Human Action and Economics

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Human Action

The science of economics deals with the production, distribution, and consumption of goods and services that can be quantified in money prices. It so happens that in our world today human beings play a vital role in all of these processes. Henceforth, human action is the foremost determinant for their outcome. Economics is nothing but a subset of the general science of all human action.

As Mises puts it:

"First we must realize that all actions are performed by individuals. A collective operates always through the intermediary of one or several individuals whose actions are related to the collective as the secondary source. It is the meaning which the acting individuals and all those who are touched by their action attribute to an action, that determines its character. It is the meaning that marks one action as the action of an individual and another action as the action of the state or of the municipality. The hangman, not the state, executes a criminal. It is the meaning of those concerned that discerns in the hangman's action an action of the state. A group of armed men occupies a place. It is the meaning of those concerned which imputes this occupation not to the officers and soldiers on the spot, but to their nation. If we scrutinize the meaning of the various actions performed by individuals we must necessarily learn everything about the actions of collective wholes. For a social collective has no existence and reality outside of the individual members' actions. The life of a collective is lived in the actions of the individuals constituting its body. There is no social collective conceivable which is not operative in the actions of some individuals. The reality of a social integer consists in its directing and releasing definite actions on the part of individuals. Thus the way to a cognition of collective wholes is through an analysis of the individuals' actions." (Mises, Human Action, Part 1, Chapter II)

What influences human action?

I will leave the exact analysis of human nature to people who understand it much better than I do. Remarkable work has already been conducted in this fascinating field of science.

For our purposes, the most important cornerstones of human nature are the following:

• Humans strive for an improvement of their current situation until they are satisfied
• Every human being decides for him/herself what he/she considers an improvement of his/her current situation
  
• A human being is first and foremost concerned about his/her own well-being ( humans act selfishly)

A human conducts an action in order to get from status A to status B. The action is performed because he/she perceive status B as more favorable than status A. The desire to improve ones
status must inevitably stem from a certain degree of uneasiness. As Mises puts it: "The incentive that impels a man to act is always some uneasiness. A man perfectly content with the state of his affairs would have no incentive to change things. He would have neither wishes nor desires; he would be perfectly happy. He would not act; he would simply live free from care." (Mises, Human Action)

All human action and economic activity aims at improving ones status, "gaining profit".

For every human being, an action is preceded by an idea. Ultimately it is an idea that determines what the action is going to be.

Every idea is influenced by and refined based on constraints.

To sum it up: Human beings permanently try to improve their status until they are satisfied. The attempt to improve a status is conducted by performing an action. An action is the outcome of an idea which is conceived and refined under certain constraints.

It is this basic behavior that determines production, distribution, and consumption of goods and services and therefore the state of the economy.

Examples:

• I see a report on how kids are starving in Brazil and how they can't even afford the most basic things. This makes me feel uncomfortable. I want to improve my status from this feeling of uncomfort to something better. My idea is to sign up with an organization that supports these kids and pay money on a regular basis. I have constraints of a certain disposable income per month. Based on that I make my decision on how much getting rid of this feeling of uncomfort is worth to me and take an action by signing up for the charity organization. I now feel much better than before and have improved my status according to my selfish human needs. (On more information about welfare in the unhampered free market, please read Mises, Human Action, Part 6, Chapter XXXV, "The Welfare Principle Versus The Market Principle")
  

• I am hungry. I know that I can improve my situation by getting from the status "hungry" to the status "content" by eating something. So my broad idea would be to obtain some food. Let's assume I am under the following constraints: my neighbor has a warehouse piled up with bread that he produced himself, also there is no other food within 50 square miles. I could refine my idea as follows: I could sneak into my neighbors warehouse, steal some bread and consume it. However I happen to know that he recently injured a guy who sneaked into his house to steal and that he is guarding his property. I am facing the constraint of a potential black eye, maybe more. Based on the possibility of transitioning to a status "starving and hurting" which is even worse than my current status "starving only" I discard that idea refinement. However, I have a better idea: I happen to be well versed and experienced in crafting wooden furniture and among other things have produced an extra table that I don't have any need for and that I am willing to exchange for 10 loafs of bread. The 10 loafs of bread are worth more to me than the table, simply by the virtue of the fact that I don't have any need for the table but at the same time am in dire need for food. My neighbor happens to have demand for a table because it helps him bake more bread. Hence, I perform an action: I go to my neighbors house and make him the according offer. He agrees and a transaction takes place. I consume the bread I obtained and have improved my status from hungry to consent. I have "gained profit" by exchanging something I perceive as less valuable for something I perceive as more valuable. How much that profit exactly is is not measurable yet because in this barter economy money has not been invented yet.

• I produce and sell wooden furniture. Every week I sell 5 pieces at 2 loafs of bread each. I can survive by doing so but at times still feel hungry during the week. I would like to have some more bread improve my status and not feel hungry anymore. I would like to get from the status "10 loafs/week" to "20 loafs/week" My idea is to increase the price of a piece by 100% to 4 loafs of bread. I perform an action and change my terms of service accordingly. People start getting upset about my business practices. An entrepreneur sees an opportunity and starts offering wooden furniture at 3 loafs per piece. I am facing the constraint of competition. People start buying the competitor's furniture and the number of pieces I sell goes down to 2 pieces. My status has gone from "10 loafs/week" to "8 loafs/week". I need to refine my initial idea to get to a status better than 10 loafs/week. Instead of 4 loafs I also start demanding 3 loafs per piece. This increases the number of pieces per week to 4. This way I now make 12 loafs/week and have finally improved my status.

• I am now in competition with another furniture selling entrepreneur and I have realized, based on my initial action and the outcome of that action, that I can't just raise the price as much as I want and expect the same number of customers. However I still want to improve my status which is currently 12 loafs/week. I am wondering how I can sell more than 3 pieces of furniture per week without lowering the price. I understand that there are some complaints about the quality of furniture that both my competitor and I sell. Some tables move and occasionally some parts of my chairs break. I have an idea: I realize there is an opportunity to improve my furniture by refining the production process. I find someone who specializes in improving processes, a consultant. I hire the consultant, he demands 9 loafs of bread for the process optimization. I pay the consultant with 9 loafs, which means that I must have earned them but don't consume them, I save 9 loafs, and make an equal investment of 9 loafs. I perform an action and improve the quality of my furniture by applying a better production process from now on. My tables stop moving and my chairs don't break at all. I am now able to sell 5 pieces per week at a price of 3 loafs/piece. I am now at 15 loafs/week. My investment is paid off within three weeks and from now on I earn more bread per week. My status has improved.

In these three examples one can see how the subjects who are part of this economy take actions based upon ideas that are conceived under certain constraints with the ultimate objective to improve their status.

Please note that it is not only me who improves his status in these examples but ALL participants in the economy. Example: By producing better quality furniture me AND my customers benefit in the long run.

The examples also show how the natural constraints of the free market constantly give humans an incentive to improve their products and services.

Improvement of Status

In my three example I merely outlined one type of status improvement: The improvement of status via production and services.

In fact, there are three ways humans can improve their status:

• Production and Services: The production of goods and the rendering of services that are demanded by other people who in return provide other goods and services. Status is improved by exchanging goods or services that are less valuable to me for goods or services that are more valuable to me.
• Homesteading: The acquisition and usage of undiscovered land.
• Expropriation: The forceful obtainment of someone else's property.

All ideas that people conceive with the objective of improving their status and their subsequent actions must be derived from one of these three categories.


All economic activity is performed by human beings based on the simple rules I outlined in this article. I will use them as reference in future articles, especially when I analyze the actions that government officials take, the ideas they conceive and the constraints they find themselves under in democratic societies.

Big Government

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Up until about 200 years ago great accomplishments were made in the field of political liberation. The statist hegemonic bonds were broken up and governments were confined in exercising their power. Private ownership of the means of production has brought about unprecedented wealth and progress. The average American worker enjoys amenities for which Croesus, Crassus, the Medici, and Louis XIV would have envied him.

Ever since things have been heading in the other direction again. Governments have increased the tax burden on people (in relative as well as in absolute terms), increased public debt, created excess money and inflation, assumed more and more power, and driven up the number of wars and civil disorders to levels the world has never ever seen before.

Let's take for example the development of taxes and government spending in the United States over the past 50 years. (source: www.taxpolicycenter.org)

Total (Federal + State + Local) Tax Revenue As Percentages of GDP (1947 - 2003)




Total (Federal + State + Local) Government Expenses As Percentages of GDP (1947 - 2003)


I have not been able, as of yet, to find %age data that goes back to the 19th century. If anybody has something please let me know, I'd be happy to update these charts accordingly.

However, I believe that after looking at this we can all conclude: There haven't been any tax cuts. Maybe taxes went up and down a little bit within shorter periods, but overall the tax burden has increased over the past 50 years. This also means that there is no so-called "neoliberalism".

I assume that most people agree that, at least to a certain degree, something seems to be wrong in our political system today, and that there are problems that need to be fixed.

Taking into consideration the numbers and facts presented here, and applying pure common sense, I assume that most people would unanimously agree to at least the following:

We do NOT need any more taxes or bigger government to solve our economic policy problems. If, in fact, government keeps increasing in size and people keep accepting it, or even calling for it, these problems will only be aggravated.

Those of us who are not part of the governmental body and yet assert that we need government spending in order to ensure a sufficient supply of basic goods and services that the poor and unfortunate people couldn't afford in a free, unhampered market, are either walking around with blinkers, or have given in to statist welfare propaganda and lack the intellectual capacity to accept and process basic principles of human action and praxeology.

But the lack of aprioristic reasoning and conceptualization (praxeology) does not seem to be the only problem here. In addition to that we see a lack of ex-post understanding of history.

The belief in the necessity of government ensuring supply of basic (or so called public) goods would, if applied consistently, imply that we need government to take care of the production of basic goods, such as food and clothes in order to avoid shortages. It is commonly agreed that a human in modern society needs those goods at the very least in order to be able to survive.

Reading this, the welfare state proponent should pretty quickly notice that we actually appear to have a more than sufficient supply of those particular goods in our western societies and that government intervention doesn't seem to be necessary here.

Moving on, the welfare state proponent has to accept the fact that it is precisely in the domain of the so called "public goods", such as government schools, domestic security, and highways where we constantly see shortages. Kids are not properly educated in schools (especially in the poor areas), our cities are everything else but safe (again, especially in the poor areas) and we constantly complain about traffic jams. And what is the reason for these problems according to the welfare state propagandist? It is of course that the state does not have enough money and needs more of the same to provide its services in a sufficient manner. According to him, we have a "shortage" of public funds.

But haven't I shown in the beginning of this article that this clamor for more money has been more than constantly addressed over time? Is there any reason to believe that the welfare state propagandists will one day stop asking for more?

It is clear that this will never happen. I have never seen a government anywhere in the world that was content with its pecuniary affairs and had its finances under control. They will keep asking for more and, as long as taxpayers comply, will keep spending more and I can assure you one thing: It won't help a bit.

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Government

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What is government?

First of all, it is an organization. An organization is a group of people intentionally organized to accomplish an overall, common goal or set of goals.

In my article "Negative Impacts of Inflation" I described government using our simple 5 people economy. Government would be person A who provides services to all other participants of the economy. This in itself does not yet essentially distinguish A from the other participants in the economy, since they all provide services to each other.

What distinguishes A is the fact that he is granted the privilege to establish forceful rules that impact the freedoms of the other participants in the economy. In particular, A has the privilege to determine how much of the money that the participants in the economy earn, they need to pay to him on a regular basis.

This is indeed a notable distinction. A, as opposed to all other participants is granted the privilege to constantly force everyone else to follow his/her rules.

In fact, there is only one type of institution that has throughout history, by the virtue of law, had the ability to impose their force on people: government.

As far as this fact is concerned, I am not making any difference between dictatorships, communist, monopolist, democratic, fascist, Islamic or authoritarian governments or whatever other labels there are to attach to governmental institutions.

The extent to which governments exercise their power, impose their force upon people, and cause inefficiencies and misallocations differ from one to another in different systems. Also the ways governments get to power differ from one to another. However, what does not differ from one government to another is the basis of their existence: compulsion and coercion.

There is no other, publicly accepted, organization that can expropriate people by forcing them to pay money for services.

A company that provides services to an individual can stop providing those services once that person does not pay anymore. If that individual would like to resume consuming the company's services he would have to start paying again.

One could assume that if I really was in dire need for the services government provides and I were to stop paying taxes, government could just stop providing its services to me in order to make me pay again.

Which brings us back to my initial question:

What is government?

Government is the social apparatus of compulsion and coercion.

The means that different people pursue or have pursued in order to get in power and form governments differ significantly.

In ancient times, they used to do it by recruiting the clerical class and making the case for a "divine law" which they supposedly merely exercised in the name of god.
Some have done it or still do it by using force, guns, and military power.

Over time, people have fought countless struggles for liberty and freedom. The outcome of those is democratic government. In a perfect democratic society the social apparatus of compulsion and coercion is elected by the people. The people are the ultimate sovereign. Government shall ensure that society functions by figthting aggressors, viz. people who try to infringe on others' freedoms.

Government's operations need to be strictly confined by rules, bills of rights, and laws. This shall ensure that it doesn't abuse its power. All the benefits brought about by the struggles for liberty stem from the confinement of government meddling with the market economy.


As Mises puts it:

"Government is in the last resort the employment of armed men, of policemen, gendarmes, soldiers, prison guards, and hangmen. The essential feature of government is the enforcement of its decrees by beating, killing, and imprisoning. Those who are asking for more government interference are asking ultimately for more compulsion and less freedom." (Mises, Human Action, Chapter XXVII, Part 2)

As Rothbard puts it:

"The State is a group of people who have managed to acquire a virtual monopoly of the use of violence throughout a given territorial area. In particular, it has acquired a monopoly of aggressive violence, for States generally recognize the right of individuals to use violence (though not against States, of course) in self-defense.5 The State then uses this monopoly to wield power over the inhabitants of the area and to enjoy the material fruits of that power. The State, then, is the only organization in society that regularly and openly obtains its monetary revenues by the use of aggressive violence; all other individuals and organizations (except if delegated that right by the State) can obtain wealth only by peaceful production and by voluntary exchange of their respective products. This use of violence to obtain its revenue (called "taxation") is the keystone of State power. Upon this base the State erects a further structure of power over the individuals in its territory, regulating them, penalizing critics, subsidizing favorites, etc. The State also takes care to arrogate to itself the compulsory monopoly of various critical services needed by society, thus keeping the people in dependence upon the State for key services, keeping control of the vital command posts in society and also fostering among the public the myth that only the State can supply these goods and services. Thus the State is careful to monopolize police and judicial service, the ownership of roads and streets, the supply of money, and the postal service, and effectively to monopolize or control education, public utilities, transportation, and radio and television." (Rothbard, War, Peace, and the State)

Ramifications of Inflation

Inflation occurs when people in an economy are supplied with more money than they need. How much money do they need? The real demand for money is whatever the people in our economy demand when they approach Z.

The economy is supplied with $10 because A approaches Z and demands money. In my example Z acts completely "demand driven".

If that economy was supplied with more money than it needed the value of money would decline and in most cases prices would go up. This includes not only consumer goods but also assets like stocks, bonds and real estate.

What is the negative impact of the inflation that we are facing? One could think that if people are supplied with more money it should not hurt them if prices go up, since they now have more money to spend.

This would actually be true if the money was supplied evenly to all individuals. In that case inflation would not be a problem.

Problems arise if the exuberant money supply is only provided to one group of people. That group of people would then be an inflation beneficiary while the individuals not supplied with money would be inflation losers.

(Please note that an excessive money supply indicates that the entity that is providing the product money is failing to do its job. In a fair and free market, if someone does not do his/her job right or provides bad products or services people start looking at other providers of that service. In today's world central banks are by law the only entity that have the permission to print and provide money for the people living within the respective country's borders. This is enforced by federal law and forced upon people. Hence, there are few ways for individuals to avoid the negative impacts of inflation and there is no natural market mechanism forcing the central bank to do a good job.)

The process of supplying economies with money is in reality a little more complicated than what I described in the article "Money". However, that description gave you a very good understanding of what the purpose of money is, why it exists, what value it provides to people using it and how it could possibly be introduced as an innovative product into a rudimentary economy for the first time.

The Process of Supplying Money

In all major industrial countries central banks provide money by buying government bonds. What does this mean exactly?

Understanding this requires a detailed understanding of government finances.

The entity government has two ways of financing itself: taxes and debt. Lets say in our 5 people economy person A says:

"I will provide services that benefit everyone and I need money to pay for this." Lets assume all other participants trust A. Lets also assume people trust A so much, they give him/her the permission to create rules that everyone needs to abide by. A creates tax laws that state that everyone has to pay him/her a portion of the money they make by providing products/services. The first thing A pays for with the tax money is a strong person that makes sure people follow his/her rules, that person represents police. It is now clear to everyone that A will not have a hard time making enough money at any time as long as he/she is able to enforce his/her rules.

In addition A establishes a rule stating that Z shall be under his/her supervision, be paid out of the tax money and make decisions "independently" and claims that Z's main job shall be providing the participants of the economy with money in case they need money.

In addition to taxes A (who represents government) can borrow money from individuals. It does so by selling a government bond to an individual that entitles that individual to a certain stream of payments. For example, government receives $10 from individual B and promises to pay $0.45 a year and pay the $10 back at the end of the 3rd year. Government has now borrowed money by issuing a 3 year treasury note at 4.5% and at a value of $10. Government debt is now $10.

The $10 treasury note that B owns is a very safe investment and the likelihood of default is very low because government has the ability to force individuals to pay taxes and can adjust the amount of taxes people have to pay. Hence, the treasury note is a safe investment as long as government can force individuals to pay taxes and individuals produce just enough to live and to pay their taxes.

Please note that individual B has already created value before in order to be able to afford the $10 treasury note. The common word for value created but not used for consumption is "savings".

Now lets say individual B wants to buy something that someone else produced that costs $10 but does not have any more money. What B has is the treasury note worth $10. B would now sell the note on the open market. In case there is no other individual who wants to buy the note, in other words, if the economy's money demand exceeds its money supply, person Z (who represents the central bank) would print money and buy the note from person B for $10.

Z would now be entitled to the annual payments of $0.45 and the payoff of the face value of $10 at the end of the 3rd year after issuance of the note. Whenever money gets back to Z this means that money is pulled out of the circulation and discreated. Z does NOT use the money to consume, all he/she is supposed to do is providing the service of printing money and injecting it into or pulling it out of the circulation. He/she is paid for this job separately out of tax earnings.

Up to now nothing has gone wrong. A seems to be providing services the participants of the economy demand, people are paying their taxes, and Z increases money supply only when money is needed and acts "demand driven". There is no inflation in this example.

How does inflation arise?

Lets go back to individual B owning the $10 treasury note. Lets now assume B does not want to buy anything and there is no supply that matches any of B's demands. Person Z, because for some reason he/she thinks the economy needs to be supplied with more money, now approaches B and wants to buy the treasury note. This is the way central banks act, backed by the virtue of law and all governmental forces available. They don't react to demand for money but rather declare and supply a certain amount of money they think is appropriate.

(For a centralized institution, at any point in time, it is virtually impossible to determine the exact demand for money ex ante, just as it is impossible to determine the exact demand for computers, cars, bread or movies or any other products that are produced in a more or less free market. We are all more or less convinced that the regulatory collectivist governments of the soviet union have failed due to this very reason. We accept that government should not produce computers, cars, bread or movies but that it should rather be up to private, forceless organizations or individuals to deliver these products or services. Yet, we still fail to understand that the product money is still being provided in the most centralized and collectivistic manner possible: central banking.)

Because B does not see any reason to sell the note, Z needs to offer B more money for it than $10. Z offers B $12 for the note, B gladly agrees and the deal is closed.

The economy as a whole now has $12 excess in money supply. At the same time the value of a 3 year $10 treasury note that pays $0.45 a year for 3 years plus $10 at the end of year 3 has now gone up to $12 on the open market. This means that the annual interest rate it pays has now gone down to $0.45/$12 = 0.0375 = 3.75%.

B now has $12 in cash that he/she does not need and that he/she is looking to reinvest safely. B has real demand for savings. The reason why people demand savings is that they want to make sure they can retire once they turn older and become incapable of producing.

What is government most likely going to do now? Currently government has borrowed $10 cash and owes Z (the current holder of the 3 year note) $0.45 a month and $10 at the end of year 3. Government can now raise more cash at a lower rate. It will issue a new 3 year note that pays $0.45 a year and $10 at the end of year 3 and sells it to B for $12. B has invested his $12 safely at the current market rate for 3 year notes, 3.75%. His/her overall nominal situation has not changed. B still receives $0.45 a year and $10 at the end of year 3 after issuance of the note.

Government in total has now raised $22 in cash. Please note that $12 out of those $22 are not matched by any supply on the market. Government however has to and wants to do something with this money and in reality governments never have problems spending money. Governments naturally do not have demand for savings because they don't need to save. Governments can always raise money by forcing people to pay taxes and naturally do not need to worry about savings.

Government will purchase an existing product on the market. The price for that product will inevitably go up afterwards because as we determined there is no additional supply matching the excess money. Wealth has been shifted to government. All other participants in the economy are worse off because prices increased without them having more money in their pockets.

This would not have happened, had Z not supplied the economy with money it did not need based on its natural development and expansion.

We have now gone through the process of printing money and we have seen how new money ultimately ends up in the hands of government. We have determined in the beginning that inflation causes problems if excess money is not provided evenly but rather to a certain group of people.

In our example this group of people is represented by government. Government is the main inflation beneficiary while all other participants are inflation losers. Governments all over the world keep increasing their debt while central banks are providing more and more money.

In my simple example here I assumed that government is represented by ONE individual.
We all know that government in reality consists of a multitude of people, paid with the money government makes by raising taxes and issuing government notes and bonds. It is very important to understand that we have to differentiate between the entity government itself and its representatives and officials. Those individuals are paid with government money, personally they do not have any obligation to the people government borrowed money from. The entity government itself still remains liable for all its debt while its officials don't. Government officials are the people who make the decisions on what to do with the money. The burden is ultimately on all those people who are not enriching themselves as government officials by paying themselves excess money, ultimately it is on the taxpayer whose tax payments serve as a collateral for all government debt.

I will write a separate detailed article about this but my general point of view is: Checks and balances in governments usually fail because bureaucrats have accomplished a governmental structure where government is not removed in case it pursues substantially flawed politics.

Governments, once elected, generally stay in power for a certain term and the way they finance themselves is widely accepted. Governments are controlling most of the economic information published and relentlessly exploit the fact that people mostly do not have enough knowledge about money, inflation, and government finances.

As long as people do not understand that central banks are the root cause of inflation or even become comfortable with the fact that there is inflation and that we have to live with it governments can stay in power and pursue inflationary policies and benefit from it.

There are certain means that enable mainstream economists and politicians to achieve the aforementioned:

• Using a wrong inflation indicator: Mainstream economists and politicians like to use a certain set of product prices (basket) as inflation indicator that usually stays at around 2%-5%. This leads people to believe that there is no significant inflation. They even come up with indicators like the "core inflation" that for some reason omits oil prices. How about we just remove all products from the basket and luckily announce that we have finally achieved a permanent 0% inflation?

• Keeping the inflation within certain limits: In order to avoid a hyperinflation which entails a so called bank run and a complete collapse of the monetary system and hence of governmental power, inflation has to stay just below a certain level. This way people rather accept that they have to live with it. This requires certain times where the central bank slows down the growth of money supply. These are the times where the central bank appears to bravely step up to the plate in order to fulfill its solemn duty of "fighting inflation". This procedure entails a period of declining prices, for example on the stock markets or in real estate, and of an overall decline in the in the growth of the number and value of products produced. Assets or products that were previously overvalued due to the previously exuberant money supply are now beginning to lose value due to the slowdown in money supply. The artificial demand for products and assets declines, people start losing their jobs, especially in the fields that were mostly affected by inflation. A good example is just ahead: we will see this very soon in the real estate industry. Overall production growth slows down. This period is called a "recession".
  

Consequences of Inflation

In the following I will describe the main problems that arise if central banks and governments keep pursuing inflationary policies. These problems would not occur if the central bank actually did what it is supposed to do and if it did not base and justify its existence on forceful laws.

Unfair shift of wealth

Inflation beneficiaries can buy products and assets at low prices. After that fact, prices for those products would go up reflecting the now lower supply. The inflation beneficiaries own products and investments that are now worth more while inflation losers are facing higher prices and a lower life standard because they cannot afford products they were able to afford before.

Misallocation of resources

Because prices for certain products and assets are rising people realize that there is money to be made. These are what I call "inflation adaptors". They start doing work that deals with selling products with rising prices.

An example would be the stock brokers during the inflationary boom prior to the stock market crash in 1929. An excellent current example is the real estate industry. The housing sector, which typically represents just 5% of the total economy, accounted for 50% of the overall growth in the U.S. economy in the first half of 2005. More than half of the private payroll jobs created since the fall of 2001 were in housing-related sectors.

People start working in sectors and providing services that they would not provide if there was no artificially created demand for those products due to exuberant money supply.

Business cycles

Due to the ever instable nature of today's process of money production and supply we have massive ups and downs in the amount and value of products and services provided by individuals and entities. This entails a permanent cycle of boom and recession along with ever changing numbers of unemployment and growth.

People have been conditioned to accept this as a "natural" inevitable phenomenon that is inherent in the nature of the economy. Mainstream economists and politicians tend to blame problems on "the overall economic circumstances" during bad times, again exploiting the fact that most people do not have sufficient knowledge about money, inflation, and government finances. (Other popular scapegoats for these governmental failures are evil speculators on financial markets, mean big corporations that greedily jack up prices to make more money, mean big corporations who fire people because they enjoy doing it, foreigners who dare to have the indecency to not buy our products anymore, terrorists, communists, capitalists etc... whatever is convenient to pick at a particular point in time.)

This point of view implies that "the economy" is an entity, if not a creature of its own that permanently changes its state of mind if not its mood for no particular reason.

If however you trace these problems back in an elaborate and thorough manner you will realize that government, in particular the central bank itself is the very reason for these instabilities.

Frustration

People who do not benefit from or adapt to inflation do not understand why wealth can be a result of a lucky investment and why the dollars they earn with hard work buy them less and less.

The main problem here is that people are not informed about the root cause. So they begin blaming random or seemingly obvious scapegoats that are presented to them by government.

The apparently unfair redistribution of wealth naturally causes frustration and a climate of uncertainty and rivalry which again affects overall economic conditions, people's lives, their relations amongst each other and their well-being.

Vicious inflation cycle

The only times your hear mainstream economists and politicians complain about the central bank are when the growth of money supply is slowed down in order to avoid hyperinflation. The majority of people follow accordingly, not knowing the true circumstances and the reasons why this is happening in the first place.

As Mises puts it:

"As human nature is, everyone is prone to overrate his own worth and deserts."

Hence, people tend to take credit for money they make during inflationary times, instead of realizing the true reason is the policy of the central bank. Then, in times of recession people see that the central bank slows down monetary growth and blame the recession solely on the insufficient supply of money.

This ensues a vicious cycle. Instead of realizing that the reason for the recession is the preceding inflation, people call for more inflation in order to end the recession.

More power to government

Government, as the main inflation beneficiary, has created an environment where there is always demand for its government bonds.

We have seen that it has the ability, at the expense of the private sector, to make more money by persuing inflationary policies and hence stabilize its power of forceful rule over people from the private sector.

I will get into this in detail in a separate article: We should never forget that when governments first started inflation, it was because they had to find a way to finance their bloody and forceful wars. No one would finance those on a voluntary level so goverments found a simple solution: printing money out of thin air, of course at the expense of the inflation losers.

Ultimately, inflation takes freedoms and liberties away from people and fosters a more and more unethical and forceful establishment of government, government agencies, and government contractors.

Money

This site has moved to http://www.economicsjunkie.com/history-of-money/

"With the possible exception of international trade, no topic in economics contains more myths than monetary theory." (http://www.mises.org/story/2057)

I am amazed by the fact that the most important thing that this world and our life seems to evolve around is still the most misunderstood economic topic at the same time.

A thorough discussion about economic issues is impossible though, if you haven't understood the way money functions.

First of all we have to be clear about why money was invented.

The Origins of Money

When society started evolving humans realized very quickly that they can't live in a self sufficient manner.

The crucial need for exchange of products and services and the division of labor arose because humans realized that the best way to improve their standard of living is letting everyone do what they do best and exchange products and services that one party deems less valuable for products and services it deems more valuable.

The reason why division of labor started evolving naturally is the fact that every human has different talents and abilities and that different geographical regions provide different circumstances for production and exploitation of natural resources.

A human being who tries to live in a completely self sufficient manner would be doomed to die from starvation with a very high certainty. Humans need to interact in order to stay alive and improve their status.

At a very early stage humans realized that if party A provides services or products to party B , party B does not always provide services or products that party A has demand for, however party B might be providing services to party C the next day and receive products or services that party A has demand for. Or, vice versa, party A might produce a product that no party in its vicinity has a demand for right away, but at a later point in time.

• Products and services needed to be channeled to their ultimate consumers in the most efficient manner
• In addition, differing time preferences of different parties needed to be bridged

The need for a medium of exchange, money, was born.

People started using products that would ultimately be used for consumption as mediums of exchange. For example, party A would produce a table, give it to party B, but instead of demanding a product that A would consume, A would rather ask for a product that he/she could give to someone else at a later point in time for exchange against a consumer product.

People started using different things as mediums of exchange, such as cattle, tobacco, tea, beans, or coffee. People started using products that made good mediums of exchange as such.

What are the requirements for a good medium of exchange?

• It has to be easily divisible
• It has to be easily measurable in a certain unit
• It has to be relatively scarce, so there is just enough for everyone to use it
  
• It should be relatively durable
• It should be homogeneous (same units should not differ in quality, e.g. two different pieces of it, both 1 ounce should have equal quality)
• It should be as widely accepted as possible

For example most people needed to eat, so cattle was accepted as medium of exchange. However, there were certain limitations as to how cattle could be used as money. For example it was not very divisible. Also different bulls could have different quality. Tea was very divisible, however, there was still the problem that one ounce of tea might be of worse quality than a different ounce of it.

This makes it clear that money is nothing but a product. A product that enables exchange which society has a natural desire for. It is not very different from answering questions, such as:

What makes a good lunch dish? (non-poisonous, healthy, pleasant taste, etc.)
What makes a good vehicle? (an object with wheels, etc...)
What makes a good material to build houses?( firm and solid structure, yet easy to apply inbetween bricks)

Individuals in a free market figure out the answers to those questions pretty quickly.

Over the centuries, in a free market, people tried lots of different products as money. Different commodities with more or less moneyish attributes competed against each other. Finally, over time people found that there was one commodity that fulfilled the requirements for a good medium of exchange best.

• It was easily divisible because it could be easily smelted and made solid again
• It was measurable in units of weight
• It was available just sufficiently not to lose value but could be used by everyone
• It was infinitely durable
• It was more homogeneous than any other potential medium of exchange
• It was widely accepted as an ornament and people enjoyed its beauty

The commodity that I am talking about, the one that prevailed as the best money in a free, unhampered society was gold. In addition to gold there was another metal that was not quite as scarce but also fulfilled all the requirements for a good medium of exchange: silver. Silver was mainly used for smaller transactions.

Again: People in a free, unhampered exchange market, tried lots of different moneys until the BEST moneys, gold and silver, prevailed. The value of products and services in gold units was determined based on the simple and efficient laws of supply and demand.

Gold Warehouses

People, over centuries, have always stored widgets and commodities in warehouses because they did not need them at that particular point in time but later. Also they did not always want to carry heavy things with them

They would receive a paper ticket from that particular warehouse which represented a claim for the item deposited.

The same was the case for gold.

People would deposit their gold in gold warehouses and receive a paper ticket that served as a claim for the amount of gold (in weight units).

Currency units, such as "Dollar", "Mark", "Pound Sterling" used to be nothing but another way of stating a particular amount of gold. The "Dollar" for example, was defined as 1/20 of a gold ounce, the pound sterling as slightly less than 1/4 of a gold ounce, and so on. This meant that the "exchange rates" between the various national currencies were fixed, not because they were arbitrarily controlled by government, but in the same way that one pound of weight is defined as being equal to sixteen ounces.

Because those paper tickets were claims to gold, people started using those instead of gold as a medium of exchange, always knowing that they could exchange them for the precious metal at any time and at a ratio stated on the paper ticket and stipulated contractually.

Gold warehouses started accepting paper tickets from other respected gold warehouses as a service to their customers. They would then approach the original issuers of those tickets and redeem the tickets for gold and by doing so take that burden away from their customers, of course demanding a price for that service.

Soon the gold warehouse owners would notice that they would always have a certain amount of gold available that would not leave their vaults. Hence they would create more paper claims to gold than they actually had gold lend them s to other people as loans and earn interest money on them.

By doing so they were violating their contractual obligation to their clients. They were committing fraud and thereby violating one of the most basic rules of ethics. At the same time they were causing inflation with its negative effects as outlined in "Negative Impacts of Inflation". Of course their clients were not stupid.

As it is in every type of business in the free market, customers will swiftly notice that something is wrong and switch to a better service provider. In the gold warehouse business, customers would notice that the value of the paper tickets was depreciating and quickly redeem them for gold at the ratio stipulated. Those gold warehouses that printed too many paper tickets would pretty soon be bankrupt and go out of business - a just punishment for their unethical and harmful practices.

The free market puts severe limits on malpractice in any type of business, and so it did in the money storage business. There is a history of bankruptcies of gold warehouses, or "deposit banks" as they would soon be called ("Deposit banking" significantly differs from "loan banking", back then the two proffessions were performed by different types of institutions, but that's a different story.) Bankruptcies, that were the well deserved result of malpractice and low quality service.

Soon it would become a major success determinant for banks to be widely trusted and to make sure their paper tickets don't lose value. It was in their own best interest not to perform malpractice. The forces of the free market ensured that banks would have a natural incentive to make sure their customers could redeem their paper tickets for gold.

The period during which this system flourished in the United States was called the classical gold standard. It was the era between 1815 and 1914. During that period, the USA swiftly became one of the most prosperous and advanced countries in the world. Unprecedented growth and technological progress were achieved, such as the application of electricity, the build up of railroads, and the invention and implementation of telecommunication systems.

As Rothbard puts it: "The international gold standard meant that the benefits of having one money medium were extended throughout the world. One of the reasons for the growth and prosperity of the United States has been the fact that we have enjoyed one money throughout the large area of the country. We have had a gold or at least a single dollar standard with the entire country, and did not have to suffer the chaos of each city and county issuing its own money which would then fluctuate with respect to the moneys of all the other cities and counties. The nineteenth century saw the benefits of one money throughout the civilized world. One money facilitated freedom of trade, investment, and travel throughout that trading and monetary area, with the consequent growth of specialization and the international division of labor." (http://www.mises.org/money/4s1.asp)

Government Meddling

Governments pursue the profession of exercising power over people in a forceful and coercive manner. Unlike in other professions and organizations, competition amongst governments leads to bloody and fierce battles. Over history governments have always tried to find convenient ways to finance their wars. Taxes were one option, however back then people were aware of the fact that governments don't spend money responsibly. Any slight increase in taxes would lead to fierce resistance and rebellions that even the police or the military could not withstand easily.

Another option was to obtain loans from industrials and banks. This was a great opportunity for those banks who intended to print more paper tickets than they had gold in their vaults. A fateful collaboration between private banks and governments evolved.

Some banks would print paper tickets out of thin air and supply those as loans to governments. This ensued all the typical effects that inflation has on society. What happened to the blessing forces of the free market? Of course people who were using these banks to store their gold would recognize that their paper tickets were losing value and that they would probably not be able to redeem them for gold ("redeem them in specie"). This would lead to a so called "bank run".

What did the banks do? Usually, in a free, non-coercive market they would not stand a chance, they would go bankrupt and be out of business. However, since they now had the support of a powerful, coercive, and arms-bearing organization, namely government, they sought for help with it. Following the principle "You scratch my back and I'll scratch yours", governments would now permit their banks to refuse specie redemption to their customers. - Probably the most fateful violation of property rights in all of history. Resistances would be crushed violently and people had to accept the fact that they would not be able to redeem in specie. After a precedence was set, governments all over the world would occasionally, and with all their power of arms and police, grant banks that financed their wars the permission to suspend specie redemption.

Banks would always try to pursue inflationary practices if they could. They would be amongst the inflation beneficiaries and could maximize their income that way. As we have seen, the free, non-coercive market system put strict limits on these ambitions. However, as soon as governments started meddling with the money market, banks realized the opportunities that this entailed. Those "private" banks that were working in tandem with the government, were the strongest proponents for the establishment of a central bank. Why?

We have seen that some banks have tried to maximize their profit by printing more paper tickets than they had gold in their vaults. We have also seen that this malpractice was prevented in a free money system. Example: If a customer C were to own accepted paper tickets from bank A, but redeemed them with bank B because it is the only bank within its vicinity, ultimately bank B would approach bank A for specie redemption. Any exuberant issuance of paper tickets by bank A would immediately result in bankruptcy of bank A's business, as soon as bank B would approach them for redemption.

If not the customers themselves redeemed their paper tickets in specie with the original issuer, ultimately bank A would approach bank B to redeem tickets from bank B in specie.

Hence, in order to avoid these market pressures different banks occasionally tried to partner up and form cartels were they agreed to inflate the paper ticket supply but not approach each other for specie redemption. However, cartels or monopolies can't exist for a long time in a free , non-coercive market, no matter how large they are. Free market competition, entrepreneurs , and a dynamic venture capital market would always quickly put and end to their practices. In addition, as the paper ticket supply would ultimately lead to hyperinflation, the customers themselves would approach the original issuers and put them out of business.

The Central Bank

The only way for a monopoly to persist in the long run is by teaming up with an entity that specialized in the unethical profession of exercising force and coercion, namely government. This would enable the monopolists to ultimately use the forceful power of arms and police in order to make people accept the way it operates. In addition, government could always force people to accept a suspension of specie payment if needed.

A government supported central bank would give banks the opportunity to finally enjoy government's benign aegis and protect them from the bothersome forces of the free, unhampered money market.

This is how it would work:

• Government would inaugurate a law that would state that only paper tickets from one bank, the central bank, shall be accepted as claims to gold and as mediums of exchange
• The central bank would store gold and provide paper tickets as claims for gold evenly to all private banks
• Private banks would then inflate their paper ticket supply by providing more paper tickets or even just demand deposits (also called checking accounts) to its customers on top of the gold-backed paper tickets (fractional reserve banking)
  
• People who were not willing to accept the depreciating paper tickets in exchange for products or services were deemed criminals and violently forced by law to accept them
• Whenever an exuberant supply of paper tickets would lead to a bank run, government would grant the central bank permission to suspend specie payment

The establishment of this system would make life a lot easier for inflationary banks and debt-hungry governments. Banks were now virtually protected against free market forces and the threads of bankruptcy and competition; governments had found a convenient way of exploiting productive individuals in a more subtle and harder to unveil manner than taxation.

However, they still weren't satisfied. The biggest problem for them was now the bothersome dependency of paper currency on real money. In order to completely free themselves from any dependency they desired to change the system in a way that allows them to print paper currency without any ties to gold or silver. They desired to be able to print paper out of thin air and completely free themselves from any obligation to redeem in specie. This would finally free them from all remaining checks and balances.

All over the world, sooner or later governments would make their central banks go "off gold". Most of the time this happened with the argument of avoiding monetary "inelasticity". However, it was clear that the ultimate reason was the incentive for government and banks to establish a permanently inflationary system.

This system in essence means that government steps in and forces people to accept a lower quality money instead of a money that has prevailed in the free, unhampered market. Coincidentally, government itself happens the producer of this low quality money.

The exact equivalent of this a market, such as the automotives market, would mean that government produces one brand of cars and does not permit any competition within its borders. This is what the governments of the former Soviet Union experimented with. I think this makes it a little more obvious how devastiating the effects of a 100% government controlled paper money system will ultimately be.

The United States were the last country to go off gold in 1970 under president Nixon subsequent to the collapse of the Bretton Woods system.

This is how we got to the monetary system of today, as described in the article "Negative Impacts of Inflation".

This system can only persist under a strong, forceful and coercive government that constantly violates the most basic ethical guidelines. Over centuries, the centralization and the monopolization of the money market went hand in hand with an ever growing and powerful government.

The government imposed central banking system has reshaped the money market from a decentralized, efficient, and fair system to a centralized, inefficient, and unethical one that allows for major violations of property rights where malpractice is not punished by the natural forces of the free, non-coercive market.

My Basic Guidelines

In order to be certain about anything in life one must have basic guidelines to refer to at anytime.

My objective is to improve my condition. Every other human being has this objective. I am not making any value judgments as to what I consider an improvement of one's condition. Everyone decides this for himself. It would be preposterous to arrogate oneself to proclaim to know what improves another man's condition.

One man might find ultimate bliss by living a life in asceticism, another one by making others happy, another one by seizing every minute of his mundane life and by indulging in the material pleasures that this world has to offer. I don't make value judgments about people's ends, I only want to analyze what means are most fit to attain the objective of ensuring that everyone can improve their condition to the fullest extent, viz attain their ends.

An improvement of condition ultimately requires a removal of a certain uneasiness. The reason why men act is in order to remove uneasiness. He who does not feel uncomfortable about anything would not act at all. He would not move, nor would there be any need to do so, he would live a life completely free from care.

He who goes out to play golf does so because he is bored. He who changes his position when lying in bed does so because he feels uncomfortable lying there in one position all the time. He who saves cash money might do so because he feels unsafe without a certain cash buffer.

My basic guidelines shall ensure the maximum satisfaction of individuals in society, viz continuous and maximized removal of uneasiness.

All human beings act in order to improve their condition which is ultimately achieved by removing uneasiness. In order to improve his condition, man needs to collaborate with other men. A man trying to live in a completely self sufficient manner would immediately die from starvation. Men need each other. Society evolves. Division of labor becomes man's primary means for attaining his ends. This is due to the inequality of men and the uneven distribution of resources all over the planet earth. Every man has different talents, thoughts, conditions to face, interests and desires. It is not my task to find out why that is the case. This is the anthropologists' and the theologists' domain. The same applies to the fact that men want to remove uneasiness and improve their condition. I don't claim to know what the ultimate reason for that is, nor is it my task to deal with that. I see as my only task to make value judgments as to which means are most fit to attain people's ends.

It is due to the inequality of men and the uneven distribution of resources than men need each other in order to improve their condition. Society evolves, not because society is the ultimate end, nor is it a being by itself. Society evolves and thrives precisely because every man wants to improve HIS own condition, it evolves because men are selfish.

The same applies to organizations. An organization is nothing but a certain number of men acting collaboratively in order to attain certain ends. However, these men only join an organization because they consider it the best means to attain their own selfish ends.

Peaceful exchange in society is based upon choices. One man exchanges something that he deems less valuable for something that he deems more valuable. The difference in perceived values is that person's profit. The same is true for the other party. Both individuals have to satisfy each other's demands in order to improve their condition. Both win. This scenario only works within a framework were people are free to make the respective choices and where people can maintain ownership of items that they acquired via peaceful exchange or by acquiring natural resources directly from their source. It is hence most desirable to ensure society can exist within the framework of free choice and private ownership.

For some reason, some economists have blithely asserted that items that are being exchanged in a barter economy have the same value. This is of course nonsense. He who deems one item's value equal to another item's value would not enter into a barter exchange. It would not make any sense. It would be a waste of his time. It is superfluous to delve into this in more detail. The Marxians have made the assertion that values are determined based upon the amount of work put into a product or a service. They have fallen prey to the illusion that value judgments are absolute. He who claims to be the absolute conveyor of true values may go ahead and do so. He may claim to have been enlightened by a divine power or by superhuman reasoning. His assertions and conclusions are useless for economics. Economics deals with human action. Human action is dependent upon individual value judgments.

The only way how one man can gain from another man's loss is by compulsion and coercion, or simply force. Examples would be theft, slavery, or murder.

Compulsion and coercion are acts against a man's individual value judgment. He would not accept the condition that he is forced into, if he was given the choice. He does not consider this an improvement of his condition. Hence, an act of compulsion and coercion, works against an improvement of one's condition and interrupts the continuous and maximized removal of uneasiness.

It is true that there are men who try and pursue coercive activities that are detrimental to the existence and the thriving of a peaceful society. In that sense, these men can be called unfit for society.

It shall hence be most desired for people who are fit for society to keep these men from pursuing such activities. (It is true that they will have to use compulsion and coercion in order to keep them from using the same against non-aggressors.)

My guidelines:

1. No Force: No individual (by individual I mean human being) shall at anytime be forced to do anything (unless it is in order to keep him/her from unrightfully forcing someone else to do something).

2 and 3 are in parentheses because they are merely rules that can be derived from #1, I am making them a basic guideline though because they manifest important economic rules:

(2. No Fraud: No individual shall at anytime present false circumstances in order to make another individual do something that he/she would not do if he was fully aware of the true circumstances (unless it is in order to keep him/her from unrightfully forcing someone else to do something.) This rule can actually be derived from rule # 1 because fraud is nothing else than theft and theft can only be conducted by applying force.

(3. Ownership: Based on rule #1 we can conclude that every individual shall be given ownership of and full decision authority over items that they find and that have not been claimed by other individuals yet. Ownership can only be transferred to someone else if the rightful owner of that item agrees to it. Applying force in order to change ownership would violate rule #1.)

Based on these simple guidelines, I want to derive the best possible way for a society to be structured. What type of society prevents violation of and promotes compliance with the ethics of liberty and at the same time achieves the objective of wide spread wealth and piece for everyone?

As Rothbard puts it:

"The fundamental axiom of libertarian theory is that no one may threaten or commit violence ("aggress") against another man's person or property. Violence may be employed only against the man who commits such violence; that is, only defensively against the aggressive violence of another. In short, no violence may be employed against a non-aggressor. Here is the fundamental rule from which can be deduced the entire corpus of libertarian theory."
(Rothbard, War, Peace, and the State)

About this blog

This blog serves the purpose of educating the masses about the economy in simple terms.

I want to discuss what type of government organization governments all over the world should be pursuing in order to maximize peoples' wealth.

I hope this blog will help people see economic dependencies and circumstances in a brighter light and empower them to make up their own minds rather than having to believe what politicians and mainstream economists try and feed us every day.