35 an ounce. Every other currency was pegged to the dollar. By anchoring the dollar to gold and the Rest of the World’s currencies to the dollar, it was hoped that the new monetary order would bring international monetary stability. And for a time, it did.

The dollar became the world’s new international medium of exchange, not gold. It was simply assumed that dollar denominated liabilities, bonds issued by the federal government, were all backed by the gold amassed at Fort Knox. While cashing in American paper for gold was allowed (imagine the consequences if it was not!), American debt largely served as collateral, an asset base, on the balance sheets of foreign central banks.

What if everybody might want to cash in on these dollar denominated securities? Would Fort Knox be able to accommodate everybody? Hypothetically, Robert Triffin postulated, no. Hence, this particular issue was eventually termed the “Triffin Problem.”

In hindsight, it is easy to see that a little “benign neglect” by the American government might have produced some unintended inflation, while the spillover effects extended into other countries. Professor Nick Crafts calls these countries “inflation takers.” At first, the expansion of the dollar served as a source of liquidity for Europe – the point Professor Crafts makes in reference to the Marshall Plan. However, the inflationary pressure originating from the dollar eventually came to be known as “malign neglect,” because it was no longer in the new monetary order’s interests that justified dollar expansion, but in the American government’s interest.

The evidence speaks for itself. The amount of monetary gold held as reserves in 1950 stood at $35.3 billion. By 1973, it rose to only 43.1 billion. (At $35 an ounce, this is not really a surprise. Then again, it did still provide the anchor for the whole system) Another potential source of liquidity, the IMF’s Special Drawing Rights, also saw a comparatively small expansion over the same period, from $1.7 billion to $7.4 billion. A clue is in the figures representing foreign exchange reserves, which were held in dollars (of course). Between only 1969 and 1973 this figure nearly quadrupled – standing at $32.4 billion in 1969 and exploding to $123.1 billion in 1973.

While general external dollar liabilities increased substantially as early as 1967, external dollar liabilities held by monetary authorities (foreign central banks) skyrocketed in 1970. So why did the United States break the post-war monetary order? The War in Vietnam is the most obvious candidate, with the bombing of the North Vietnam beginning in 1965. Additionally, I hypothesize that funding NASA during this time period wasn’t cheap either. After all, the first moon landing was in 1969. 

Defining Inflation

Oh the meaning of words… always problematic if they are not defined in a straightforward manner. Today’s word is “inflation.” It is unfortunate that a dictionary definition will not suffice.

The mainstream definition, that is, the definition commonly accepted in academia is a simultaneous, but not necessarily proportionate, rise in the prices of all goods and services. It is an observational definition that refers neither to a cause nor effect. The price of one good cannot be inflated; it must be the price of all goods and services that rise together.

Austrians, broadly speaking, do not like this definition. In addition, Milton Friedman is always famously quoted for stating that inflation is, “always and everywhere a monetary phenomena.” Indeed, if the prices of all goods and services are rising, the logical implication is that the purchasing power of the monetary unit is falling. Furthermore, purchasing power is falling because of an increase in the supply of money relative to the amount of goods and services in an economy.

Apply the converse of this theoretical insight to the Great Depression and you have the recipe for the monetarist hypothesis. So where does this leave us with a definition for inflation? Most economists certainly associate inflation with the monetarists. In my opinion, it is a loaded word, filled with assumptions and therefore inappropriate.

I propose a strict definition: Inflation is an increase in the supply of money. A medium of exchange that circulates in an economy, and in which all prices are denominated in the terms of this medium, is called money. If any amount new money enters the economy, this is called inflation. Note that this definition has no bearing whatsoever on what the price level is.

However, it was Keith Weiner, one of the young guns of the “New Austrian School of Economics,” who pointed out that this strict definition is problematic at best.

There are essentially two kinds of monetary orders – one based on commodity money and the second on fiat money. Keith pointed out that the market process behind the production of each kind of money is entirely different. Whereas commodity money, historically gold and silver, enters a given economy based on the structure of production and relevant costs associated with mining the precious metal, fiat money enters the economy when central banks buy government debt and facilitate loans.

I could not agree more with the fact that the process by which money comes into circulation is entirely different in the aforementioned systems. Strictly speaking though, the supply of “money” (defined as the commonly accepted medium of exchange) can increase in both cases. What I call the “strict” definition of inflation is simple and straightforward, as the meanings of words should be.

I was (erroneously) under the impression that Austrian economists from the Mises Institute subscribed to this “strict” definition of inflation I just put forth. To make amends, I find it appropriate to quote Guido Huelsmann at length on the topic:

We can define it [inflation] as an extension of the nominal quantity of any medium of exchange beyond the quantity that would have been produced on the free market. This definition corresponds by and large to the way inflation had been understood until World War II. Yet it differs from the way the word “inflation” is used in contemporary economics textbooks and in the financial press. Most present-day writers mean by inflation a lasting increase of the price level or, what is the same thing, a lasting reduction of the purchasing power of money. Let us hasten to point out that, as far as mere vocabulary is concerned, both meanings of the word are perfectly fine, if only they are used consistently. Definitions do not carry any intrinsic merit; but they can be more or less useful for the understanding of reality. Our definition of inflation singles out the phenomenon of an increase of nominal quantity of any medium of exchange beyond the quantity that would have been produced on the free market for the simple reason that this phenomenon is causally related to a large number of other phenomena that are relevant from an economic and moral point of view. As we shall see, inflation in our sense is the cause of unnatural income differentials, business cycles, debt explosion, moderate and exponential increases of the price level, and many other phenomena. This is why we hold our definition to be the most useful one for the purposes of the following analysis. The reader will soon be in a position to verify this contention.

Inflation is an extension of the nominal quantity of any medium of exchange beyond the quantity that would have been produced on the free market. Since the expression “free market” is shorthand for the somewhat long-winded “social cooperation conditioned by the respect of private property rights,” the meaning of inflation is that it extends the nominal money supply through a violation of property rights. In this sense, inflation can also be called a forcible way of increasing the money supply, as distinct from the “natural” production of money through mining and minting. This was also the original meaning of the word, which stems from the Latin verb inflare – to blow up (The Ethics of Money Production, 2008: p. 85 – 86).

Monopolies and Morals

Can any moral implications be derived from the existence of a natural or hypothetical monopoly? Can such a firm be considered evil merely for being a monopoly? The answer is no!   

According to the standard neoclassical interpretation, a monopoly is a firm that is the sole producer of a good or service. This firm has the ability to restrict its supply given some level of demand and thereby raises the final price of that product. The profit maximizing formula for this particular kind of firm, the optimum output so to say, can be found for any such firm by equating its marginal production with the marginal cost of producing its product.

What makes a monopoly unique then is its ability to restrict output to increase profits. There is certainly nothing morally repugnant about profit seeking behavior. If this particular firm’s structure of production was not acquired by the aid of theft, fraud or political privilege, then its owners should be free to dispose of their property as they see fit.

At best, such a scenario may be considered undesirable for some number of consumers. When the market for such a product is compared with the hypothetical case of the same market for the product under perfect competition, a neat geometric proof shows that a large portion of consumers are excluded from access to the product due to a higher price.

However, this hypothetical comparison of a monopolistically determined output and price to that of a “perfectly competitive” one is an atrociously misguided framework for an understanding of reality and hence, history. The comparison between two polar opposite industry concentrations and cetaris paribus assumptions make the implications worthless. Nonetheless, these abstractions are often the basis on which well-intentioned economists condemn the existence or even idea of monopolies.   

The Diminishing Marginal Utility of “Money”

The first issue I wish to take up in this blog is that of diminishing marginal utility and its application to money. At a glance, it is a simple, almost trivial exercise in microeconomic theory. In fact, I just explained the connection to my grandmother and she was fascinated by its simplicity. So lets jump right in!

The concept of diminishing marginal utility, that the utility gained from acquiring one additional unit of an economic good is less than the utility gained from the same economic good that was acquired prior, is a wonderful tool for understanding the limits of human desire for a number of homogenous commodities. To put it simply, it explains why most people do not want an endless amount of the same stuff.

Let us take delicious Bavarian beer as our example. It is a warm, sunny day and you decide to go out to the Biergarten with your friends. According to the law of diminishing marginal utility, you will enjoy the first beer the most. With each successive beer that you drink, the pleasure you derive from consuming another beer will diminish. That is, you will enjoy the first beer more than the second, the second more than the third and the third more than the fourth.

Take any economic good you can think of and apply this thought experiment. Couches, TVs, bacon, pants, houses, ovens, glasses and even drinking water are all subject to the law of diminishing marginal utility – and don’t forget to assume ceteris paribus!

Now, what is unique about the application of this theorem to money? According to Professor Fekete, the acknowledged father of what is now termed the “New Austrian School of Economics,” money has the “slowest rate of declining marginal utility.” This means that in comparison to any other economic good, you will get sick of or satiated by accumulating more money more slowly than any other good.

Why? The answer is simple. Money has the unique quality of being desired by all participants in a given market economy for the same reason – it can be used to buy other things. Thus, the rate at which the utility of each additional monetary unit will decline is less than the rate at which the marginal utility any other good will decline.

While this explanation is simple, it leads to far more interesting historically based question. Is a given item classified as money because it has the “slowest rate of declining marginal utility” or vice versa? At present, the most informed answer I can offer to this question is the case of the latter – that an item has the slowest rate of declining marginal utility and therefore becomes money.