On Minimum Wage

A friend recently sent me this article on minimum wage:

Ending Minimum Wage Likely Wouldn't Dent Jobless Rate


Response:

There are effects of the second order that this article ignores. For example, even if a drop in minimum wage did not increase employment levels (which it would), goods will become cheaper. I experience this first hand in Georgia when I eat out. Even in the city, beers are 1 to 2 dollars less than in California, and meals cost 2 to 4 dollars less on average. The chief culprit? Lower minimum wage.

The real question is: What gives government the right to force owners of factories, restaurants and any other firms to pay workers a wage higher than they would normally agree upon? Nothing but might. The truth is, low wages are important because they allow workers to get experience in in fields with which they unacquainted, they keep prices low, they allow for higher levels of employment, and most of all, because people should be free.

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Economics Without Context: Why Shiller is Wrong about Interest Rates - Revised

Economics Without Context: Why Shiller is Wrong about Interest Rates

     

            In his article, “Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models,” Professor Robert J. Shiller of Yale argues that an increase in asset prices over the last decade has little to do with real, long-term interest rates – interest rates adjusted for inflation – because the public is not aware of the impact and meaning of real interest rates. They are more familiar with nominal interest rates, and therefore, their decisions to invest are much more dependent on nominal rates, not real interest rates.[1]

Shiller first presents a record of real interest rates over the last 60 years and compares them to asset prices during the same time period. On the surface, his findings are compelling: there is little evidence of an inverse correlation between high asset prices and low real interest rates throughout this time period. Specifically, he looks at the early 1980s, a time period where real interest rates rose dramatically both in the U.S. under Chairman of the Federal Reserve Paul Volker, and around the world. At the end of the first quarter of 1980, both the annualized increase in CPI and the Fed Funds rate were over 17%. Seeing no direct link between real rates and asset prices during this time, he critiques the mainstream interpretation of the Volcker-led Federal Reserve:

Focus on Paul Volcker as the stimulus for change in the worldwide policy stance toward inflation may be misplaced. On a worldwide basis, the major turning point toward lower inflation looks more like 1975 than 1981, before Volcker's term as chairman began.

After real interest rates began rising, the world experienced a second round of price inflation that was a consequence of an irrational market.

Shiller also supports his argument by comparing real interest rates with housing and stock dividend values. Real interest rates reached their height in the U.S. in the early 1980s, and they continued in a downtrend until the present. Housing prices, however, did not show a substantial uptrend until the late 1990s and early 2000s. If the assumption that there is an inverse relationship between real interest rates and asset prices is correct, housing values should have begun their upward trek long before the end of the 1990s. He also applies this logic to stock dividends. During the late 1970s and early 1980s, dividends show a similar trend. He notes that “the correspondence with interest rates is not very tight,” and only shows consistent correlation in recent decades. While a consistent correlation of a longer period of time intuitively makes sense, the dissonance between reality and theory is, according to Shiller, due to a lack of public understanding:

Thus, ex post real rates may have shot up very high even though ex ante real rates did not. From this analysis of changing popular thinking about monetary policy, one is left in some doubt about the public's appreciation of the relation between interest rates and inflation, and their understanding of real long-term interest rates.

But does this confusion lead investors to act irrationally is there more to the story?

Shiller leaves out an explanation of the dynamic relationship between money and interest rates. This information is vital in formulating a theory of interest rates – real or nominal – and asset prices. Increases and decreases in the money supply are non-neutral in their effects. That is, when the supply of money changes, not all prices are affected in the same magnitude nor in the same time period. As Ludwig von Mises notes in Money, Method, and Market Processes, this is due to a combination of asymmetrical distribution of newly created money and the varying of individuals’ subjective preferences for specific goods and services [2] As rates change, so do subjective preferences for consumption and investment – not to be confused with a change in time preference – which alters the distribution of money in the economy. An increase in the money supply and a subsequent decrease in both nominal and real interest rates may increase liquidity but have only a minor inflationary effect on asset prices if the drop in interest rates is either shallow or short term. Likewise, an increase in both nominal and real interest rates after an extended period of credit expansion may, in the short and medium run, lead to inflated asset prices as higher interest rates attract previously latent money into the market. By looking for a direct, synchronous correlation between real interest rates and asset prices that ignores such complexities, Shiller misses this phenomenon.

This lens of monetary non-neutrality and subjective value reveal a strong correlation between asset prices and real interest rates. The asset boom of the early 1980s is a textbook example. The loose credit policies of 1975-77 did not heavily affect asset prices until the money from such policies entered different markets when interest rates rose. Shiller’s observation of a “lack of correspondence” between real interest rates and asset prices loses its mystery as one sees that the new money from open market purchases may simply sit in low yielding assets or in bank reserves. It is more likely to be employed when higher interest rates provide new opportunities for profits. Therefore, a market’s immediate reaction to a contractionary monetary policy can be to increase temporarily the supply of investment capital as investors in bonds and securities take advantage of higher interest rates. In other words, interest rates may, in the short term, react to a change in the money supply with greater magnitude than the actual change itself.

A similar event occurred when the Federal Reserve began to tighten monetary policy in 1928 after having engaged in three major rounds of open market purchases in 1922, 1924, and 1927. Benjamin Anderson of Chase National Bank noted that with other investments saturated, 5 years of expansionary monetary policy led to an extended bull market. When the Federal Reserve attempted to reverse policy in 1928, these efforts proved futile. A rise in interest rates was not enough to offset the boom psychology, and in fact, only emboldened it. Stock investors continued to buy on margin and financiers were more than happy to loan their extra funds directly to them for high rates of return.[3] The Dow Jones Industrial average rose from 197 in February 1928 to 269 in November of 1928: a 36% increase in only 6 months! Once again, a scenario of simultaneously increasing interest rates and asset prices can be logically explained through the flow and distribution of currency.

Shiller not only ignores the effect of currency flows on asset prices, but also the effects of moral hazard created by government sponsored enterprises (GSE) and efforts by the Federal Reserve to prop up failing markets. Most important of the GSEs that supported the boom were Fanny Mae and Freddie Mac. In his recent book, Meltdown, economic historian Thomas Woods shows that, although the two GSEs began as minor operations, by “the eve of the federal government takeover in 2008 they had a hand in about half the country’s mortgages, and nearly three-quarters of new mortgages.”[4] Investors and lenders knew that the government gave these GSEs carte blanc and that it would cover any losses sustained from these mortgages.[5] This especially became a problem as financial firms bought mortgages from Freddy and Fannie, employed them in Collateralized Debt Obligations, insured them with underfunded Credit Default Swaps (insurance), and leveraged them to increase profits. Of course activities like this are usually discouraged by fear of loss, but more moral hazard was added to the situation during the late 1990s and early 2000s when, on multiple occasions, the Federal Reserve flooded the market with liquidity – one need only think of its response to the failure of Long Term Capital Management, the Dotcom Bust, and 9/11 in recognizing a pattern of risk-encouraging market rescues by the Federal Reserve.[6] These interventions allowed many firms to avoid bankruptcy and continue the high risk activities that led to systemic risk.

The growth of the money supply and of moral hazard led to the housing boom and massive price inflation in housing between 1999 and 2006. Low interest rates set the stage for this world-wide boom while the growth of GSE activity, risky investment instruments, and Federal Reserve intervention in the markets gave it momentum. Given this context and others discussed, there is a clear correlation between low interest rates – real and nominal – and increased asset prices. Shiller’s overconcentration on the real interest rate and his inability to take into account the asymmetric effects of inflation distorts his analysis of fundamental market processes, thus leading him to invalid conclusions that rely more on belief in animal spirits than sound economic theory.

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[1] Robert J. Shiller, “Low Interest Rates and High Asset Prices: An Interpretation in Terms of Changing Popular Economic Models,” Brookings Papers on Economic Activity 2007, no 2 (2007): 111-132.

[2] Ludwig Von Mises, Money, Method, and Market Processes (Norwell, MA: Kluwer Academic Publishers, 1990), 70.

[3] Employing a metaphor, Economist for Chase National Bank Benjamin Anderson wrote, “When a bathtub in the upper part of the house has been overflowing for five minutes, it is not difficult to turn off the water and mop up. But when the bathtub has been overflowing for several years…a great deal of work is required to get the house dry. Long after the faucet is turned off, water still comes pouring from the walls and from the ceiling. It was so in 1928 and 1929.” Benjamin M. Anderson, Economics and the Public Welfare (Indianapolis, IN: Liberty Press, [1949] 1979), 196-199.

[4] Thomas Woods, Meltdown: A Free Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts will Make Things Worse,” (Washington D.C.: Regnery Publishing, Inc., 2009), 15.

[5] Ibid., 14.

[6] Although not an opponent of the Federal Reserve as an institution, Scott Patterson describes in detail the moral hazard created by its intervention throughout his recent book, The Quants. Scott Patterson, The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, (New York: Crown Business, 2010).

Liquidation, not Consumption, Key to Recovery: A Critique of Martha Olney on the Role of Credit Default in the Great Depression

In her article, “Avoiding Default: The Role of Credit in the Consumption Collapse of 1930,” Martha Olney claims that high consumer indebtedness in the early years of the Great Depression curtailed consumer spending and amplified the economic hardship. At the same time, major providers of consumer credit faced minimal losses. This was largely due to the structure of debt installments. She explains that this was the result of heavily punitive financial laws and organization:

The 1930 drop in consumption resulted from the unique combination of historically high consumer indebtedness and punitive default consequences. Down payments were large, and contract terms short, so equity was acquired quickly. If an installment payment was just 30 days late, the good being purchased could be and often was repossessed. The defaulting household was not compensated for the "surplus," the difference between the net resale value of the good and the remaining payments.[1]

She closes the articles by arguing that “the vast majority of auto and other installment contracts were completed as scheduled because default would have triggered wealth-reducing repossession. In order to avoid default, indebted families reduced consumption in nearly all spending categories.” According to Olney, this reduction in consumption turned “a minor recession into the Great Depression.”

            Olney draws from several others on the subject: Christina Romer, Paul Flacco and Randall Parker. They argue that the market crash at the end of the 1929 increased income uncertainty. While Flacco and Parker establish this with regression analysis, Olney supports her thesis by providing raw data. In March of 1930, “only 7 firms increased wages, but 117 firms cut the wages of over 20,000 employees. Then in July 1930 no firms reported raising wages, but 133 firms reported cutting wages of nearly 25,000 people, 86 percent of the workers in those firms. The depression had begun in earnest.” With the increased possibility of wage decreases and layoffs, most American households decreased consumption. In fact, despite the economic downturn at the end of the decade, delinquency rates on auto loans only increased by from 4.1% in 1928 to 5.4% in 1930. Olney connects this lack of default with an increase in the severity of the Great Depression.

            The expectations of consumers during the 1920s changed faster than that of the law. Before the 1920s, consumer debt was viewed as a social anathema, but by the end of the decade dependence on consumer credit became the status quo. Though the habits of consumers changed, the law regarding repayment of credit did not. The law favored lenders over their debtors. When the workers feared loss of work, and therefore a loss of income, “decreasing consumption and setting aside funds with which to make future installment payments was the only…option.” This fear inhibited the individual’s willingness to consume.

Between 1929 and 1930, total consumption decreased by 6.2%. Olney compares this to the recession in 1938 where consumption only fell by 2.2%. The difference, Olney claims, is due debt levels. All lagged data of debt between 1919 and 1941 shows a strong correlation for its effect on consumption. The magnitude of the effect of debt on consumption correlates with the level of debt one must repay. The volume of debt repaid in 1930 was much higher than in 1938 due to an unwillingness of consumers to default at the beginning of the decade. A change in the laws and subsequent reduction in burden of default on consumers explains this discrepancy. Furthermore, Olney shows that an expected 10% decrease in income demands a proportionally larger reduction in consumption if the reduction is expected within one month. Thus, the Crash of 1929, coupled with strict laws regarding consumer debt, slowed the economy – an economy largely dependent on high levels of consumption – to a crawl.

The moral of the story, Olney asserts, is that laws that make default expensive for the consumer only worsen economic downturns:

The strategies households pursue to avoid expensive default can harm those whose livelihoods depend upon the consumer goods industries. Policy makers who want to avoid another consumption collapse similar to that of 1930 should focus their attention on the consequences of default. Avoiding default can do more harm than good.

Olney’s stance is clear: An economy centered on consumption cannot prosper if consumption levels drop dramatically. Therefore, government legislation must make default less burdensome so that consumption can continue. But is Olney’s solution an economic panacea or simply band-aid?

            Olney presents a solid case. Clearly a drop in consumption precipitated a shrinking economy and an increase in unemployment. Her underlying, but unstated, assumption is that economic health can be defined by indicators such as unemployment, consumption levels, and GDP. While these can indicate economic health, the information they provide is not differentiated. They only identify values in terms of aggregates.

The crisis of 1929 was a crisis of pricing. Federal Reserve open market purchases encouraged resource misallocation, moving wealth away from rural producers to urban financiers, producers, and consumers.[2] That is, when the Federal Reserve increases liquidity, currency is not uniformly distributed throughout the economy. It clusters into certain sectors: First to the investors who sell their assets to the Federal Reserve, then to banks, businesses, and consumers.[3] This creates a bubble in nascent industries whose existence and growth is largely, though not always wholly, dependent on credit expansion. The indicators aforementioned – unemployment, consumption, and GDP – did not, and still do not, account directly for these problems. The Roaring Twenties experienced unprecedented growth in GDP and low unemployment levels. Though this led many analysts and economists, including Irving Fischer, to predict no end to the prosperity and no crisis in value, their analysis was flawed in that they did not consider the economic distortions created by expansionary monetary policy.[4]

            Olney makes a similar mistake. Her analysis is correct in that the unfair terms on the repayment hurt producers of consumer goods and the economy in general. It encouraged higher levels of unemployment than might have occurred otherwise. She errs, however, in her claim that default laws ought to be less harsh for consumers so that they can continue consuming and support producers of consumer goods. Even without harsh terms for default, consumption levels still would have dropped, unemployment rates still would have increased, and credit still would have tightened. These are the short term effects of economic readjustment after a boom induced by credit expansion. In the early 1930s, economic depression, both in the United States and across the globe, were side effects of economic and monetary distortions created by money creation and borrowing during World War I and interventionist central banking policies that attempted to avert these distortions’ negative effects by creating inflation.[5]

A drop in consumption was the inevitable consequence of years of overconsumption and resource misallocation, in addition to unresolved debt insolvency from World War I.  Concerning consumer debt in 1930, the problem was not so much that consumers were unable to continue consuming at the same rate as they chose not to default, but that capital was locked up and assets remained overvalued. The law did not permit goods bought on installment to be sold to repay the loan, even if they had equity. This weakened the financial position of individuals as they were unable to increase savings. It also prohibited the liquidation which is pivotal to asset reappraisal and to helping volatile markets find a bottom. If markets had been allowed to bottom, investment would have more than likely resumed as resources would have been more accurately valued and the Great Depression would not have been so great. Again, Olney is correct in almost all of her assertions. She only needs to reevaluate her fundamental assumptions and consider the effects of central banking and government policies and the fundamental causes of volatility after World War I.

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[1] Martha L. Olney, “Avoiding Default: The Role of Credit in the Consumption Collapse of 1930,” The Quarterly Journal of Economics 114, no 1 (February, 1999): 320.

[2] Jim Caton, “Urban Prosperity, Rural Chaos: Federal Reserve Policy During the Roaring Twenties,” http://theknowledgeproblem.blogspot.com/2010/12/urban-prosperity-rural-chaos-federal.html

[3] “The primary beneficiaries of inflation are commercial banks, financial centers, and large corporations requiring long-term financing… New projects involving heavy machinery, construction, and research benefit tremendously from new financing.” (Skousen draws his claim from Mises and Wicksell.) Mark Skousen, Economics on Trial: Lies Myths and Realities, (Homewood, IL: R.R. Donnelley & Sons Company, 1991), 91-92; Ludwig von Mises, Theory of Money and Credit, (Auburn, AL: Ludwig von Mises Institute, [1913] 2009), 349.

[4] See The Austrian Business Cycle Theory. Roger W. Garrison, “The Austrian Theory of the Business Cycle,” (Auburn University), http://www.auburn.edu/~garriro/a1abc.htm

[5] During the 1920s, central banking policies in the U.S. and Britain aimed to stabilize the British Pound and weaken the U.S. Dollar. Governor Benjamin Strong of the Federal Reserve Bank of New York stated this goal clearly in a letter to Mellon in 1924: “The burden of the readjustment must fall more largely upon us than upon them [Great Britain]. It will be difficult politically and socially for the British Government and the Bank of England to face a price liquidation…” Jim Caton, “Courting Disaster: How Inflationary Central Banking Policies Made the Great Depression Unavoidable,” http://theknowledgeproblem.blogspot.com/2010/12/courting-disaster-how-inflationary.html; See also Silvano A. Wueschner, Charting Twentieth-Century Monetary Policy: Herbert Hoover and Benjamin Strong, 1917-1927, (Westport, CT: Greenwood Press, 1999); Murray N. Rothbard, America’s Great Depression, (Auburn, AL: Ludwig von Mises Institute, [1963] 2008); Murray N. Rothbard, A History of Money and Banking (Auburn, AL: Ludwig von Mises Institute, [2002] 2005); Benjamin Anderson, Economics and the Public Welfare (Indianapolis, IN: Liberty Press, [1949] 1979)

The Federal Reserve and Wealth Reallocation During the Roaring Twenties

The Federal Reserve, QE2, and Dollar Instability

           In early November the Federal Reserve initiated a new round of government securities purchases. It committed to buying $600 billion dollars by mid-2011 in an attempt to bolster the U.S. economy.[1] Federal Reserve Chairman Bernanke hopes that an increase in liquidity will encourage consumers to resume borrowing and thus reinvigorate the economy. In addition to an expansion of consumer credit, Bernanke also hopes to maintain bank solvency by keeping the federal funds over-night rate as low as possible. Commentators note that this action looks similar to the Federal Reserve’s 2008 policy. At the end of 2008 the Federal Reserve launched a massive program in which it purchased $1.7 trillion in securities with intent to stabilize the economy during the instability that occurred between November 2008 and March 2009.

Like many main stream economists, Ben Bernanke follows the line of reasoning presented by Milton Friedman and Anna Jacobson Schwartz in A Monetary History of the United States, 1867-1960 which claims that the Great Depression was result of tightening of credit in 1928-29 and a decrease in the stock of money in the years that followed. Speaking at Milton Friedman’s ninetieth birthday he stated, “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you we won’t do it again.”[2] What Bernanke meant was that as Federal Reserve Chairman, he will maintain a policy of “low and stable inflation.” In other words, he will not allow price deflation to occur. No matter how low interest rates are, if prices intimate any sort of decrease, Bernanke will keep the federal funds rate depressed and continue to increase open market purchases by the Federal Reserve. However, Ben Bernanke is not unopposed.

Several financial experts have criticized Bernanke’s latest round of securities purchases. Former Federal Reserve Chairman Paul Volcker spoke out on November 5^th. He claimed, “It’s hard to have a big impact on the short-term interest rate that is already zero…”[3] In fact, if price inflation becomes a problem, Bernanke’s policy might bring about in real interest rate that is negative.[4] Germany’s finance minister, Wofgang Schauble, voiced similar concerns as Volcker. “It is not consistent,” he argued, “when the Americans accuse the Chinese of exchange rate manipulation and then steer the dollar exchange rate artificially lower.”[5] More dollars in circulation will more than likely result in a devalued dollar and bring further instability to global markets.

Bernanke has responded to critics of his easy money policy. At a conference on Jekyll Island, he attempted to ease concerns and said that his program will not bring about “super ordinary” inflation levels.[6] Investors do not share his confidence. Bernanke’s outspoken attitude concerning easy money has weakened the dollar over the last month as investors anticipate more securities purchases by the Federal Reserve.  Many worry that further bond buying could do more harm than good by providing tinder for inflation that will ignite when the recovery finally gains traction. As rising interest rates encourage savings and attract increased investment, the markets may risk another boom much the same way that the stock market boomed in 1928 as interest rates rose. The economic imbalances brought about by Federal Reserve intervention will likely be worse than most anticipate and may even foment a crack-up boom in commodities.[7]

One must consider the role of the interest rate in a free market economy in order to understand the effect of money creation from the central bank. The interest rate is the price of money that allows the supply of savings to equal demand for loans. When supply is increased due to Federal Reserve purchases on the open market, interest rates fall and individuals feel a false sense of abundance. The consequences are myriad. The most immediate problem is that individuals are encouraged to decrease savings and increase consumption. They continue to consume lower order goods, but also increase consumption of goods from lengthened production structures.[8] The tendency is for consumers to begin to rely on credit rather than savings.[9] Over a long enough period of time, savings are liquidated. Meanwhile, industry grows accustomed to the new levels of consumption which were dependent, not on real savings, but on an artificially high level of available credit. Loose credit is no replacement for savings. As the spigot of credit dries due to default and reserve requirements, the economy enters a recession and investments in the higher order goods must be liquidated before recovery can start. [10] The Federal Reserve can respond by expanding liquidity, but it only delays the inevitable correction and increases economic distortions.

Of course central banks are not beholden to reserve requirements in the modern era, so the only limitation to increased liquidity is the bank’s willingness to devalue its currency relative to other currencies. A currency’s value, however, is not only dependent on its supply. If there is a loss of faith in a currency, demand for it will fall, decreasing its value further. The Bretton Woods Conference in 1945 made the U.S. dollar the world reserve currency and, consequently, increased demand for dollars. To this day the dollar has dominated the exchange markets and investors have had little reason to drastically reduce exposure to the currency, but as the dollar devalues a decrease in demand will become more likely.

After the crisis in 2008, the dollars role has received numerous challenges from bankers, economists, and governments. The BRIC countries (Brazil, Russia, India, and China), for example, have made agreements amongst themselves to forego trade in dollars. If the Federal Reserve continues to expand the money supply, other countries may minimize their employment of the dollar or even stop using it entirely. A decrease in demand of large magnitude will likely initiate a period of extensive devaluation. As international demand for dollars plummets, many of the dollars abroad will begin to flow back to U.S. that will shrink further its domestic purchasing power.

Bernanke’s latest decision may make this doomsday scenario a reality. Like the British pound after 1931, the dollar risks a major loss in purchasing power relative to other currencies. Currently the U.S. Dollar Index is on a downward trajectory toward its all-time lows reached in early 2008. If this is the state of the dollar while much of the stimulus lays relatively latent in the vaults of the Federal Reserve – collecting only 1-2% interest – the results will be disastrous as decreased investor confidence drives the interest rate higher. Then the Federal Reserve will lose control over the flow of dollars as investors flock to commodities and high yielding investments in order to shield themselves from dollar devaluation.

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[1] “Fed to spend $600 Billion More to Help Boost US Economy,” Reuters 03November 2010,  http://www.cnbc.com/id/3990450

[2] Ben Bernanke, “Remarks,” in Milton Friedman and Anna Jacobson, The Great Contraction: 1929-1933 (Princeton, NJ: Princeton University Press, [1963] 2008), 247.

[3] “Volcker: Future Inflation Risk Limits Easing Effect,” Reuters 05 November 2010, http://www.cnbc.com/id/40023233

[4] While many economists point to this as a positive occurrence, a negative interest rate may cause many investors to lose faith in the dollar. As long as the Federal Reserve is so heavily distorting the value of the dollar, it is preventing price from reflecting true scarcity and value at a given time. An inflationary Federal Reserve Policy may thus discourage nations from employing dollars in exchanges, as is evidenced by recent agreements between BRIC countries. Robert F. Mulligan, “A Hayekian Analysis of the Term Structure of Production,” The Quarterly Journal of Austrian Economics 5, no 2 (Summer 2002): 19. (Accessed December 5, 2010) http://mises.org/journals/qjae/pdf/qjae5_2_2.pdf

[5] “World Bank Chief Sparks Gold Standard Debate,” Financial Times 08November 2010, http://www.cnbc.com/id/40064723

[6] “Bernanke Defends new Fed Plan to Boos Economy,” Associated Press 06 Nov 2010, http://www.cnbc.com/id/40043717

[7] “The expectation of a general progressive upward movement of all prices does not bring about intensified production and improvement in well-being. It results in the "flight to real values," in the crack-up boom and the complete breakdown of the monetary system.” Ludwig von Mises, Human Action: A Treatise on Economics (Auburn, AL: Ludwig von Mises Institute,  1998), 466-467.

[8] The description of goods as lower or higher refer to the length of their production processes.  The higher the order of the good, the greater the amount of resources consumed when production is finished. See the Hayekian Triangle. http://wiki.mises.org/wiki/Hayekian_triangle; Mulligan explains that the lower the slope of the hypotenuse, the lower the interest rate and the longer and more round about the process of production. Robert F. Mulligan, “A Hayekian Analysis of the Term Structure of Production,” 17-33.

  

[9]Ludwig von Mises, Theory of Money and Credit (Auburn, AL: Ludwig von Mises Institute, [1952] 1998), 361.

[10] Murray Rothbard, America’s Great Depression, (Auburn, AL: Ludwig von Mises Institute, [1963] 2008), 14.

Thomas Paine v. Edmund Burke: A Look at Their Metaphysical Beliefs and the Nature of Their Arguments

From its inception, the French Revolution was built upon conflicting ideals. France was to have an egalitarian society, but also individual property rights. Men could act in their self-interest, but not if that interest did not support the “common benefit.” Individual liberty, though it received praise by many revolutionaries, was not seen as good in itself. Rather, it was dependent upon the common good, a concept which is highly subjective and in all practicality, indefinable. The confusing language demonstrated and reinforced a dichotomy that pit the individual against society. Driven by these conflicting ideologies, participants and observers attempted to shape the political environment in France.

This conflict was well represented by one participant, and one observer: Thomas Paine and Edmund Burke, respectively. Burke, who had conservative leanings, wanted to see change that occurred slowly over time and that respected tradition. Most important, he did not want to see the state usurp the power of the individual. Thomas Paine, on the other hand, believed that monarchy was unnatural and evil, and therefore the people had the right to overthrow such an institution at any given time. Paine saw the new state as an agency which represented the people, and he unconsciously ignored the injustice of some of its actions. As the French Revolution intensified and the Oath of the Tennis Court gave way to the execution of Louis XVI and the Reign of Terror, Burke’s arguments proved more consistent, and even Paine’s love for the revolution grew cold.          

The political upheaval in France during 1789 grew from public dissatisfaction that had grown throughout the century. Falling grain prices in the two decades preceding the revolution brought hardship to farmers and two years of bad harvest in 1787 and 1788 spread hardship to wage earners.[1] As discontent brewed among the ranks of the lower class, the upper and part of the middle class were economically well off. The nobility and the clergy successfully avoided many taxes and often held seigniorial rights. Many from the upper bourgeoisie held government positions or prospered from investments.[2] Those left out of the relative prosperity included many members of the lower bourgeoisie such as merchants and guildsmen. It was the strength of the middle and upper classes in light of a bankrupt monarchy and discontent among the masses that sparked the Revolution.

Burke noted that the French Revolution grew out of a crisis in government and tradition, and was radical compared to Britain’s Glorious Revolution. Though there was a “small and a temporary deviation from the strict order of a regular hereditary succession,” the deposition of Britain’s King James II by William of Orange “was an act of necessity” and was only a slight variance from tradition. [3] It was the exception, not the rule. The practice of hereditary succession immediately resumed and brought stability.

Political discontent in 1789 France did not find resolution through such minor alterations of the existing system. The unbending attitude of a weak Louis XVI made this impossible. The years preceding the revolution witnessed a massive expansion of government debt due to expenditures which far outpaced revenues.[4] In 1787 the Assembly of Notables refused to aid the king by increasing taxes, and the situation worsened. “The financial crisis of the state was in full swing” within a year and French Finance Minister resigned.[5] The door was opened for the calling of the Estates General and a shift in the balance of power.

The dysfunction of the Estates General quickly led the Third Estate to assert its legitimacy and create the National Assembly. The National Assembly consequently inherited the financial problem and sought a remedy. It took unprecedented action by nationalizing church lands and created a currency, the assignat, which derived its value from those lands. Thus, soon after its inception the National Assembly pragmatically disregarded property rights, and in so doing, laid an unstable foundation on which to build a government that respects individual liberty. It is at this point that the arguments of Edmund Burke and Thomas Paine find their form.

            Burke and Paine both held arguments which depend on aprioristic assumptions. Paine’s fell into the camp of Rousseau who held that “Man is born free, but everywhere he is in chains.”[6] Likewise, the Declaration of the Rights of Man and of Citizens declares in its first article that “Men are born and always continue to be free, and equal in respect of their rights. Civil distinctions, therefore, can be founded only on public utility.”[7] In his support for this, Paine makes a metaphysical which assumes that any lack of freedom, outside of that which supports the common good (“public utility”), is incompatible with human nature. This led Paine to see the world in dualistic terms of freedom and slavery, natural and aberrant. His arguments thus inevitably exhibit a flavor of extremism which purports any form of monarchy to be evil, while democracies, like the one formed in revolutionary France, are inherently good. In a monarchy the king “consigned the people, like beasts of the field, to whatever successor they appointed,” and according to Paine’s metaphysical belief structure the legitimacy of kingship “is now so exploded as scarcely to be remembered, and so monstrous as hardly to be believed.”[8] Paine’s belief in an abstract free man as apriori allowed him to deride as illegitimate those social institutions that opposed his ideals. This abstraction, not dependent on time, place, or circumstance, stands in stark contrast to Edmund Burke’s concept of human nature and freedom.

            Burke, unlike Paine, did not believe in an abstract man who lacked context. Burke viewed man, not as having an inherent nature, but “as naturally involved with [social] links, and…as those links dissolve, man's identity does too.”[9] Burke correctly sensed the seeds of nihilism which lay in the philosophical soil of the revolution. If man is not confined and influenced by the past, he is defined by nothing. He is then rootless and the society comprised of individuals like him risks social instability. Burke claims instead that freedom is discovered over time and requires context:

Indeed in the gross and complicated mass of human passions and concerns… therefore no simple disposition or direction of power can be suitable either to man’s nature, or to the quality of his affairs…The rights of men are in a sort of middle, incapable of definition, but not impossible to be discerned.[10]

Essentially, Burke takes a subjective view of human nature and opposes any assumptions of an objective, natural man that lack a social environment. This difference in metaphysical worldviews inevitably led to disagreements between Burke and Paine over the legitimacy of monarchy, the role of government, and the nature of individual property rights.

Burke disdained the French Revolution for its disregard for tradition and for its inherent political instability. To move as quickly away from a monarchical state as the French did was to irreparably damage the foundation of society. On stability in government he wrote:

The science of government being therefore so practical in itself, and intended for such practical purposes, a matter which requires experience, and even more experience than any person can gain in his whole life, however sagacious and observing he may be, it is with infinite caution that any man ought to venture upon pulling down an edifice which has answered in any tolerable degree for ages the common purpose of society.[11]

Whether one judged monarchy as good or evil, it maintained order. If society is not defined by its structures and traditions, if it abandons its history, it loses its coherent form. Burke saw the disregard for Louis XVI among many revolutionaries as a disaster. French society was largely defined by “a majestic monarchy,” but after the revolution is was better defined by political chaos.[12] In confronting revolutionaries who looked to England for support, he wrote:

I hear it is sometimes given out in France that what is doing among you is after the example of England. I beg leave to affirm, that scarcely anything done with you has originated from the practice or the prevalent opinions of this people, either in act or in spirit of the preceding.[13]

The Glorious Revolution respected tradition and the past, the French Revolution did not. The Glorious Revolution only slightly weakened the role of the king. The French Revolution destroyed the power of the throne.

Paine and those like him, due to their conceptions of natural rights, failed to see this as a hazard. In fact, it was to them a blessing of the revolution. It was a sign of progress. Paine claimed that monarchy required “a belief from man, to which reason cannot subscribe, and which can only be established upon his ignorance.” He compared this to a republic which “requires no belief from man beyond what his reason can give.”[14] Paine did not believe in continuity. He did not believe in incremental progress. He instead demanded that society shift from its historical foundation toward a radical liberalism. He continued, “A mixed Government is an imperfect everything, cementing and soldering the discordant parts together by corruption.”[15] Paine was an ideological purist. Only an enlightened democracy, he believed, could properly govern a nation.

Burke’s push for gradual reform to better society naturally struck discord with Paine’s chimerical ideal of immediate social perfection. Paine decried Burke as “contending for the authority of the dead over the rights and freedoms of the living.” [16] According to Burke, this was inevitable, and should only be refined, not obliterated. For Burke the revolution was destructive and “was at its roots characterized by a hatred of the very idea of society.”[17] Revolutionaries wanted to destroy and rebuild the government. In the process government took on a new role.

Revolutionaries radically redefined and empowered government. The basis of the new government can be inferred from several articles in the Declaration of the Rights of Man:

1.      Men are born and remain free and equal in rights; social distinctions can be established only for the common benefit.

2.      The aim of every political association is the conservation of the natural and imprescriptible rights of man; these rights are liberty, property, security, and resistance to oppression.

17.  Property being an inviolable and sacred right, no one may be deprived of it unless public necessity, legally determined, clearly requires such action, and then only on condition of a just and prior indemnity.[18]

Government took on a new mandate. It was formed in order to serve the “common benefit.” While a seemingly valid ideal, there was no historical precedent which suggested that a strong, centralized government could help enact the “common benefit.” Furthermore, the government could violate the rights of its subjects if its actions supported the “common benefit.” Many in the National Assembly saw themselves as acting for this cause, but their knowledge of how to enact this good was imperfect and their motives were sometimes questionable.

            Burke immediately sensed the danger of the situation. Government in itself is antithetical to egalitarianism. It is the only agency with a monopoly on the legal use of force. Therefore government officials can, in the name of the people, strip away the civil liberties of specific portions of the population. Backed by force, they can redistribute wealth. “Those whose operations can take from, or add ten per cent to, the possession of every man in France,” wrote Burke, “must be the masters of every man in France.”[19] With power conveniently consolidated, individuals empowered themselves through government and the “common benefit” was often obscured by self-interest. Burke elaborated,

France will be wholly governed by the agitators in corporations, by societies in the towns formed of directors of assignats…and adventurers, composing an ignoble oligarchy founded on the destruction of the crown, the church, the nobility, and the people. Here end all the deceitful dreams and visions of the equality and rights of men.[20]

The power vacuum created from the disempowerment of the monarchy was inevitably filled, and, as Robespierre exemplified in his Reign of Terror, the men who took on new positions of power could be far less scrupulous than King Louis XVI.

            Still, Paine responded with indignation. In the dualistic fashion of a man raised as a Quaker from childhood, Paine proposes that with the French Revolution:

Monarchical sovereignty, the enemy of mankind, and the source of misery, is abolished; and sovereignty itself is restored to this natural and original place, the nation. Were this the case throughout Europe, the cause of wars would be taken away.[21]

Paine implicitly asserts that republican representatives naturally support the interests of “mankind.” Republican government then took on an aura of holiness while all monarchies, in Paine’s eyes, were forces of evil. Paine’s tendency to reduce governments to these terms disallowed him to judge them according to their merit. Paine projected the success of the American Revolution onto the French Revolution. He consistently refers to both as near equivalents. “From the Revolutions of America and France,” he asserts, “are a renovation of the natural order of things…”[22] Political revolution was the road each nation needed to travel in order to help man reach a more natural state. In the process, the French government’s power was centralized and its control over the population increased. The state grew “infinitely stronger than the monarchy of Louis XIV…[and] it absorbed society in the name of the people. Consequently its ability to force change upon its subjects also increased.[23]

Since government action ultimately translates to the use of force, one should not be surprised that one of the earliest actions of the activist revolutionary government was to confiscate church lands and use them as collateral for its new currency: the assignat. That is, the government, led by the National Assembly, violated the rights of the Catholic Clergy, one of France’s largest property holders.[24] In its first year, the revolutionary government exhibited utter disregard for Article 17 from its Declaration of the Rights of Man. Burke was appalled while Paine applauded. “The property of France does not govern it,” remarked Burke. “Of course property is destroyed, and rational liberty has no existence. All you have got for the present is a paper circulation, and a stock-jobbing constitution…All this policy in the end will appear as feeble as it is now violent.”[25] The stability and prosperity that had existed in France before the revolution was at least in part dependent on property rights. The revolutionary government’s decision to disregard the property rights of the clergy literally shook the foundation of French society and threatened its collapse.[26] From this disorder, Burke saw that embodied in the revolution was the “hatred of the very idea of society.”[27]

Unlike Burke, Paine’s response to this confiscation was enthusiastic. He despised the Catholic Church and defended land confiscation by denouncing the tithe-system. He reasoned that rent should be fixed, however the tithe took a proportion of the tenant’s income. Paine claimed that “the French constitution has abolished tythes,” and since the “land was held on tythe” confiscation was justified.[28] To discharge its debts the National Assembly “ordered it [property of the Church] to be sold for the good of the nation, and the priesthood to be decently provided for.”[29] Paine’s logic here falters. If it is legitimate, the law must apply equally to all subjects. If liberties can be stripped from a few law abiding subjects, it can be stripped from all. Paine’s love for the revolution blinded him to this problem.

Additionally, Paine is ambiguously silent on the danger of assignat inflation. This is especially curious considering a polemical he wrote during the 1780s concerning colonial paper currencies: “Paper Money, Paper Money, and Paper Money! is now…both the bubble and the iniquity of the day…A tender law…operates to take away a man’s share of civil and natural freedom…”[30] Paine’s rhetoric against paper currencies in the United States was also applicable to the assignat. William Playfair, a contemporary observer, wrote of the terrible consequences in France which were similar to those spoken of by Paine:

Gold and silver, by degrees, became dear and scarce; small assignats became necessary, and were created; so that before the end of the year 1791, a traveller might go from one end of France to the other, and see neither gold, silver, copper, nor any currency but the assignats which were at 28 percent loss.[31]

The proliferation and devaluation of the assignats was too dramatic to ignore, and the French Government’s disregard for property rights was too radical for a supporter of liberty to justify. Property rights are a prerequisite to liberty.[32] If property rights are inconsistently upheld by a government, so too will civil liberties be inconsistently upheld. The French government’s disrespect for property rights thus represented an utter disregard for individual liberty. Paine’s loathing for monarchy and nobility allowed him to support a government whose actions were incongruous with ideals of freedom.

            Paine did eventually come to judge the actions of the revolution as radical. In a letter to Danton written in May 1793, he expressed dismay at the enforcement of price controls:

I see also another embarrassing circumstance arising in Paris of which we have had a full experience in America. I mean of fixing the price provisions… The People of Paris may say they will not give more than a certain price for provisions, but as they cannot compel the country people to bring provisions to market the consequence will be directly contrary to their expectations, and they will find dearness and famine instead of plenty and cheapness.[33]

The social chaos which resulted in part from assignat inflation could not be solved by price controls. Here Paine’s attitude stands in stark contrast to his exchanges with Burke. Paine also voiced concern as the Reign of Terror transformed the revolutionary government into a dictatorship:

There ought to be some regulation with respect to the spirit of denunciation that now prevails. If every individual is to indulge his private malignancy, or his private ambition, to denounce at random and without any kind of proof, all confidence will be undermined and all authority be destroyed.[34]

A government is only as good as the people who run it. France had been run by the king and then by ideologues, but, according to Francois Furet, during the course of the revolution “’pure’ democracy” restored “without knowing it…the image of the old monarchical power.”[35] The revolution had left French government with a power vacuum, and the Robespierre almost inevitably was drawn to fill it. Only a few years after the revolution began, the chaos that Burke predicted became a reality, and Paine was unable to deny this. Paine’s poorly founded aprioristic assumption of monarchy as evil was no match for Burke’s holistic understanding of society as unfathomably complex.

Bilbiography

Altorfer, Stefan. History of Financial Disaster. London: Pickering & Chatto, 2006.

Breunig, Charles. The Age of Revolution and Reaction, 1789-1850. New York: Norton, 1977.

Burke, Edmund. Reflections on the Revolution in France. New York: Oxford University Press, [1790] 1993.

Hart, Jeffrey. “Burke and Radical Freedom.” Review of Politics 29, no 2 (April 1967): 221-238.

Kates, Gary. The French Revolution: Recent Debates and New Controversies. New York: Routledge, 1998.

Levausseur, E. “The Assignat: A Study in the Finances of the French Revolution.” The Journal of Political Economy 2, no 2 (March 1894): 179-202.

Mises, Ludwig von. Liberalism: In the Classical Tradition. New York: Foundation for Economic Education, 1985.

Paine, Thomas. Rights of Man in Thomas Paine: Collected Writings. Ed. Eric Foner. New York: Library of America, 1995.

Popkin, Jeremy D. A Short History of the French Revolution. Upper Saddle River, NJ: Pearson Prentice Hall, [1995] 2006.

Rothbard,Murray. For a New Liberty: A Libertarian Manifesto. Auburn, AL: Ludwig von Mises Insititute, [1973] 2006.

Rousseau, Jean Jacques. On Social Contract or Principals of Political Right, in Rousseau’s Political Writings. Trans. Alan Ritter and Julia Bondanella. New York: W.W. Norton and Company, 1988.

Spinner, Jeff. “Constructing Communities: Edmund Burke on the Revolution.” Polity 23, no 3 (Spring 1991): 395-421.

White, Eugene Nelson. “Was There a Solution to the Ancien Regime’s Financial Dillema.” The Journal of Economic History 49, no 3 (September 1989): 545-568.

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[1] Charles Breunig, The Age of Revolution and Reaction, 1789-1850 (New York: Norton, 1977), 3.

[2] Jeremy D. Popkin, A Short History of the French Revolution (Upper Saddle River, NJ: Pearson Prentice Hall, [1995] 2006),  10-11.

[3] Burke employs the phrase “Privilegum non transit in exemplum:” The exception does not become the rule. Ibid., 17-18.

[4] Eugene Nelson White, “Was There a Solution to the Ancien Regime’s Financial Dilemma,” The Journal of Economic History 49, no 3 (September 1989): 550.

[5] Ibid., 567.

[6] Jean Jacques Rousseau, On Social Contract or Principals of Political Right, in Rousseau’s Political Writings, trans. Alan Ritter and Julia Bondanella (New York: W.W. Norton and Company, 1988), 85.

[7] Thomas Paine, Rights of Man [1791] in Thomas Paine: Collected Writings, ed. Eric Foner (New York: Library of America, 1995), 506.

[8] Ibid., 438.

[9] Jeffrey Hart, “Burke and Radical Freedom,” Review of Politics 29, no 2 (April 1967): 231.

[10] Edmund Burke, Reflections on the Revolution in France (New York: Oxford University Press, [1790] 1993), 62.

[11] Ibid., 61.

[12] Jeff Spinner, “Constructing Communities: Edmund Burke on the Revolution,” Polity 23, no 3 (Spring 1991): 398.

[13] Burke, Reflections, 88.

[14] Thomas Paine, Rights of Man, 522.

[15] Ibid., 523.

[16] Ibid., 438-439.

[17] Hart, “Burke and Radical Freedom,” 224.

[18] Paine, Rights of Man, 506-508.

[19] Burke, Reflections, 195.

[20] Ibid., 196.

[21] Paine, Rights of Man, 539.

[22] Ibid., 538.

[23] Francis Furet, “The French Revolution Revisited [1981],” in The French Revolution: Recent Debates and New Controversies, ed. Gary Kates (New York: Routledge, 1998), 89.

[24] E. Levausseur, “The Assignat: A Study in the Finances of the French Revolution,” The Journal of Political Economy 2, no 2 (March 1894): 180-181.

[25] Burke, Reflection, 52-53.

[26] As economist and philosopher Mises claimed, “the continued existence of society depends upon private property” Ludwig Von Mises, Liberalism: In the Classical Tradition (New York: Foundation for Economic Education, 1985), 87.

[27] Hart, “Burke and Radical Freedom,” 226.

[28] Paine, Rights of Man, 481.

[29] Paine, Rights of Man, 532.

[30] Thomas Paine, “Attack on Paper Money Laws” in Thomas Paine: Collected Writings, 364-365.

[31] William Playfair, “A General View of the Actual Force and Resources of France in January 1793,” in History of Financial Disasters, ed. Stefan Altorfer (London: Pickering & Chatto, 2006), 106.

[32] For the sake of this argument, the author uses the definition employed  by economist and historian Murray Rothbard: “Freedom is a condition in which a person’s ownership rights in his own body and his legitimate material property are not invaded, are not aggressed against. Murray Rothbard, For a New Liberty: A Libertarian Manifesto (Auburn, AL: Ludwig von Mises Insititute, [1973] 2006), 50.

[33] Thomas Paine, “Paine to Danton [1793]” in Thomas Paine: Collected Writings, 393.

[34] Ibid., 394.

[35]  Francis Furet, “The French Revolution Revisited,” in The French Revolution, 75.