Money Supply and Bank Reserves

~ Jim Berger ~ Leave a comment

Introduction

The fact that we perpetuate false or inaccurate theories causes at least one problem for understanding money and its role.

For years economic classes have taught that the Federal Reserve controls the supply of money. When they buy government bonds from banks, they pump reserves into the banks’ reserve accounts, and that addition to reserves somehow causes an expansion in the supply of money.

We continue to talk in these terms even though (thanks to Ben Bernanke) we now have evidence that that might not be the case. And possibly never was the case.

Contradiction

This chart shows the money supply (the Blue Line — scale on the left) rising continually from April 2014 to April 2019.

During that same period, bank reserves (the reddish line — scale on the right) declines continuously. (The thin green line at the bottom shows required reserves during that same period.)[1]

Figure 1 -2014-04-01 to 2019-04-01[2]

According to popular theory, this behavior should not happen. When bank reserves decline, the money supply should also decline.

Real behavior, at least for this period, seems to contradict popular theory. The data and the theory both cannot be true. Either the data contains an error (or an unknown influence), or the theory contains an error.

An Apparent Connection

If we look at historical data from past periods, we can see how people made a connection between bank reserves and the money supply.

During the period from 1963 to 1973, both bank reserves and the money supply traced similar patterns. Only in the latter part of those ten years did the patterns diverge.

Figure 2 – 1963-01-01 to 1973-01-01

In the chart below, as bank reserves rose from 1985 to roughly 1989, the money supply followed a similar pattern. Only at the end of this period from 1989 into 1990 did the patterns of bank reserves and the money supply diverge.

Figure 3 – 1985-04-01 to 1990-04-01

The two periods represented by these two charts seem to indicate a reasonably close connection between the rise of bank reserves and the increase of the money supply. They seem to confirm the popular theory that the Federal Reserve drives the growth of the money supply.

Can we reconcile the apparent contradiction between this evidence and that shown in the first chart?

Sign of Broken Connection

When we look at a longer period — from 1985 to 2008, we have evidence that no connection exists between bank reserves and the quantity of money.

Figure 4 – 1985-04-01 to 2008-04-01

Could this chart, and the first chart, provide signs that a pre-existing connection between bank reserves and the money supply had broken?

If there was a connection that no longer exists, that calls the original theory (or the data) into question.

Let’s look at a longer period of time to see if it gives evidence as to which to question — the data or the theory.

A Break From the Theory

If we look at a chart for an extended period, from 1985 to 2019, we see that the data seems to have had a fairly long break from the theory.

Figure 5 – 1985-04-01 to 2019-04-01

During that period bank reserves rose at a relatively insignificant rate up until 2008. During that same period, the money supply grew at a much faster pace.

Then, in 2008 — in response to the financial crisis of that same year, bank reserves grew at a phenomenal rate until roughly 2015 at which time the quantity of bank reserves began to decline. During this entire period, from 1985 two 2019, the money supply grew at a fairly consistent rate, never in real correlation with the level of bank reserves.

Can we draw any firm conclusions from the evidence that I have given above?

Conclusion

We need to find some way to reconcile the apparent conflict between popular theory and the data that I have provided in the charts above.

If the theory contains no flaws, a very powerful influence must exist to cause the data to diverge so far from what the theory would dictate.

If, on the other hand, the data reflects reality, we must conduct a thorough examination of the popular theory.

In future posts, I will explain why the popular theory contains fatal flaws. A more accurate theory will explain and predict results consistent with the data given.

Footnotes:

  1. I divided the Reserve Balances Required, which were stated in millions of dollars, by 1000 to convert the quantities into billions of dollars, making the figures uniformly comparable between total reserves and required reserves. ↑
  2. The Federal Reserve Economic Data (FRED) site at the St. Louis reserve bank generated all the charts used in this article. ↑

 

A Triumph for Tyranny

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Introduction

In 1831 Alexis de Tocqueville, along with his companion Gustave de Beaumont, traveled from France to the United States for — ironically — studying the U.S. prison system. Democracy in America, the book in which he recorded his observations from his nine-month tour, has provided background for many discussions about democracy even to this day.

In Democracy in America, de Tocqueville raises the possibility of a tyranny of the majority under democratic forms of government. Although he saw a risk of that form of tyranny in the U.S., he also observed elements of the Republic structure of the United States government that might mitigate the tyranny of the majority. In fact, he entitled one of his chapters “Causes Which Mitigate the Tyranny of the Majority in the United States.”

Over the years, and particularly in the 20th century, the U.S. Government — abetted by its citizens — has swept aside the protections against the tyranny spawned by democratic forms of government. The concerns expressed by Alexis de Tocqueville and the fears of many of the founding fathers have come to pass in ways they could only imagine. We have created the tyranny of the majority of the minority over the population.

I have chosen “healthcare” legislation as an outstanding example.

Healthcare Tyranny

In 2009, with a vote on The Affordable Care Act (Obamacare), the U.S. Government Congress enacted another triumph for tyranny. Two hundred nineteen people (in essence only eight people), not even elected by most citizens, place further limits on the liberty of over 300,000,000 Americans. In the original version, they had the audacity to force people to take actions they would not have chosen on their own.

I don’t see this as an issue of Democrats versus Republicans. Both parties believe in more oppression—they want to control the lives of other people. We just got the Democrat form of oppression rather than the Republican form. I favor neither.

Contrary to popular misconception, the United States of America does not need “healthcare” reform of any sort. It requires, instead, the repeal of all existing legislation that hampers the emergence of a free market in all forms of care for the sick and needy.

To those who argue that a free-market will not care for those people I have two from responses:

First, you cannot provide any empirical evidence to support your claim. A free market for these services — or any other for that matter — has never existed in this country. Without the interference of the federal government, American citizens have traditionally stepped forward to help those in need voluntarily.

Second, in a free market, both parties win in every voluntary transaction, for every product/service. In every government controlled market, the monopoly force of government picks winners and losers. In such a system — in which winners pick the pockets of losers — we all lose in the long run. These statements apply to “healthcare” as much as any other service.

If you favor any form of legislation regarding “healthcare,” you don’t favor liberty or economic efficiency. You favor the freedom of getting what you want and the freedom of others to get what you want them to get. You favor a misguided view of economic efficiency that practices stealing from healthier and more productive people to support less healthy and less productive people. These forms of freedom and economic efficiency will eventually make you less free, less healthy, and less productive.

Conclusion

Cloaked in altruism, tyranny and oppression in the U.S. of America takes on a particularly sinister character. It creates the unseen tyranny of one citizen over another. The atrocious legislation, known as “Obamacare,” provides only one example of the many and more frequent examples of tyranny within a “democratic” form of government. Many other examples, both real and proposed, of the tyranny of the majority exist.

Minimum wage laws, consumer “protection” laws, labor laws, etc., all provide living examples of a minority of representatives restricting the freedom of all citizens. Little hope exists in the trend of this legislative tyranny. Now, many legislators — and citizens — actually support the horrendously to hear radical proposal referred to as The Green New Deal.

Don’t enslave your neighbor; set him free.

Climate, Freedom, & Money

~ Jim Berger ~ Leave a comment

Introduction

“Climate change” represents the crisis de jure. We have no choice but to accept that human activity has created a crisis level of change in the climate of the world. To deal with this crisis, we must implement an unprecedented level of government intervention.

The complexity of this subject boggles the mind. How do we determine the validity of this problem, and what to do about it? To reduce the complexity, I will address only a couple of questions I have about this “problem” and the proposed intervention.

The Problem

Consensus

One reason people give for why we should believe in this crisis: 97% of scientists agree on calamitous findings regarding climate change.

Now I don’t have any certified credentials in science. I do, however, know enough to know that real scientists pride themselves on believing in the principle of non-confirmation. They do not believe in “settled” science. Even as a layman I know we cannot determine facts by popular vote. Those who believe otherwise must not have heard of Einstein, Copernicus, etc. Need I continue?

Carbon Poison

I have some important questions about carbon. Much of what I hear does not make any sense to me.

Believers in the impending climate crisis want to reduce the amount of CO2 created by human activity. They talk as if CO2 were a poison. Does that make sense?

I remember from high school biology that CO2 provides a food source for plants. Without enough CO2, plants would die. Without plants, we would die.

I admit my years in high school occurred a really long time ago. Maybe new technology has found a poisonous property in CO2. But, don’t people who run greenhouses add CO2 to the air inside?

Does it make sense to reduce our production of plant food?

The people who believe in the risk of climate change all think the solution will require some form of economic intervention. These interventions consist of everything from taxes on the use of carbon-based fuels to complete government take over of the economy.

Before I discuss the proposed interventions, I would like to make a general review of some of our current interventions. That might give us a clue as to the most effective interventions for the future.

Existing Intervention

I will reflect on the three categories of interventions: 1) monetary policy, 2) spending, and 3) regulation.

Money

Expanding the money supply has become one of politicians favorite ways to meddle with the economy. It’s stealthy—few people notice it. It taxes citizens without the painful process of passing tax legislation. It’s easy. But it has consequences.

Artificial monetary expansion distorts price signals. This misinformation leads people to misallocate resources. People spend money on goods they cannot afford. Investors acquire producer goods they do not need.

Monetary expansion leads to inefficient burning of carbon fuels.

Spending

Government officials have adopted the euphemism “spending” for a broad range of redistributions. In general, government redistributes resources from producers to consumers. “Spending” leads to less effective, efficient use of resources.

Government “spending” leads to more use of carbon fuels than would occur without redistribution.

Regulation

Regulation forces segments of the population to engage in activities which they would not otherwise choose. They must consume resources they would not consume if left to their own choices.

Similar to spending, regulation leads to the use of more carbon fuels than would have occurred without such regulation.

Proposed Intervention

Instead of examining the current political environment, the people with deep-seated concern about climate change propose additional government intervention. I will discuss those in the reverse order.

Regulation

Instead of trusting people to clean up their personal environments, politicians, as usual, think they can achieve a better result by forcing people to change their behavior. As a result, people will engage in behaviors in which they would not otherwise engage. In doing so, they will either follow the regulations or figure a way to work around the rules.

Spending

Politicians recommend massive spending programs in order to “clean up the environment.” Somehow, magically, they think they can do that without consuming additional resources or burning additional fossil fuels.

They have not learned that the redistribution of resources by government spending always leads to less efficient use of resources.

Money

When asked how they plan to pay for it, the people promoting green projects say that should not be a problem. That amounts to code for “we’ll just have the government print money.”

This attitude indicates they have not come to grips with the connection between monetary expansion and the wasteful boom and bust cycles in the economy. The malinvestments created as a result of monetary expansion create far more pollution than actors in a free-market would create on their own.

A Solution

Examine the Science

People making disastrous predictions regarding climate change should first go back and re-examine their science. Who knows; they might be correct. But, as long as one dissenting voice exists — and there are many — the science requires re-examination.

Answer, for example, the question I posed at the beginning of this article. Why do we consider carbon dioxide (a food for life) as a poison that could kill us?

Rollback Regulation, Spending, and Monetary Expansion

Instead of adding new interventions to the already ineffective interventions, rollback those that are already contributing to the ineffective use of resources and the excessive consumption of carbon fuels.

Conclusion

When you take a close look at the people promoting “Green New Deals” and Paris Accords, you realize that the majority of them either have political power or seek political power. Whether the people advocating these programs have the science correct or not, should we allow them to take further control of our lives?

This environmental scare, when you pull back the curtain, amounts to a great power grab, whether you agree with their desired results or not.

 

Economic Principles

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Principles play a critical role in the development of any theory. Including economic theory.

Definition

Principle:
“A fundamental truth or proposition that serves as the foundation for a system of belief or behavior or for a chain of reasoning.” from Oxford Dictionary

Introduction

Reasoning begins with principles. We tend to ignore principles because, frequently, they seem so obvious. When we want to throw a ball over a fence, we don’t think about gravity, air pressure, friction, and other principles. But, they all affect the process of getting the ball over the fence. But, we just want to get it over the fence.

If we want to calculate exactly where the ball will land, we must define all of these principles explicitly and precisely.

The same use of principles applies to economic reasoning.

Implicit Principles

An infinite number of principles influence economic behavior. Even for sound economic reasoning, many principles can remain implicit. The existence of gravity, weather, the curvature of the earth, etc. can remain implicit unless they play an essential role in our analysis.

To think more clearly and precisely, however, we need to make some principles more explicit.

Explicit Principles

Quite a number of economic principles need explicit statement just to acknowledge their influence. Such statements avoid misunderstanding resulting from mistaken assumptions about the principles in play.

Fundamental Elements

All economic goods come from two fundamental elements: land and labor.

Land

All agricultural and “capital” goods originate with land. Agricultural goods require land on which to grow. “Capital” goods originate from elements either grown on land or excavated from land. Goods that come from water also fall within the category of land.

Labor

All goods also require labor for their production. Even the most basic goods found in nature require processing by labor. Hunters and gatherers must expend some labor to make their goods usable.

Value

Value lies at the core of many economic theories. In spite of the disagreement about the source and measure of value, all economists agree that value does exist. Because it plays such a critical role in the development of economic theories, I will discuss the theory of value in more detail in other sections of this blog.

Action

Ludwig von Mises usually gets credit for introducing the “action axiom” to economic thinking. He recognized that all economic activity begins with the action of individuals.

Mises developed this axiom using pure reason. He realized that to attempt to prove non-action a person must act—which verifies the validity of the axiom. The axiom requires no empirical testing. Its truth results from reasoning alone.

Exchange

The principle of exchange might seem obvious. It gets ignored, however, in many discussions of “buying,” “selling,” “international trade” and other market activities. These terms all represent internal references. (Left and right are internal references; north and south are external references.)

Accurate discussions of market transactions require the use of an external reference: “exchange.” A consciousness of the principle of exchange reminds people that all market transactions, as observed by third parties, involve two parties.

When discussing internal references, such as buying and selling, we must always ask about the influence and impact on the other party.

Markets

The combinations and interrelationship of exchanges created the related principle of “markets.” Most economic theory involved markets.

Money

I include money as a principle because its existence and use remains beyond a doubt. That existence provides the basis for chains of reasoning. Much reasoning regarding money remains flawed because of misunderstanding the definition of money and the source and measure of its value.

I will devote most of “Money Matters” to clearing up much of the flawed reasoning regarding money.

More…

I will discover (or reveal) more principles as I examine various topics on this blog.

Conclusion

Without principles, we cannot make theories. Without the explicit statement of important principles, precise reasoning becomes difficult.

I will expand on these principles as I continue the discussions on this blog.

Money Matters: Introduction Part 2

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In addition to the topics raised in the last post, we will discuss the following topics on the way to a fuller understanding of the importance and function of money.

Monetary Systems

We will examine the essential characteristics of an unfettered monetary system. How would people use money if governments and central banks did not interfere with the system?

Banking Systems

We refer to the organizations that handle the storage and transfer of money as banks. A network of banks forms what we call the banking system.

Banking systems can facilitate the coordination of basic banking functions. But, they can also manipulate the underlying monetary system.

Subsistence Fund

When we use money in market transactions, the money simply facilitates goods for goods transfers. Those transfers involved a vast number of goods, and each transaction has a different characteristic.

To make general statements about money I will describe a mental model frequently referred to as a “Subsistence Fund.”

Without further description, the subsistence fund consists of a collection of consumer goods required for the population of an economic system to subsist. I will flesh out this description later on this blog.

Pricing Mechanisms

Pricing mechanisms — particularly those based on money — perform a critical function in the transfer of market information.

We will examine market pricing and how flexible prices facilitate dynamic markets.

Intervention

Unfortunately, government and the banking system intervene in the smooth flow of money. This intervention disrupts the pricing mechanism creating a massive amount of misinformation within otherwise effective and efficient markets.

Money Myths

During the course of this blog, we will address many of the misconceptions about money and the banking system. We will address some of the more egregious myths and misstatements about money and banking.

Conclusion

Many people seem to disconnect money from goods or products. They either mention money and say very little about products exchanged, or they mention products and basically ignore the existence of money. Every mention of economic transactions should include the interrelationship between products and money.

The lack of systemic thinking provides one reason why people talk about one side of these exchanges and not the other.

Ignorance and misunderstanding provide another reason for people to ignore the connection between goods-for-goods exchanges and the role of money.

Money Matters will address these connections and correct much of the ignorance and misunderstanding about money and markets.

The next time you go to a store, a coffee shop, or a restaurant, think about the critical role that money plays in your everyday life. Don’t you think you should understand it?

 

Money Matters: Introduction

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The ubiquity of money in market transactions means that a precise understanding of market activity requires a precise understanding of money. Money Matters will expand the understanding of money and reduce much misunderstanding.

The Donkey

A rich man stopped in a small town. He encountered two men haggling over a mule. The rich man, thinking he could use the mule, out bid the two men and bought the mule.

Several weeks later the rich man again stopped in that small town. By coincidence, he encountered the same two men who had been haggling over the mule. The two men asked the rich man what he had done with the mule.

He responded, “That old mule could not do the work for which I wanted him; so, I had him put down.”

The other two men suddenly look very disappointed. The rich man asked them why they acted so disappointed.

The men responded, nearly in a single voice, “Until you came along, we had made a good living trading that mule.”

Market References

Fast food, shoes, iPads, Ferraris, Stocks & Bonds, and the national economy, we relate to all of them through references to money. We use phrases like: it costs…, it’s worth…, it increased by…, all followed by a number of dollars. We use these phrases as if they actually mean something and that we understand that meaning.

But, do these phrases mean anything?

Do we know whether we speak real meaning? If they do speak meaning, do they comprehend that meaning?

The Comprehension Gap

When we discuss market transactions, we tend to either ignore the role of money in those transactions, or we discuss monetary transactions, with little attention to the goods at the focus of the exchange. By ignoring the interrelationship between money and products we tend to expose what I have dubbed a “Comprehension Gap.”

What don’t we understand? Money or markets?

The donkey trade and the economic references provide hypothetical examples of this “Comprehension Gap.”

Money & Markets

You cannot fully understand most economic exchanges without understanding money and its role in exchanges. If we base our understanding of free markets on our current assumptions about money, we could suffer from grave misunderstanding. We need to make those assumptions explicit and precise to assure that our assumptions correlate with the real nature of the transactions.

So many misconceptions exist about money that clear thinking and communication about economics becomes nearly impossible. To clear up this confusion, we must start with some basic concepts

Economic Reasoning

Money exists inside and as part or market systems, not as separate from market activity. Thus, in order to fully understand money (and close the comprehension gap), we must first understand the principles and theories that govern market behavior.

I will address some of the basic elements of economic reasoning that will support our discussion about money.

Market Systems

Expanding production and limited consumption result in savings, and creates the need for exchange and the use of money.

How does the production process create a need for exchange?

How does increased production and exchange benefit all members of an economic system?

Exchange

Nearly all market exchanges involve money. In large markets, systems of exchange become highly complex.

How does that complexity lead to the use of money?

To understand to role of money in complex market exchanges we should know the basics of market exchanges.

We will examine market exchanges at all levels of complexity — from the simplest, which might operate based on direct exchange, to the complex, which require indirect exchange and the use of money.

To be continued…

Money Matters – Preface

~ Jim Berger ~ Leave a comment

With this post, I begin blogging a book I will entitle Money Matters. When I finish, I hope that both you and I have a better understanding of money and free markets.

Economic systems operate in the context of markets. Without the exchange of goods and services that create markets, no economic system would exist. Learning about economic systems, or markets, should help us to operate more effectively within them. We don’t want to learn about markets in order to change the rules by which they function. Those” rules” have manifested from the interactions of millions of people over thousands of years. We cannot outsmart the distributed intelligence of all those individuals. We can, however, play the “game” and operate in the market more effectively, if we know the rules.

If you want to become proficient at chess, you first learn the rules of play. You then develop strategies, within those rules, for “winning” the game. The same holds true of the “game” of markets.

Most exchanges involve the use of money. Understanding markets, therefore, requires understanding the meaning of “money,” its role in markets, its source of value, its measure of value, and the operation of the banking system that handles money transactions.

In other words, Money Matters.

But, most people do not understand the most important aspects of money. You might say they are like the novice chess player who doesn’t know how to distinguish the chess pieces. Reading the rules does no good for developing a strategy. In his ignorance about a fundamental element of the game he misinterprets the rules of the game, or, worse yet, he starts making up his own rules.

If I have not stretched the chess analogy too far, I mean to convey the idea that people don’t understand markets when they don’t understand money. Because of this lack of understanding, they misinterpret the “rules” of markets. Based on their misunderstanding of markets they attempt to write new rules. Changing the rules does not improve the game. It changes it.

Free markets, unlike chess, do not have winners and losers. All free market players win.

It concerns me that, because people do not understand money, they don’t understand markets. As a result, they operate in markets by unrealistic rules that create winners and losers, instead of just winners. -For that reason, I have decided to blog a book that I will title Money Matters.

I base this book on the premise that: you cannot understand modern markets if you don’t understand money. The real focus of this book will be markets, not money. I will clear away many misunderstands about markets by refuting some of the false assumptions that people have about money and the banking system. Since money exists as an integral part of the market system, I will explain money in terms of market principles and theories. In the end, I want readers, and me, to understand markets and money in a way in which we can make them understandable to friends and acquaintances.

This book represents a work in progress. I strive for clarity and accuracy. If you have the basics of an idea, you will have the tools with which to learn the details.

Please help me, with comments and questions, to improve this book as I move along. I will respond to all comment by either:

  • editing existing posts, or writing new ones, if the comments are general, or
  • responding in the comments, if the comments are specific for you.

I will also post this preface on the About Money Matters page.

 

Green New Deal – 2030

~ Jim Berger ~ Leave a comment

Commenting on The Green New Deal would waste my time, except for the attention some influential people have given it. It would, if passed, lead to a life of misery that would make catastrophic climate change seem like a marvelous alternative.

I receive letters from strange people and strange places. Most of them, If they make reasonable comments, I respond to privately. Recently I received a letter from a rather different place: the future. Because it discusses a topic of present-day interest, I have posted it in its entirety.

Dear Jim,

Roughly 10 years have passed since the signing of the Green New Deal bill in 2020. Climate change hysteria rose to such a fever that voters elected Kamala Harris as President and Cory Booker as Vice President. The House of Representatives elevated Alexandria Ocasio-Cortez to the speaker of the House.

The rapidity with which they passed this legislation surprised many people except a few who remembered chants of,” Better off Red than dead.” I found it equally surprising how quickly they acted on the legislation. I guess people liked the Nirvana promised by the supporters.

I have nearly gotten used to having to make these entries by candlelight. I hardly remember the day before May of 2026 when we had to turn in our last smartphones. We just don’t produce enough power for recharging those devices and transmitting the messages we composed. I do have more time during the day to do my writing since I lost my job. But, I hear that pencil and paper will soon become in short supply.

Losing that job does not bother me so much, because the government sends me a check every month. I had planned, when I first heard of this change, of traveling a lot and seeing the world. I had to scuttle those plans when I found I could not get airline reservations. The airlines were not overbooked by people in my situation. They just could not fly because of the lack of fuel. You can still fly, if you need to, but you have to book your flight three months in advance, and it can cost millions of dollars-subject to increase at boarding time. That brings up the issue of inflation.

I have noticed, when I have an opportunity to walk to the store, that the prices of the few items available have increased dramatically. I get an increase in my government stipend every month, but it never seems to keep up with price increases. I have heard that price inflation amounts to 1,000% per month. I have no way to verify that because I get no regular news. I have to rely on rumor.

Someone told me that the central planners have adopted the strategies of the Modern Monetary Theorists. Having government “spend money into the economy,” according to them, will stimulate the economy. I have not seen the results yet. But, what can I do?

I would like to continue, but I have to leave to get to my Chinese language class.

The Chinese have done relatively well in the past ten years. Maybe not adopting their own “green new deal” has something to do with their progress.

Anyway, they allow a few immigrants each year, if they speak and write Chinese. I might get a job there that pays a lot more than my government stipend, or, I might get a job at one of the companies in the U.S. that the Chinese have acquired.

More later,
Roger

I hope Roger does better than this. We can change the future now, if we choose to.

 

The Politics of Socialism

~ Jim Berger ~ Leave a comment

Even if you’re willing to ignore the economic costs, socialism brings a political cost most people — particularly in America — would find unacceptable. Socialism eventually leads to the loss of liberty and tyranny.

In previous posts, I’ve explained the impracticality of socialism as an economic system. We cannot deliver full value to workers when we don’t know the price of the final products, and we can’t separate the contribution of labor versus the contribution of capital. Although I want to focus primarily on economics in this blog, socialism causes a political price that I don’t think most people would be willing to pay.

Central Planning

Having workers own the means of production sounds like a wonderful program. But, have you ever experienced large groups making decisions? When groups get together and try to make decisions in unison, they tend to be impractical and ineffective. The larger the group, the worse the results achieved. So, imagine a nationwide economy depending on all the owners of production making decisions in unison.

Even ardent socialists agree with this picture. They know that having all the members of society deciding together how resources get distributed simply would not work. Socialism, therefore, requires central planning. When initially presented the idea of “central planning” seems quite reasonable and harmless. Why not let the representatives of the workers decide how does distribute resources and work?

Was it Lord Acton who pointed out the problem of corruption that arises from power? Whether the attribution is correct, the observation certainly is. Central planners would discover the benefit of having the power given to them, and they would do their best to increase that power. The end result would be something we’ve seen in most, if not all, socialist countries: absolute tyranny.

But couldn’t this be avoided with a democratic form of government and a socialist economy?

Democratic Socialism

Democracy, as pointed out by Alexis de Tocqueville and Hans Herman Hoppe, has its own set of problems. But, even in the idealized form of democracy, the socialism part of Democratic Socialism would drag the system down.

In the economic system known as socialism the countervailing power of open markets does not exist. Elected officials would have far more power than they would under a democratic government and a market economic system. Since those who have power tend to strive for more, the system would ultimately break down, and some form of tyranny would arise. Look, for example, at the “democratically” elected president of Venezuela. Not working too well.

Socialism, even under a democratically elected form of government, would eventually lead to lost liberty.

Lost Liberty

The Lurking Threat of Socialism

Regardless of the form of government socialism will always lead to a loss of liberty. In the abstract, that may not seem too bad. Most people would give up a certain amount of liberty in exchange for a bit more certainty on the economic front. Who wouldn’t prefer to have education, healthcare, retirement, and other essential economic concerns guaranteed by someone else?

At a more personal level, however, lost liberty would mean, particularly for Americans, the loss of a reasonable lifestyle. How would you like to have someone else to decide what you do for work, where you go to school, what you eat, whether you eat, where you live, who you associate with, and anything else that you control through your own free choice?

Free stuff comes at an extremely high price.

Conclusion

Socialism represents such an outrageously impractical economic system it seems incredible that anyone would suggest it in the first place. But, even in an idealized form, socialism comes at a price that includes a lot more than the loss of economic well-being.

Under any political system, socialism robs you of free choice and your very humanity.

Serious consideration of socialism represents a far greater threat to humanity than climate change, volcanoes, asteroids, or any other natural disaster. For the sake of your economic well being and your personal liberty, reject the concept now.

 

Wage & Price Discovery

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Socialists show reluctance to accept deferred payment or agree to absorb any losses. Even before they face those issues, how can they establish what portion of revenues they actually deserve? They cannot determine the price of the end product beforehand, and they cannot separate their real contribution to revenue. They have a real dilemma.

Value and Price of Product

Socialists don’t seem to understand that, even after having the capitalist subsidizes their wages during the production process, the market price for their wages remains unknown. The consumer has the final say on the price of the end product — the pencil. If the product sells for enough that the capitalist can replenish his subsistence fund and more, he will have profited from the risk he took. For the ongoing business, the replenishment of the subsistence fund allows the capitalist to repeat the process, which includes paying workers at every stage of production.

Yes, the capitalist does gain when he accurately estimates the price at which consumers will buy enough of the product to give him a profit. If, on the other hand, the market price — as established by consumers — does not replenish his subsistence fund. The capitalist will suffer a loss — even after workers have received their agreed upon wage.

Because consumers establish the value and price of products, it becomes impossible to, in any way, extrapolate the value of labor until after the sale of the product. Neither the capitalist nor the worker knows the market price of the product until after the sale.

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Neither the value nor the price of any capital or labor involved in the production of the product in question can be determined until after a sale. Even then, the value of labor remains a subjective judgment on the parts of the capitalist on the one hand and the worker on the other hand. The capitalist prefers to pay as little as possible, and the worker prefers to get paid as much as possible. The actual wage — or price — results through the process of negotiation between the capitalist and the worker.

But, of all the ingredients that go into the production of a product, how can a person separate the value of labor alone?

Separating Price of Labor

If we assume that the product will sell for the same amount on the next cycle as it did the last, and we further assume the same amounts of capital and labor are used in the production on the next cycle, how can we extrapolate the proportion of that revenue that accrues to labor? If the socialists would only think about it, they would realize that we cannot determine the proportion that goes to labor.

As a socialist so readily point out, capital and labor must operate together to produce products. Either one without the other would produce nothing. Capital and labor represent two elements of a system — a system in which the whole produces more than the sum of the parts.

Because of the systemic nature of production, the contribution of the individual components cannot be determined separately. The person who contributes the most of the productivity of the manufacturing process is the person who designs the process, usually a person who is either a capitalist or works for a capitalist.

The Solution

Socialist face an economic dilemma. To achieve their ends of being paid “what they’re worth,” they must do all of the following:

  1. Defer payment and allow determination of wages until after consumers buy the product.
  2. Agreed to absorb a share of any losses incurred.
  3. Acknowledge that relative contribution to value is unknown and unknowable.
  4. Accept a negotiated wage after the fact.

In other words, for socialists to resolve the dilemmas created by socialism, they must become capitalists.

They should acknowledge the flaws in socialism and give it up as a failed system.