Government the Destroyer, Part I

The long-standing battle between Austrian and Keynesian economists is one that will most likely rage on forever. But why? Well, as Lew Rockwell points out, seeing the fundamental differences between these two schools of thought can be fairly easy. Just look for the broken windows.

The claim of the Austrian School that has scandalized members of other schools for 150 years is the following. The propositions of economics are universal. The principles apply in all times and all places, because they derive from the structure of reality and human action.

What brought about economic growth, inflation, or the business cycle in China 300 BC are the same institutions that drive phenomena in the United States in AD 2008. The circumstances of time and place change, but the underlying economic reality is identical.

That claim has made other economists – to say nothing of sociologists, historians, and politicians – scatter like pigeons. The Historical School poured scorn on this idea, and Carl Menger, the founder of the Austrian School, fought them tooth and nail. The Chicago School of positivists found the claim preposterous, and Mises and Hayek and Rothbard battled them. The Keynesians have long been outraged, and the postwar Austrian generation reasserted the truth. The socialists, who posit that rearranging property titles will transform all of reality, say that the claim is absurd, capitalistic nonsense.

But there it stands. No matter where or when, the essential prerequisite for economic growth is capital accumulation in a framework of freedom and sound money. The consequence of price control is shortage and surplus. The effect of money expansion is inflation and the business cycle. The effect of every form of intervention is to make society less prosperous than it would otherwise be.

The list of universals is endless, which is why every age needs good economists to explain and articulate the truth.

Well, I would like to add that there are universal fallacies too.

Frédéric Bastiat pointed to one: the belief that the destruction of wealth fuels its creation. He explains this by means of an allegory that has come to be known as the story of the broken window. Most famously it was retold as the opening of Henry Hazlitt’s Economics in One Lesson, which is probably the bestselling economics book of all time.

A kid throws a rock at a window and breaks it, and everyone standing around regrets the unfortunate state of affairs. But then up walks a man who purports to be wise and all-knowing. He points out that this is not a bad thing after all. The man fixing the window will get money for doing so. This will then be spent on a new suit, and the tailor too will get money. The tailor will spend money on other items and the circle of rising prosperity will expand without end.

What’s wrong with this scenario? As Bastiat put it, “It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented.”

You can see the absurdity of the position of the wise commentator when you take it to absurd extremes. If the broken window really produces wealth, why not break all windows up and down the whole city block? Indeed, why not break doors and walls? Why not tear down all houses so that they can be rebuilt? Why not bomb whole cities so construction firms can get busy rebuilding?

It is not a good thing to destroy wealth. Bastiat puts it this way. “Society loses the value of things which are uselessly destroyed.”

It sounds like an unexceptional claim. But herein rests the core case against everything the government does. Perhaps, then, we can see why the allegory is not better known. If we took it seriously, we would dismantle the whole apparatus of American economic intervention.

If you are with me to this point, perhaps you have a hard time believing that anyone really believes that wealth destruction is actually a good thing. Let me try to show that the fallacy is as pervasive as ever.

After every natural disaster, we at the Mises Institute start what we call the Broken Window Watch.

After Hurricane Katrina, the Labor Secretary said: “What will happen – and I have seen this in previous catastrophes and hurricanes – there is a bright spot in that new jobs do get created.”

And The Economist said, “While big hurricanes like Katrina destroy wealth, they often have a net positive effect on GDP growth, as the temporary downturn immediately after the storm is more than made up for by the burst of economic activity that takes place when the rebuilding begins.”

And the New York Times said: “Economists point out that although Katrina has destroyed a lot of accumulated wealth, it ultimately will probably have a positive effect on growth data over the next few months as resources are channeled into rebuilding.”

After last year’s California fires, we heard this. “In the odd nature of economic accounting, this will probably be a stimulus,” said Alan Gin, a University of San Diego economist. “There will be a huge amount of rebuilding in the next couple of years, financed by insurance payments.”

And CBS MarketWatch said: “Economists have noted the perverse reality that in the wake of disasters, re-construction spending helps the economy, even as people are still struggling to recover from their personal losses.”

Note that personal loss here is deemed rather irrelevant compared with the beneficial macroeconomic results. Here we have a theme we find often in economics, the attempt to drive a wedge between what makes sense for individuals and what is good for society. We see this on display in this recessionary environment, when people are told to spend spend spend, even though most people understand that recessions are times for saving.

Continuing on, we find the Broken Window fallacy popping up even after 9-11.

Timothy Noah of Slate wrote: “We live in a very wealthy nation that responds to horrible disasters by spending large sums of money… It will also provide a meaningful Keynesian stimulus to a national economy that, let’s face it, was tottering on the brink of recession well before Sept. 11. The recession may still come, but the countercyclical spending should help shorten it.”

Another economist declared: “Initially, this could provide a significant boost to an economy that had been slumping. The construction industry could benefit from the rebuilding process. There may also be a boon for slumping tech sales, in replacing lost equipment.”

Thus can we see the continuing relevance not only of Bastiat’s allegory but also of the characters in the story. The posturing wiseguy who says that breaking windows is good for the economy keeps reappearing again and again. So entrenched is this mistake that we might call it official economic doctrine for the whole country.


Lew Rockwell
for The Daily Reckoning
February 14, 2008

Llewellyn H. Rockwell, Jr. is founder and president of the Ludwig von Mises Institute in Auburn, Alabama, editor of, and author of Speaking of Liberty.

First, we turn to romance. We’re talking about money…nowhere is the sky more full of stars and the streets full of more starry-eyed romantics than the wide-open spaces of the financial world. Investors are willing to overlook wrinkles and sags…morning tempers and evening fatigue. And they are willing to believe anything.

What is romance, after all…but the willingness and eagerness to see something more than is really there… or overlook something that really is? We look into our lover’s eyes…and see what we want to see, something grander, sweeter, nicer than others might notice. And why not? No matter where we look, we see what we train our eyes to look for. If we want to see evil and cupidity…we will open our eyes and they will be right in front of us. If we want to see beauty and benevolence, we will see that too. And the most remarkable thing…sometimes, looking is creating. Because we are looking for it…and seeing it – suddenly, it is really there.

But enough riddles…we don’t know what we are talking about. And we don’t have time to figure it out.

So, let’s move on…

Yesterday, the Dow rose another 178 points. This has been a good week, so far, for the feds. The Dow has risen. Buffett has stepped in to rescue the bond insurers. And Bush and Paulson inaugurated their plan to save Americans from the humiliation of getting kicked out of their houses for nonpayment of the mortgage.

The smart money, we are told, is taking big positions in bank debt; their sense is that the banks have been oversold. “It’s not smart to short the United States,” said Buffett. A lot of people – probably most people – believe him. They think that now is a good time to go long on America…and bank debt as a good thing to go long with.

They may be right. We have no opinion on bank debt. But we do have an opinion on the currency in which the bank debt is calibrated – the U.S. dollar. In short, we don’t like it. Yes, it may be going up against the euro. But we still don’t like it. And we don’t care for the euro much either.

The problem with both paper currencies is obvious. When Buffett buys a business, he says he wants a ‘business with a moat around it.’ What he means is that he wants some protection from competition – either a trade secret, a patent, or a brand. Without a moat, the barbarians can attack. They may be able to run you out of business…or simply force you to trim your profit margins. Either way, it’s not a good position for a business to be in.

The problem with the dollar is that it has no protection at all. Worse, the people in charge of it have no interest in protecting it. Each new dollar that comes into existence competes with every old dollar. Inevitably, they all fall in value.

This insight is of no particular concern to people who don’t have dollars. But it comes as a recurring nightmare to those who have a lot of them. And who has dollars?

The monetary system of planet earth, circa 2007, is simple. Arab nations export oil. Europe exports luxuries. Asia exports autos and gadgets. America exports dollars. Yes, dear reader, the buck gets around. It has more stamps in its passport than we do.

The Treasury Department tells us that most of the world’s dollars are now outside the 50 states. Sixty percent of them pass from hand to hand without hearing an English word or getting a chance to go to a baseball game. The same is true for U.S. government debt. There’s three times as much of it in the hands of foreigners – $2.11 trillion – as there is in American mitts.

The trouble, as we’ve pointed out on many occasions, is that there is no moat around this money. It takes a whole chain of supply…machinery…capital…and skilled labor…to produce an automobile. An automaker has a moat – because the costs of entering the business are so high. But it takes almost nothing to make a dollar. And as the greenback sinks in value – thanks to the competition from billions of new dollars all bidding for the same oil, gold, wheat and autos – many of these foreign dollar holders are going to look for other places in which to park their wealth.

*** “Mortgage crisis spreads to those with good credit,” says a front page headline in yesterday’s International Herald Tribune.

It was bound to happen.

“As the world’s largest economy grapples with the worst housing slump in two decades, people with good credit histories are falling behind on house payments, auto loans and credit cards at an accelerating pace,” says the article.

“This collapse in housing value is sucking in all borrowers,” said economist Mark Zandi at Moody’s.

House sales in Southern California are at a 20-year low. And foreclosures are on the rise. This is having the obvious consequence – more houses on the market…sold at distress prices.

In 2007, 17.5% of all the houses sold in Nevada were ones that had been foreclosed. The figure was 15% in Colorado and 11% in California. These foreclosed house sales are pushing prices down further.

As prices go down, more people are tempted to walk away from their mortgages and their homes. Bloomberg provides an estimate: by the end of this year, 15 million U.S. households will be “upside down,” meaning, their houses will be worth less than the value of their mortgage loans. Almost half of the people who took out subprime loans over the last two years have no equity in their houses, says Bloomberg. And of the people who bought two years ago, 39% are already upside down.

Over the last five years, trillions of dollars was “taken out” of U.S. housing values. In 2006, for example, owners took out $318 billion by refinancing their houses, and another $142 billion from home equity lines of credit. We predicted that the day would come when they’d have to put back money into their houses. That day is now here.

Of course, how much they’ll have to ante up…how many will go into foreclosure…and how many will walk away depends on how far houses go down. Estimates are all over the place – maybe 5% more…maybe 15% more…maybe 50% more. The total value of U.S. housing is $20 trillion. A 10% loss takes $2 trillion of implied wealth out of the economy. Ten percent is no big deal to the fellow who owns his home outright…or has substantial equity. But one of the starry eyed delusions of the bubble era was that Americans were really saving much more than the numbers reported. They were buying houses and the houses were going up in value. This was the equivalent of savings, we were told.

Well, not exactly. Those savings are now disappearing…causing huge problems for the heavily leveraged, marginal housing speculator of the ’97-07 period.

*** Medieval Europe was a rough place. The ruling aristocracy didn’t get its position at the top of the heap by virtue of its social graces. It got there by fighting…killing…and conquering. The Grimaldi clan, for example, scrambled into Monaco disguised as monks…then, threw off their robes, slaughtered the people in charge, and took over. A thousand years later, they were able to bring a rich American actress into the family and brighten the place up.

The first of the Merovingian kings of France, such as it was at the time, was Clovis – a barbarian. Clovis won the Battle of Soissons in 486 and the famous Vase of Soissons, a holy vessel from the church, fell into his hands. The Bishop of Reims sent an envoy to try to get it back. Clovis agreed, though he was not yet Christian himself. But the barbarians had their own codes – which included dividing up the spoils of war. So outraged was one of Clovis’s soldiers, at having to give up the vase, that he whacked it with his battle axe and broke it. Clovis was not one to forgive and forget. A year later, reviewing his army, he saw the soldier, grabbed his battle axe, the same one that had crushed the vase, and slew him with it.

Clovis later was baptized. The barbarian chiefs and captains followed his lead. Then, they developed new codes – including chivalry.

“Chivalry might be called the baptism of Feudalism,” says Chesterton. “It was an attempt to bring the justice and even the logic of the Catholic creed into a military system which already existed.”

And from chivalry came the idea of romantic love…and St. Valentine’s Day.

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning